Annuity Fraud: What to Look Out For

Annuity fraud can be committed by the underwriting company, the agent, or both. Fraud is usually associated more with variable annuity products than with fixed annuities, but it can be committed with any product.

Agent-driven annuity fraud

Generally speaking annuities pay higher commissions to agents than other insurance products. This fact is often the proximate cause of agent-initiated fraud. One of the more common forms of annuity fraud committed by agents is a practice known as “churning.” Churning is defined as the unnecessary replacement of an insurance product with another insurance product, resulting in excessive new business commissions paid to the agent. By contrast, churning often results in the client needlessly losing money thorough surrender charges and other unnecessary fees. In extreme cases churning can be done multiple times on the same portfolio in a relatively short amount of time. Churning is an illegal practice according to SEC regulations as well as state insurance laws. Policy replacement may only be done if there is an appreciable benefit to the client in doing so.

Other agent practices which may be considered fraudulent include “tied selling,” or basing approval of one insurance product on the purchase of another, selling an unsuitable product to obtain a higher commission, verbally guaranteeing a specific return on investment that’s not plainly stated in writing (especially on a variable annuity), and recommending an investment in a variable annuity just under a breakpoint, or a funding level where service charges are reduced, without disclosing that fact.

Company-driven annuity fraud

Annuity fraud at the company level can range from blatant theft through phony products to more subtle indiscretions often involving failure to fully disclose all fees associated with otherwise perfectly legitimate annuities.

Beginning in 2001, Massachusetts insurance agent Bradford C. Bleidt sold through his company, Allocation Plus Asset Management Company, what were purported to be products akin to fixed annuities targeted primarily to senior citizens. On the surface Bleidt looked legitimate; he was properly licensed as an agent and broker/dealer in Massachusetts, and Allocation Plus was registered with the SEC. Even so, Bleidt used the proceeds from his investment sales to prop up his failing businesses – including a Boston-area radio station – in what effectively amounted to little more than a Ponzi scheme. By the time the scheme fell apart in 2004 Allocation Plus had defrauded investors of approximately $30 million. It was also found that Bleidt failed to disclose his license in Maine was terminated due to an administrative action in 2001. Because of this and other infractions related to his fraudulent operations, Bleidt’s Massachusetts insurance licenses were permanently revoked in January 2005. Soon after he was sentenced to 11 years in prison.

Although established insurance companies are highly unlikely to commit fraud to the extent of Allocation Plus, even respected companies can occasionally run afoul of established rules regarding annuities. In 2004, Prudential suspended two employees over complaints of undisclosed fees charged to some of its clients’ policies. The company was also accused of providing false information concerning commission rates.

Annuity fraud against senior citizens

Senior citizens are especially vulnerable to annuity fraud, and as such the topic of annuity fraud is often inextricably linked to insurance fraud against seniors in general. Fraudulent activity directed against seniors with respect to annuities is often linked to suitability. Placing senior citizens in annuity products, especially variable annuities, must always be done with particular care to suitability concerns. For example, it would not be suitable to place a 75-year-old in an annuity product with a 15-year surrender charge schedule. It would also be unsuitable to sell a senior citizen a variable annuity with an abundance of aggressive (and therefore high-risk) separate accounts, especially if the client has little to no investment experience. As a general rule the older a client is, the less risk tolerant they’re likely to be.

What recourse do annuity fraud victims have?

Annuity fraud victims have several places to turn for help. Most states mandate a “free look” provision regarding annuities and other life insurance products which allow a customer to return a policy with no adverse consequences within a certain time frame, usually within 21 days. Some life insurance companies have a free look policy in excess of the state-mandated requirement.

If stronger action is needed, assistance can be obtained from the state attorney general, the state insurance commission and the SEC.

How to avoid annuity fraud

Education and research are the best tools to fight annuity fraud. Both the client and the agent should have a clear understanding of one’s financial picture before money exchanges hands. As long as that simple guideline is followed, the chance of any client being defrauded decreases significantly.

Since by definition annuities are issued by life insurance companies, one should ensure that the life insurance agent they’re dealing with and the life insurance company he or she represents are legitimate. Remember, both the insurance agent and the insurance company must be licensed in any state they do business in. In most states this can be easily checked with a visit to the state’s insurance commission web site. Links are readily available at the National Association of Insurance Commissioners (NAIC) web site. If a life insurance company isn’t registered in your state, or the agent isn’t correctly licensed – or both – steer clear. If an agent or company is in trouble with a state insurance commission, that information is available as well. Today a simple Internet search would likely expose irregularities in an agent’s record similar to Bradford Bleidt’s.

Another useful research source on a prospective insurance company is A. M. Best. The vast majority of reputable insurance companies are audited annually by this independent, third-party credit rating organization on a variety of metrics, most importantly reserves, or the amount of cash and assets a company has on hand. After all, it’s very important to deal with a life insurance company that can consistently demonstrate an ability pay its claims. A. M. Best ratings are similar to school grades: A++ is the best rating, followed by A+, A, A- and so on. Anything lower than a B+ should be considered suspect.

Suitability is a key component of any annuity sale, especially a variable annuity. The agent should have a clear understanding of the client’s needs and risk tolerance before recommending any annuity product. In addition to age, planned retirement date, expected rate of return and assets available, he should know what sort of experience the client has in investments, how the client feels about investing in higher-risk instruments such as stocks as opposed to lower-risk instruments such as government securities. The agent should never suggest exchanging one insurance product for another unless doing so provides a clear benefit for the client. If any sort of variable product is considered, the agent should make sure you have a copy of all relevant prospectuses. Be very wary of anyone who is even remotely hesitant to provide you with a prospectus.

No reputable insurance agent will ask for or accept cash to fund an annuity, or any other life insurance product. Among other things, cash receipts on life insurance products have been tied to illegal money laundering practices. It’s a serious violation for any insurance producer to accept cash payments on variable life insurance products, one which could result in license revocation and possibly criminal action. As a matter of policy many reputable life insurance companies prohibit cash receipts entirely.