By Arthur D. Postal
WASHINGTON – Issuers of variable annuities (VAs) are being forced to revisit the types of money market mutual funds they offer within their VAs. This is because of changes to Securities and Exchange Commission (SEC) rules that impose new requirements on money market mutual funds (MMFs).
In a note to clients, lawyers at Carlton Fields Jorden Burt, say VA issuers must consider what type of MMFs to make available in their VA offerings as a result of the SEC action.
And, if necessary, depending on the VA, “issuers are considering how to move various groups of existing owners out of one type of MMF and into another, for example, due to unavailability of retail MMFs to institutional investors, as well as how to avoid or implement gates and fees required” under the amendments, according to Chip Lunde, author of the Carlton Fields note.
The issue is important because industry officials say most VA products offer MMFs as investment options.
Lunde says he hasn’t heard whether any issuers are considering discontinuing the use of MMFs in VAs.
“One reason VA issuers are likely to keep MMFs in VAs is that MMFs are a convenient default option for certain transactions (e.g., during the free look period or in the event another fund liquidates and the contract owner doesn’t give reallocation instructions),” Lunde said.
The rules start going into effect in April 2016, when diversification, stress testing, disclosure, and certain form filings provisions go into effect for money market mutual funds. Other parts of the changes go into effect in October 2016, when MMFs which offer floating net asset values are affected. MMFs also will be required at that time to impose liquidity fees or redemption gates if the amount of “weekly liquid assets” that they hold falls below certain levels.
Lunde cautioned that the changes create several problems that are making it difficult for some insurance product funds to decide whether to offer institutional MMFs, retail MMFs, a government MMF or some combination of the three. And, the time periods allotted to transition to the new rules “do not seem overly accommodating,” Lunde said.
He said insurance product funds considering offering an institutional MMF may need to consider several factors. These include whether a floating net asset value (NAV) is compatible with the actuarial assumptions of issuers of insurance products for which the MMF serves as an investment option; and complications of administering any fees and gates at the insurance product level.
The final rules were published in July 2014 by the SEC through amendments to Rule 2a-7 under the Investment Company Act of 1940.
Under the rules, institutional prime MMFs will be required use an NAV; retail MMFs will be limited to beneficial owners who are “natural persons;” and government MMFs must invest at least 99.5 percent of their assets in cash, U.S. government securities and/or fully collateralized repurchase agreements.
The amendments were supported by the mutual fund industry as somewhat of a Hobson’s choice. That is because the Financial Stability Oversight Council (FSOC) was taking a hard look at money market mutual funds in the wake of the 2008-2009 financial crisis, when the federal government was forced to advance money to bail out troubled MMFs. In particular, the federal government was hurt because of its heavy investment in Lehman Bros. commercial paper when that company was allowed to go under in September 2008.
The fallout from the government’s decision to allow Lehman to fail ultimately led the Treasury and Federal Reserve to use other means to prop up financial institutions facing insolvency when the price of all securities started to collapse in a sort of domino effect in the last half of 2008.
The SEC moved to strengthen its oversight of MMFs in 2014 in a compromise supported by asset managers, who wanted to avoid being designated as systemically important financial institutions (SIFI) by the FSOC at all costs — an issue which has still not been completely resolved. If designated as (SIFI), asset managers operating MMFs would have been subject to oversight by the Federal Reserve Board as well as their current regulator, primarily the SEC.
According to Lunde, some insurance product funds have considered offering an ultra-short bond fund as an MMF alternative. “However, using an ultra-short bond fund may also involve unique considerations,” Lunde said.
The issues insurers may need to consider before using an ultra-short bond fund include investor and insurance product issuer perception of risk; possible unavailability of the fund for free-look period investments and investment of proceeds from unaffiliated fund liquidations; tax issues (e.g., the absence of any exemption from the “wash” sale rule), and transition issues (including possible loss of prior performance history), he said.
InsuranceNewsNet Washington Bureau Chief Arthur D. Postal has covered regulatory and legislative issues for more than 30 years. He can be reached at [email protected].
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