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AAA: State Regulation Framework Just Peachy for Contingent Annuities, But What if They're Hybrids?

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Contingent annuities function in a very similar manner to products with guaranteed lifetime withdrawal benefit (GLWB), with the basic framework  already in place at the state level for them to be regulated as annuity products, according to a report by the American Academy of Actuaries (AAA) during a NAIC teleconference. 

The products enable the use of existing accumulated assets for guaranteed lifetime income without requiring policyholders to transfer their assets to an insurance company, declared the AAA report, delivered on Dec. 22. 

The NAIC’s Contingent Deferred Annuity Subgroup (CDAS) of the Life Insurance and Annuities (A) Committee is considering the nature of these financial products, which many in the insurance industry and in the regulatory arena believe can be a valuable product for those who are concerned that they will outlive their assets. See:

However, there has been some concern by some companies and regulators that the products are not even annuities, but instead are financial guaranty products. 

The AAA analysis  by its Contingent Annuity Work Group (CAWG) sought to clarify this issue by noting that financial guaranty insurance products, like bond insurance, protect against specific types of financial losses and contain no life contingent element. Life annuities, on the other hand, protect for a lifetime and protect against outliving one’s assets, and contain a life contingent element, the AAA noted, so the product is a longevity protection product.

The AAA did hold that contingent annuity covered assets differ from those of GLWBs because they are external to the life insurance company. GLWBs provide guaranteed lifetime income based on the value of insurance company held assets.

The relationship between market performance and contingent annuity payments is indirect, the AAA further stated. 

The regulatory framework that is already in place includes most states’ adherence to  the NAIC models for reserves and capital for GLWBs and all states’ existing procedures for approval of GLWBs, according to the AAA report.

Any differences and similarities to GLWBs should be disclosed in product filings, the AAA advised the NAIC. 

The statutory reserve guidelines for CDAs or CAs are the same as for GLWBs and are addressed under Actuarial Guideline 43,(AG 43) the statutory risk-based capital requirements for contingent annuities are also addressed by current requirements and both are generally risk-managed through capital markets hedging programs by life insurers, the AAA pointed out. 

The issue, which came to a fore at the NAIC fall meeting, divided some, even as most agreed the product is valuable for consumers.

A contingent annuity is essentially a stand-alone guaranteed living withdrawal benefit, Olsen had told regulators at the NAIC Fall meeting. 

The AAA working group also looked at an IRS tax treatment, a Securities and Exchange Commission (SEC) treatment, a nonforfeiture treatment,  as well as state guaranty fund coverages to reach its conclusions.

In several private letter rulings, the IRS ruled that CAs are considered annuities for tax purposes and at the SEC, CAs, like GLWBs, are generally registered as securities (except for certain qualified retirement plans), the AAA pointed out. 

“The product had a material longevity component, and the life industry has the experience to manage these risks,” Olsen said. 

It is believed that the NAIC has to come out with a position either way, so there isn’t a lack of uniformity on this issue from state-to-state. 

New Jersey leads the CDAS and believes the product is a hybrid. However, a hybrid position would likely need its own new NAIC model. 

New Jersey is home to Prudential Insurance, of course, one of the supporters of CDAs as straight annuity products. Business rival and usual regulatory ally MetLife is one of the companies that is against the annuity classification. 

This is the first time in my career, both in industry and as a regulator, where I’ve seen MET and PRU so diametrically opposed on a core insurance/annuity issue,” New Jersey Commissioner of Banking and Insurance Tom Considine told National Underwriter.

The AAA’s own contingent annuities working group compared key risks and benefits of a contingent annuity to those of the widely accepted variable annuities with guaranteed living withdrawal benefits. 

Prudential Financial, in New Jersey, publicly supported the AAA working group’s analysis back in November, noting the product does not “indemnify loss.”

However, Mark Birdsall – the influential Kansas Insurance Department actuary – has expressed reservations. 

“We reviewed a product similar to what is being described here – we determined this product structure doe not fit the current regulatory structure,” while it may be in the public interest, Birdsall said at the NAIC Fall meeting.  

MetLife will not be selling the product, according to Eric DuPont of the New York-domiciled company, speaking at the Fall meeting. In fact, MetLife does not think the product is even an annuity, and  that it could  lead to reserve  problems. And New York does not take lightly to reserve issues generated from a financial product.

“Among MetLife’s concerns is that we believe it is very difficult to measure and manage the risk associated with the guaranty on a contingent annuity. Therefore, it is difficult to determine adequate reserving needed to support the product,” Dupont stated. 

Moreover, DuPont noted that the then- New York Insurance Department (now the combined Department of Financial Services) asserted in 2009 that contingent annuities are financial guaranty insurance under New York law. 

The New York law the DFS referenced follows the NAIC’s Financial Guaranty Insurance Model Law. That October 2008 contains a lengthy definition of financial guarantee insurance. 

In its report, the AAA did caution that contingent annuities risks to life insurance companies demand strong, comprehensive risk management practices by the life insurer and appropriate regulatory oversight by the state.


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