SEC Commissioner Uyeda Issues Remarks at American Law Institute Continuing Legal Education 2023 Conference

WASHINGTON, Nov. 3 -- The Securities and Exchange Commission issued the following remarks on Nov. 2, 2023, by Commissioner Mark T. Uyeda at the American Law Institute Continuing Legal Education 2023 Conference on life insurance company products:

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Forty-one years is an amazing streak and demonstrates a deep commitment to continuing legal education. Congratulations to Steve on his 25th year as co-chair, and I understand that this is Richard [Choi's] 17th year. Congratulations to each of you for longstanding efforts.

After serving a couple of years as counsel to SEC Commissioner Paul Atkins, I joined the Division of Investment Management ("IM") in 2008 as part of its Office of Disclosure Regulation and Insurance Products, led by then-associate director Susan Nash. Although I was the assistant director in the disclosure rulemaking part of that office, I hopefully picked up a thought or two from the insurance products side, which was overseen by assistant director Bill Kotapish.

Eventually, there was a re-organization of the Division, and I later moved back to the Commission's executive staff and then served on detail to other governmental entities, including the Senate Committee on Banking, Housing, and Urban Affairs. Some recent rulemaking efforts, however, have caused me to return full circle, so to speak, to the insurance products world. My role now at the SEC as a Commissioner, though, is quite different then it was as part of the staff.

Today, I will discuss the SEC's recent proposals on registered index-linked annuities and predictive data analytics. Before turning to those proposals, though, I want to spend a few minutes discussing the role of variable insurance products and their regulation. My remarks reflect my individual views as a Commissioner at the SEC and do not necessarily reflect the views of the full Commission or my fellow Commissioners.

I. Variable Insurance Products: Role and Regulation

Variable insurance products can help individuals fulfill financial security, retirement, and other goals. In particular, these products combine the potential for long-term investment appreciation with insurance guarantees. They also offer deferred tax treatment of the underlying investments and any re-allocations among them. For example, variable life insurance products can help contract owners with their estate planning and other needs. They provide contract owners with the potential to grow the contract's cash value beyond what is offered by traditional life insurance, although they are also subject to investment risk. In this regard, contract owners may allocate their premiums to a variety of investment options or to a fixed account option, if available. Contract owners may also have the ability take loans against the policy or otherwise make withdrawals, and many contracts offer numerous riders in addition to a death benefit, such as long-term care, disability, or income benefits.

Variable annuity products provide investors with the potential to grow their investment through allocating their purchase payments to a variety of investment options, and to receive a stream of guaranteed payments indefinitely or for a specific time period. Like variable life insurance contracts, variable annuities provide contract owners with death benefits, and may also offer other benefits, such as long-term care insurance, guaranteed withdrawal benefits, and others.

While FINRA and the SEC regulate broker-dealer sales practices in recommending variable insurance products to their customers, many regulators outside of the securities realm also have touchpoints. For example, the states regulate insurance companies and license those that sell insurance, including variable insurance, to consumers. The U.S. Department of Labor generally regulates employee benefit plans, plan fiduciaries, and plans' service providers as "parties in interest" under the Employee Retirement Income Security Act (ERISA). The Internal Revenue Code regulates the tax treatment of variable insurance products.

With respect to SEC regulation of variable insurance products, the securities laws were not enacted with these products in mind and the result has been, at times, a "square peg in a round hole." The SEC and its staff have undertaken efforts over the years to make our regulations a better fit. The SEC's rulemakings and other regulatory efforts greatly benefit from insight from the insurance industry and investors regarding these products, thus I encourage continued engagement with the Commission and its staff.

Notably, in 2021, the SEC issued a statement to permit an insurance company to substitute a fund supporting its SEC-registered variable product without seeking an exemptive order, provided that terms and conditions of the substituted fund would be substantially similar to the fund for which the insurer obtained an order.[1] The SEC based its statement on its experience in administering substitution orders over a forty-year period. This type of initiative will lower costs for investors and market participants while preserving - and even enhancing - investor protection.

Another area where the SEC significantly impacts variable insurance products is through disclosure. The SEC designed Form N-4 to provide investors with information about purchasing a variable annuity contract, while Form N-6 was designed to provide investors with information about purchasing a variable life insurance contract. These forms permit separate accounts that are unit investment trusts to register under the Investment Company Act of 1940 and for their securities to be registered under the Securities Act of 1933 ("Securities Act").

These forms were recently amended to permit variable life and annuity contracts to use initial and updating summary prospectuses, instead of the full statutory prospectus.[2] The summary prospectuses were designed to streamline and simplify key disclosures to provide investors with a better understanding of the contracts' features, fees, and risks, while making more comprehensive information available on the Internet. This "layered" approach to disclosure was first introduced with the mutual fund summary prospectus in January 2009.[3] It was a privilege to lead the IM team that worked on that rule's adoption. There was some concern as to whether investors, particularly older investors, would be receptive to the layered approach. As the 15th anniversary of the fund summary prospectus approaches, I am pleased that those concerns did not materialize.

II. RILAs

Speaking of disclosure, the SEC recently proposed that registered index-linked annuities register their offerings on Form N-4.[4] Registered index-linked annuities, or RILAs, were introduced about ten years ago. In 2022, there were an estimated $41.1 billion in RILA sales, which was a significant increase from $7.3 billion in 2016.[5] A RILA is a type of annuity contract that has features similar to both variable and fixed annuities. For instance, a RILA is a tax-deferred investment that protects principal and provides a guaranteed income stream. RILAs also allow contract owners to participate in the performance of the securities markets. However, RILAs have some unique features. They generally link their performance to an index such as the S&P 500, or an ETF that tracks an index. While RILAs offer some downside protection through a buffer, which can limit losses up to a certain amount of the referenced index's negative returns, they also limit the upside potential through a cap on positive returns. A RILA's buffer and cap generally reset over a particular time period, such as twelve months.

Currently, RILAs register their offerings on Forms S-1 or S-3. These general forms are often used to register securities where no other specific form is applicable. These forms have requirements on executive compensation, management's discussion and analysis, and the use of generally accepted accounting principles (GAAP) in the preparation of financial statements, all of which are not typically required of variable annuities. In particular, variable annuity disclosures generally focus on the contracts' features, benefits, and risks, and do not include detailed disclosure about the registrant.

In 2022, Congress passed the bipartisan RILA Act, which required the SEC to prepare and finalize rules within eighteen months to enable RILAs to register on a form that would ensure that a purchaser using the form receives the information necessary to make knowledgeable decisions.[6] The Act also required the Commission to engage in investor testing.

In September, the SEC proposed rules and form amendments that would require RILAs to register on Form N-4 and would apply rule 156 under the Securities Act to RILA sales literature, among other proposed amendments.[7] Form N-4 is currently used by variable annuities to register their offerings. Registering RILAs on Form N-4 could provide certain benefits. For insurance companies, these benefits include potential efficiencies in filing on a familiar form. In addition, Form N-4 permits insurance companies to file financial statements prepared in accordance with statutory accounting principles, rather than GAAP, under certain circumstances. The rulemaking would also provide registrants with the ability to use a summary prospectus to satisfy their delivery obligations under the federal securities laws. For investors, these benefits could include the ability to compare among various RILAs and compare index-linked options and variable options as offered by a particular insurance company.

As part of the rulemaking, the Commission proposed to amend several form items to facilitate disclosure particular to RILAs. For example, proposed amendments to the cover page are intended to alert investors to a RILA's complexities and risks. The SEC also proposed specific disclosures about index-linked options, including how interest is calculated, credited, and any limits on losses or gains. RILA issuers would also be required to provide examples of common crediting methods and to include a numeric example to illustrate the mechanics of the index crediting methodology. With respect to buffers and caps, RILA issuers would include a bar chart for each index of the index-linked options showing annual return for the last 10 calendar years (or for the life of the index, if less than 10 years) and a hypothetical example that applies a 5% cap and a -10% buffer to each return. The bar chart is similar to that required in mutual fund prospectuses and is designed to show investors the effects of caps and buffers over historical periods.

Certain aspects of proposal would affect the key information table, or "KIT." The KIT was added to Form N-4 as part of the Commission's variable summary prospectus rulemaking in 2020 and is unique to insurance product prospectuses. It is intended to provide investors with the key features of the contract - such as fees and expenses, risks, restrictions, taxes, and conflicts of interest - while also including cross-references to more detailed disclosures about those topics in the summary and statutory prospectuses. The KIT disclosure must be presented in a particular order without any modifications or substitutions to the title, headings and sub-headings, unless otherwise provided. This standardized presentation helps investors more easily compare contracts, among other benefits.

The Commission's proposed amendments to the KIT - which would apply to RILAs and to variable annuities - result from the staff's experience in administering the new summary prospectus and the Congressionally-mandated RILA investor testing, which revealed investors' challenges with understanding RILAs and variable annuities generally. Specifically, if adopted, the KIT would be re-framed in a question-and-answer format, and the KIT would move to appear after - rather than before - the Overview of the Contract section. The Overview of the Contract section would also include detailed descriptions and examples to better prepare investors with basic information before reviewing the KIT.

The RILA Act required the SEC to conduct investor testing with the goal of ensuring that key information is conveyed in terms that are easy for a purchaser to understand. Under this mandate, the Office of the Investor Advocate conducted qualitative and quantitative testing.[8] The qualitative testing largely focused on a hypothetical KIT, which found that participants were generally confused about jargon, such as "index," "buffer," and "interim value adjustment," and had trouble understanding the underlying concepts. The quantitative testing consisted of over 2,500 surveys of participants' comprehension of RILA features and of the KIT. For the KIT, the surveys included the KIT in a Q&A format and as statements. The surveys indicated that while these participants also difficulty in understanding jargon, they exhibited higher levels of comprehension when the concepts were presented in plain English.

The Commission should work in my view to incorporate more investor testing into its disclosure-based rulemakings, even if not mandated by Congress, since disclosure fails if information is not understood by investors. This often means that disclosure should be tailored, succinct, and layered so that investors can seek more information should they need it. SEC initiatives such as the summary fund prospectus, variable annuity and variable life summary prospectuses, and streamlined shareholder reports are examples of good, retail investor-oriented rulemakings on which the Commission should focus.

Finally, the SEC proposed to amend rule 156 under the Securities Act to apply its guidance to RILA sales literature. Rule 156 is an interpretative rule that provides guidance about what factors should be weighed in whether a material fact in investment company sales literature could be materially misleading. Rule 156 currently applies to variable annuity sales literature, and the Commission noted its views on how rule 156's guidance might apply to RILA sales literature. For example, RILA sales literature that emphasized a RILA's buffer to protect against downside losses would need to discuss the costs and limitations of such protection.

I encourage you to comment on this rulemaking. For example, did the Commission capture the key disclosures to help investors make informed investment decisions in an efficient way? Is the mix of information correct, or is there too much disclosure or too little? Are the changes to the KIT for the better or the worse? Does filing on Form N-4 provide insurance companies with efficiencies, as the Commission believed, or should there be a new, separate form for RILAs?

The Commission's prior efforts on the variable products' summary prospectuses were greatly informed by public comments, which led to a much-improved final rulemaking. I deeply appreciate the time and care it takes to provide thoughtful comments, particularly in light of the Commission's ambitious rulemaking agenda that touches nearly every aspect of our financial markets.

III. Predictive Data Analytics

Another Commission proposal issued this past July addresses conflicts of interest associated with the use of predictive data analytics by investment advisers and broker-dealers.[9] The Commission proposed sweeping rules that would cover a broad range of technology used by investment advisers and broker-dealers. These proposed rules generally provide that when an investment adviser or a broker-dealer uses "covered technology" in an investor interaction, it must (i) identify conflicts of interests when using this technology in interactions with investors, and (ii) adopt policies and procedures that eliminate or neutralize, rather than disclose or mitigate, those conflicts of interests.

The proposed definition and application of "covered technology" is extremely broad. Under the proposal, covered technology includes not just artificial intelligence, but also any other analytical, technological, or computational function, algorithm, model, correlation matrix, or similar method or process that optimizes for, predicts, guides, forecasts, or directs investment-related behaviors, in investor interactions. For example, this rulemaking has the potential to curtail a financial professional's recommendations of variable insurance products, such as when the professional might use technology, such as a computer, in understanding and recommending an insurance product to investors. Even common financial modeling and analytical tools that can help financial professionals provide more informed advice to investors would be swept into the rulemaking. Simply showing how saving more money each month could affect retirement outcomes would likely count as "covered technology" that "guides" an investor under the proposal.

The proposal's broad sweep could mean that firms would spend inordinate amounts of resources to identify all covered technologies, evaluate and test those technologies to determine whether any potential conflict of interest exists, and then eliminate or neutralize these potential conflicts of interest. This process would be required with respect to the most basic of technologies, such as a spreadsheet. All of these efforts would be required to be documented, maintained, and preserved under the applicable recordkeeping rules.

As a responsible regulator, the first step should be looking at ways to better understand these technologies, their benefits, and risks. There should not be a rush to impose regulations that might stifle innovation and may also take away current technologies used by investors for their benefit. I am also concerned about the SEC's recent track record of issuing far-reaching proposals only to significantly change them at final adoption.[10] While it is tempting to breathe a sigh of relief in that the adopted rules may be less onerous, it is concerning that the original proposals were so "off the mark" on a particular policy issue. Recent SEC proposals seem more akin to a brainstorming exercise, replete with hundreds of questions for the public. Coupled with the speed at which the proposals are issued, it is worrisome as to whether the public can provide meaningful and high-quality comments to assist the Commission in its analysis.

The comments that have already been submitted, including by market participants and investors with knowledge of variable insurance products, are greatly appreciated. As variable insurance products often do not neatly fit into in the securities regulatory framework, it is helpful to hear how proposals will affect investors and those who develop these products. Although the comment period has passed for the predictive analytics proposal, please feel free to add additional thoughts - the SEC's general practice has been to consider all comments submitted, including those after the due date has passed. I look forward to considering all of them as part of any final decision-making process.

Thank you again for the opportunity to speak to you this morning and your efforts to serve investors.

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Footnotes:

[1] Commission Statement on Insurance Product Fund Substitutions, Investment Company Act Release No. 34199 (Feb. 23, 2021) [86 FR 11813 (Feb. 26, 2021)], available at https://www.sec.gov/files/rules/policy/2021/ic-34199.pdf.

[2] Updated Disclosure Requirements and Summary Prospectus for Variable Annuity and Variable Life Insurance Contracts, Securities Act Release No. 10765 (Mar. 11, 2020), [85 FR 25964 (May 1, 2020)], available at https://www.sec.gov/files/rules/final/2020/33-10765.pdf.

[3] Enhanced Disclosure and New Prospectus Delivery Option for Registered Open-End Management Investment Companies, Securities Act Release No. 8998 (Jan. 13, 2009) [74 FR 4545 (Jan. 26, 2009)], available at https://www.federalregister.gov/documents/2009/01/26/E9-1035/enhanced-disclosure-and-new-prospectus-delivery-option-for-registered-open-end-management-investment.

[4] Registration for Index-Linked Annuities; Amendments to Form N-4 for Index-Linked and Variable Annuities, Securities Act Release No. 11250 (Sept. 29, 2023) [88 FR 71088 (Oct. 13, 2023)], available at https://www.sec.gov/files/rules/proposed/2023/33-11250.pdf ("RILA Proposal").

[5] Id. at FR 71147.

[6] The RILA Act was included as part of the Consolidated Appropriations Act of 2023. See Pub. L. 117-328; 136 Stat. 4459 (Dec. 29, 2022) (Division AA, Title I).

[7] RILA Proposal, supra note 4.

[8] Investor Testing Report on Registered Index-Linked Annuities, Office of the Investor Advocate, Securities and Exchange Commission (Sept. 2023), available at https://www.sec.gov/files/rila-report-092023.pdf.

[9] Conflicts of Interest Associated with the Use of Predictive Data Analytics by Broker-Dealers and Investment Advisers, Exchange Act Release No. 97790 (July 26, 2023) [88 FR 53960 (Aug. 9, 2023)], available at https://www.sec.gov/files/rules/proposed/2023/34-97990.pdf. Both Commissioner Peirce and I dissented from the proposal. See Hester M. Peirce, Through the Looking Glass: Conflicts of Interest Associated with the Use of Predictive Data Analytics by Investment Advisers and Broker-Dealers Proposal (July 26, 2023), available at https://www.sec.gov/news/statement/peirce-statement-predictive-data-analytics-072623 and Mark T. Uyeda, Statement on the Proposals re: Conflicts of Interest Associated with the Use of Predictive Data Analytics by Investment Advisers and Broker-Dealers (July 26, 2023), available at https://www.sec.gov/news/statement/uyeda-statement-predictive-data-analytics-072623.

[10] See, e.g., Investment Company Names, Securities Act Release No. 11067 (May 25, 2023) [88 FR 70436 (Oct. 11, 2023)], available at https://www.sec.gov/files/final/2023/33-11238.pdf; Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews, Advisers Act Release No. 6383 (Aug. 23, 2023) [88 FR 63206 (Sept. 14, 2023)], available at https://www.sec.gov/files/rules/final/2023/ia-6383.pdf and Money Market Fund Reforms, Securities Act Release No. 11211 (July 12, 2023) [88 FR 51404 (Aug. 3, 2023)], available at https://www.sec.gov/files/rules/final/2023/33-11211.pdf.

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Original text here: https://www.sec.gov/news/speech/uyeda-remarks-cle-2023-conference-110223