The annuity industry is beginning to struggle with how best to address civil unions within the scope of the spousal continuation provisions of nonqualified annuity contracts, said Reed Lloyd during a breakout session of a retirement conference here.

To be issued as a NQ annuity, complete with tax deferral, the annuity must have a provision required under IRC? 72(s), said Lloyd, assistant vice president of advanced marketing in the annuities and mutual funds division of Pacific Life Insurance Company, Newport Beach, Calif.

Section 72(s) says that, for federal income tax purposes, the contract must include a provision stipulating that a surviving spouse who is the named beneficiary may continue the annuity, summarized Lloyd.

This is the language that creates the parameters for spousal continuation of NQ annuities.

It’s a “huge issue” for annuity insurers, he said, because if the spousal continuation provision is not included, the contract may not be considered an NQ annuity and so may not qualify for tax deferral.

This issue is now coming face-to-face with another issue–the fact that states have begun adopting civil union laws and extending insurance benefits out to civil union partners, as if the partners were spouses, said Lloyd.

When companies go to file a new rider or modify an annuity contract in these states, he explained, the states are saying they want the new contract to follow the civil union laws. That is, the states want the NQ annuity contract language to say that civil union partners “will be treated as spouses for purposes of spousal continuation under the federal tax code,” said Lloyd.

For example, New Jersey has said that insurers have to provide spousal continuation of civil union partners if the company wants to continue writing annuity business in the state, he said.

That creates a problem for insurers, because they want to adhere to the 72(s) requirement and thus keep tax deferral for their annuities, he indicated.

“When writing insurance contracts, we (insurance companies) put in the language for 72(s),” he said, so that NQ annuities will adhere to the federal tax code.

This language has been backed up by the Defense of Marriage Act of 1996, Lloyd continued. The act defines marriage as a legal union of a man and a woman as husband and wife, and says a spouse is a husband or wife of the opposite sex, he said.

Therefore, he said, “we (insurers) have to say we issue contracts within the federal tax code, and unfortunately, we cannot recognize civil union partners for purposes of spousal continuation.”

This is an ongoing matter, he indicated, noting that some states, when creating civil union partnerships, specifically recognize such partnerships for the purposes of insurance. In Vermont, for example, Lloyd said the department of insurance notified all insurance companies that “72(s) does not apply to civil union partners.” The department did this in response to insurer concerns about losing tax deferral, he suggested.

The industry is watching the developments carefully, and “a lot of lobbying is going on,” said Lloyd.

Meanwhile, “some insurers are drafting endorsements and modifying contracts to treat civil union partners as spouses at the contract level, allowing for contract continuation.” There could be some risks in that, but it’s too soon to tell, he added.

The industry is “struggling” to educate regulators about the issues, and the federal tax perspective related to potentially disqualifying the annuity contract in its entirety. “Unfortunately, that argument is falling on deaf ears right now,” Lloyd said.

The civil union discussion was part of an advanced market session during the annual retirement industry conference held by LIMRA International, Windsor, Conn.; LOMA, Atlanta; Society of Actuaries, Schaumburg, Ill.; and National Association of Fixed Annuities, Milwaukee.