Suitability and Regulatory Requirements

These requirements apply narrowly: only to recommended purchases, exchanges, and initial subaccount allocations of deferred variable annuities, not to later reallocations or to most tax-qualified employer-sponsored plan transactions.

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, in general terms, of the deferred variable annuity's features, including:
  • The surrender period and surrender charges
  • Potential tax penalties for early withdrawal before age 59 1/2
  • Mortality and expense (M&E) fees and investment advisory fees
  • Charges for and features of any riders
  • The insurance and investment components of the contract and its market risk
• 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

This suitability rule applies to recommended purchases and exchanges of deferred variable annuities and to recommended initial subaccount allocations. It does not apply to later reallocations among subaccounts or to funds paid after the initial purchase or exchange, nor to transactions inside a tax-qualified employer-sponsored retirement plan, unless the representative recommends a deferred variable annuity to an individual plan participant.

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 investment and life insurance holdings)
• 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. The variable-annuity sales-practice rule 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 subject to increased fees or charges (M&E fees, investment advisory fees, or rider charges) on the replacement contract
• 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.

Variable Contracts of an Insurance Company

• Applications and purchase payments must be transmitted promptly to the issuing insurance company
• A sale must use the value determined after receipt of payment, under the contract, the prospectus, the Investment Company Act, and applicable rules
• A purchase payment ordinarily is not treated as received until the insurance company accepts the application, though the parties may agree to treat actual receipt as received at the purchaser's risk
• 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 $300 per year per person, and may not be conditioned on a sales target
  • Offeror-paid training or education requires the associated person's prior firm approval, an appropriate location, no guest expenses, and no sales-target condition
  • Records must identify the offeror, the recipient, and the cash or non-cash compensation involved

Exam Tip: Gotchas

• $300 per year is the gift limit for non-cash compensation to representatives selling variable contracts.
• The gift limit was raised from $100 to $300 effective March 30, 2026. Older study materials and practice questions may still show $100, so know both numbers and apply the limit in effect at the time of the gift.
• Commission must be returned if the contract is surrendered within 7 business days of purchase.

Key Rules Tested in This Unit

What Should You Check on Exam Day?

• Confirm the transaction is a recommended purchase, exchange, or initial subaccount allocation of a deferred variable annuity; the suitability rule does not reach later reallocations or most qualified-plan transactions.
• Verify principal approval happened before transmittal to the insurer, within the 7-business-day maximum.
• For an exchange, check all factors together: surrender charge, new surrender period, lost benefits, increased fees, and whether the prior exchange fell within 36 months.
• Match the non-cash compensation gift limit ($300 per year per person) and the 7-business-day commission-return trigger to the correct rule.