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Structured product annuities pose challenges for regulators

Jul 9, 2014 @ 4:30 pm

By Darla Mercado

annuities, fixed annuities, variable annuities, structured products, regulators, morningstar
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Structured product annuities are the latest retirement product but they are so new that regulators are struggling to figure out the best way to classify them.

These contracts, dubbed hybrid or buffered annuities, use structured products to absorb downside losses in client accounts and provide modest and steady account value growth that's linked to the performance of an index. It's a different world from the high accumulation potential in a traditional variable annuity.

(More: Check out this tutorial on structured product annuities)

So far, four companies offer structured product annuities: AXA Equitable Life Insurance Co., Allianz Life Insurance Co. of North America, CUNA Mutual Group and MetLife Inc.

Voya Financial, formerly ING U.S., is also getting into the game, judging by a May 30 filing with the Securities and Exchange Commission.

Voya's new product is tentatively called the PotentialPlus Annuity. It has an eight-year surrender schedule, and it can buffer 10%, 20% or 30% of downside losses. PotentialPlus appears to offer a choice between four not-yet-specified indexes, plus a death benefit equal to the accumulation value in the contract.

What's interesting about these products is that while they're generating plenty of interest from brokers, they're still in a gray area as far as how regulators view them: are they fixed annuities or variable annuities?

Where these products land matters from a state insurance regulator's point of view.

“What reserves should apply to these products?” asked Jim Mumford, first deputy insurance commissioner in Iowa. He was a panelist at the Insured Retirement Institute's Government, Legislative and Regulatory conference in Washington last week.

For instance, reserve requirements tend to be lower on variable annuities than on fixed annuities, Mr. Mumford noted.

There's also the matter of the standard non-forfeiture rule, which requires that carriers have a minimum interest rate guarantee that they can credit to a fixed annuity contract. The minimum permitted in a state is determined by the insurance regulator in that jurisdiction, but it's generally no greater than 3%. These rules apply to deferred fixed annuities but not variable annuities. Structured product annuities don't offer minimum guaranteed rates the way deferred fixed annuities do.

Regulators at the National Association of Insurance Commissioners have found the issue perplexing enough that it created a Separate Account Risk Working Group, chaired by Minnesota insurance regulator and actuary Blaine Shepard, to determine whether there need to be updates to state insurance laws to accommodate these structured product annuities and where they stand with respect to reserving and nonforfeiture laws.

To make things more interesting from a product intel point of view, the latest round of structured product annuities have presented annuity researchers with new difficulties when harvesting flow data.

For instance, Morningstar Inc. can track variable annuity products as long as they have a legal subaccount that's filed with the Securities and Exchange Commission, according to John McCarthy, product manager, annuity solutions at the firm.

But not all structured product annuities have subaccounts, which makes it difficult for Morningstar to follow them. The annuity research team is discussing how to best cover these new annuities, Mr. McCarthy said.

Indeed, the major distinction for Morningstar is that true variable products use separate accounts, have investments that mimic open-ended mutual funds and the client can lose money.

“The differentiator [between structured product annuities and whether they're truly fixed or variable] is how safe is your principal: Voya and AXA lean toward a variable product, where the principal isn't guaranteed,” Mr. McCarthy said. “But if the principal is guaranteed, that would lean more toward [fixed].”

This story has been changed to say that the minimum interest rate guarantee tied to the non-forfeiture rule is no greater than 3%. A previous version stated that it was generally about 3%.

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