‘Last In’ to be Out for Annuity Penalties in Oregon

The Oregon Insurance Division is developing rules to eliminate “Last In, First Out” calculations when assessing early withdrawal charges under the authority of a new law enacted this spring.

The law, House Bill 2467, calls for “Regulating Penalties, Fees and Other Charges Imposed for Early Withdrawal from Individual Deferred Annuities.”

The measure passed the state legislature last May and the governor signed it a few days later. Now the state insurance division is starting the rulemaking.

The language in the bill’s title — about “regulating penalties, fees and other charges” — sounds controversial, especially in view of the ongoing national debate about fees and charges in annuity products.

However, a division spokesperson says Oregon officials “do not anticipate this to be a controversial subject.”

Eliminate LIFO treatment

“We are focusing the rulemaking on eliminating the LIFO (last in, first out) approach to (calculating) surrender charges,” according to Jake Sunderland, public information officer in the state’s Department of Consumer and Business Services.

The division’s position is that the LIFO approach “is not in the best interest of consumers.” In addition, “it is not the standard approach in the industry,” he said in an e-mail.

In fact, the Interstate Insurance Product Regulation Commission (IIPRC) uses another method — the FIFO (first in, first out) calculation approach — as its standard for surrender charge calculations used in individual deferred annuities filed with the IIPRC, he said.

IIPRC has 44 member states representing over 70 percent of the premium volume nationwide for life and annuities.

“We are working closely with the IIPRC on this issue to align our rule to match their product standards on this issue,” Sunderland said.

The state has the support of the American Council of Life Insurers (ACLI), and of Standard Insurance, on this issue, he said.

Why now?

The issue had been on the division’s radar for some time, according to Sunderland. What happened is that “some companies” have been calculating their individual deferred annuity surrender charges using the LIFO type of calculation.

Since Oregon does not currently have rules addressing the practice, it has been legal to file such products in the state.

The division’s concern is that many seniors buy individual deferred annuities as part of their retirement planning. These buyers “tend to be less sophisticated in understanding the subtle nuisances and meaning of surrender charges and how they work,” according to the division.

The division says it does not, in principle, have an issue with surrender charges being used to discourage people from making early withdrawals from their deferred annuity contracts. However, Sunderland said regulators are concerned about the LIFO calculation on such withdrawals.

Here is the explanation the division provided to InsuranceNewsNet about the nature of that concern:

“Companies tend to calculate surrender charges on payments typically made within the past 10 years, although this can vary, by one of two methods:

• First-in, first-out (FIFO) – calculating whether surrender charges are due based on the original date the contract was issued
• Last-in, first-out (LIFO) – calculation based on the most recent premium payment

“The surrender charges can end up being significantly higher when applying the LIFO method.

“For example, a person who paid annual premiums for 20 years who then makes a withdrawal equal to five years of annuity value would have no surrender charges under the FIFO method, because the withdrawals would count against the payments made more than 10 years ago. But with the LIFO calculation, the person could be subjected to a surrender charge calculated on the five most recent years of premium payment.

“LIFO-calculated surrender charges may also penalize beneficiaries if a death occurs years after the annuity is purchased. The FIFO approach still allows companies to fairly deploy surrender charges and it gives the best consumer protection.”

Rulemaking starts Oct. 1

The actual rulemaking will begin on Oct.1 at an open division meeting in Salem. The new rules will apply to all individual deferred annuities filed in Oregon, according to officials.

The enabling legislation, House Bill 2467, casts a fairly wide net on issues to consider. Included are not only the expected requirements to review existing standards, regulations, etc. regarding withdrawals but also specifics.

The specifics include “whether the penalty, fee or charge the insurer imposes is appropriate for and suited to achieving the insurer’s purpose,” “whether the insurer could take actions other than imposing a penalty, fee or charge in order to achieve the purpose,” and “limitations on the amount of the insurer’s penalty, fee or charge.”

Sunderland said the division “will be transparent and open to all input as usual from all stakeholders during the rulemaking.”

InsuranceNewsNet Editor-at-Large Linda Koco, MBA, specializes in life insurance, annuities and income planning. Linda can be reached at [email protected].

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Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected].