It remains to be seen whether the regulatory problems surrounding this potentially appealing product can be satisfactorily resolved.
We have written in the past about the progress that contingent deferred annuities are making toward the market in a time of regulatory concern about the product and the insurers that issue them.
Simply stated, a contingent deferred annuity is a guarantee by a life insurer to make lifetime income payments to the insured in the event the "covered assets" that are the underlying investments for the product become worthless. It is very much the same as the "guaranteed minimum income benefits" that have been included in many variable annuities for the past number of years. The difference is that, unlike the variable annuity where the insurer holds the underlying assets in the insurer's separate accounts, the contingent deferred annuity is issued with reference to a group of assets that are not held by the insurer. Thus, the contingent deferred annuity can use as the underlying assets a mutual fund account, separate investment accounts, or a pension account--none of which are the reserves held by the insurer for the annuity.
The contingent deferred annuity is, in reality, pure insurance protection in that it protects the insured both with respect to longevity risk and with respect to the value of assets. The contingent deferred annuity is of little value to the insured unless the underlying assets become worthless. Until the recent "meltdown" in the American economy, observers may well have believed that this product was, in fact, unnecessary. Recent economic conditions have changed this belief.
State insurance regulators have been studying the product in order to determine if it is a "life insurance product" or merely a form of financial guarantee. There is also some controversy among certain insurers as to what is the actual nature of the product. To the extent that the contingent deferred annuity provides longevity protection, it certainly appears to qualify as a life insurance product. However, since the guarantee only becomes viable when the underlying assets become worthless, it also has trappings of a financial guarantee.
Actuarial organizations have been studying the product for quite some time in order to provide guidance to the life insurance industry and life insurance regulators as to the correct nature of the product. It is not yet clear how traditional life insurance concepts that apply to traditional products will apply to the contingent deferred annuity. For instance, it needs to be determined how reserves will be established for the product; what level of reserves is appropriate; does the product develop cash values that are subject to the traditional minimum non-forfeiture requirements; and what "risk-based capital requirements," if any, apply to the reserves held for the product or to the assets underlying the product. It is not even clear if current life insurance statutes permit the issuance of such a product. These questions about contingent deferred annuities also presume that the insurers issuing the product are able to correctly establish a cost for the insurance protection provided.
It is not clear what marketing considerations will affect the product. The initial thrust for the product has come from asset managers desiring to add a benefit to their services that would appeal to retiree's need for longevity and volatility protection. Thus, a mutual fund could provide for such a "wrapper" for the owners of shares in the fund. Or pension funds could provide such a protection to all participants in the pension plan. Likewise, the contingent deferred annuity could be offered on an individual basis to any investor or pension plan participant desiring such protection.
The marketing regulatory structure for the product is also not settled. Clearly, since only a life insurer can legally insure longevity risk, the product will be regulated by life insurance regulators. Likewise, those selling the product will require appropriate licensing and regulatory oversight.
However, it is not clear whether the product is a "security" subject to the federal securities laws in a similar manner as they apply to variable annuities and variable life insurance. Annuities themselves are exempt from most federal securities laws. Variable annuities and variable life insurance are "investment company securities" because the investment risk is shifted from the insurer to the owner of the variable annuity or variable life insurance policy. While the contingent deferred annuity relates to assets where the insured has the investment risk, the contingent deferred annuity is pure insurance where the insurer has no control over the outcome of the investment process. Federal securities laws have long been interpreted as treating a guarantee issued with a registerable security as also being subject to registration as a security.
Whether the contingent deferred annuity is itself subject to registration and thereby requiring sales by a registered representative of a broker-dealer may well depend on whether the product is offered as a "wrapper" for specific assets that are themselves "securities," or if the product is offered as a stand-alone "insurance" product. In any event, state suitability requirements will probably apply, and time will reveal whether the SEC or FINRA become involved in the product.
An impressive group of commentators have postulated that contingent deferred annuities are potentially too dangerous to the financial stability of the insurers that issue them because the charges that insurers can make to provide the product are not sufficient to cover the risks involved. The argument is that only the traditional method of having the assets underlying the product held by the insurer provides adequate compensation to the insurer to justify the risk.
The need for the average American retiree to provide protection against outliving retirement funds coupled with worries about the volatility of the market make the contingent deferred annuity an appealing product. Whether the regulatory problems can be satisfactorily resolved remains to be seen. We anticipate that the National Association of Insurance Commissioners will, in the not-too-distant future, determine the fate of the contingent deferred annuity.