Regulators Approve Guideline for Index-Linked Variable Annuities

What You Need to Know

The National Association of Insurance Commissioners met in Louisville, Kentucky, last week.
One possible effect of the meeting: You might start calling a popular type of annuity product by a new name.
NAIC members put off making decisions about some of the more controversial topics related to indexed life and annuity products.

Members of the National Association of Insurance Commissioners have approved two measures that could change how agents and advisors talk about indexed life and annuity products.

NAIC members voted Saturday, at an in-person meeting in Louisville, Kentucky, to approve new rules for registered index-linked annuities (RILAs), or variable annuities with credit rates tied to the performance of one or more investment indexes, an NAIC representative said Tuesday.

The NAIC also approved model rule changes for the “illustrations,” or materials, that agents, advisors and insurers use to show clients how indexed universal life insurance (IUL) policies might perform.

In states that adopt the new NAIC measures as-is, new RILA rules could take effect for contracts issued on or after July 1, 2024.

The IUL policy illustration rules update could apply to policies sold on or after May 1, 2023.

What It Means

Products that offer a combination of returns linked to investment indexes and value guarantees get clients’ attention, and they’re also starting to get more attention from regulators.

The NAIC

The U.S. federal government leaves regulation of the business of insurance to the states.

The NAIC is a Kansas City, Missouri-based group for insurance regulators in states and other state-like jurisdictions, such as the District of Columbia.

The NAIC cannot normally set insurance rules directly, but many states have arranged for certain types of NAIC rule changes to take effect automatically. In other cases, states implement NAIC models, model changes or other measures by adopting regulations or passing legislation.

RILA Background

A RILA contract is a relatively new type of annuity with a crediting rate linked partly or wholly to the performance of one or more investment indexes.

Unlike a non-variable indexed annuity, which is registered only with state insurance departments and not with the U.S. Securities and Exchange Commission, a RILA contract is registered with the SEC as a variable insurance product and a security.

Because the RILA contract is registered as a security, the issuer must meet many extra securities-related requirements. Agents who sell RILA contracts must pass securities sales representative exams.

But because the RILA contract is registered with the SEC, the issuer can choose whether to provide any account value guarantees, or how much value to protect if it does offer guarantees.

Issuers of traditional variable annuities tie the crediting rates for those to the performance of baskets of stocks, bonds or other investments. An issuer can update the value of the baskets, or separate accounts, every day.

RILA issuers use investment index “derivatives,” or contracts with other big financial services organizations, to power their contracts. The issuers typically base the contract performance on how the price of an index, or collection of indexes, changes between one date and another date.

State insurance regulators began to develop the newly approved RILA measure, Actuarial Guide LIV: Nonforfeiture Requirements for Index-Linked Variable Annuity Products, in 2021, because of a concern that insurers had no standard approach for valuing a RILA contract when a client cashed the contract out before the end of the term described in the contract.

The RILA Actuarial Guidelines

The new Actuarial Guideline IV could standardize the language that financial annuity professionals use to talk about RILA contracts — and it could change the RILA product’s name.

The new guideline includes a short RILA glossary. The glossary defines terms such as “index” and “hypothetical portfolio.”

An Open RILA (or ILVA) Question

The regulators who developed the new guideline held off on adding specific requirements for how an issuer should compute the contract value when a client cashes out early.

“In place of specific market-value adjustment requirements, a drafting note was added that granted more flexibility to the states to be able to approve products that are consistent with the principles laid out in the actuarial guideline,” according to a project history included in an NAIC meeting packet.

“In particular, the first principle of the actuarial guideline states that the interim values must provide equity between the contract holder and the insurance company,” regulators added.

The IUL Policy Illustration Change

An indexed universal life policy is designed in such a way that the premium contribution schedule is flexible, and growth in the policy death benefit depends partly or wholly on the performance of one or more investment indexes.

Because an IUL policy is a non-variable product, registered only with state insurance regulators and not with the SEC, it cannot expose the holder to the risk of investment-market-related loss of death benefit value.

The NAIC began developing an update to an existing set of rules — Actuarial Guideline XLIX-A: The Application of the Life Illustrations Model Regulation to Policies with Index-Based Interest Sold — because of a concern that performance illustrations for some IUL policies with complicated features, such as benefits growth multipliers, look better than they should.

Actuarial Guideline XLIX-A already includes two rules designed to make IUL illustrations look realistic.

The measure that the NAIC members approved Saturday will add a third reality-check rule. The third rule will connect the crediting rate included in an IUL illustration with what the issuer is spending on the derivatives used to power the IUL policy benefits growth rate.

Regulators note in an IUL illustration rule update project update history that some drafters wanted the NAIC to revamp the life insurance policy illustration rules in Actuarial Guideline 49.

The NAIC’s Life Actuarial Task Force “decided to move forward with a phased approach that would address the immediate issues by revising AG 49-A, while continuing to consider larger changes to life insurance illustration regulations,” according to the project history.