Even though the two of us have focused mostly on variable annuities during our collective 75+ years in the annuity business, if we were to start over today knowing all we have learned, we believe we would probably design index annuities (IAs) rather than VAs.
We say this despite all the controversy over index products, despite the bad reputation that some index products have with regulators and despite the bad press many have had with the financial media.
In fact, we believe an index product can accomplish most of the goals of a VA and of a traditional fixed annuity (FA) and yet be free of many problems inherent with both.
The VA was originally created to provide retirement funds that could not be outlived while affording protection against the ravages of inflation of a portfolio of professionally managed and widely diversified equity investments. But shortly after their creation, federal securities regulators determined that VAs were little more than mutual funds with slight trappings of insurance and thus were not exempt from federal securities registration and regulation.
The US Supreme Court, in SEC v. VALIC, 359 U.S. 65 (1959), agreed, and so the VA entered an era of multiple levels of regulation–not only by the SEC, but also by state insurance regulators and the National Association of Securities Dealers.
In recent years, even state securities regulators have begun to try to exercise degrees of jurisdiction over VAs and their sales process.
The regulation is such that it seems the only thing more thoroughly regulated than VAs is nuclear waste.
The critical element in the Supreme Court decision to subject VAs to federal securities regulation was the fact that the entire investment risk in a VA is, unlike with traditional FAs, shifted from the insurer to the policy owner. Thus, the court determined that a VA was not the type of annuity Congress intended to be exempt from the federal securities laws. The result is the abundance of regulation that the product is subjected to today.
By comparison, IAs have the ability to provide consumers with the VA’s 2 main advantages: income for life and a hedge against inflation. Yet, the IA insurer guarantees stated principal and a minimum investment return. These factors operate to retain the most meaningful elements of the investment risk in the insurer, rather than shifting it to the policy owner.
It is this guarantee of investment results that enables the IA to avoid the federal securities laws and to remain subject only to the regulatory constraints applicable to life insurance products.
Recent pronouncements by the NASD have caused concern regarding whether IAs would continue to be treated as “insurance” rather than “securities.”