ALI-ABA Course of Study Investment Management Regulation

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1 215 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 of Law November 30 - December 1, 2006 New York, New York Current Variable Insurance Product Trends and Issues By Stephen E. Roth Pamela K. Ellis and Patrice M. Pitts Sutherland Asbill & Brennan LLP Washington, D.C.

2 216 2

3 217 TABLE OF CONTENTS I. Introduction... 1 II. Variable Annuity Guaranteed Living Benefits... 2 A. Living Benefits During the Accumulation Period Guaranteed Minimum Withdrawal Benefits (or GMWBs ) Guaranteed Minimum Income Benefit ( GMIB ) Guaranteed Minimum Accumulation Benefits ( GMABs ) Hybrid Accumulation and Annuity Period Earnings Enhancement Benefit...6 B. Hedging and Other Risk Management Techniques Associated with Living Benefits Asset Allocation Models Limiting Investment Options Mandatory Reallocation at Insurer s Discretion Other Techniques...8 C. Living Benefits During the Annuity Period Guaranteed Minimum Annuity Payout Stabilized Annuity Payout Commutation of Annuity Payouts Withdrawals of Annuity Value Trends Regarding Living Benefits During the Annuity Period...11 D. Disclosure, Regulatory, and Compliance Issues Raised By Living Benefits Disclosure Considerations Raised by Living Benefits Regulatory Issues Raised by Living Benefits Sales Practice Compliance Issues Raised by Living Benefits III. Other Variable Insurance Product Trends A. Distributors Imposing Variable Annuity Fee Guidelines On Manufacturers B. Immediate Variable Annuities IV. Proposed NASD Rule A. Background B. Applicability of Proposed Rule, as Amended C. Summary of the Proposed Rule, as Amended Recommendation Requirements Principal Review and Approval Supervisory Procedures Training...21 D. Effective Date E. Status of Proposed New Rule, as Amended Strong Industry Opposition NASD Expects SEC Approval of Rule...22

4 218 Sutherland Asbill & Brennan LLP V. Rule 22c-2 Issues and Impact on Variable Insurance Products and Underlying Funds 24 A. Overview Adoption of Rule Proposed Amendments Rule Amendments...26 B. Provisions of the Rule Redemption Fee Board Determination Shareholder Transaction Information and Restrictions C. Operation of the Amended Rule in the Context of Variable Contracts Variable Annuity Contract Provisions Transfer Requests Deference to Intermediary s Frequent Trading Policies Narrowed Definition of Financial Intermediary Shareholder Information Agreements Intermediary Chains Consequences of No Agreement No Mandatory Uniform Redemption Fee Standards Limits on Frequency of Information Requests D. Status of Rule Implementation VI. Recent Tax Developments That Directly or Indirectly Affect Underlying Funds A. Qualified Plans Investments in Variable Product Funds B. Investor Control Private Letter Ruling for Underlying Mutual Funds VII. Conclusion ii -

5 219 CURRENT VARIABLE INSURANCE PRODUCT TRENDS AND ISSUES Stephen E. Roth Pamela K. Ellis Patrice M. Pitts Sutherland Asbill & Brennan LLP Washington, DC I. INTRODUCTION Life insurance companies first began offering variable insurance products over 45 years ago. Variable annuity contracts were first offered in 1952 by the College Retirement Equities Fund. Life insurers began offering them in the late 1950s. Variable life insurance policies were first offered in the U.S. in the early 1970s. These early products were relatively simple in concept in that they utilized existing designs for fixed annuities or life insurance, but instead of crediting interest to premiums received, the premiums were invested in insurers separate accounts, which in turn invested in equities. Thus, designs originally conceived for fixed insurance products were transformed into variable products, with all the attendant investment risk borne by contract owners. Only the pure insurance elements of the contracts generally were guaranteed the amount of the death benefit and the rates at which annuity payments could be purchased on the maturity date. Variable insurance products have since become more complicated - and more sophisticated. The basic designs now can be enhanced by a number of options offered by the insurer that provide more guarantees or insurance features. For both variable life insurance and annuity products, a clear trend is to offer these enhancements and features as unbundled contracts (that is, contracts that allow the owner to elect from a menu of different benefit options those benefits he would like). More specifically, in response to several recent economic factors i.e., low interest rates and volatility in the equity markets as well as the pending retirement of the baby boom generation (who are willing to pay for a degree of retirement security while also participating in some market gains) -- insurers have developed variable annuity products and features to protect investors from intermediate and long-term investment risks. These product innovations, known as living benefits, offer guarantees during the accumulation and/or annuity periods. This outline summarizes current guaranteed living benefit features available under variable annuity products, and briefly identifies the disclosure, regulatory and compliance issues raised by those benefits. In addition, the outline addresses other variable insurance product trends, including trends related to the lowering of variable annuities fees in certain distributions channels and immediate variable annuities. Lastly, the outline

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