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Regulation and Compliance > Federal Regulation > SEC

IRI Conference: SEC Official Sees Possible Living Benefits Conflicts

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WASHINGTON BUREAU — The U.S. Securities and Exchange Commission (SEC) is keeping a close eye on variable annuity living benefits disclosures.

Eileen Rominger, director of the SEC’s division of investment management, talked about those concerns here at a regulatory conference organized by the Insured Retirement Institute (IRI), Washington.

Rominger said the SEC has become “increasingly concerned” about potential conflicts of interest that may result from the fact that the amount of an insurance company’s liability under living benefit riders is directly related to the performance of funds that are managed by its affiliate.

“Recently, we have begun to see prospectus disclosure acknowledging the conflict, and even indicating that the management of a fund could be influenced by the risk exposure faced by the adviser’s affiliate, the insurance company,” Rominger said.

One recent filing disclosed an arrangement under which a fund, which will be a required investment allocation for participants in certain living benefit riders, will be managed through adherence to a formula that uses data provided periodically by the affiliated insurer, Rominger said.

“Beyond the disclosure implications here, keep in mind that separate accounts and underlying funds, as investment companies, are subject to the Investment Company Act’s conflict of interest provisions,” Rominger said.

She said it is important that the board of directors of any fund that may be subject to conflicting interests on the part of its advisor “be vigilant watchdogs for the fund’s investors,” ensuring that arrangements entered into are for the benefit of those investors.

“To accomplish that goal, I believe board deliberations should squarely address any potential conflict on the part of the fund’s adviser and other service providers,” Rominger said.

Meanwhile, “a fund’s advisor and the insurance company that offers a fund on its platform should be careful in formulating arrangements to head off any potential for overreaching in their dealings with the fund,” Rominger said

She said the SEC is paying close attention to the disclosure filings because living benefit riders in variable annuity contracts have proliferated, especially since the market decline of 2008.

Living benefits riders has been one of the dominant factors driving VA sales in recent years, Rominger said.

Since 2008, when many living benefits riders were “in the money” because of the financial crisis, “the [SEC] staff has seen many filings reflecting increased fees charged for these benefits,” Rominger said.

In many cases, Rominger said, buyers of living benefits are facing more limits on investment choices, reflecting an effort by insurers to limit volatility of the investments that are subject to the benefits.

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 benefit riders, Rominger said.

“I believe an investor purchasing a living benefit rider should be fully informed of any aspect of the arrangement that could limit the market participation reasonably expected by the investor,” she said.

The SEC believes that it is vitally important that investors in these type of arrangements understand the trade-offs inherent in an investment of this type, Rominger said.

“While living benefit riders do provide a measure of protection from a down market, it should be clear to those purchasing the riders that these investment restrictions minimize the likelihood that the riders will ever be ‘in the money’ and actually provide a benefit to the investor, and that such restrictions also may limit the upside potential of the investment.,” Rominger said.

VA sellers also should disclose when they can unilaterally change account allocations, Rominger said.

“It should also explain the effects of such changes, such as the possibility of missing a market uptick during a period of fixed income allocations,” Rominger said.

Structured Products

Some new indexed annuities resemble structured notes with principal protection, and the SEC has some concerns about those products, Eileen Rominger told IRI conference attendees.

The products have reassuring names but are not risk-free, Rominger said, citing an investor alert issued by the SEC along with the Financial Industry Regulatory Authority (FINRA).

Some of the products could return as little as 10% of principal, and some have complicated pay-out structures that make assessing their risk and growth potential difficult, Rominger said.

“In addition, the products have fees, whether implicit or explicit, even if the sales materials suggest otherwise, which of course will limit returns,” Rominger said.

“I believe it is important that anyone working towards future filings regarding similar products should do all that you can to prepare disclosure aimed at ensuring that investors are not confused or misled, Rominger said. “And I would caution you, as well, that you will be well served by exercising vigilance with respect to the suitability of sales of these products.”

- Allison Bell

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