August, 2009

Variable Annuity Litigation - The Next Wave

By Connie M. Anderson, Esq.

The first wave of variable annuity litigation consisted of securities fraud class actions involving the placement of variable annuities into 401K plans. Plaintiffs claimed that they were paying for a redundant tax deferral, as their 401K plan already had tax deferred status. Ultimately, many of these cases were settled for significant sums.

The next wave of variable annuity litigation will likely also involve high exposure class actions, but this time the lawsuits will likely focus on advertising related to the products, as well as certain attributes of the products themselves. Essentially plaintiffs may allege fraud, false advertising, suitability, and negligence claims concerning, among other things: (1) the impact of fees on hypothetical returns shown in advertising materials; (2) suitability given the customer’s age; and (3) the fees related to death benefits.

Plaintiffs may claim that advertising materials that show the value of a variable annuity over time as compared to a mutual fund do not include the fees associated with the annuity. When fees are included, the comparison favors the mutual fund for over 20 years. Plaintiffs may also make claims that given high fees and early withdrawal penalties, variable annuities are not suitable for older investors.

Another strategy Plaintiffs could adopt is to assert that advertising fails to disclose the relative cost of death benefits. While this example is simplified for brevity, in a hypothetical account with an initial investment of $200,000, an accumulation value of $225,000 in the second policy year, and an accumulation value at the time of death of $175,000, one argument that might be made is that the amount “insured” is not the $225,000, but only the $50,000 difference between the value at the time of death and the earlier accumulation value. Plaintiffs may claim that the cost of the benefit is multiple times what is actually insured and is therefore unwarranted.

Defending against variable annuity claims will require in-depth knowledge of the products and previous related litigation. One strategy to consider in defending against variable annuity claims is based on the many attributes and available add-ons to the annuities. In particular, the higher fees are justified by a guaranteed principal investment, particularly given the current economic crisis. The current economy also aids defendants in making the argument that the true death benefit provided by an annuity includes the principal investment.

There are other aspects of the annuities that may be attacked, and the specific allegations will vary by product. There are likewise numerous possible strategies and defenses for dealing with such claims. This article, however, provides an example of what we may soon be facing.

Connie M. Anderson, Esq.
Chair, Financial Products & Services Litigation Group
Klinedinst PC

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