RILA Re-Form: Statement on Registration for Index-Linked Annuities and Registered Market-Value Adjustment Annuities; Amendments to Form N-4 for Index-Linked Annuities, Registered Market-Value Adjustment Annuities, and Variable Annuities
July 3, 2024 by Commissioner Hester M. Peirce
In the last few years, the Commission’s staff has often had to complete rulemakings on tight deadlines. Even with aggressive time constraints, the staff succeeded admirably in meeting the congressional mandate to provide a tailored form to register the offerings of registered index-linked annuities (“RILAs”). [1] I support the Commission’s general approach to implementing the congressional mandate but would have preferred a more merits-neutral approach and a greater focus on facilitating the use of creative disclosure techniques to foster deeper investor understanding.
The congressional mandate that prompted this rulemaking appropriately spurred the Commission to rethink the registration forms used for RILAs. Allowing RILAs and registered MVA annuities to register on Form N-4 instead of on one of the S Forms will benefit non-variable annuity [2] investors and issuers. As commenters highlighted, the Regulation S-K disclosures were ill-suited for RILAs and costly to boot. The new N-4 regime provides a number of benefits. Unlike the S Forms, Form N-4 is designed to provide investors with particularized information concerning variable contracts. Filing on Form N-4 will allow insurance companies to file financial statements in accordance with statutory accounting principles when the insurance company does not otherwise prepare GAAP financial statements. Investors likely will have an easier time comparing non-variable products to other annuity products. Finally, allowing insurance companies to use a summary prospectus will simplify investor research. The new approach should help the many Americans that consider purchasing RILAs better understand the products. As with many other investments, RILAs can be complex and potentially have consequential downsides, [3] so investors need to have good, clear disclosures. Today’s amendments are a step in the right direction.
Tempering the rule’s positive aspects are the traces of anti-RILA bias. Our disclosure rules should be designed to elicit objective, realistic disclosure of a product’s potential benefits, risks, and costs. We want disclosures that neither give unduly short shrift to a product’s upsides, nor exaggerate its potential downsides. This rule, to turn an old classic on its head, accentuates the negative. [4] RILA issuers, for example, will have to disclose on the front cover page “the maximum potential loss that an investor could experience in connection with a negative contract adjustment.” [5] The Commission insists that the disclosure “is not intended to suggest the maximum loss is likely to occur,” [6] but, absent necessary context, the disclosure seems designed to dissuade investors from purchasing RILAs. As commenters rightly point out, no other securities offerings are burdened by the same disclosure. [7] The disparity is almost certainly going to confuse potential RILA investors and lead them to conclude that these products are riskier than they are. [8]
Investor confusion will also arise from the absence of realistic data points with respect to caps and buffers. The RILA prospectus will include a bar chart showing each index’s annual return, coupled with “a hypothetical example alongside each index return that reflects the return after applying a 5% cap and a -10% buffer.” [9] As commenters remarked, these hypothetical caps and buffers do not reflect industry practice. [10] As an alternative to these fixed hypothetical rates, one commenter quite naturally suggested that the bar charts should have “an overlay of actual rates.” [11] To do otherwise, as the commenter suggested, compels insurance companies to publish “misleading” information. [12] The Commission points weakly to an accompanying legend that will inform investors that hypotheticals do not reflect “an investor’s returns[, which] will differ from that of the index perhaps significantly.” [13]
Mischaracterizing a fundamental feature of RILAs as a fee will contribute to the confusion. RILA investors knowingly give up potentially higher returns for “some ability to customize a level of risk with which they are comfortable.” [14] That give-up is no more a fee than the downside buffer is a rebate. The Commission acknowledges that “contractual limits placed on an investor’s gains, such as a cap rate or participation rate, are not fees or charges in a conventional sense,” [15] yet requires insurance companies to include these caps under the rubric of “Ongoing Fees and Expenses.” By characterizing these caps as “implicit fees,” we have abandoned the plain language we demand of registrants. [16] Our regrettable homage to Humpty Dumpty in Alice in Wonderland [17] could confuse investors, thus making it more difficult for them to determine whether a RILA is the right product for their portfolio.
This rulemaking would be stronger if it included a formal transition period for rule 156, the interpretive rule that we have amended to include non-variable annuity sales literature. As the Commission acknowledges, “these amendments . . . could result in insurance companies reviewing their sales literature in light of the final amendments to rule 156 .” [18] Our rationale for disallowing a transition period with respect to the rule 156 amendments springs from longstanding investor protection concerns, [19] which I share, but those concerns will be addressed most thoroughly if issuers undertake careful reviews of their sales literature in light of the Commission’s newly applicable interpretation. I echo the Commission in encouraging insurance companies to contact us with any questions they may have regarding how to navigate rule 156. [20]
More generally, the Commission needs to stretch its ninety-year-old self and explore new ways for firms to communicate with investors. Our standard disclosure formula needs retooling. Because of their features, RILAs provided a unique opportunity to try new things, like decision trees and interactive technologies, and shed old ones, like requiring issuers to file ten copies of forms. [21] My hope is that the Commission will commit itself to working with the public to see how our disclosure regime can be improved to take advantage of approaches and technologies that will enhance investor engagement and understanding. Part of that work should be investor testing, such as the testing that preceded these amendments.
[1] See Final Release at 5 (“The amendments implement Congress’ directive to the Commission in Division AA, Title I of the Consolidated Appropriations Act, 2023 (‘RILA Act’) to adopt a new registration form for RILAs within 18 months of enactment. The RILA Act requires the Commission to design the form to ensure that a purchaser using the form receives the information necessary to make knowledgeable decisions, taking into account (1) the availability of information; (2) the knowledge and sophistication of that class of purchasers; (3) the complexity of the RILA; and (4) any other factor the Commission determines appropriate.”).
[2] A non-variable annuity is made up of RILAs and annuity contracts that offer fixed investment options and apply market value adjustments (“MVAs”).
[3] See, e.g., Final Release at n.16 and accompanying text (“Charges and penalties for early withdrawals are another prevalent feature of RILAs. Investors can lose significant money if they withdraw their money early from an investment option or from the contract. This can arise in several circumstances: (1) ‘surrender charges’ that apply when an investor withdraws money from the contract within a certain period following the investor’s last premium payment; (2) ‘interim value adjustments’ (or ‘IVAs’), which adjust the investor’s contract value if amounts are withdrawn (for instance, because of movements to a different investment option, movements out of the contract, or payment of certain benefits) from an index-linked option before the end of its crediting period….”).
[4] Mercer, J. (1944). Ac-Cent-Tchu-Ate the Positive [Lyrics]. Retrieved from https://genius.com/Johnny-mercer-ac-cent-tchu-ate-the-positive-lyrics .
[5] See, e.g., Final Release at 287 (“The final amendments also require certain other specific disclosures about contract adjustments, such as requiring disclosures about the maximum potential loss that an investor could experience in connection with a negative contract adjustment.”); at 45 (“Providing the maximum possible loss in these circumstances on the front cover page will alert investors to these risks in concrete terms.”).
[6] Final Release at 45.
[7] Comment Letter from VIP Working Group at 2 (Nov. 10, 2023) (“Disclosing the maximum loss on the cover page and elsewhere in the prospectus is inappropriate where no other securities offerings are required to do the same.”), VIP Working Group (sec.gov) . (“VIP”)
[8] Comment Letter from The Committee of Annuity Insurers at 14 (Nov. 28, 2023) (“Without appropriate context, stating maximum potential loss as a percentage (especially in a prominent manner) is confusing for investors and unfairly portrays RILAs as high-risk investments. For that reason, numerical maximum potential loss disclosure should not be presented in isolation or in disclosure sections that lack appropriate context (such as the cover page or the KIT).”), s71623-303439-781302.pdf (sec.gov) . (“CAI”)
[9] See Final Release at 109 (“We are also requiring, as proposed, the prospectus for contracts that offer index-linked options to include a bar chart for each index showing the index’s annual return for each of the last 10 calendar years (or for the life of the index, if less than 10 years), with the corresponding numeric performance adjacent to each bar. Specifically, insurance companies must provide a hypothetical example alongside each index return that reflects the return after applying a 5% cap and a -10% buffer.”). (Internal citations removed.)
[10] Comment Letter from Ova Datop at 1 (Oct. 25, 2023) (“ The SEC will require an illustration of a RILA with a 5% cap and a 10% buffer. Caps have never been near that low. At present, fixed annuities guarantee more than 5%. Today, RILA cap rates are hovering just over 20% ”), s71623-292039-711342.pdf (sec.gov) .
[11] VIP at 3 (“The historical index performance presentation is problematic. Historical index performance should not be overlaid with a made-up artificially low cap. This is misleading. The SEC should not compel misleading disclosure. Cap rates have never been that low. If you are going to require actual index performance, you should require actual buffer and cap rates.”). (Emphasis added.)
[12] Id.
[13] Final Release at 110 (“The performance below is NOT the performance of any Index-Linked Option. Your performance under the Contract will differ, perhaps significantly. The performance below may reflect a different return calculation, time period, and limit on Index gains and losses than the Index-Linked Options, and does not reflect Contract fees and charges, including surrender charges and the Contract Adjustment, which reduce performance.”). (Emphasis added.)
[14] Final Release at 270 (“RILAs limit or reduce downside risk, but also limit upside performance. In exchange for giving up the complete protection of principal offered by fixed annuities, a RILA investor is potentially afforded greater upside potential than that provided by fixed annuities, though typically less than the potential upside of investing in the same index within a variable annuity. RILAs allow investors some ability to customize a level of risk with which they are comfortable.”). (Internal citations removed.)
[15] Final Release at 74 (“While contractual limits placed on an investor’s gains, such as a cap rate or participation rate, are not fees or charges in a conventional sense, these limits can have the effect of reducing investment returns (e.g., where the index outperforms a cap or a participation rate is less than 100%). As a result, it is appropriate to characterize these contractual limits as ongoing implicit fees given they have the same impact on investors.”). (Emphasis added and internal citation removed).
[16] See generally Plain Writing Initiative (“As a disclosure agency, the SEC is committed to communicating with investors in easily understandable language.”), SEC.gov | Plain Writing Initiative .
[17] Lewis Carroll, Through the Looking Glass, Chapter Six (“When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean—neither more nor less.” “The question is,” said Alice, “whether you can make words mean so many different things.” “The question is,” said Humpty Dumpty, “Which is to be master—that’s all.”), https://www.alice-in-wonderland.net/resources/chapters-script/through-the-looking-glass/chapter-6/ .
[18] Final Release at 256-7.
[19] Final Release at 256 (“The rule is designed to protect investors by addressing practices that could lead to materially misleading sales literature in connection with the offer or sale of a security, and historically the Commission has not provided a transition period to comply with amendments to this rule in light of investor protection concerns associated with the dissemination of materially misleading sales literature.”).
[20] Final Release at 257 (“In considering these changes, insurance companies are encouraged to contact the Commission staff with any questions they may have about these issues.”).
[21] See, e.g., section 230.497(c) (“For investment companies filing on §§239.15A and 274.11A of this chapter (Form N-1A), §§239.17a and 274.11b of this chapter (Form N-3), §§239.17b and 274.11c of this chapter (Form N-4), or §§239.17c and 274.11d of this chapter (Form N-6), or an offering of registered non-variable annuities being filed on Form N-4, within five days after the effective date of a registration statement or the commencement of a public offering after the effective date of a registration statement, whichever occurs later, 10 copies of each form of prospectus and form of Statement of Additional Information used after the effective date in connection with such offering shall be filed with the Commission in the exact form in which it was used.”).
