SEC Presses for Better Disclosure on VA Living Benefits

WASHINGTON—The Securities and Exchange Commission is paying close attention to the disclosures related to variable annuities that contain living benefit features.

These concerns include the disclosures related to VAs with a living benefit feature that use derivatives to enhance yields, about the “guarantees” included in these products, and about living benefit products that limit the investment options offered to purchasers.

In comments today at an investment conference in Washington, a SEC official “encouraged” insurers and their lawyers to assess the effectiveness of disclosures in VAs that feature living benefits and use derivatives to enhance yields.

Eileen Rominger, director of the SEC Invest Management Division said that this should include elimination of boilerplate disclosure that do not reflect the actual use of derivatives in a fund’s portfolio.

If necessary, Rominger added, insurers should “improve your disclosure so that it more clearly reflects the actual role that derivatives play in the overall investment strategy of your funds.”

Rominger made her comments at a Conference on Life Insurance Products sponsored by the American Law Institute/American Bar Association. The conference is being held in Washington.

Rominger made clear that the SEC views living benefits, “even when offered as riders’, to be an integral part of the contract offering.”

For that reason, Rominger said, insurers and their lawyers “should pay as much attention to disclosure concerning these benefits as you do to other features of a variable contract.”

Another issue is that the SEC finds that a number of living benefit products limit the investment options offered to purchasers.

“Indeed, purchasers of these optional benefits are facing increasing limitations on investment choices, reflecting an effort by insurers to limit volatility of the investments that are subject to the benefits,” Rominger said.

For example, she said variable annuity contracts often prohibit allocations to the more volatile funds, or require participation in a conservative asset allocation model that is designed and maintained with reference to the insurer’s exposure under its living benefits.

She said an important staff concern has been to ensure that investors are apprised of the trade-offs involved in such an arrangement.

“I believe that prospectuses should make clear to investors purchasing the benefits that these investment restrictions may limit the upside potential of their investment, and that such restrictions also reduce the likelihood that the downside protection offered by these benefits will ever actually be ‘in the money’,” she said.

Rominger also said that many insurers also control underlying investments by implementing asset allocation models that move account value among underlying funds pursuant to a formula.

“Account allocations to equity funds, or to funds that may involve a higher level of volatility, are changed to more conservative investments, such as government bond funds or money market funds, during declining markets and, in some cases, moved back to the original fund allocation during periods of sustained market growth,” she said.

As a disclosure matter, “I believe that it is important that any ability of an insurer unilaterally to change account allocations be clearly explained,” Rominger said.

Similarly, the contract prospectus should make clear to investors the circumstances under which account allocations may be changed and the effects of such changes, such as the possibility of missing a market uptick during a period of fixed income allocations, she said.

Regarding the tax-advantaged component of VAs, she said that “it is important that an investor purchasing a living benefit be fully informed of any aspect of the arrangement that could limit the market participation reasonably expected by the investor.”

She also voiced concerns about the use of “guaranteed” in VAs that provide living benefits.

She said that the term “guaranteed” as used in other contexts often connotes some level of support of an issuer’s obligations by a third-party guarantor.

She said that as used in the variable products context, the term generally has been used to signify a promise by the insurer, the fulfillment of which is subject to the claims-paying ability of the insurer and is not backed by any third-party guarantor.

For this reason, Rominger said that the SEC staff is concerned about potential confusion on the part of investors over the nature of so-called “guaranteed” benefits.

“I would encourage you to review your disclosure to ensure that it makes clear the credit risk associated with any insurer obligation to pay a living benefit — or any other benefit — offered under a variable contract,” she said.

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