Conference on Life Insurance Company Products Featuring Current SEC, FINRA, Insurance, Tax, and ERISA Regulatory and Compliance Issues

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1 171 THE AMERICAN LAW INSTITUTE Continuing Legal Education Conference on Life Insurance Company Products Featuring Current SEC, FINRA, Insurance, Tax, and ERISA Regulatory and Compliance Issues November 1-14, 014 Washington, D.C. New Generations of Deferred Income Annuities By Stephen E. Roth Thomas E. Bisset Sutherland Asbil & Brennan LLP Washington, D.C.

Compliance Issues November 1-14, 014 Washington, D.C. New Generations of Deferred Income Annuities By Stephen E.

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3 173 Introduction New Generations of Deferred Income Annuities Stephen E. Roth, Esq. Thomas E. Bisset, Esq. Sutherland Asbill & Brennan LLP ALI-CLE Conference on Life Insurance Company Products November 13-15, 014 As a result of the baby boomer generation s demand for financial products that provide a stable source of income for retirement in the face of increasing longevity risk 1 and increasing financial risk from the inability of both Social Security and employersponsored retirement plans to provide sufficient retirement income, in recent years insurance companies have begun to offer new generations of deferred income annuity products ( DIA ). DIAs offer important benefits from both a longevity protection and retirement planning perspective. For fixed DIAs, one benefit is that purchasers are informed at the time of sale of the amount of future annuity payments under the contract: the sponsoring insurer can quote the purchaser a specific annuity payment amount (which may be a monthly, quarterly, semiannual, or annual payment amount) that the purchaser would receive in the future based upon the amount of the initial premium, the payment option chosen by the purchaser, and the date upon which annuity payments would commence. A second benefit is that under fixed DIA contracts sponsoring insurers guarantee annuity payout rates that are favorable to purchasers relative to other retirement income products such as traditional deferred annuity products. The tradeoff for the guarantee of favorable annuity payout rates is that contract owners must cede more control of monies contributed under the contract to the sponsoring insurance company, are locked into the 1 LIMRA, The Real News on Life Expectancy and Retirement Planning (June 18, 013), irement_planning.aspx. 1

retirement in the face of increasing longevity risk 1 and increasing financial risk from the inability of both Social Security and employersponsored retirement plans to provide sufficient retirement

4 174 date on which annuity payments must commence (with some exceptions) and generally cannot change the amount of the annuity payment once payments begin. This outline examines the history of DIAs and summarizes the features common to the new generations of fixed DIA contracts currently being offered by insurers as well as the features of certain variable annuity contracts that employ comparable deferred income strategies. It then addresses certain regulatory issues potentially relevant to DIAs. It first discusses the eligibility of fixed DIAs for exemption from regulation under the federal securities laws, focusing particularly on the insurance exemption under Section 3(a)(8) of the Securities Act of 1933 (the 1933 Act ), as well as the safe harbors provided by Rule 151 of the 1933 Act and Section 989J of the Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly known as the Harkin Amendment. It then examines certain state insurance standards for fixed DIA contracts and the effect of those standards on DIA product design. Lastly, it summarizes regulations recently adopted by the Internal Revenue Service aimed at facilitating the ownership of fixed DIA contracts and other deferred annuity contracts offering longevity protection in connection with certain retirement plans. Background on DIAs The DIAs currently being offered in the market have evolved from pure longevity insurance, also known as advanced life deferred annuities, which were niche products primarily designed to provide income later in one s life to cover the financial risk associated with outliving one s life expectancy. 3 The product was typically purchased by persons in their 50s and 60s and had deferral periods of 0 to 40 years. 4 Because of the long deferral periods and mortality pooling, insurance companies offering longevity insurance were able to offer future income at very favorable rates. However, income from longevity insurance typically was not provided until the contract owner was well into retirement. During the deferral period, contract owners had no cash value from which they could access funds and longevity insurance typically did not provide a death benefit. As a result of the lack of liquidity associated with longevity insurance, sales of the product were underwhelming even though conceptually the product provided a meaningful safety net if the client outlived their assets and life expectancy. 5 See Deferred Income Annuities: Insuring Against Longevity Risk, a report by the Insured Retirement Institute dated August 7, 013 ( IRI Report ) at 7. 3 IRI Report at 6. 4 Id. The deferral period is the length of time between the date on which annuity contract is issued ( issue date ) and the date annuity payments would commence ( annuity commencement date ). 5 Id.

variable annuity contracts that employ comparable deferred income strategies. It then addresses certain regulatory issues potentially relevant to DIAs.

5 175 In 011, the New York Life Insurance Company ( New York Life ) launched the first of a new generation of fixed DIA contracts. The New York Life DIA contract offered a shorter deferral period than pure longevity insurance (5 15 years) and an optional death benefit. New York Life also positioned the contract as a personal pension for purchase at age 55 to 60 with retirement income payments beginning within ten years. 6 From negligible sales in 011, sales of DIAs reached $1 billion in 01 and $. billion in 013, 7 and industry observers are commenting that over the next few years DIAs may be the fastest growing annuity product on a percentage basis. 8 As of May 014, at least twelve insurance companies were offering one or more versions of their own DIA contract while a number of other companies appear to be in the process of either developing their own DIA contract or seeking state regulatory approval for a product that they have developed. 9 The recent increase in the number of insurers offering DIA contracts and growth in sales of DIAs can be attributed to the product s ability to satisfy the baby boomer generation s demand for both longevity protection and supplemental income in retirement. 10 With the new generations of fixed DIA contracts, we have begun to see some product variation as insurers develop products designed to provide greater liquidity and flexibility in changing the annuity commencement date. Two insurers have recently introduced variable annuity contracts with riders that allow for the allocation of contract value to the sponsoring insurer s general account during the deferral period in return for guaranteed deferred fixed annuity payments. In addition, three insurers have introduced variable annuity contracts with a single investment option and a non-optional guaranteed lifetime withdrawal benefit designed to guarantee an annual amount of income in retirement. 6 See Kerry Pechter, A Liquidity Option for DIAs?, Retirement Income Journal, Jan., See Kerry Pechter, The One True Path to Income, Retirement Income Journal, May 16, IRI Report at 5. 9 The following insurance companies currently offer one or more versions of their proprietary DIA contract: (1) American General Life Insurance Company; () CMFG Life Insurance Company; (3) First Investors Life Insurance Company; (4) The Guardian Insurance & Annuity Company, Inc.; (5) The Lincoln National Life Insurance Company; (6) Massachusetts Mutual Life Insurance Company; (7) MetLife Insurance Company of Connecticut ( MetLife ); (8) New York Life Insurance and Annuity Corporation; (9) The Northwestern Mutual Life Insurance Company; (10) American United Life Insurance Company; (11) Principal Life Insurance Company; and (1) Symetra Life Insurance Company. 10 See Tara Siegel Bernard, Buying a Guaranteed Retirement Income, for Some Peace of Mind, The New York Times, June 6, 014 ( Buying a Guaranteed Retirement Income ) at 1 (Noting that some persons purchase DIAs for longevity insurance while others do so for the guarantee of supplemental income in retirement). 3

New York Life also positioned the contract as a personal pension for purchase at age 55 to 60 with retirement income payments beginning within ten years.

ALI-ABA Course of Study Investment Management Regulation

215 ALI-ABA Course of Study Investment Management Regulation Sponsored with the cooperation of the Philip D. Reed Chair and the Center for Corporate, Securities and Financial Law, Fordham University School