Industry pushes back on linking ‘financial strength’ to annuity illustrations

State insurance regulators are currently debating multiple options to restrict how annuity products are marketed to consumers. However, an intriguing clause within the drafting language drew attention from industry.

The Life Insurance and Annuities Illustrations Working Group is tinkering with Model Regulation #245, which governs annuity illustrations, although it has only been adopted by about 10 states. The working group exposed a wide-ranging document for public comment last month. Tucked far down the “List of Potential Modifications” was this option:

Disclose financial strength of company as a differentiating factor between carriers.

The American Council of Life Insurers urged the working group to abandon the language.

“It would not be in keeping with the focus of this effort as there is not a direct connection between financial strength and product illustrations,” wrote ACLI executives Carrie Haughawout, senior vice president, life insurance and regulatory policy, and James Szostek, vice president and deputy, retirement security.

“There are multiple metrics of financial strength that are not uniform; to be meaningful, any effort here would require a significant, lengthy, and complex disclosure. Incorporating such information into illustrations would add complexity without improving consumer understanding of the product.”

Regulators began looking harder at annuity illustrations this year after learning that some products were illustrating as high as 27%.

The National Association of Insurance Commissioners’ working group plans to address illustration length, disclosures, accountability and illustrated crediting rates before considering whether an interim actuarial guideline or other temporary measure is needed.

‘Important aspect’

The financial strength proposal came from the Life Insurance Consumer Advocacy Center. Richard M. Weber, a 59-year veteran of the life insurance industry and treasurer of LICAC, said the group considers a carrier’s financial rating an “important aspect of the decision to purchase an annuity.”

Insurance companies don’t have backstops such as the Federal Deposit Insurance Corp., Weber noted.

“While I wouldn’t be concerned about the difference between an Aaa and an Aa rating from Moody’s, I would want to know about any lower financial rating,” Weber explained. “Once I decide to purchase an annuity as part of my overall financial planning, I want to be confident in the insurance company's ability to redeem the annuity's value in the future.”

The working group is in the middle of four planned meetings to review the comments received on the lengthy list of proposals. The next conference call is scheduled for Sept. 1.

Among other comment letters, the New York Department of Financial Services proposed capping the return a carrier may assume on the derivatives that fund an index credit at 1.1 times what the carrier earns on its own general account holdings.

The NY proposal would apply to any illustration beyond one year, the department wrote.

“So, if the company is earning 5% on its fixed income assets they could assume 5.5% is earned on their derivatives.”

Backtested performance limits proposed

The Indexed Annuity Leadership Council proposed limits on the impact of back-tested index performance while allowing insurers to continue using newer index strategies in sales materials.

The IALC letter said its proposal is designed to balance consumer protection with continued product innovation by placing new restrictions on the use of hypothetical historical returns in fixed indexed annuity illustrations.

Regulators are especially concerned that some illustrations relying on back-tested index data may create unrealistic expectations for consumers.

Under the IALC proposal, insurers would still be permitted to illustrate newer indices that lack long operating histories. However, all back-tested performance would be subject to a cap based on the index's realized volatility.

Specifically, annual back-tested returns would be limited to 150% of an index's realized volatility, rounded to the nearest one-quarter of a percentage point.

The group said the approach would "materially lower" illustrated returns for indices using back-tested data while allowing consumers to see the benefits of diversification across different index strategies.

According to the proposal, using realized volatility as the basis for the cap would allow the limitation to adjust automatically to the characteristics of each index, rather than favoring one type of index design over another.

The proposal also would change how insurers present performance scenarios in indexed annuity illustrations.

Current requirements call for illustrations that include the lowest historical period of index performance. The IALC instead proposes requiring insurers to show the contract's guaranteed minimum values over the "Scenario Period," defined as the longer of five years or the surrender charge period, alongside the most recent performance scenario and the high-performance scenario.

"This is intended to prevent consumers from getting the impression that the lowest historical period of performance from an index would be the 'worst case scenario' for the contract values they could see in the product," wrote Jim Poolman, executive director of the IALC.

Instead, illustrating the product's guaranteed minimum values would provide consumers with a clearer understanding of the minimum benefits available under the contract, according to the proposal.

The IALC said the changes would establish stronger guardrails around the use of back-tested data while preserving insurers' ability to develop new index strategies and product designs. Regulators are expected to consider the proposal as part of their broader review of annuity illustration standards.

Working group chairman Ben Slutsker, director of life actuarial valuation at the Minnesota Department of Commerce, set a goal to develop technical proposals after the NAIC Summer National Meeting, which wrapped up last week in Columbus, Ohio.

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InsuranceNewsNet Senior Editor John Hilton has covered business and other beats in more than 20 years of daily journalism. John may be reached at [email protected]. Follow him on Twitter @INNJohnH.