5.5 Deferred Variable Annuities and the Seven-Business-Day Principal Review

Scope of Rule 2330

FINRA Rule 2330 applies when an associated person recommends that a customer purchase or exchange a deferred variable annuity, including a recommended initial allocation among subaccounts. It does not govern transfers among subaccounts after purchase or transactions involving an immediate annuity, although other rules still apply. Reg BI governs a recommendation to a retail customer at the same time; Rule 2330 adds annuity-specific findings and principal review.

The rule addresses why a customer should commit assets to a long-term, tax-deferred insurance contract whose costs and liquidity constraints differ from mutual funds, fixed annuities and direct portfolio investments. Using a variable annuity inside an IRA provides no extra tax deferral, so the recommendation must rely on other features that benefit the customer.

Representative Determinations

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

1. the customer was informed, in general terms, of material features such as surrender charges, tax penalties, mortality and expense charges, investment options, market risk, riders and death benefits;
2. the customer would benefit from one or more features, such as tax-deferred growth, annuitization or a death or living benefit; and
3. the contract as a whole, the underlying subaccounts at purchase, and any exchange are suitable under the rule. For a retail customer, the analysis must also satisfy Reg BI.

Relevant customer information includes age, annual income, financial situation and needs, experience, objectives, intended use, horizon, existing assets, liquidity needs, liquid net worth, risk tolerance, tax status and whether the purchase is in a tax-qualified account. The representative must document this information and the basis for the recommendation.

Exchange Analysis and the 36-Month Look-Back

For a recommended exchange, the representative must consider whether the customer:

• will incur a surrender charge, start a new surrender period, lose existing benefits, or pay higher fees and charges;
• would benefit from new features; and
• has made another deferred-variable-annuity exchange within the preceding 36 months.

The 36-month item is a required inquiry, not an automatic prohibition. Multiple exchanges can still be approved when a documented, customer-specific benefit outweighs the costs. A pattern of replacements by one representative should be analyzed for switching and compensation conflicts.

Disclosure and Documentation

The customer must receive a current prospectus and a clear explanation of material costs, market risk, liquidity restrictions, tax consequences and the effect of an exchange. Rule 2330(b) requires the representative to document and sign the purchase or exchange determinations, and Rule 2330(b)(3) requires the representative to send the complete and correct application package to an OSJ promptly after receiving the information needed to prepare it. Firms often also obtain a customer acknowledgment, but a customer signature does not shift the regulatory duty to the customer.

The Principal's Seven-Business-Day Review

Before the application is sent to the issuing insurer for processing—and no later than seven business days after an OSJ receives a complete and correct application package—a registered principal must review and approve or reject the recommended transaction in writing. The reviewer evaluates the same customer and product factors and, for an exchange, the comparative costs and benefits. The principal may approve only if there is a reasonable basis to believe the transaction is suitable under those factors, and must document and sign the approval or rejection.

The clock begins only when the OSJ receives a complete and correct package, but firms may not exploit incompleteness to warehouse checks or delay review. Rule 2330's supplementary material addresses customer funds during the review. A firm permitted to hold customer funds under SEC Rules 15c3-1 and 15c3-3 may deposit them before approval in an account that meets Rule 15c3-3 (Rule 2330.01). A firm may forward a check payable to the insurer before approval only if it discloses the transfer to the customer and has a written agreement under which the insurer segregates the funds and does not issue the contract until notified of the principal's decision (Rule 2330.03). Otherwise, prompt-transmittal and customer-protection rules apply.

Procedures, Surveillance, and Training

Rule 2330(d) requires written procedures reasonably designed to achieve compliance, surveillance to determine whether associated persons have rates of exchanges that raise concern, and policies to implement corrective measures for inappropriate exchanges and the people who make them. Reports commonly rank representatives by exchange count and percentage, repeat exchanges within 36 months, age, contract duration, surrender charges, compensation and replacement of valuable riders.

Rule 2330(e) requires training for people who recommend, review or supervise deferred VA transactions. Training should cover contract features, riders, costs, tax, insurer risk, exchange analysis, Reg BI and the firm's documentation system—not merely how to complete an application.

Worked Review

A 72-year-old customer with modest liquid assets is asked to exchange a six-year-old VA whose surrender period has ended for a new contract paying the representative a commission. The new contract offers a withdrawal rider, but starts an eight-year surrender period and increases annual cost by 0.70%. Approval requires evidence that the customer needs and can use the rider, can tolerate the lost liquidity and higher cost, and received balanced disclosure. “Newer contract” is not a sufficient benefit.