Regulation & Licensing
Dual regulation******
MR. WATSON: In 1959 the Supreme Court ruled that variable contracts are subject to federal law and were to be regulated by SEC. Because they are insurance contracts as well, they are also regulated by the states and thus are dually regulated. So, they are regulated by the Department of Financial Services and the Office of Insurance Regulation at the state level, but the separate account is regulated as a security by the SEC and FINRA at the federal level.
Agent licensing******
MR. WATSON: An agent must hold a life and variable contracts license as well as a Series 6 or Series 7 license, (both of which are securities licenses.)
Marketing Practices & Suitability
Prospectus
MR. WATSON: Variable products carry the risk that the contract owner could lose money from bad investment decisions and so have to have a prospectus given to the client. For variable products, a prospectus is prepared by the insurance company and reviewed by the SEC. It contains information regarding the nature and purpose of the variable product, the separate account, and the risk involved. It must precede or accompany any sales presentation.
Agent's Identification on annuity contracts
MR. WATSON: This is the same identifying information that we mentioned in Chapter 9. The cover of the application must contain:
- the name of the insurance company
- name of the agent
- agent's I.D.
Change of Address *****
MR WATSON: Agents must notify the department, in writing, of any change of any type of contact information (address, business street address, mailing address, phone, or email) within 30 days. Failure to comply is a $250 fine for the first offense and a $500 fine for the second and any subsequent time after that, as well as possible suspension or revocation of the license.
Suitability *****
MR. WATSON: An agent must be clear as to the purpose of the sale and that it makes sense and is suitable to the insured whether it is a fixed, variable, or indexed annuity. The following information must be collected on a form approved by the department and signed by the applicant and the agent. If the applicant refuses to sign (I don't know why he wouldn't sign, but if he refused), the applicant must sign a form stating that he refuses. Also, if the applicant wants a certain type of annuity that does not suit him and the agent has advised against this purchase, yep, there's a form for that too. The agent's recommendations must be recorded.
MR. WATSON: To figure out if the product is appropriate for your client, you will ask about all the following stuff:
- personal information
- tax status
- investment objectives
- source of funds being used to fund the annuity
- annual income
- intended use of the annuity
- existing assets
- liquid net worth
- financial situation and needs
- risk tolerance
Replacement or exchange of an annuity ****
MR. WATSON: This is similar to life insurance replacements. If an exchange or replacement is being done, the agent must provide, on an approved form, information concerning the differences between the two annuities, including:
- a comparison of the benefits
- a comparison of any fees
- a written basis for the recommended exchange, including advantages and disadvantages
- the agent must disclose any tax consequences as a result of the exchange or advise the client to consult a tax advisor
Income tax treatment of benefits *****
MR. WATSON: We have discussed this, but, here we go again.
- Cash Value Life Insurance: Loans are not taxed. Partial surrenders are taxed as "ordinary income" according to FIFO, first in, first out. So when you withdrawal from cash value life insurance your principal is used first, and anything in excess of that is taxable as income. If you put in $5000 the first $5000 you withdrawal is NOT taxed. Complete surrenders simply add any gain as income and is taxed as such (total premiums paid in less any policy dividends equals the "cost basis." Anything above that is taxed.)
- Annuities: You're not taxed on interest earned during the accumulation period. Lump-sum payouts and partial withdrawals are taxed the opposite as above - LIFO, or last in, first out. So we withdraw from the interest first, which is taxed, and after that's exhausted the principal comes out tax-free. In addition, a penalty of 10% is imposed on withdrawals taken before age 59 1/2.
Exclusion Ratio Fixed Annuity
MR. WATSON: Because money paid into an annuity is done with after tax dollars, the amount you receive each month once you annuitize representing the principal is not taxed. If annuitized, some portion of each check represents principal and is not taxed, and the balance, representing interest, is taxed as income for the year. LIFO does not apply here. We use an exclusion ratio to determine what is not taxed. The total amount invested is spread out over one's lifetime. The ratio, once again, is amount invested/expected return. For example, $150,000 / $200,000 equals 75%...75% of each check received is tax free, which means that 25% of each check would be taxable.
