The 72-Year-Old Switching From a Low-Cost Variable Annuity
Robert, 72, owns a variable annuity purchased 9 years ago with a $200,000 account value and a $230,000 living benefit base. The existing contract has a 4-year surrender schedule that has fully expired, an annual mortality-and-expense charge of 1.10%, and a living benefit rider costing 1.25%. An agent recommends replacing it with a new variable annuity that has a 7-year surrender schedule starting at 7%, a 1.40% M&E charge, a 1.50% living benefit rider, and a 5% upfront commission. The new contract offers a 6% premium bonus vesting over 8 years. Robert's stated goal is guaranteed lifetime income starting at 75. He does not mention any need for liquidity. The agent's replacement notice lists only the new product's features and does not compare costs or surrender schedules.
1. Perform a replacement analysis. What must be compared, and what does the comparison reveal?
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A replacement analysis must compare, at minimum: surrender charges and their duration, all fees and charges (M&E, riders, admin, fund expenses), living and death benefit values, bonus vesting/recapture, liquidity provisions, and the consumer's objectives.
Comparison here:
| Item | Existing | Proposed |
|---|---|---|
| Surrender schedule | Expired (0%) | 7 years, starting 7% |
| M&E | 1.10% | 1.40% |
| Living benefit rider | 1.25% | 1.50% |
| Bonus | None | 6%, vests over 8 years |
| Commission | Sunk | 5% upfront |
The proposed contract increases annual costs by ~0.55% (1.40% + 1.50% vs. 1.10% + 1.25%) on top of new surrender charges and an 8-year bonus vesting period. The existing contract is already out of surrender and has a higher benefit base ($230,000 vs. $200,000 account value). Replacing restarts surrender exposure and raises ongoing costs, while the bonus is partly illusory because it vests over 8 years and may be recaptured. For a 72-year-old seeking income at 75, a 7-year surrender schedule is a poor fit. The replacement is not in Robert's best interest on these facts unless the new contract's income benefit is demonstrably superior after costs - which the file does not show.
2. The agent says the 6% bonus "more than pays for" the higher fees. Test that claim and explain the regulatory significance of the incomplete replacement notice.
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Testing the bonus claim: A 6% bonus on $200,000 = $12,000, vesting over 8 years. The added annual cost is ~0.55% of account value ≈ $1,100/year, or ~$8,800 over 8 years (more if the account grows). Add the new 7% surrender charge exposure (up to ~$14,000 if she exits early) and the loss of the existing contract's higher benefit base. The bonus is not free money: it is typically funded by higher fees and a longer surrender period, and it is forfeitable/recapturable if she leaves early. Net of costs and vesting, the bonus does not "pay for" the higher fees; it is a feature that must be evaluated on a net basis.
Regulatory significance of the incomplete notice: A replacement notice that lists only the new product's features and omits a comparison of costs, surrender schedules, and benefits fails the replacement-disclosure requirement. The consumer cannot make an informed decision without knowing what is being given up. This is a sales-practice and disclosure deficiency that a supervisor should catch before approval, and it undermines any claim that the replacement was in the consumer's best interest.
3. What should the supervisor do, and what documentation would make a replacement defensible?
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Supervisor action: Do not approve the replacement as submitted. Require a complete replacement analysis and a corrected notice. Given the facts (higher costs, new 7-year surrender, lower benefit base, 8-year bonus vesting, age 72), the replacement should be declined unless the agent can show a concrete, quantified benefit that survives the cost comparison.
Documentation that would make a replacement defensible:
- A side-by-side comparison of surrender charges, all fees, rider costs, benefit bases, death benefits, and bonus vesting.
- The consumer's stated objective (income at 75) and why the existing contract cannot meet it.
- Quantified net cost of the replacement over the expected holding period.
- Alternatives considered (e.g., annuitizing the existing contract, exercising the existing living benefit, or a no-surrender income product).
- Signed consumer acknowledgment of the surrender schedule, bonus vesting/recapture, and higher fees.
- A corrected replacement notice delivered to the consumer.
Absent that, the file does not support the recommendation and the transaction should not proceed.