Suitability and Regulatory Requirements (FINRA Rule 2330)

With a complete understanding of how variable annuities and variable life insurance work, you can now examine the regulatory framework that governs their sale, particularly FINRA Rule 2330, which imposes specific suitability obligations for deferred variable annuities.

Suitability Obligations for Deferred Variable Annuities

Before recommending a purchase or exchange, the representative must have a reasonable basis to believe:

• The customer has been informed of the general features, including:
  • The surrender period and surrender charges
  • Potential tax penalties for early withdrawal before age 59 1/2
• The customer would benefit from certain features such as:
  • Tax-deferred growth
  • Annuitization options
  • Death/living benefit features
• The particular deferred variable annuity, its subaccounts, and riders are suitable for the customer based on their investment profile

Information Gathering

The firm must make reasonable efforts to obtain:

• Age
• Annual income
• Financial situation and needs
• Investment experience
• Investment objectives
• Intended use of the annuity
• Investment time horizon
• Existing assets (including other annuities)
• Liquidity needs
• Liquid net worth
• Risk tolerance
• Tax status

Principal Review and Approval

• A registered principal must review and approve or reject each transaction before the application is transmitted to the issuing insurance company
• The principal must complete the review no later than 7 business days after the office of supervisory jurisdiction receives the complete application
• Both the recommending representative and the approving principal must sign their determinations

Exam Tip: Gotchas

• Principal approval must happen before transmittal. FINRA Rule 2330 requires the principal to approve or reject the transaction before the application is sent to the insurance company, not after.
• 7 business days is a deadline, not a waiting period. The principal has up to 7 business days to review, but can approve sooner.
• The sequence matters: Representative recommends → principal reviews within 7 business days → approves or rejects → then application is transmitted.

Exchange Suitability (36-Month Lookback)

For exchanges or replacements of deferred variable annuities, the firm must determine whether the customer would:

• Incur a surrender charge on the existing contract
• Be subject to a new surrender period on the replacement contract
• Lose existing benefits or features (e.g., death benefit step-ups, living benefit riders)
• Be exchanging a contract that was purchased within the preceding 36 months (a red flag for churning)

Product enhancements and improvements on the new contract must be weighed against the costs of the exchange.

Why 36 Months?

• Frequent exchanges generate commissions for the representative while subjecting the customer to new surrender periods and potential loss of benefits
• The 36-month lookback identifies a pattern of churning - excessive trading to generate commissions
• The firm must document its inquiry and the customer's response regarding prior exchanges

Exam Tip: Gotchas

• 36-month lookback applies to exchanges, not initial purchases. If a customer purchased a variable annuity within the last 36 months and wants to exchange it, that is a red flag for churning.
• New surrender periods restart on the replacement contract. Even if the old contract's surrender period was nearly over, the customer starts a fresh surrender period on the new one.

FINRA Rule 2320 - Variable Contracts of an Insurance Company

• Applications and purchase payments must be transmitted promptly to the issuing insurance company
• If a contract is surrendered within 7 business days of purchase, the selling broker-dealer must return the commission to the insurance company
• Non-cash compensation rules apply:
  • Gifts limited to $100 per year per person
  • Training and education expenses must meet specific criteria

Exam Tip: Gotchas

• $300 per year is the gift limit for non-cash compensation to representatives selling variable contracts.
• Commission must be returned if the contract is surrendered within 7 business days of purchase.

Key Rules Tested in This Unit