By Linda Koco
Contributing Editor, AnnuityNews
State regulators are planning what could become a “robust discussion” this Friday about whether so-called contingent annuities are actually annuities or perhaps financial guaranty type of product.
Independent advisors may not have even heard of contingent annuities, let alone sold one that they know of, so they might well be wondering what this regulatory inquiry will be about. The annuity is “essentially” a guaranteed lifetime withdrawal benefit (GLWB) for a mutual fund, so that if investors drain their accounts’ value, the insurer would step in and provide the income stream for life.
Contingent annuities are most often portrayed as a group annuity (either variable or fixed), although some are individual products, according to a report issued earlier this year by the Contingent Annuity Subgroup at National Association of Insurance Commissioners (NAIC).
In some jurisdictions, the products “may have been represented” as a form of a synthetic guaranteed interest contract (GIC), the report says.
According to the subgroup, the contingent annuity is a new type of insurance product that has been filed in virtually all states and that has subsequently raised some “regulatory concerns.”
The concerns include not only whether the products are in fact annuities but also the need for the products, the risks they present, the consumer issues they might raise, and the reserving and capital considerations they may entail.
Some regulators are even concerned that some contingent annuity filings were not properly vetted or may have been “disguised” in some way.
The inquiries started last year when NAIC’s Life and Health Actuarial Task Force [now the Life Actuarial (A) Task Force] began hearing comments about the products. The Task Force responded by creating a Contingent Annuity Subgroup to look into the matter. The subgroup studies the products, issued a report, and also recommended that NAIC’s influential Life Insurance and Annuities (A) Committee also look into the matter, since some issues the subgroup uncovered are not actuarial in nature.
Now, the (A) Committee will take up the topic of contingent annuities during a phone conference this Friday. The regulators will have a lot to talk about since there is a lot of uncertainty about what the products are and do.
What are contingent annuities?
According to the Contingent Annuity Subgroup report, contingent annuities are most often portrayed as a group annuity (either variable or fixed), although some are individual products. In some jurisdictions, the products “may have been represented” as a form of a synthetic guaranteed interest contract (GIC), the report adds.
Insurance advisors may not have encountered the products or even been aware of them because the products are generally offered to mutual fund investors as standalone guaranteed lifetime withdrawal benefits (GLWBs). Insurance advisors would therefore not be working with the products as individual annuity policies.
According to the subgroup, the contracts cover investments in a range of mutual funds that meet the insurer’s criteria. The NAIC report terms these mutual funds “covered funds.”
“The key feature of the contract is that covered funds are neither owned nor maintained by the insurer,” the subgroup report says.
The mutual fund investor pays a fee for the product. The fee equals a percentage of the current account value, the subgroup report says.
The investor can start taking GMWB withdrawals from the account value after reaching a specified age. The withdrawal amount equals a percentage of the account value at the time the distributions begin. This percentage is based on the investor’s age and gender and as specified in the contract, the subgroup report says.
Depending on the investment results and the longevity of the investor, those withdrawals “may eventually exhaust the account value,” the report continues. If that happens, the insurer issues a “certificate of insurance” to the investor and begins making payments to the investor in an amount that equals the amount of the systematic withdrawals.
The payments under the certificate will continue for as long as the investor lives.
Where is the problem?
The subgroup report says contingent annuities appear not to have received a thorough regulatory review due to either lack of resources or the manner in which the product was presented.
The report also says regulators in different states have raised a number of issues with the products. Examples include use of separate accounts; ownership of the covered fund assets; classification of the contingent annuity as a fixed annuity, variable annuity, financial guaranty or derivative; and a “possibly misleading manner” of filing the product with various insurance departments.
A task force conference call in May aired many of these issues and others.
A few insurance company representatives also weighed in during the task force conference call. A summary of their comments, as published by the task force, shows that these representatives said contingent annuities are indeed legitimate annuities and are viable products for the retirement income marketplace.
The discussion over whether product is an annuity may be of particular interest to insurance advisors, who confront complexity in product design on a daily basis and sometimes wonder whether they are dealing with fish or fowl.
Here are some highlights of that discussion, shown as excerpts from the subgroup report:
Is a contingent annuity an annuity? “At least one state deemed the contingent annuity not to be insurance under the state law, and therefore not subject to the department’s regulation.”
Do contingent annuities meet the definition of an annuity? “Another state determined that the contingent annuity does not meet its definition of an annuity. The determination was based on the fact that an annuity means an agreement to make periodic payments for a period certain or over the life of the individual. The definition implies that the annuity contract stipulates a date on which the payments commence. This is in contrast to other insurance products that provide periodic payments, like disability income or unemployment insurance, where payments commence upon the occurrence of a specified condition. Payments under the contingent annuity contract commence upon exhaustion of the account value which may never happen.”
Can insurance companies offer contingent annuities? “If it is deemed not to be insurance under the state law it raises a question whether it can be offered by an insurer. State laws typically restrict activities of insurers to the ‘business of insurance’ or ‘business incidental to business of insurance.’”
Is a contingent annuity financial guarantee insurance? “Several states determined that the contingent annuity constitutes financial guaranty insurance and as such cannot be sold by a life insurer. One state determined that it constitutes an impermissible form of financial guaranty insurance. The determination that the contract is financial guaranty insurance was based on the fact that the guarantee of the lifetime payments with no reduction for the negative market performance appears to be a guarantee that those assets will not decline in value. It was held that it purports to provide indemnification for financial loss resulting from changes in the values of specific assets.”
Is a contingent annuity a fixed annuity? “In some states the contingent annuity has been deemed to be a fixed annuity. The determination was based on the manner in which the product has been filed and the fact that the amount of periodic payment from the insurer is fixed and equal to the amount of the systematic withdrawal. Moreover, the amount of the systematic withdrawal equals a specified percentage of the account value on the date systematic withdrawals initiate.”
Is a contingent annuity a variable annuity? “In some states the contingent annuity has been deemed to be a variable annuity. The determination was based on the manner in which the product has been filed and the fact that the timing of the payments depends on the market performance of the covered funds. The primary risk under the contract appears to be the poor performance of the covered funds. The actuarial memorandum submitted with the filing states that reserves will meet the requirements of Actuarial Guideline XLIII CARVM for Variable Annuities which sets forth the requirements for variable annuities. All of the above suggest a variable nature of the benefit.”
The products are certainly getting attention. The Contingent Annuity Work Group of the American Academy of Actuaries has already signaled that plans to provide NAIC with a “comprehensive” comment letter on specific topics related to contingent annuities. The work group has also offered to assist the NAIC “in any other way” in the study of these products.
Linda Koco, MBA, is a contributing editor to AnnuityNews, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected].
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