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CDAs Are Hybrids of an Annuity, Financial Guarantee Product, says NAIC Subgroup

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And it’s a … hybrid.

Contingent deferred annuities (CDA) are a hybrid product, the NAIC regulatory subgroup working on classifying and evaluating the product, believes at this point, it has announced.

Insurance departments could regulate the product as  an “annuity” after through reviews/adjustments, especially modifications in reserve methodologies (AG 43), and the filing process for guaranteed lifetime withdrawal benefit features, according to the subgroup’s discussion.

CDA Subgroup Chair and the New Jersey Department of Banking and Insurance’s chief actuary Felix Schirripa told industry on a conference call Thursday that the group has come to believe the product is a hybrid of an annuity and a financial guaranty product, contrary to the beliefs of many industry actuaries. 

Industry support for the CDA as an annuity has been great, with the notable exception from MetLife. See: 

Underwriting CDAs as annuities could even cause financial problems to those companies, MetLife warned the NAIC. It added that such demand–if it in fact existed–combined combined with the difficulty of determining adequate reserving, could lead to solvency concerns for companies that have not adequately supported their CDAs.

“Relative to variable annuities with living benefits, we believe the amounts required to support CDAs would be potentially higher and more volatile (again, since these reserve and capital requirements look at both the base contract and the guaranty and the contingent annuity does not have the base contract to provide stability),” MetLife warned senior NAIC life and health policy staff in a letter last month. 

However, regulators need to decide if there needs to be a new supervisory mechanism established with elements of both the annuity and the financial guaranty models, unless there is another path. See: 

One regulator noted that if a company wasn’t writing the product now, it should hesitate to start until the regulatory landscape became clearer-and if a company is writing them, it should reserve conservatively.

Companies are clamoring to sell them, while regulators evaluate the risk, which MetLife has stated it is wary of. There is another state besides New York which considers the product a financial guarantee product, Schirripa suggested on the call, in response to Great-West Life & Annuity Insurance Co. official calling the New York regulatory opinion an “outlier.”

Schirripa said on the call that the product can indeed potentially benefit consumers with its longevity protection, but presented possible design changes to make the product more palatable to regulators, and add more disclosures and consumer protections.

With regard to longevity risk, it is real only if buyer behavior “is efficient and moves into a higher risk/reward portfolio,” but  “there is  no meaningful longevity protection if the covered portfolio is too conservative, or …(if) the policyholder behavior is sufficiently inefficient,” Schirripa warned.

Insurers would have to emphasize that the purpose of CDA is lifetime income protection, not asset preservation  and explain what happens to guarantee if policyholder wishes to fire manager “for cause” or underperformance, according to the CDA discussion guide on policyholder behavior  and product design that Schirripa prepared.

The focus would be on the longevity of the annuitant as opposed to the indemnification of market loss, according to Schirripa.

To reduce the financial guaranty component, companies could restrict exposure to equities and other high volatility investments and retain contractual right to auto-rebalance covered assets (when, and if, losses occur), Schirripa’s presentation suggested.

Insurers could also add more longevity protection, for example, making withdrawal percentages (or fee percentages) more age-dependent and having no  fees beyond, say, age 90, say, the actuary proffered.

But the industry trade group reaction showed reluctance to accept a hybrid designation.

The industry has pointed several times to IRS private letter rulings which suggest he product is not a financial guaranty product, but an annuity.

“We do not understand the ‘hybrid’ classification proposed in today’s call and what the ramifications of such a classification would be. If, as the subgroup proposed, contingent deferred annuities would be regulated as an annuity then they can only be an annuity and only issued by life insurers,” said Whit Cornman, a spokesman for the American Council of Life Insurers (ACLI).

“As annuities, these products would be subject to the regulatory framework already in place. Certainly, it would be appropriate for the subgroup to discuss how these may differ from other annuities on the market and what needs to be addressed that isn’t already in the regulatory framework. We are prepared to participate in that discussion,” Cornman stated. 

Great-West said to the NAIC  in its presentation that the products showcase the fundamental characteristics of annuities because the payments are dependent on “As annuities, these products would be subject to the regulatory framework already in place. Certainly, it would be appropriate for the subgroup to discuss how these may differ from other annuities on the market and what needs to be addressed that isn’t already in the regulatory framework. We are prepared to participate in that discussion.” 

The  Prudential, which hasn’t been shy on pursuing the controversial issue, reiterated its support for these type of products, and their  future in the  company.

“Prudential continues to focus on the development of innovative product designs that  bring protection and income guarantees to previously unprotected investments. Advisors are looking for a broader array of options that are complementary to their business models and meet the needs of their clients.  We are actively engaged in designing and creating  new solutions,” the company has stated.

Prudential has stated in a letter last month to Schirripa that it thinks “life insurance companies with appropriate expertise, resources, and proven experience to appropriately design and manage the risks associated with CDAs should be allowed to deliver this attractive product to the market and thus make it available to consumers who are demanding such a solution.”

The subgroup intends to report the matter to the parent Life Insurance and Annuities Committee at the Spring National meeting in New Orleans.