Kenneth L. Racowski
Kenneth L. Racowski ()

Annuities have historically been a popular retirement investment option. In particular, variable annuities, which combine an insurance policy and mutual funds, can provide tax-deferred retirement savings, upside growth with downside protection and guaranteed income throughout the holder’s lifetime. The aftermath of the financial crisis, however, has led issuers to seek changes to variable annuity products and their terms. Given the volume of variable annuities in the market, such product changes raise the prospect of increased litigation involving variable annuities.

The U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority and the Pennsylvania Insurance Department each have a role in regulating the sale of variable annuities in Pennsylvania. Many individual cases involving variable annuities proceed to FINRA arbitration. Since virtually all brokerage firms incorporate a predispute arbitration clause in their new-customer account documentation, investors that bought variable annuities from a broker are usually required to arbitrate their claims.

Those who are not forced to arbitrate can bring individual actions in state or federal court against annuity issuers, brokers or others involved in the marketing, sale and administration of the subject annuities. Individual actions involving variable annuities initially brought in state or federal court, however, may ultimately wind up in FINRA arbitration either by operation of a contractual provision or agreement of the parties.

A party may, however, be found to have waived its right to arbitration by failing to raise the issue of arbitration promptly, as in Stanley-Laman Group v. Hyldahl, 939 A.2d 378, 387 (Pa. Super. Ct. 2007). Since class actions are not permitted in FINRA arbitration, class claims involving annuities proceed in federal and state courts.

Lawsuits against issuers or brokers alleging unsuitability, loss of principal or other theories involving the sale or modification of variable annuities can be based on myriad common-law causes of action, such as breach of contract, fraud, fraudulent concealment, breach of fiduciary duty, unjust enrichment, promissory estoppel and malpractice. Pennsylvania’s Unfair Trade Practices and Consumer Protection Law, the federal Racketeer Influenced and Corrupt Organizations Act and elder-abuse statutes may also be available to plaintiffs bringing such claims.

Annuity Class Actions

The U.S. Court of Appeals for the Third Circuit, in In re LifeUSA Holding, 242 F.3d 136, 145-47 (3d Cir. 2001), provided the benchmark for determining whether claims premised on annuity sales practices satisfied the prerequisites for class certification. The plaintiffs’ allegations involved fraudulent nondisclosures and misrepresentations in the sale and marketing of so-called “accumulator” annuities.

In vacating the district court’s certification of the class, the Third Circuit concluded that the class could not meet the commonality and predominance requirements of Rule 23(b)(3) because the claims did not arise out of one single event or misrepresentation. The court distinguished the sales practices in LifeUSA from those found in In re Prudential Insurance Co. of America Sales Practices Litigation, 148 F.3d 283 (3d Cir. 1998). In Prudential, the class claims involved uniform, scripted and standardized sales presentations, whereas in LifeUSA the claims involved “nonstandardized and individualized sales ‘pitches’ presented by independent and different sales agents, all subject to varying defenses and differing state laws.”

Similarly, in Smith v. John Hancock Life Insurance, No. 06-3876, 2008 U.S. Dist. LEXIS 67250 (E.D. Pa. Sept. 3, 2008), the court denied certification of national and Pennsylvania classes, finding that common questions did not predominate over individual claims. The court concluded that reliance may not be presumed because the claims were predicated on a misrepresentation. As a result, “the individualized issues attendant on proving reliance bar class certification.”

Class actions involving suitability claims often include RICO allegations. Although district courts within the Third Circuit have taken different approaches, class claims are frequently dismissed for one or more failures to meet the strict requirements for a civil RICO claim. In a multidistrict litigation relating to the marketing and sale of annuities that consisted of consolidated individual and class action suits, the court dismissed one of the two primary putative class actions for the failure to plead the necessary elements of its RICO claims in In re American Investors Life Insurance Co. Annuity Marketing & Sales Practices Litigation, MDL No. 1712, 2008 U.S. Dist. LEXIS 43085 (E.D. Pa. May 30, 2008).

The plaintiffs alleged that defendants engaged in a fraudulent scheme to market and sell unsuitable annuities to senior citizens, including the failure to disclose surrender penalties and maturity dates that exceeded the life expectancy of the purchasers. The court found that the putative class consisting of the annuitant beneficiaries could not meet the demanding standard for RICO standing.

In Luzerne County Retirement Board v. Makowski, 627 F. Supp. 2d 506 (M.D. Pa. 2007), the U.S. District Court for the Middle District of Pennsylvania may have closed the door on RICO claims involving variable annuities. There, a county retirement board brought RICO claims against former board members and others involved in investments for the county’s retirement fund. Although Section 3(a)(8) of the Securities Act of 1933 exempts from its provisions “annuity contracts,” the court went on to distinguish variable annuities from fixed annuities.

While variable annuities are primarily sold by insurance companies, the policies must be offered through “separate accounts” registered with the SEC under the Investment Company Act of 1940. Moreover, the variable annuities at issue were “investment contracts,” and therefore fell within the definition of a “security” under 15 U.S.C.A. § 77b(a)(1). Since the court found that the variable annuities were a security, and the plaintiff’s claims were therefore actionable as securities fraud under Section 10(b) and Rule 10b-5, the claims were barred by the Private Securities Litigation Reform Act.

Individual Annuity Actions

In the early 2000s, annuity issuers commonly sold variable annuity products that contained riders. Since one of the primary reasons investors purchase annuities is to guarantee income during retirement, many of these riders were aimed at providing income guarantees or guaranteeing the return of an investor’s principal. Following the financial crisis, issuers have increasingly provided notices changing the terms of such riders under the change rights provided in the annuity contract or prospectus.

For example, issuers have sought to suspend or limit future contributions into already purchased annuities, and have declined to extend the annuitization dates on existing contracts, resulting in forced annuitizations where a holder’s death benefit exceeds the current account value. Such changes have fueled an uptick in annuity litigation and attempts to hold annuity issuers liable for bad faith. Pennsylvania law, however, is clear in that annuities are not properly the subject of statutory bad-faith claims.

Under Pennsylvania law, an annuity is not an insurance policy subject to statutory bad-faith claims. Pennsylvania’s bad-faith insurance statute only applies in “an action arising under an insurance policy,” per 42 Pa. C.S.A. § 8371. The Supreme Court has held that Section 8371 “applies only in limited circumstances … and it only permits a narrow class of plaintiffs to pursue the bad-faith claim against a narrow class of defendants,” as in Ash v. Continental Insurance, 932 A.2d 877 (Pa. 2007).

Although annuity contracts are regulated by the Pennsylvania Insurance Department, they are not insurance policies, as in Commonwealth v. Metropolitan Life Insurance, 98 A. 1072, 1073 (Pa. 1916), and In re Custom Coals Laurel, 258 B.R. 597, 601-02 (W.D. Pa. Bankr. 2001), which provided examples of differences between annuities and insurance policies. Moreover, “it is well established under Pennsylvania law that annuity contracts and insurance contracts are distinct animals,” as in Smith v. John Hancock Insurance, No. 06-3876, 2008 U.S. Dist. LEXIS 66912, at *15-16 (E.D. Pa. Sept. 2, 2008).

Since an annuity is distinguishable from an insurance contract, it is not properly the subject of a bad-faith claim under Section 8371, and therefore should be dismissed, as in Prusky v. Allstate Life Insurance, No. 09-5156, 2010 U.S. Dist. LEXIS 105864 (E.D. Pa. Sept. 30, 2010).

Annuity claims may also arise in Orphans’ Court litigation. Issuers and brokers can find themselves involved in will contests facing allegations that they did not properly recognize a beneficiary change.

The Pennsylvania Supreme Court recently reaffirmed longstanding Pennsylvania precedent that an annuity holder has to abide by the terms and procedures provided in the annuity contract to change the beneficiary of the annuity, as in Alkhafaji v. TIAA-CREF Individual & Institutional Services, 69 A.3d 219, 222-24 (Pa. 2013), which rejected an attempt to change a beneficiary by will when notice provisions of annuity contract did not expressly forbid it. The court concluded that to “allow modification of nontestamentary contractual assets by testamentary documents blurs … the distinction” set forth in 20 Pa. C.S.A. Section 6108. Nonetheless, Pennsylvania law still provides a limited exception when notice is received after death if the annuitant made every reasonable effort to comply with the notice requirements of the annuity contract.

Courts, however, have set a high bar as to what constitutes “every reasonable effort,” particularly when the annuitant had time to effectuate the change of beneficiary properly, pursuant to clear and unambiguous terms, as in Carruthers v. $21,000, 434 A.2d 125, 127 (Pa. Super. Ct. 1981), and Prudential Insurance Co. of America v. Alkhafaji, No. 09-cv-1477, 2011 U.S. Dist. LEXIS 11277 (W.D. Pa. Feb. 4, 2011).


Although the decisions discussed herein have restricted certain claims and remedies, their complexity and prevalence ensure that Pennsylvania state and federal courts will continue to see a steady stream of variable annuities litigation. Whether the annuity products or features at issue are considered insurance, securities or contracts not only will determine the applicable regulatory framework but also likely will impact how courts resolve the litigants’ claims. 

Kenneth L. Racowski is the leader of Wilson Elser’s Philadelphia commercial and business litigation practice. He can be reached at 215-606-3913.