Proposed Rule2023-21986
Registration for Index-Linked Annuities; Amendments to Form N-4 for Index-Linked and Variable Annuities
Primary source
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Published
October 13, 2023
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("Commission") is proposing rule and form amendments to provide a tailored form to register the offerings of registered index-linked annuities ("RILAs"). Specifically, the Commission is proposing to amend the form currently used by most variable annuity separate accounts, Form N- 4, to require issuers of RILAs to register offerings on that form as well. To facilitate this amendment, the Commission is also proposing to amend certain filing rules and make other related amendments. These changes would, if adopted, implement the requirements relating to RILAs contained in Division AA, Title I of the Consolidated Appropriations Act, 2023. Further, the Commission is proposing other amendments to Form N-4 that would apply to all issuers that would use that form under the proposal. The Commission is also proposing to apply to RILA advertisements and sales literature a current Commission rule that provides guidance as to when sales literature is materially misleading under the Federal securities laws. The Commission is proposing a technical amendment to Form N-6 to correct an error from a prior Commission rulemaking. Finally, the Commission requests comment as to whether to require the registration of market-value adjustments associated with certain annuities on Form N-4 as well.
Full Text
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<title>Federal Register, Volume 88 Issue 197 (Friday, October 13, 2023)</title>
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[Federal Register Volume 88, Number 197 (Friday, October 13, 2023)]
[Proposed Rules]
[Pages 71088-71259]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-21986]
[[Page 71087]]
Vol. 88
Friday,
No. 197
October 13, 2023
Part II
Securities and Exchange Commission
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17 CFR Parts 230, 232, 239, and 274
Registration for Index-Linked Annuities; Amendments to Form N-4 for
Index-Linked and Variable Annuities; Proposed Rule
Federal Register / Vol. 88, No. 197 / Friday, October 13, 2023 /
Proposed Rules
[[Page 71088]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 230, 232, 239, and 274
[Release No. 33-11250; 34-98624; IC-35028; File No. S7-16-23]
RIN 3235-AN30
Registration for Index-Linked Annuities; Amendments to Form N-4
for Index-Linked and Variable Annuities
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
proposing rule and form amendments to provide a tailored form to
register the offerings of registered index-linked annuities
(``RILAs''). Specifically, the Commission is proposing to amend the
form currently used by most variable annuity separate accounts, Form N-
4, to require issuers of RILAs to register offerings on that form as
well. To facilitate this amendment, the Commission is also proposing to
amend certain filing rules and make other related amendments. These
changes would, if adopted, implement the requirements relating to RILAs
contained in Division AA, Title I of the Consolidated Appropriations
Act, 2023. Further, the Commission is proposing other amendments to
Form N-4 that would apply to all issuers that would use that form under
the proposal. The Commission is also proposing to apply to RILA
advertisements and sales literature a current Commission rule that
provides guidance as to when sales literature is materially misleading
under the Federal securities laws. The Commission is proposing a
technical amendment to Form N-6 to correct an error from a prior
Commission rulemaking. Finally, the Commission requests comment as to
whether to require the registration of market-value adjustments
associated with certain annuities on Form N-4 as well.
DATES: Comments should be submitted on or before November 28, 2023.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="https://www.sec.gov/rules/2023/09/rila">https://www.sec.gov/rules/2023/09/rila</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#3e4c4b525b135d5153535b504a4d7e4d5b5d10595148"><span class="__cf_email__" data-cfemail="cfbdbaa3aae2aca0a2a2aaa1bbbc8fbcaaace1a8a0b9">[email protected]</span></a>. Please include
File Number S7-16-23 on the subject line.
Paper Comments
<bullet> Send paper comments to Secretary, Securities and Exchange
Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number S7-16-23. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method of submission. The Commission will post all
comments on the Commission's website (<a href="https://www.sec.gov/rules/2023/09/rila">https://www.sec.gov/rules/2023/09/rila</a>). Comments are also available for website viewing and printing
in the Commission's Public Reference Room, 100 F Street NE, Washington,
DC 20549, on official business days between the hours of 10 a.m. and 3
p.m. Operating conditions may limit access to the Commission's public
reference room. Do not include personal identifiable information in
submissions; you should submit only information that you wish to make
available publicly. We may redact in part or withhold entirely from
publication submitted material that is obscene or subject to copyright
protection. Retail investors seeking to comment on their experiences
with annuities generally and RILAs in particular may want to submit a
short Feedback Flyer, available at Appendix D.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at <a href="http://www.sec.gov">www.sec.gov</a> to receive notifications by email.
A summary of the proposal of not more than 100 words is posted on
the Commission's website (<a href="https://www.sec.gov/rules/2023/09/rila">https://www.sec.gov/rules/2023/09/rila</a>).
FOR FURTHER INFORMATION CONTACT: Christian Corkery, Michael Khalil,
Rachael Hoffman, James Maclean, Amy Miller, or Laura Harper Powell,
Senior Counsels; Bradley Gude, Branch Chief; Amanda Hollander Wagner,
Senior Special Counsel; or Brian McLaughlin Johnson, Assistant
Director, Investment Company Regulation Office, at (202) 551-6792;
Elisabeth Bentzinger or Min Oh, Senior Counsels; Michael Kosoff, Senior
Special Counsel, Disclosure Review and Accounting Office, at (202) 551-
6921, Division of Investment Management, Securities and Exchange
Commission, 100 F Street NE, Washington, DC 20549-8549.
SUPPLEMENTARY INFORMATION: The Commission is proposing amendments to
the following rules and forms:
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\1\ 15 U.S.C. 77a et seq.
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Commission reference CFR citation (17 CFR)
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Securities Act of 1933 (``Securities Act''): \1\
Rule 156.............................................. Sec. 230.156
Rule 172.............................................. Sec. 230.172
Rule 405.............................................. Sec. 230.405
Rule 415.............................................. Sec. 230.415
Rule 424.............................................. Sec. 230.424
Rule 456.............................................. Sec. 230.456
Rule 457.............................................. Sec. 230.457
Rule 485.............................................. Sec. 230.485
Rule 497.............................................. Sec. 230.497
Rule 498A............................................. Sec. 230.498A
Regulation S-T:
Rule 313 of Regulation S-T............................ Sec. 232.313
Rule 405 of Regulation S-T............................ Sec. 232.405
Forms:
Form N-4.............................................. Sec. 239.17b and 274.11c
Form N-6.............................................. Sec. 239.17c and 274.11d
[[Page 71089]]
Form 24F-2............................................ Sec. 239.66 and Sec. 274.24
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Table of Contents
I. Introduction and Background
A. Typical RILA Features
B. Current Registration Process
C. Evidence of Investor Views and Areas of Potential Confusion
D. Overview of Proposal
II. Discussion
A. Use of Form N-4
B. Contents of Form N-4
1. Front and Back Cover Pages (Item 1)
2. Key Information Table (Item 3)
3. Principal Disclosure Regarding RILAs (Items 2, 6, and 17)
4. Principal Risks of Investing in the Contract (Item 5)
5. Addition of Contract Adjustments and Other Amendments to Fee
and Expense Disclosures (Items 4, 7, and 22)
6. Information About Contracts With Index-Linked Options (Item
31A)
7. Other Amendments and Provisions
8. Remaining Form N-4 Items
9. Inline XBRL
C. Option To Use a Summary Prospectus
D. Accounting (Items 16 and 26)
E. Filing and Prospectus Delivery Rules
1. Fee Payment Method and Amendments to Form 24F-2
2. Post-Effective Amendments and Prospectus Supplements
3. Prospectus Delivery
F. Materially Misleading Statements in RILA Sales Literature
G. Existing Commission Letters
H. Registered Market-Value Adjustment Annuities
I. Technical Amendment to Form N-6
J. Compliance Period
K. General Request for Comment From Retail Investors
III. Economic Analysis
A. Introduction
B. Baseline
1. Affected Parties
2. Current Regulatory Requirements
3. Market Practice
C. Benefits and Costs
1. Benefits
2. Costs
D. Effects on Efficiency, Competition, and Capital Formation
E. Reasonable Alternatives
1. Creating an Entirely New Registration Form for RILAs
2. Alternatives to Specific Form N-4 Amendments
3. Require the Use of Form N-4 for Registered MVAs
4. Limiting Scope of Structured Data Requirements
F. Request for Comment
IV. Paperwork Reduction Act
A. Rule 498A
B. Form N-4
C. Form 24F-2
D. Investment Company Interactive Data
E. Request for Comment
V. Regulatory Flexibility Certification
VI. Consideration of Impact on the Economy
Statutory Authority
I. Introduction and Background
An annuity contract (``annuity'' or ``contract'') is a type of
insurance product in which an investor makes a lump-sum payment or a
series of payments in return for future payments from the insurance
company to meet retirement and other long-term financial goals. A RILA
is one of several types of annuity contracts offered by insurance
companies. An investor in a RILA allocates purchase payments to one or
more investment options under which the investor's returns (both gains
and losses) are based at least in part on the performance of an index
or other benchmark (collectively, ``indexes''), over a set period of
time (``crediting period'').\2\ In some cases, insurance companies
offer RILAs on a standalone basis with various index-linked investment
options (``index-linked options'') for investors to choose from. In
other cases, insurance companies offer ``combination'' annuity
contracts that provide index-linked options together with other
investment options, such as mutual funds (``portfolio companies'')
offered as investment options under a variable annuity (``variable
options'').\3\ An investor purchasing a combination contract, for
example, may have the ability to allocate purchase payments under the
contract to index-linked options; variable options that pass on the
returns of mutual funds selected by the investor; and/or fixed account
options for which the insurance company promises to pay a fixed and
stated minimum rate of interest. The market for RILAs has grown
significantly in recent years, with annual RILA sales of $41.1 billion
in 2022 alone, more than tripling since 2017.\4\ We understand that
RILAs are predominantly sold by broker-dealers, although investment
advisers may also provide advice on RILAs, and insurance companies also
may offer RILAs directly.
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\2\ Insurance companies frequently refer to crediting periods as
``investment terms'' or sometimes simply ``terms.'' See, e.g.,
Investor Testing Report on Registered Index Linked Annuities, Office
of Investor Advocate Division (``OIAD Report'') at Section 2, RILAs:
Structure of Contracts and Investment Options, Investment Terms. As
noted in OIAD's report, investor testing suggested that investors
consistently struggled with this terminology, and a number of
participants seemed to equate ``investment term'' or ``term'' with
the length of the insurance contract rather than the length of the
investment product options within the RILA contract, leading them to
misunderstand the operation of the RILA. Id. at Section 5,
Qualitative Testing, Results from Round 1. In an effort to mitigate
that confusion, we have opted to use the term crediting period in
this release and in the proposed amendments to Form N-4. The most
common crediting periods are one, three, and six years. See id. at
Section 3, Overview of the RILA Market and Simulated Performance
over Historical Periods, RILA Indexes, Investment Terms, and
Insurance Features, Figure 2.
\3\ Variable annuity contracts and variable life insurance
contracts (together, ``variable contracts'') combine both investment
and insurance features. Investors generally allocate their purchase
payments to a range of investment options, typically mutual funds
which are separately registered and have their own prospectuses. The
investor's account value changes depending on the performance of the
investment options selected. Variable annuities allow investors to
receive periodic payments for either a definite period (e.g., 20
years), or for an indefinite period (e.g., the life of the
investor). See Updated Disclosure Requirements and Summary
Prospectus for Variable Annuity and Variable Life Insurance
Contracts, Investment Company Act Release No. 33814 (Mar. 11, 2020)
[85 FR 25964 (May 1, 2020)] (``VASP Adopting Release'') at nn.4-5
and n.8 and accompanying text.
\4\ See LIMRA, ``LIMRA: Record Annuity Sales in 2022 Expected to
Continue Into First Quarter 2023,'' news release, Mar. 8, 2023
(reporting 2022 RILA sales of $41.1 billion), <a href="https://www.limra.com/en/newsroom/news-releases/2023/limra-record-annuity-sales-in-2022-expected-to-continue-into-first-quarter-2023/">https://www.limra.com/en/newsroom/news-releases/2023/limra-record-annuity-sales-in-2022-expected-to-continue-into-first-quarter-2023/</a> and LIMRA, ``LIMRA
Secure Retirement Institute: Total Annuity Sales Continued to
Decline in 2017,'' news release, Feb. 21, 2018 (reporting 2017 sales
of structured annuity products, i.e., RILAs, of $9.2 billion),
<a href="https://www.limra.com/en/newsroom/news-releases/2018/limra-secure-retirement-institute-total-annuity-sales-continued-to-decline-in-2017/">https://www.limra.com/en/newsroom/news-releases/2018/limra-secure-retirement-institute-total-annuity-sales-continued-to-decline-in-2017/</a>.
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RILAs are securities for purposes of the Securities Act of 1933
(``Securities Act'').\5\ Unlike variable annuity contracts for which
the Commission has adopted a specific registration form tailored to
those products, insurance companies currently register offerings of
RILAs on Securities Act registration
[[Page 71090]]
Forms S-1 or S-3.\6\ In 2022, Congress enacted Division AA, Title I of
the Consolidated Appropriations Act, 2023 (``RILA Act''), directing the
Commission to adopt a new registration form for RILAs within 18 months
of enactment.\7\ The RILA Act requires the Commission to design the
form to ensure that a purchaser using the form receives the information
necessary to make knowledgeable decisions, taking into account (1) the
availability of information; (2) the knowledge and sophistication of
that class of purchasers; (3) the complexity of the RILA; and (4) any
other factor the Commission determines appropriate. The RILA Act also
requires the Commission to engage in investor testing as part of its
rulemaking process and to incorporate the results of the testing in the
design of the form, with the goal of ensuring that key information is
conveyed in terms that a purchaser is able to understand. If the
Commission fails to adopt the form within 18 months of enactment, the
RILA Act provides that RILA issuers can begin registering RILA
offerings on existing Form N-4.
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\5\ Depending on the context, ``RILA'' is also used in this
release to collectively refer to both stand-alone RILAs and the
index-linked options available in a combination contract. When
referring to the entity registering the RILA, we use the term ``RILA
issuer'' or ``insurance company.'' Index annuities that meet the
requirements of section 989J of the Dodd-Frank Wall Street Reform
and Consumer Protection Act (Pub. L. 111-203) or section 3(a)(8) of
the Securities Act are treated as exempt securities for purposes of
the Securities Act, but RILAs do not fall within this exemption due,
in large part, to the shifting of a significant level of investment
risk from the RILA issuer to the investor. RILAs and index-linked
option, as used in this release, refer only to those index annuities
that are securities for the purposes of the Securities Act. See,
e.g., sections 101(a)(5) and (6) of Division AA, Title I of the
Consolidated Appropriations Act, 2023.
\6\ The registration forms for variable annuity contracts are
Form N-3 (for variable annuity separate accounts structured as
management companies) and Form N-4 (for variable annuity separate
accounts structured as unit investment trusts). The separate account
established by the sponsoring insurance company is the legal entity
that registers its securities. Separate accounts are typically
registered as investment companies under the Investment Company Act.
See section 2(a)(37) of the Investment Company Act. The Commission
first adopted the registration form for variable annuities over 30
years ago. See Registration Forms for Insurance Company Separate
Accounts that Offer Variable Annuity Contracts, Investment Company
Act Release No. 14575 (June 14, 1985) [50 FR 26145] (June 25,
1985)]. In this release, we focus only on Form N-4, and not Form N-
3, because Form N-4 is the registration form identified in the RILA
Act and the form used to register the majority of variable annuity
contracts.
\7\ Public Law 117-328; 136 Stat. 4459 (Dec. 29, 2022).
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We are proposing to amend Form N-4 to require RILA issuers to
register RILA offerings, including associated features of the RILA such
as any contract adjustments, on that form and to tailor the form's
requirements accordingly.\8\ We also are proposing to amend other rules
related to the securities offering process to allow these issuers to
conduct RILA offerings in the same way issuers conduct offerings of
variable annuities. Consistent with the RILA Act, these proposed
amendments collectively are designed to provide investors disclosures
tailored to RILAs and highlight key information about these complex
products, building on the Commission's layered disclosure framework in
place for variable annuities. We are also proposing certain amendments
to Form N-4 that would apply to offerings of variable annuities, based
on our experience with the form since its last amendment and the
investor testing conducted in connection with this rulemaking.\9\ In
addition, we are proposing to apply a current Commission rule that
provides guidance as to when sales literature is materially misleading
under the Federal securities laws to RILA advertisements and sales
literature. Finally, we are proposing a technical amendment to Form N-6
to correct an error from a prior Commission rulemaking.
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\8\ Under this proposal, the amended Form N-4 will not register
the RILA issuers themselves, only the offering of RILA securities.
Unlike separate accounts which register variable annuities, RILA
issuers are not investment companies, and thus need not register
with the Commission as an investment company as separate accounts
do.
\9\ See VASP Adopting Release.
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A. Typical RILA Features
RILAs are complex financial products that are sold to retail
investors. The following are some of the most prevalent features that
contribute to this complexity, and that might make it challenging for
an investor to assess the features, risks, and possible return profile
of a RILA. These features also are important ones for financial
professionals to consider when recommending that an investor purchase a
RILA.
<bullet> Bounded Return Structure. Under a RILA, the insurance
company will credit positive or negative ``interest'' to the investor's
contract value at the end of each crediting period. The amount credited
is based, in part, on the performance of the specified index (e.g., the
S&P 500).\10\ The amount of any positive interest credited will also
depend on whether the contract includes provisions such as a ``cap
rate'' or ``participation rate.'' A cap rate places an upper limit on
an investor's ability to participate in the index's upside performance
directly (e.g., with a current cap rate of 5%, if the index is up 10%
at the end of the crediting period, the investor's contract value will
be credited with only 5% positive interest). A ``participation rate''
sets an investor's return to some specified percentage of the index's
return (e.g., an 80% participation rate would result in an investor
receiving positive interest of 80 cents on the dollar of gains in the
index). The contract generally will include one of these limits on how
much the insurance company will credit the investor if the performance
of the index goes up in value by the end of the crediting period
(collectively ``limits on gains''). Similarly, the contract generally
will include terms limiting the investor's losses to some extent if the
performance of the index goes down in value. This might include a
``buffer'' (which limits the investor's exposure to losses up to a
fixed percentage), or a ``floor'' (which places a lower limit on the
investor's exposure to loss) (collectively ``limits on losses''). For
example, with a ``buffer'' of -5%, if the index is down 2%, that
investor will not lose anything, but if the index is down 7% the
investor will lose 2% (the difference between the loss and the buffer
rate). With a ``floor'' of -5%, if the index is down 2%, the investor
will lose 2%, but if the index is down 7%, the investor will only lose
5%. These limits can be complex and overlapping, and may change at the
beginning of each new crediting period, subject to certain minimum
guarantees stated in the contract. Over time, the investor's contract
value will increase or decrease, depending on the performance of the
index and the particular contract provisions (such as the bounded
return structure). Despite the bounded return structure, a RILA is not
necessarily a low-risk investment product as the investor could lose a
significant amount of money if the index performs poorly.
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\10\ Insurance companies typically choose indexes for the RILA
contract where any gains in the value of the index do not include
dividends paid on the securities that make up the index.
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<bullet> Fees and Expenses. For many RILAs, the investor pays no
direct or explicit ongoing fees and expenses under the RILA, and this
is sometimes a feature disclosed in RILA marketing materials. However,
the RILA's bounded return structure requires investors to agree to
tradeoffs that come with their own economic costs. In exchange for some
protection against losses if the index goes down in value, investors
must also agree to contractual provisions limiting the amount of gains
they will receive if the index goes up in value. A RILA's upside limits
on gains can reduce an investor's return in the same way that a direct
fee can and can help make the RILA more profitable to the insurance
company.
<bullet> Charges and Penalties for Early Withdrawals. Investors
also can lose significant money if they withdraw their money early from
an investment option or from the contract. This can arise in several
circumstances. First, a RILA typically will specify a period of time
during which a ``surrender charge'' will apply, for example nine years
following an investor's last premium payment. Typically, this charge is
greatest in the first year of the surrender period, decreasing each
year until the end of the surrender period. An investor who
[[Page 71091]]
withdraws money during this period will pay a fee, such as 9% of the
amount withdrawn. Second, an insurance company may make an adjustment,
either to the investor's contract value or to the amount paid to the
investor, if amounts are withdrawn from an index-linked option before
the end of its crediting period or from the contract before the end of
a specified period. For example, when an investor in a RILA chooses a
particular index-linked option, the RILA may provide that the index-
linked option's crediting period is one year. If amounts are removed
from that index-linked option before the end of this one-year crediting
period, typically for any reason, the insurance company will apply an
``interim value adjustment'' or ``IVA.'' The IVA will adjust the
contract value based, generally, on a complex formula where the IVA may
change daily and can be positive or negative.\11\ As a result, the
investor could lose a significant amount of money, even if the index
has a gain at the time of the withdrawal.
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\11\ Common methods of calculating this adjustment include
prorating the crediting method based on the number of days that have
elapsed since the start of the crediting period, employing a market-
based formula designed to approximate the present value of the index
and/or employing interest-rate-based MVAs to offset certain insurer
losses and costs, or some combination of these two. See Clifford E.
Kirsch, Variable Annuities and Other Insurance Investment Products
(Third Edition 2022) at 29-8, available at <a href="https://plus.pli.edu/Details/Details?start=0&rows=50&fq=%7e2B%7etitle_id%7e3A282B22%7e240085%7e2229%7e&fq=%7e2B%7eid%7e3A282B22%7e240085-CH29%7e2229%7e&sort=s_date+desc&origin=title">https://plus.pli.edu/Details/Details?start=0&rows=50&fq=%7e2B%7etitle_id%7e3A282B22%7e240085%7e2229%7e&fq=%7e2B%7eid%7e3A282B22%7e240085-CH29%7e2229%7e&sort=s_date+desc&origin=title</a>.
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Similarly, the insurance company might apply a positive or negative
``market value adjustment'' or ``MVA'' (collectively with IVAs, a
``contract adjustment'') to the contract value if the investor
partially or fully withdraws amounts from the contract. Contract
adjustments could be made in response to a number of contract
transactions, such as a surrender, withdrawal, payment of the death
benefit, or the start of annuity payments, and an investor could
experience a negative contract adjustment even when the investor takes
an otherwise permissible withdrawal, such as under a guaranteed living
benefit.\12\ These adjustments can also negatively impact other values
under the contract, such as the surrender value and death benefit.
Moreover, these fees and adjustments are not always mutually exclusive.
Indeed, under the terms of certain RILA contracts, an investor could
experience a decrease in contract value from a negative interim value
adjustment and a negative market value adjustment, depending on the
timing of the withdrawal, and also pay a surrender charge. An investor
may also be subject to income taxes and face a Federal income tax
penalty if the investor withdraws money before a certain age.\13\
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\12\ Id. at 29-13. Under these benefits, RILA investors are
permitted to take a certain amount of guaranteed withdrawals from
their contract each year without reducing the value of guaranteed
withdrawals for future years. These can be a standard feature or an
optional rider chosen by an investor. Id. at 29-12.
\13\ See Updated Investor Bulletin: Indexed Annuities, SEC's
Office of Investor Education and Advocacy, July 31, 2020, <a href="https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_indexedannuities">https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_indexedannuities</a>.
Staff reports and other staff documents (including those cited
herein) represent the views of Commission staff and are not a rule,
regulation, or statement of the Commission. The Commission has
neither approved nor disapproved the content of these documents and,
like all staff statements, they have no legal force or effect, do
not alter or amend applicable law, and create no new or additional
obligations for any person.
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<bullet> Changes by Insurer. Crediting periods for an index-linked
option in a RILA contract generally range from one to six years. The
insurance company may change or remove key features of index-linked
options, such as the cap rates, floors, or even change the index. These
changes may often be made at the insurance company's discretion and
renewal provisions can and do change over time. Also, RILA contracts
typically state that an investor will be automatically renewed at the
end of a crediting period into the same or substantially similar index-
linked option, often with a new limit on gains. If the same index-
linked option is unavailable, the terms of the contract generally
provide that the insurance company may place the investor into a more
conservative investment option as a default, such as a fixed account or
an index-linked option with a 0% floor.
<bullet> Taxes. Special tax rules generally apply to RILAs and
other annuities, with both tax advantages and potential adverse tax
impacts in certain circumstances. For example, assets within a RILA
generally grow tax-deferred. As discussed above, however, investors may
face a Federal income tax penalty if money is withdrawn before the
investor reaches a certain age.\14\
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\14\ For these and other reasons, insurance companies generally
advertise RILAs as a long-term investment. This is similar to the
treatment of variable annuities. See VASP Adopting Release at n.14
and accompanying text.
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Providing investors with key information is particularly important
in the context of RILAs, since their features are typically complex and
their risks may not be apparent or easily understood by prospective
investors absent clear disclosure. Form N-4's existing disclosure
requirements regarding features of annuities would complement the
proposed RILA-specific disclosures, such that the amended Form N-4
would provide investors with key information both about the annuity
contract and the associated registered index-linked or variable
investment options.
B. Current Registration Process
The current requirements for issuers offering RILAs and variable
annuities differ in many respects, both in terms of the disclosure
issuers must provide, and with respect to the registration process. We
highlight here some of these key differences.
On required disclosure, because the Commission currently does not
have a specific registration form for RILAs, insurance companies
register the offerings of RILAs on Forms S-1 or S-3.\15\ Although
specific disclosure requirements apply for certain securities such as
capital stock or debt, the forms' disclosure requirements are not
specifically tailored to particular kinds of securities given the wide
range of securities offerings that can be registered on the forms.\16\
Forms S-1 and S-3 thus do not include specific line-item requirements
addressing disclosures about RILAs and their complex features, such as
how limits on gains operate or the application of contract adjustments.
These forms also require issuers to disclose information about the
offering itself as well as extensive information about the registrant
issuing the securities that may be less material to a RILA investor
than information about the contract's features. Required information
about the registrant includes, for example, management's discussion and
analysis of financial condition and results of operations (``MD&A''),
which requires a narrative discussion of the registrant's financial
statements, and disclosure about executive compensation. Domestic
registrants also must include financial statements prepared in
accordance with U.S. generally accepted accounting principles
(``GAAP'').\17\
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\15\ See, e.g., General Instruction I of Form S-1 (``This Form
shall be used for the registration under the Securities Act of 1933
(`Securities Act'); of securities of all registrants for which no
other form is authorized or prescribed'').
\16\ See Item 9 of Forms S-1 and S-3 and 17 CFR 229.202
(providing specific disclosure requirements for certain securities
such as capital stock, debt, warrants or rights, and directing
issuers of other types of securities to include a brief description
that is comparable to that required for the specified kinds of
securities).
\17\ See 17 CFR 210.4-01(a)(1) (stating that financial
statements filed with the Commission which are not prepared in
accordance with GAAP will be presumed to be misleading or inaccurate
unless the Commission has otherwise provided). See also infra
footnote 20.
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[[Page 71092]]
Most variable annuities, in contrast, are registered on Form N-
4.\18\ This form is designed for variable annuities and has disclosure
requirements tailored to these investments. Providing investors with
key information in a reader-friendly format is particularly important
in the context of variable annuity contracts because their structure is
complex. Accordingly, Form N-4's disclosure requirements are designed
to provide investors with key information relating to a variable
contract's provisions, benefits, and risks in a concise and reader-
friendly presentation, along with targeted information about the
insurance company and the offering. Form N-4's disclosure requirements
thus focus more on the specific features of variable annuities than on
the issuing insurance company. This presentation is designed to
highlight the most important information for an investor in a variable
annuity, so that the only matters included in the prospectus are those
for which there is a substantial likelihood that a reasonable investor
would consider them important in deciding whether to invest.\19\ This
focus on the provisions of the variable contract itself, rather than
certain details about the operation of the insurance company, reflects
that a variable annuity contract is not a direct investment in the
capital stock or debt of the insurance company, but rather a contract
with the insurance company under which the investor's exposure to the
insurance company generally is limited to the company's ability to
honor any guarantees associated with the contract. In addition, rule
498A together with Form N-4 implements a layered disclosure approach
for variable annuities by permitting insurance companies and others to
use a summary prospectus framework for variable annuities while making
the more-detailed statutory prospectus, as well as the contract's
statement of additional information (``SAI''), available online. Form
N-4 also provides a limited exception for insurance companies to file
financial statements prepared in accordance with statutory accounting
principles (``SAP''), referred to as ``statutory requirements'' in the
form instructions, rather than GAAP. Specifically, insurance companies,
which act as the depositors of variable annuity separate accounts
registered on Form N-4, may use SAP financials solely when the
insurance company does not otherwise prepare GAAP financial statements
or GAAP financial information for use by a parent in the parent's
Securities Exchange Act of 1934 (``Exchange Act'') reports or the
parent's registration statements filed under the Securities Act.\20\
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\18\ According to Form N-CEN filings received through March 23,
2023, there were 419 variable annuity separate accounts registered
as unit investment trusts (``UITs'') in 2022.
\19\ The Commission has long sought to tailor disclosures for
annuity products. See Registration Forms for Insurance Company
Separate Accounts, Investment Company Act Release No. 13689 (Dec.
23, 1983) [49 FR 614 (Jan. 5, 1984)] (``Form[] N-4 would permit
shorter and simpler prospectuses than are required under current
practice, . . . by incorporating many of the reduced disclosure
requirements of Form N-1A. Separate account disclosure requirements
that experience has shown are unnecessary also would be eliminated,
as well as certain disclosure requirements that are holdovers from
the requirements applicable to non-separate account unit investment
trust.''); Registration Form Used By Open-End Management Investment
Companies, Investment Company Act Release No. 12927 (Dec. 27, 1982)
[48 FR 813 (Jan. 7, 1983)] (``In order to shorten and simplify the
prospectus for mutual funds, the Commission has concluded that it is
necessary to eliminate certain types of information from the
prospectus, so that only matters of fundamental importance to most
mutual fund investors will be included in the prospectus'').
\20\ See, e.g., Instruction 1 to Item 31(b) in Form N-3 and
Instruction 1 to Item 26(b) in Form N-4. In addition, although Form
S-1 requires GAAP financial statements, exemptions have been granted
pursuant to 17 CFR 210.3-13 that permit insurance companies to
substitute SAP financials in lieu of GAAP financials when
registering RILAs on Form S-1 in circumstances permitted by Form N-
4. See, e.g., Letter from Jenson Wayne, Chief Accountant, Division
of Investment Management, to Stephen E. Roth, Eversheds Sutherland
(US) LLP, regarding Fidelity & Guaranty Life Insurance Company and
Fidelity & Guaranty Life Insurance Company of New York (Mar. 17,
2023) (available at <a href="https://www.sec.gov/files/fidelity-guaranty-031723.pdf">https://www.sec.gov/files/fidelity-guaranty-031723.pdf</a>) (``F&G Life Letter'').
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With respect to the registration process, insurance companies
registering an offering of RILA securities are required under the
Securities Act to pay a registration fee to the Commission at the time
of filing a registration statement.\21\ This means that they pay
registration fees at the time they register the offer and sale of the
securities, regardless of when (or if) they sell them. The registration
statement for the RILA offering also must include current financial
information, including any annual update required by section 10(a)(3)
of the Securities Act.\22\ An insurance company registering a RILA
offering on Form S-1 must provide any section 10(a)(3) update to the
registration statement by filing a post-effective amendment which must
be declared effective, typically by the staff acting pursuant to
delegated authority.\23\
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\21\ Section 6(b)(1) of the Securities Act [15 U.S.C.
77f(b)(1)]. Certain ``well-known seasoned issuers'' or ``WKSIs'' can
use a different registration process than what is described here.
See generally Securities Offering Reform, Investment Company Act
Release No. 26993 (July 19, 2005) [70 FR 44722 (Aug. 3, 2005)]
(``Offering Reform Release''). None of the insurance companies
offering RILAs are WKSIs, however, and we generally do not
anticipate that RILA issuers will meet the conditions to operate as
a WKSI. We therefore do not generally discuss the WKSI registration
process in this release. Even if a RILA issuer were to qualify as a
WKSI, the Securities Act rules that provide a streamlined offering
process for WKSIs generally would be inapplicable to RILA offerings
on Form N-4, as proposed. For example, although a WKSI can file an
automatic shelf registration statement, this would not be applicable
under the proposal because Form N-4 does not permit a shelf
registration statement and an automatic shelf registration statement
must be filed on Forms S-3, F-3, or N-2. See rule 405 (definition of
``automatic shelf registration statement''). As another example,
WKSIs are permitted to use the ``pay-as-you-go'' method of paying
securities registration fees, but the registration fees for RILA
offerings would be paid annually in arrears under the proposal. See
17 CFR 230.456(b).
\22\ Section 10(a)(3) of the Securities Act provides that when a
prospectus is used more than nine months after the effective date of
the registration statement, the information contained therein shall
be as of a date not more than sixteen months prior to such use. 15
U.S.C. 77j.
\23\ See Section 8(c) of the Securities Act [15 U.S.C. 77h(c)]
and 17 CFR 230.462 (``rule 462'').
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If the offering is registered on Form S-3, the insurance company's
annual report on Form 10-K containing audited financial statements will
operate as a post-effective amendment to the registration statement for
purposes of section 10(a)(3).\24\ The insurance company is required to
provide a complete set of its financial statements, certain schedules,
and executive compensation disclosures in a structured data format
using Inline XRBL, but is not otherwise required to provide other
information in the registration statement as structured data.\25\
Insurance companies offering RILAs also are not required to deliver
prospectuses to investors because they can rely on the Commission's
``access equals delivery'' framework in rule 172, although in practice
we understand that insurance companies typically deliver prospectuses
to accompany or precede other communications.
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\24\ An issuer filing a registration statement on Form S-3 will
incorporate by reference information in reports under the Exchange
Act filed after the registration statement has become effective,
including the issuer's annual report on Form 10-K. Accordingly,
certain information required to be included in the prospectus may be
included directly in the prospectus or included in an Exchange Act
report that is incorporated by reference into the prospectus.
\25\ See rule 405(b) of Regulation S-T.
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When an insurance company registers a variable annuity separate
account on Form N-4, in contrast, it pays registration fees based on
the net issuance of securities, no later than 90 days after each fiscal
year end.\26\ The insurance company can update its registration
statement to include updated financial information required by section
10(a)(3) by filing an immediately effective post-effective amendment
under rule 485. These
[[Page 71093]]
provisions together are designed to allow insurance companies to
efficiently conduct continuous offerings of variable annuities. The
insurance company also must structure certain key information in Inline
XBRL to enhance the utility of that information to investors and must
deliver a prospectus to investors because the ``access equals
delivery'' framework in rule 172 is not available for variable
annuities.
---------------------------------------------------------------------------
\26\ See 17 CFR 270.24f-2 (``rule 24f-2'').
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C. Evidence of Investor Views and Areas of Potential Confusion
Consistent with the RILA Act, the Commission received feedback on
individuals' comprehension and views on RILA disclosure through
investor testing. Specifically, we received feedback through
qualitative investor testing interviews, as well as quantitative
testing designed to assess whether the design of certain hypothetical
RILA disclosure provided to participants affects their comprehension of
the disclosed information. Each of these aspects of investor testing
was designed by the Commission's Office of the Investor Advocate
(``OIAD''). As described in more detail in section II.B below, this
feedback helped us to identify areas of Form N-4 that we propose to
amend to help ensure that a RILA purchaser receives key information
that the purchaser is able to understand.
OIAD conducted two rounds of qualitative interviews with a mix of
investors across demographic characteristics, locations, and levels of
financial literacy who either already owned annuities or had expressed
interest in investing in an annuity product.\27\ These interviews aimed
to generate hypotheses about certain content areas in RILA disclosure--
specifically, disclosure that could appear in select rows of the ``Key
Information Table'' (or ``KIT'') in RILA registration statements, as
discussed below--that may cause confusion and lead to impediments to
investor understanding of key information.\28\ These interviews
concentrated on assessing: (1) potential RILA disclosure, focusing on a
hypothetical KIT, for areas of confusion or misunderstanding; and (2)
participants' mental models regarding the way RILA products function,
including potential benefits, drawbacks, and risks of a RILA
investment. The interviews also included hypothetical scenarios.\29\
---------------------------------------------------------------------------
\27\ OIAD's qualitative testing consisted of two rounds of in-
depth hour-long interviews with twenty participants, using a semi-
structured, open-ended format so that participants could express
their reactions and beliefs, regardless of whether they are
accurate, in order to assess the reasoning of a sampling of
investors regarding RILA products, and their reactions to potential
RILA disclosures. See OIAD Report at Section 5, Qualitative Testing,
Methods.
\28\ OIAD Report at Section 1, Introduction and Executive
Summary.
\29\ See OIAD Report at Section 5, Qualitative Testing, Methods.
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Feedback from both rounds of qualitative interviews generally
showed that the interview participants did not have much, if any,
familiarity with RILAs. Furthermore, interviews in both rounds
illustrated that many participants struggled to understand the details
of the RILA contract presented in sample KIT disclosure.\30\
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\30\ Several participants in Round 2 were ``significantly more
sophisticated than the average investor,'' with some having worked
in a financial field or had over $1 million in retirement assets,
and these participants also ``struggled to correctly apply the
concepts discussed in the KIT.'' OIAD Report at Section 5,
Qualitative Testing, Results from Round 2.
---------------------------------------------------------------------------
With regard to the first round specifically, participants indicated
significant confusion about the features and fees associated with
RILAs, and often cited certain specific terminology, such as ``index
option,'' ``interim value adjustment,'' ``buffer,'' and ``investment
term,'' as confusing to them.\31\ For example, many participants
mistakenly conflated ``investment term'' with the length of the entire
insurance contract, leading them incorrectly to conclude that they
could avoid any fees or charges if they liquidated their investment at
the end of an initial one-year investment period.\32\ Participants
often did not appear to understand that there are multiple aspects of a
typical RILA contract that could negatively affect an investor's
contract value or the amounts an investor could withdraw from the
contract (e.g., the fact that a withdrawal could be subject to a
surrender charge, interim value adjustment, and tax penalty).\33\ Some
participants expressed that a chart or graph would be useful to help
them understand certain information presented about a RILA contract,
such as surrender periods or how the contract's bounded return
structure would function.\34\ Additionally, some participants indicated
they would need more specific information--besides the information in
the hypothetical KIT rows shared with them--to evaluate the
appropriateness of a RILA.\35\
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\31\ See OIAD Report at Section 5, Qualitative Testing, Results
from Round 1. As noted above, supra footnote 2, to alleviate the
confusion generated by ``investment term,'' we use the term
``crediting period'' in this release and in the proposed amendments
to Form N-4.
\32\ See, e.g., OIAD Report at Section 5, Qualitative Testing,
Results from Round 1.
\33\ See OIAD at Section 5, Qualitative Testing, Results from
Round 1.
\34\ OIAD Report at Section 5, Qualitative Testing, Results from
Round 1.
\35\ OIAD Report at Section 5, Qualitative Testing, Results from
Round 1.
---------------------------------------------------------------------------
While first-round interview participants may not have been able to
understand RILA features and economic tradeoffs fully after reviewing
sample KIT disclosure, some were able to identify certain potential
drawbacks and explain certain aspects of RILA contracts following their
review of this sample disclosure. This was demonstrated in
participants' responses to sample scenarios, where the interview
facilitator presented facts about a hypothetical investor's background,
and participants were asked to provide their opinions about whether a
RILA contract would be an appropriate investment option for those
investors and discuss their reasoning. For instance, participants in
the first-round interviews could generally identify that a RILA
contract could present particular risks for individuals without a long
time horizon.\36\ On the other hand, as noted above, these participants
often identified only a single charge or penalty that would apply even
in scenarios where, for example, a surrender charge, early withdrawal
tax penalty, and interim value adjustment might all apply.\37\ Some
participants were able to identify that a RILA contract could be
appropriate for an individual in light of factors such as desire to
protect against losses in the stock market, taking into account
considerations such as age, investment time horizon, and other sources
of liquid funds.\38\ Some interview participants also demonstrated that
they could use the KIT disclosure to discern quickly that they would
not be interested in purchasing a RILA contract, for example because of
liquidity needs or relatively short investment time horizons.\39\
---------------------------------------------------------------------------
\36\ OIAD Report at Section 5, Qualitative Testing, Results from
Round 1. However, OIAD's report also notes that in the second round
of testing, many participants did not understand that RILAs are
intended as a retirement savings vehicle, and that there may be tax
penalties for withdrawal prior to age 59\1/2\. See id., Results from
Round 2. Similarly, only 12.6% of participants in the quantitative
testing correctly identified that RILAs are investing vehicles that
are intended purely as retirement savings vehicles. Id., Section 6,
Quantitative Testing, Results, Summary of Quantitative Testing.
\37\ OIAD Report at Section 5, Qualitative Testing, Results from
Round 1.
\38\ OIAD Report at Section 5, Qualitative Testing, Results from
Round 1.
\39\ OIAD Report at Section 5, Qualitative Testing, Results from
Round 1.
---------------------------------------------------------------------------
Commission staff used this feedback to update sample KIT disclosure
in between qualitative interview rounds. In particular, in the second
round, sample
[[Page 71094]]
KITs were modified to include: (1) the phrase ``investment term''
rather than ``term,'' (2) a table to show how investment term interacts
with contract length, (3) graphics to provide more information about
RILA loss limitation features such as floors and buffers, and (4)
expanded links to additional information to indicate that more
information could be available.\40\ Following these changes,
participants demonstrated modestly improved comprehension in certain
limited areas. For example, the sample KIT disclosure used in the
second-round of qualitative testing emphasized that contract
adjustments can substantially reduce the value of an investment if
investors withdraw money before the end of an investment term.
Participants who viewed this modified disclosure had greater success in
identifying the potential financial impact of this feature, with some
expressing concern about the potential magnitude of the contract
adjustment.\41\ Additionally, some second-round participants who viewed
the KIT contract adjustment disclosure also asked for more specific
information about how the adjustment is calculated, which suggests that
layered disclosure might be useful for these concepts.\42\ Even though
these participants were unable to define certain terms relevant to
contract adjustments (e.g., interim value adjustment), most second-
round participants seemed to understand that RILAs are not a short-term
investment and should only be used if an investor will not need to make
early withdrawals.\43\
---------------------------------------------------------------------------
\40\ See OIAD Report at Section 5, Qualitative Testing, Results
from Round 1, and Appendix C.
\41\ See OIAD Report at Section 5, Qualitative Testing, Results
from Round 2.
\42\ See OIAD Report at Section 5, Qualitative Testing, Results
from Round 2.
\43\ See OIAD Report at Section 5, Qualitative Testing, Results
from Round 2.
---------------------------------------------------------------------------
The second round of testing also introduced a table in the sample
KIT disclosure that attempted to help illustrate how fees were charged
over the surrender period of the contract, the difference between the
investment term (i.e., the crediting period) and the contract length,
and how the surrender charge and potential contract adjustments could
vary over different time frames.\44\ Nonetheless, participants in the
second round of testing still had difficulty distinguishing between
surrender charges and contract adjustments or understanding that both
can apply cumulatively to reduce an investor's contract value in cases
of early withdrawal.\45\ Most participants in the second round of
testing also continued to struggle with the mechanics of ``buffers,''
despite the inclusion of graphics in the hypothetical KITs designed to
illustrate how buffers work.\46\ There were a number of areas where
participants wanted information that was not part of the KIT rows being
tested, such as the specific index-linked options available under the
contract, and some participants with more investing experience wanted
information about past returns on the RILA, as well as additional
information on fees and charges--particularly regarding caps on gains
and other bounded return features--in order to understand the ways in
which insurance companies profit from RILAs.\47\
---------------------------------------------------------------------------
\44\ See OIAD Report at Section 5, Qualitative Testing, Results
from Round 1, and Results from Round 2.
\45\ See OIAD Report at Section 5, Qualitative Testing, Results
from Round 2.
\46\ See OIAD Report at Section 5, Qualitative Testing, Results
from Round 2.
\47\ See OIAD Report at Section 5, Qualitative Testing, Results
from Round 2.
---------------------------------------------------------------------------
Following the qualitative interviews, OIAD conducted quantitative
testing designed to assess comprehension of key concepts about RILAs
and the extent to which the organization of disclosures affected
participants' comprehension of the disclosed information.\48\
Approximately 2,500 participants completed OIAD's quantitative testing
study, which was fielded over an eight-day period and targeted groups
who were more likely to have some experience with financial
products.\49\ Participants received focused portions of a hypothetical
KIT to test disclosures. For example, participants were randomly
assigned to one of two formats for the sample KIT disclosure, one with
a Q&A format and one with a statement-based format.\50\ Overall, the
results of OIAD's quantitative testing suggest that most investors
experience challenges in understanding RILAs.\51\ This round of testing
reviewed overall comprehension of participants as well as whether
participants were able to assess four sub-scores: (1) appropriateness
of RILAs for investors based on their characteristics, (2) how a RILA
works, (3) how the charges and penalties associated with RILAs affect
liquidity, and (4) the insurance protections offered by RILAs.\52\
Across all participants, the average percentage of questions scored
correct was 58%, which, while higher than the expected score for people
randomly guessing (50%), was lower relative to what might be considered
a well-informed purchaser of a RILA product.\53\ However, the results
of the sub-scores varied, specifically 57% for appropriateness, 49% for
how a RILA works, 57% for insurance, and 62% for liquidity.\54\
Comprehension varied depending on the particular concept tested. For
example, 80.7% of participants were able to correctly identify that
RILA investors cannot access their money whenever they need it at no
cost, suggesting that the tested disclosures were sufficient to put
participants on notice to the potential for contract adjustments and
surrender charges.\55\ Conversely, only 12.6% of participants correctly
identified that RILAs are intended purely as retirement savings
vehicles, rather than a product appropriate for other, shorter-term
investing goals (e.g., education and home purchasing), suggesting
continued investor confusion on this topic.\56\ Additionally,
participants in the quantitative testing were classified into three
groups based on their experience with investing. Not surprisingly,
increased investment experience correlated with greater overall
comprehension, with non-investors (those with no existing investments)
averaging slightly less than 50% correct, 11.7 percentage points lower
than the average for the group with the most investment experience.\57\
The Q&A KIT format demonstrated a statistically significant, albeit
quantitatively small, improvement over the non-Q&A KIT format,
particularly with regard to the non-investor group, who saw a 5.7
percentage points increase in comprehension in connection with the Q&A
format with regard to overall comprehension.\58\
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\48\ OIAD Report at Section 6, Quantitative Testing.
\49\ OIAD Report at Section 6, Quantitative Testing, Methods.
\50\ OIAD Report at Section 6, Quantitative Testing, Study
Design and Overview.
\51\ OIAD Report at Section 6, Quantitative Testing, Summary of
Quantitative Testing.
\52\ OIAD Report at Section 6, Quantitative Testing,
Comprehension Measures.
\53\ OIAD Report at Section 6, Quantitative Testing, Results.
\54\ OIAD Report at Section 6, Quantitative Testing, Results,
Table 6.
\55\ OIAD Report at Section 6, Quantitative Testing, Results.
\56\ OIAD Report at Section 6, Quantitative Testing, Results.
\57\ See OAID Report at Section 6, Quantitative Testing,
Results, Subgroup Analysis, Investor Status.
\58\ See OIAD Report at Section 6, Quantitative Testing,
Results, Subgroup Analysis, Investor Status.
---------------------------------------------------------------------------
Overall, investor testing successfully identified a range of
barriers to investor understanding of RILAs and associated disclosures.
However, with the few
[[Page 71095]]
exceptions noted above, variations in disclosures did not result in
significant improvements in investor comprehension in the investor
testing. Accordingly, while OIAD's investor testing has been successful
in identifying specific areas of investor confusion regarding RILAs,
those results were largely inconclusive in terms of determining
specific disclosures that are relatively more successful in addressing
the identified confusion.
We have incorporated those results in our design of the proposed
Form N-4 amendments, endeavoring to give particular attention to areas
of identified investor confusion while leveraging existing disclosure
requirements. Because investor testing did not, for the most part,
provide persuasive evidence of superior disclosures, we are proposing
to largely utilize the existing Form N-4 disclosures which have been
developed over time, and with which staff, investors, and RILA issuers
are already familiar. Building upon these existing disclosures has
additional benefits, because combination contracts offering both
variable and index-linked options will be required to comply with Form
N-4, making it more efficient to build on the form's requirements for
both types of investment options. We seek comment throughout this
release on specific areas for improvement that can aid investor
comprehension. Further, we are requesting specific input from the
retail investor community, through a short Feedback Flyer, relating to
their experiences with annuities generally and RILAs specifically.\59\
---------------------------------------------------------------------------
\59\ See infra section II.K; Appendix D.
---------------------------------------------------------------------------
Further, in addition to investor testing focused specifically on
sample RILA disclosure, our proposal--and the current disclosure
requirements in Form N-4 that we are building upon--also draw on the
Commission's past investor testing efforts, outreach, and other
empirical research concerning investors' preferences. This includes,
for example, information about summary content and layered disclosure
approaches.\60\ The Commission has historically received feedback
showing that investors generally prefer concise, layered
disclosure.\61\ Investors participating in certain past quantitative
and qualitative investor testing initiatives on the Commission's behalf
have also expressed preferences for, wherever possible, the use of a
summary containing key information about an investment product or
service written in clear, concise, and understandable language and
presented in an accessible format.\62\ Each of these sources of
evidence of investor preferences, understanding, and behaviors in
response to disclosures specific to RILAs and other investment products
more generally has provided important context and support for our
proposal's approach to RILA disclosure.
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\60\ See Updated Disclosure Requirements and Summary Prospectus
for Variable Annuity and Variable Life Insurance Contracts,
Investment Company Act Release No. 33286 (Oct. 30, 2018) [83 FR
61730 (Nov. 30, 2018)] (VASP Proposing Release) at paragraphs
accompanying nn.38-43.
\61\ See, e.g., Request for Comment on Fund Retail Investor
Experience and Disclosure, Investment Company Act Release No. 33113
(June 5, 2018) [83 FR 26891] (June 11, 2018] (``Investor Experience
RFC''). Feedback in comment letters generally showed that retail
investors prefer concise, layered disclosure and feel overwhelmed by
the volume of information they currently receive. Multiple comment
letters reflected a preference for shorter summary disclosures, with
additional information available online or upon request. See, e.g.,
Comment Letter of C. Scott (July 26, 2018) (expressing preference
for shorter summary disclosures, and suggesting disclosures ``trim
the fat and replace the text-heavy disclosures with something that
is clear, succinct, and transparent''); Comment Letter of Helena
Krus (July 29, 2018) (noting a preference to receive shorter summary
disclosures, with additional information available online or upon
request, and suggesting that the option should be available for all
documents over 5 pages).
\62\ See supra footnote 61; see also, e.g., SEC Staff, Study
Regarding Financial Literacy Among Investors (Aug. 2012). The key
information that investors found useful and relevant before
purchasing an investment product includes information on fees and
expenses, investment performance, principal risks, and investment
objectives. With respect to the presentation of disclosure, the
study indicates that investors preferred disclosures being ``written
in clear, concise, understandable language, using bullet points,
tables, charts, and/or graphs.'' Materials relating to this study,
including the staff's report, are available at <a href="http://www.investor.gov/publications-research-studies/sec-research">http://www.investor.gov/publications-research-studies/sec-research</a>.
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D. Overview of Proposal
We are proposing to modernize and enhance the registration and
disclosure framework for RILAs by adapting the existing registration
and disclosure framework that is familiar to investors and issuers for
variable annuity separate accounts to accommodate RILAs.
<bullet> Use of Form N-4. We are proposing to amend Form N-4 so
that issuers seeking to register the offering of RILAs must use that
form. To accommodate this, we are also proposing amendments to that
form that specifically address the features and risks of RILAs. For
example, we are proposing amendments to the form's ``Key Information
Table'' that highlight key features of RILAs that should be disclosed
so that investors may determine whether a RILA is an appropriate
investment for them. In particular, the KIT highlights key features of
a RILA contract that may be substantially different from the features
of investment products investors may be more familiar with, and that
investor testing suggests may not be readily apparent to investors.
Further, because the insurance company would register the offering of a
RILA on Form N-4 under the proposal, it would be subject to the
requirements in the form related to financial statements, including the
form instruction that currently permits variable annuity issuers to
file insurance company SAP financial statements in certain
circumstances.
<bullet> Form N-4 Amendments for All Issuers. In addition to adding
RILAs to Form N-4, we are also proposing amendments to the form that
would be applicable to offerings of variable annuities. These proposed
amendments are informed by the staff's historical experience in
administering the form and respond to observations from investor
testing relevant to variable annuity offerings. For example, one
takeaway from investor testing was that the complicated jargon of RILA
contracts was a consistent impediment to investor comprehension of KIT
disclosures.\63\ To address this confusion, we are proposing to switch
the order of the Key Information Table and Overview of the Contract
items to introduce investors earlier to the terminology and concepts
underlying annuity contracts, in the hopes that this context will
improve investor comprehension of KIT disclosures. Because variable
annuities are also complicated investment products, we are proposing to
switch the order for these products as well, so that variable annuity
investors also have the benefit of this additional context.
---------------------------------------------------------------------------
\63\ See OIAD Report at Section 6, Quantitative Testing, Summary
of Quantitative Testing.
---------------------------------------------------------------------------
<bullet> Summary Prospectus. Consistent with the inclusion of RILAs
on Form N-4, we are proposing to permit RILA issuers to make use of the
summary prospectus framework available to variable annuity registrants
on Form N-4.
<bullet> Updates to the Filing Rules. To accommodate RILA
registrations on Form N-4, we are proposing to require RILA issuers to
pay fees in arrears on Form 24F-2 and we are proposing amendments to
address RILAs in the rules that variable annuities use to file post-
effective amendments and to update prospectuses.
<bullet> Materially Misleading Statements in Sales Literature. The
proposed amendments would require RILA issuers to comply with rule 156,
which provides guidance as to when sales literature is materially
misleading under the Federal securities laws.
Our proposal, if adopted, would implement the RILA Act's mandate.
[[Page 71096]]
II. Discussion
A. Use of Form N-4
We propose to require insurance companies to use Form N-4 to
register the offering of RILAs, as well as amendments to the form to
require disclosures specific for these securities.\64\ As discussed
above, the registration forms currently used by RILA issuers do not
include line-item disclosure requirements addressing the unique aspects
of RILAs, like limits on gains or the application of contract
adjustments. They also require information about the issuer, such as
MD&A, that may be less important to annuity investors, given that they
are not making a direct investment in the insurance company, and that
the Commission has not determined to require for variable annuities.
Conversely, most variable annuity issuers already use Form N-4 to
register their securities and the form is designed to provide investors
with product-specific information about annuity contracts.\65\
Requiring insurance companies to register RILA offerings on Form N-4
therefore leverages the form's existing insurance-product specific
disclosure requirements, including disclosure requirements that help
effectuate the relatively new summary prospectus layered disclosure
framework the Commission adopted in 2020 for variable contracts. With
the RILA-specific disclosures we are proposing to add to Form N-4, we
intend that the form will provide investors with the information
necessary to make informed decisions about RILAs.
---------------------------------------------------------------------------
\64\ See proposed General Instruction B.1 of Form N-4. Form N-4,
as we propose to amend it, would provide that Form N-4 is ``to be
used by insurance companies to register index-linked annuity
contracts under the Securities Act of 1933.'' Insurance companies
therefore would not be permitted to register RILA offerings on Forms
S-1 or S-3, as they do today.
\65\ Variable annuities register on Form N-3 if they are issued
by separate accounts that are organized as management investment
companies. However, most variable annuities are issued by separate
accounts that are organized as unit investment trusts and therefore
use Form N-4. See supra footnote 6.
---------------------------------------------------------------------------
Including RILAs on Form N-4 also could provide further benefits to
investors by facilitating not only investor comparison among RILAs, but
also the comparison of index-linked options to variable options in the
same annuity contract. For example, investors would be able to review
summary information of all the available investment options of an
annuity contract--index-linked options, variable options, and fixed
options--and compare these options in one place in the prospectus
appendix required by Form N-4.\66\ Currently, we understand that
approximately 44% of the RILAs offered in the marketplace are offered
as index-linked options through combination products.\67\ Registering
the offerings of RILAs on Form N-4, rather than a new or different
form, also would be more efficient for insurance companies and
Commission staff. In this regard, insurance companies would benefit
from using a single form, with tailored disclosure requirements, to
register the offerings of both RILAs and combination contracts with
index-linked options. In addition, many of the insurance companies
issuing RILAs also issue variable annuity contracts and therefore are
familiar with the requirements of Form N-4. Using Form N-4 for RILAs
also would be efficient for our staff because the disclosure
requirements for variable contracts and RILAs would be consolidated in
one place. Further, because Congress has authorized RILA issuers to use
Form N-4 if the Commission fails to adopt a registration form for RILAs
within 18 months of the RILA Act's enactment, we believe that requiring
insurance companies to use the form is consistent with congressional
intent.
---------------------------------------------------------------------------
\66\ See infra section II.B.3(c).
\67\ Based on an informal Commission staff review of RILA
filings on the EDGAR system as of May 2, 2023.
---------------------------------------------------------------------------
Requiring insurance companies to register RILA offerings on Form N-
4 under the proposal would result in changes to RILA disclosure, in
that they would have to comply with the current Form N-4 disclosure
requirements in addition to the proposed new RILA-specific disclosure
requirements. While Form N-4 contains some of the issuer- and offering-
specific disclosures required by Forms S-1 and S-3, it does not contain
them all. Specifically, Form N-4 does not include many of the
disclosures relating to the mechanics of the offering (e.g., use of
proceeds, dilution, etc.); offering participants other than the issuer,
such as selling securities holders; and certain details of the issuer
(e.g., descriptions of property, executive compensation, etc.). These
disclosures may be more useful to an investor considering an investment
in the capital stock or debt securities of the insurance company rather
than an investment in a RILA issued by the insurance company. Unlike an
investor in the insurance company itself, a RILA investor's direct
investment exposure to the insurance company is limited to the
insurance company's claims-paying ability, which also is supported by
State insurance regulations and supervision designed to ensure that
insurance companies are able to satisfy their obligations under their
insurance contracts. Requiring insurance companies to register RILA
offerings on Form N-4 would leverage that form's annuity-focused
requirements to ensure that investors receive those disclosures that
would be the most important in the RILA context.
To accommodate the offering of RILAs on Form N-4 and to provide a
consistent framework for all offerings registered on the form, we are
proposing, as discussed in more detail below, changes to certain rules
and requirements such that RILA issuers would be subject to the same
process requirements as variable annuities.\68\ For example, similar to
the current offering processes for issuers of variable annuities,
insurance companies registering RILA offerings would be permitted to
use a streamlined summary prospectus and required to pay fees to
register their securities annually rather than at the time of filing a
registration statement.\69\ These changes would provide efficiencies
for insurance companies and Commission staff in establishing consistent
requirements for offerings registered on Form N-4. It would, however,
result in some trade-offs for RILA issuers. For example, insurance
companies currently registering RILA offerings on Form S-3 would lose
the ability to update their registration statement by incorporating by
reference their annual report but would be able to update their
registration statement annually with an immediately effective
amendment. On balance, and as discussed in more detail throughout this
release, requiring insurance companies registering RILA offerings to
follow the offering processes proposed in this release should result in
efficiencies for insurance companies and our staff. We anticipate that
requiring RILA offerings to be registered on Form N-4 will also benefit
investors by leveraging the form's annuity-specific disclosure
requirements and extending the variable annuity summary prospectus to
RILAs. Having a common registration form also should make it easier for
investors deciding between an investment in a RILA or a variable
annuity to compare the offerings.
---------------------------------------------------------------------------
\68\ See infra sections I.C and II.E.
\69\ See also infra section II.E.3 (discussing proposed changes
to rule 172).
---------------------------------------------------------------------------
We request comment on the proposed requirement to register RILA
offerings on Form N-4.
1. As proposed, should we require RILA issuers to use Form N-4? Is
another existing registration form more
[[Page 71097]]
appropriate for RILAs? If so, which registration form and why?
2. Given that any existing registration form would require RILA-
specific amendments, should the Commission instead develop a new form
specifically for RILAs?
3. Is it appropriate to require an annuity that offers different
types of investment options (e.g., variable options as well as index-
linked options) to address these different types of investment options
on the same registration form? Would requiring different registration
forms for annuities offering different types of investment options be
more or less efficient for insurance companies that offer variable
annuities, RILAs, and combination contracts?
4. Is there any information currently required by Forms S-1 or S-3
that we should also require RILA issuers to disclose?
5. Would requiring RILAs to follow the same filing and other
process requirements as variable annuities (such as requirements for
paying registration fees, and the ability to use a summary prospectus)
be efficient for insurance companies because they could use the same
processes to pay registration fees and update registration statements
for variable annuities, RILAs, and combination contracts?
6. Do commenters believe that there are any disclosures from Forms
S-1 and S-3 we are not including in the proposed Form N-4, particularly
the MD&A and executive compensation disclosures, that could be of
material relevance to RILA investors? If so, please explain their
relevance to RILA investors.
7. Do commenters agree with our estimate that approximately 44% of
RILA securities offered in the marketplace are offered as index-linked
options through combination products? If not, what percentage do
commenters think more accurately reflects RILA securities offered as
index-linked options through combination products, and what is the
basis for this estimate?
8. Should Form N-4, as amended, be the only form that insurance
companies could use to register RILA offerings? Should we permit the
continued use of Forms S-1 and S-3 in addition to the amended Form N-4?
Would this be appropriate, given that RILA issuers can already use
those forms? How would we ensure that investors receive the information
necessary to make informed decisions through use of those forms,
including the benefit of the proposed RILA-specific disclosure
requirements informed by investor testing?
9. Do commenters expect that any RILA issuers will meet the
conditions to operate as a WKSI, and if so, what is the basis for this
expectation?
10. Do commenters agree that leveraging Form N-4's annuity specific
disclosure requirements and summary prospectus regime would benefit
investors? Would registering RILA offerings on Form N-4 make it easier
for RILA investors to compare RILA offering with variable annuity
offerings? Are there any other potential benefits or disadvantages to
investors in registering RILA offerings on Form N-4 as compared to
other forms?
B. Contents of Form N-4
As proposed, many items of current Form N-4 would apply to RILAs.
We are also proposing updates to Form N-4 to include disclosures
specific to RILAs. In certain circumstances, we propose changing the
disclosures provided on the form that would apply to both RILAs and
variable annuities. The chart in Table 1 below outlines these items and
any substantive changes we are proposing.\70\ We discuss these changes
in more detail in the sections that follow.
---------------------------------------------------------------------------
\70\ Some proposed changes entail a non-substantive change such
as a change to a defined term or specifying that the provision would
continue to be applicable only to a registered separate account or
variable option. These are not flagged in the following table but
are instead discussed in section II.B.7 supra.
Table 1--Overview of Proposed Form N-4
----------------------------------------------------------------------------------------------------------------
Item Description Substantive changes Discussion
----------------------------------------------------------------------------------------------------------------
Prospectus (Part A)
----------------------------------------------------------------------------------------------------------------
1.................................. Front and Back Cover Adding new legends and Section II.B.1.
Pages. other standardized
disclosures applicable to
all issuers.
2.................................. Overview of the New RILA-specific Section II.B.3(a).
Contract. disclosures; moving order
of appearance up.
3.................................. Key Information....... New RILA-specific Section II.B.2.
disclosures; changing to a
question-and-answer
format; moving order of
appearance down; change
discussion of restrictions
on optional benefits to
cover all benefits.
4.................................. Fee Table............. New contract adjustment Section II.B.5.
disclosure.
5.................................. Principal Risks of Providing more detailed Section II.B.4.
Investing in the disclosures applicable to
Contract. all issuers.
6.................................. Description of the New RILA-specific Section II.B.3(a).
Insurance Company, disclosures and one new
Registered Separate item regarding variable
Account, and options.
Investment Options.
7.................................. Charges............... New disclosures related to Section II.B.5.
contract adjustments.
8.................................. General Description of No substantive change...... Section II.B.8(b).
Contracts.
9.................................. Annuity Period........ No substantive change...... Section II.B.8(b).
10................................. Benefits Available No substantive change...... Section II.B.8(b).
Under the Contract.
11................................. Purchases and Contract No substantive change...... Section II.B.8(b).
Value.
12................................. Surrenders and No substantive change...... Section II.B.8(b).
Withdrawals.
13................................. Loans................. No substantive change...... Section II.B.8(b).
14................................. Taxes................. No substantive change...... Section II.B.8(b).
15................................. Legal Proceedings..... No substantive change...... Section II.B.8(c).
16................................. Financial Statements.. No substantive change (but Section II.D.
see Item 26).
[[Page 71098]]
17................................. Investment Options New RILA-specific Section II.B.3(b).
Available Under the disclosures.
Contract.
----------------------------------------------------------------------------------------------------------------
Statement of Additional Information (Part B)
----------------------------------------------------------------------------------------------------------------
18................................. Cover Page and Table No substantive change...... Section II.B.8(b).
of Contents.
19................................. General Information No substantive change...... Section II.B.8(c).
and History.
20................................. Non-Principal Risks of No substantive change...... Section II.B.8(b).
Investing in the
Contract.
21................................. Services.............. No substantive change...... Section II.B.8(b).
22................................. Purchase of Securities New disclosure of specific Section II.B.5.
Being Offered. contract adjustment
information.
23................................. Underwriters.......... No substantive change...... Section II.B.8(c).
24................................. Calculation of Clarifying only applies to Section II.B.7.
Performance Data. variable options.
25................................. Annuity Payments...... No substantive change...... Section II.B.8(b).
26................................. Financial Statements.. Providing that RILA issuers Section II.D.
can use the relevant
instructions and adding
requirements relating to
changes in and
disagreements with
accountants for RILAs.
----------------------------------------------------------------------------------------------------------------
Other Information (Part C)
----------------------------------------------------------------------------------------------------------------
27................................. Exhibits.............. Adding power of attorney Section II.B.7(d).
for all issuers and
accountant letters for
RILA issuers as exhibits.
28................................. Directors and Officers No substantive change...... Section II.B.8(c).
of the Insurance
Company.
29................................. Persons Controlled or No substantive change...... Section II.B.8(c).
Under Common Control
with the Insurance
Company or the
Registrant.
30................................. Indemnification....... No substantive change...... Section II.B.8(c).
31................................. Principal Underwriters No substantive change...... Section II.B.8(c).
31A................................ Information about New disclosure of RILA Section II.B.6.
contracts with Index- specific information.
Linked Options.
32................................. Location of Accounts No substantive change...... Section II.B.7.
and Records.
33................................. Management Services... No substantive change...... Section II.B.8(b).
34................................. Fee Representation and Adding new RILA Section II.B.7(d).
Undertakings. undertakings.
----------------------------------------------------------------------------------------------------------------
1. Front and Back Cover Pages (Item 1)
We propose to require RILA issuers to include the information Form
N-4 currently requires on the front and back cover pages of the
prospectus. Currently, issuers are required to include on the front and
back cover pages basic identifying information about the issuer and the
contract, information on how to review the document (e.g., what the SAI
is and where to find it), as well as certain legends, for example, one
relating to the ability for an investor to cancel the contract within
10 days.\71\ The table below outlines these existing disclosures that
RILAs would be required to include if applicable.
---------------------------------------------------------------------------
\71\ One change specific to this legend would be to indicate
whether the insurance company will apply a contract adjustment on
any money returned during this period. Contract adjustments are a
defining element of a RILA, but can apply in other circumstances.
Nonetheless, given the context of this legend, we believe that it is
important for investors to know whether they will be subject to this
charge if they elect to have their money returned. See supra
sections II.B.5 (discussing contract adjustments generally) and II.F
(discussing that it could be materially misleading to advertise that
investors can receive their money back during a period of time
without indicating that a contract adjustment could apply).
Table 2--Existing Information Required by Item 1 of Form N-4
[With proposed adjustments]
------------------------------------------------------------------------
Item No. Disclosure Cover
------------------------------------------------------------------------
Identifying Information
------------------------------------------------------------------------
Item 1(a)(2).................. Insurance company's Front.
name.
Item 1(a)(3).................. Types of contracts Front.
offered (e.g., group,
individual, etc.).
Item 1(a)(4).................. Name and class of Front.
contract.
Item 1(a)(9).................. Date of prospectus.... Front.
Item 1(b)(4).................. EDGAR identifier Back.
number.
------------------------------------------------------------------------
[[Page 71099]]
Legends
------------------------------------------------------------------------
Item 1(a)(10)................. Statement that the Front.
Commission has not
approved or
disapproved of the
securities or passed
upon the accuracy or
adequacy of the
disclosure in the
prospectus and that
any contrary
representation is a
criminal offense (as
required in 17 CFR
230.481(b)(1)).
Item 1(a)(11)................. Statement that Front.
additional
information about the
contract is available
on <a href="http://Investor.gov">Investor.gov</a>.
Item 1(a)(12)................. A legend that states Front.
that if you are a new
investor, you may
cancel your contract
within 10 days of
receiving it with
some details about
the operation of this
process.
------------------------------------------------------------------------
Other Information
------------------------------------------------------------------------
Item 1(b)(1).................. Statement that the SAI Back.
contains additional
information, that it
is available to
investors, and how
investors may obtain
the SAI or make
inquiries about their
contracts.
Item 1(b)(2).................. Statement about Back.
whether and from
where information is
incorporated by
reference.
------------------------------------------------------------------------
In addition, we are proposing to add several new disclosures to the
cover page to accommodate RILAs. The first proposed amendment would
require the insurance company to identify the types of investment
options offered under the contract and cross-reference the prospectus
appendix that provides additional information about each option.\72\
Given the addition of investment options beyond variable options to the
form, this would help investors better understand what investment
options are available under the contract.
---------------------------------------------------------------------------
\72\ See proposed Item 1(a)(5) of Form N-4.
---------------------------------------------------------------------------
The other proposed amendments to the cover page would require
additional new disclosures that highlight RILAs' complexities and
certain associated risks. These include RILA's limitation on gains and
potential for loss, that they are not short-term investments, and that
payments under the contract are subject to the insurance company's
financial strength and claims-paying ability. The proposed legends
would require issuers to include statements on the front cover
disclosing the following:
(1) The contract is a complex investment and involves risks,
including the potential loss of principal;
(2) For contracts that include index-linked options, a prominent
statement that the insurance company limits the amount the investor can
earn, the potential for investment loss could be significantly greater
than the potential for investment gain, an investor could lose a
significant amount of money if the index declines in value, and a
prominent statement disclosing as a percentage the maximum amount of
loss from negative index performance that an investor could experience
after taking into account the minimum guaranteed limit on index loss
provided under the contract;
(3) The contract is not a short-term investment and is not
appropriate for an investor who needs ready access to cash, and
withdrawals could result in surrender charges, negative contract
adjustments, taxes, and tax penalties as applicable with a prominent
statement of the maximum potential loss resulting from a contract
adjustment, if applicable; and
(4) The insurance company's obligations under the contract are
subject to its financial strength and claims paying ability.\73\
---------------------------------------------------------------------------
\73\ See proposed Item 1(a) of Form N-4.
---------------------------------------------------------------------------
This cover page disclosure is designed to put an investor on notice
of these key considerations to help the investor make informed
decisions.
While these proposed additional disclosures are important for
investors in RILAs, they are also relevant in many cases to investors
in variable annuities. For example, while RILAs are complex
investments, variable annuities are complex as well. Variable
annuities, like RILAs, also are not short-term investments. As a
result, we are proposing to apply the proposed new disclosures to all
Form N-4 issuers to ensure that investors in both RILAs and variable
annuities receive appropriate disclosures.
We request comment on the requirement of RILAs to include the
information in Item 1 of Form N-4 on their registration statement and
the inclusion of new legends for all Form N-4 filers, as applicable, on
the front cover of the registration statement.
11. Would the new legends be effective in helping investors make
informed decisions with regards to RILAs? Do commenters agree that it
is appropriate to require the legends for variable annuities? Are the
disclosures in the Overview of the Contract, Key Information Table, and
elsewhere in the prospectus--as discussed later in this release--
sufficient such that these legends are not necessary? Conversely, are
legends effective in alerting investors to key concepts for a RILA or
variable annuity on the cover page of the prospectus? Are there
additional legends that are appropriate in light of the complexity of
RILAs and variable annuities? For example, should a legend be required
that specifically discloses a contract's upside limitation, such as due
to a participation rate or cap rate?
12. Are there any examples or illustrations of how RILAs operate
that we should require on the front or back cover pages? Are examples
or illustrations more effective communication tools than legends on the
cover page of the prospectus? Should examples or illustrations be
provided in addition to legends?
13. Is there any other information we should require on the front
or back cover pages?
[[Page 71100]]
2. Key Information Table (Item 3)
RILA issuers, like variable annuities issuers currently, would be
required to provide a Key Information Table in their registration
statements under the proposal. We also are proposing amendments to the
KIT's disclosure requirements to address key RILA features, as well as
other amendments that would apply to all Form N-4 issuers.
The KIT provides summary prospectus disclosure, including a brief
description of key facts about a variable annuity in a specific
sequence and in a standardized presentation.\74\ Specifically, the KIT
currently includes a summary of five topic areas: (1) fees and
expenses; (2) risks; (3) restrictions; (4) taxes; and (5) conflicts of
interest. The KIT functions as an integral part of the layered
disclosure approach in Form N-4 by identifying key considerations
upfront, with more detail to follow later in the prospectus. The
proposed amendments to the KIT, which are informed by investor testing,
are intended to build on this framework and highlight important
considerations related to RILAs, including certain aspects of RILAs
that our investor testing observed are difficult for investors to
understand and thus require clear disclosure in order to help investors
make informed investment decisions.\75\
---------------------------------------------------------------------------
\74\ See VASP Adopting Release at section II.A.1.c.ii; see also
infra section II.C.
\75\ See, e.g., OIAD Report at Section 5, Qualitative Testing
(following two rounds of in-depth interviews to assess potential
RILA KIT disclosure for areas of confusion or misunderstanding,
qualitative interviews suggested confusion with RILA terms and
concepts relating to, for example, contract adjustments such as
interim value adjustments and loss limiting features such as
buffers); OIAD Report at Section 6, Quantitative Testing, Results,
Subgroup Analysis (noting 5.7 percentage point effect of the Q&A KIT
structure on overall comprehension for ``non-investors'' during
quantitative testing).
---------------------------------------------------------------------------
Form N-4 currently prescribes format requirements for the KIT to
enhance the readability and comparability of the disclosure that also
would apply to RILA offerings under the proposal.\76\ Specifically,
RILA issuers would be required to disclose the required information in
the tabular presentation reflected in the instructions, in the order
specified, without any modification or substitution with alternate
terminology of the title, headings, and sub-headings for the tabular
presentation, unless otherwise provided. Consistent with the form's
current requirements, RILA issuers, however, would be permitted to
exclude any disclosures (other than the title, headings, and sub-
headings for this tabular presentation) in the KIT that are not
applicable, or modify any of the statements required to be included, so
long as the modified statement contains comparable information. RILA
issuers also would be required to provide cross-references to the
location in the statutory prospectus where the subject matter is
described in greater detail, either accessed by direct electronic link
or through equivalent methods or technologies, as required for variable
annuity KIT disclosure. Consistent with current requirements, RILA
issuers would include these cross-references adjacent to the relevant
disclosure, either within the table row, or presented in an additional
table column. As currently is required, all disclosures for the KIT
should be short and succinct, consistent with the limitations of a
tabular presentation.
---------------------------------------------------------------------------
\76\ See proposed instruction 1 to Item 3 of Form N-4.
---------------------------------------------------------------------------
We are proposing three modifications that would apply to
registration statements both for RILAs and for variable annuities.
These changes are designed to provide investors with a better
understanding of these products, and are informed in part by the
results of investor testing. First, we are proposing to require issuers
to present the information in the KIT in a question-and-answer
(``Q&A'') format.\77\ As a result of this change, the various line
items of the KIT would be rephrased as questions (e.g., ``Are there
charges for early withdrawals?'' instead of ``Charges for Early
Withdrawals''). The instructions would further require that, unless the
context otherwise requires, issuers should begin the response with a
``Yes'' or ``No'' in bold text when answering a question presented in a
given row of the KIT. Consistent with the directional results of the
quantitative investor testing, we anticipate that the Q&A format may
improve investor comprehension of RILA-specific topics. Because the
effect of the Q&A KIT structure on overall comprehension was larger for
non-investors than independent investors, this format may particularly
improve comprehension for less-experienced investors.\78\ We also
expect that rephrasing the current line items in a Q&A format would
more clearly convey the importance of the KIT information to help RILA
and variable annuity investors make informed investment decisions.\79\
---------------------------------------------------------------------------
\77\ Proposed instruction 1(d) to Item 3 of Form N-4.
\78\ For purposes of investor testing, participants were
classified into three groups: those with no investments in stocks,
bonds, mutual funds, or other securities (non-investors); those with
investments exclusively in retirement savings accounts (retirement
only); and those with investments outside of retirement accounts
(independent investors). See OIAD Report at Section 6, Quantitative
Testing, Subgroup Analysis, Investor Status. The report noted a 5.7
percentage point effect of the Q&A KIT structure on overall
comprehension for ``non-investors''. Id.
\79\ The Commission's proposed Q&A format is consistent with
previous rulemaking experience. See Form CRS Relationship Summary;
Amendments to Form ADV, Investor Act Release No. 5247 (June 5, 2019)
[84 FR 33492 (June 12, 2019)] (adopting question-and-answer format
in response to feedback from surveys and studies and commenters who
noted that ``the question-and-answer format is a more effective
design for consumer disclosures because it focuses on questions to
which a consumer wants answers and allows a consumer to skim quickly
and understand where to get more information.''). The proposed
format is also supported by prior surveys and studies to help design
effective disclosures to retail investors. See, e.g., Angela A.
Hung, et al., RAND Corporation, Investor Testing of Form CRS
Relationship Study (2018), available at <a href="https://www.sec.gov/about/offices/investorad/investor-testing-form-crs-relationship-summary.pdf">https://www.sec.gov/about/offices/investorad/investor-testing-form-crs-relationship-summary.pdf</a>, at p. 23 (reporting that about 60% of respondents
favored a question-and-answer format over the sample relationship
summary format presented in the survey); Kleimann Communication
Group, Inc., Report on Development and Testing of Model Client
Relationship Summary, Presented to AARP and Certified Financial
Planner Board of Standards, Inc. (Dec. 5, 2018), available at
<a href="https://www.sec.gov/comments/s7-07-18/s70718-4729850-176771.pdf">https://www.sec.gov/comments/s7-07-18/s70718-4729850-176771.pdf</a>, at
p. 4 (``Readers ask questions when they read, especially of
functional documents. . . . For good design, we want to build upon
this tendency by identifying key questions investors should or are
likely to ask and featuring them prominently in the text, thus
easing the cognitive task for readers. As a result, we used
questions in the headings to introduce each section's major
topic.''); Susan Kleimann, Making Disclosures Work for Consumers,
Presentation to the SEC's Investor Advisory Committee (June 14,
2018), available at <a href="https://www.sec.gov/spotlight/investor-advisory-committee-2012/iac061418-slides-by-susan-kleimann.pdf">https://www.sec.gov/spotlight/investor-advisory-committee-2012/iac061418-slides-by-susan-kleimann.pdf</a> (encouraging
the use of question-and-answer format, the use of headings to make
structure clear, and a strong design grid to organize elements,
among other disclosure design principles, to promote readability),
cited in VASP Adopting Release at n.112 and accompanying text. See
also Office of Investor Education and Assistance, U.S. Securities
and Exchange Commission, A Plain English Handbook (Aug. 1998) (``You
can make complex information more understandable by giving your
readers an example using one investor. This technique explains why
`question and answer' formats often succeed when a narrative
abstraction fails.'').
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Second, we propose to change the order in which the KIT (current
Item 2) appears relative to the Overview of the Contract (current Item
3) disclosures.\80\ The Overview of the Contract disclosures provide
general information about the contract and important context about the
information summarized in the KIT. Based on our observations of
investor testing, we believe RILA investors may generally benefit from
more context to understand
[[Page 71101]]
the KIT disclosures. For example, interview participants generally
found certain RILA-specific terminology confusing, such as ``index,''
``investment term,'' ``interim value adjustment,'' and ``buffer.'' \81\
Further, investor testing indicated that investors had difficulty in
understanding the basic features and concepts of RILA contracts.\82\
The proposed Overview of the Contract disclosures would require
descriptions and examples to help investors understand these RILA
features and provide a basis for better understanding the issues
flagged by the KIT disclosures.\83\ Thus, based on investor testing, we
propose to change the location of the KIT so that it appears after
(rather than before) the Overview of the Contract section. Placing the
Overview of the Contract section first may similarly provide context of
the issues flagged in variable annuity KITs.
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\80\ The current instructions to Form N-4 require that,
notwithstanding 17 CFR 230.421(a), the KIT, Overview, and Fee Table
must be disclosed in numerical order. General instruction C.3(a) of
Form N-4. The proposal would change this instruction to reflect the
change in order.
\81\ See, e.g., OIAD Report at Section 5, Qualitative Testing,
Results from Round 1, Summary of Qualitative Testing, Section 6,
Quantitative Testing, Summary of Quantitative Testing.
\82\ See, e.g., OIAD Report at Section 5, Qualitative Testing,
Summary of Qualitative Testing, Section 6 and 7 Quantitative
Testing, Summary of Quantitative Testing, Section 7, Conclusions,
Summary of Findings.
\83\ See, e.g., proposed Item 2(b)(2) of Form N-4.
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Third, we propose to delete Form N-4's general instruction stating
that where the discussion of information required by the Overview of
the Contract (currently Item 3) or KIT (currently Item 2) also responds
to the disclosure requirements in other items of the prospectus,
registrants need not include additional disclosure in the prospectus
that repeats the information disclosed in the Overview of the Contract
or the KIT.\84\ In administering Form N-4, we have observed that this
instruction has led to confusion on the part of registrants. For
example, while both the KIT and Item 5 require disclosures about
principal risks, the KIT expressly contemplates that more detailed
information will be repeated later in the prospectus, specifically
requiring registrants to provide cross-references to the more detailed
prospectus discussion.\85\ Item 5 requires registrants to summarize the
principal risks of the contract in one place, and was not intended to
permit an insurance company to omit principal risks from that section
if those risks were also disclosed in the KIT.\86\ Moreover, the
layered disclosure framework requires a degree of repetition to ensure
both that the KIT contains key disclosures and that the detailed
sections that follow contain all of the key information about the given
topic. We believe this is particularly important for RILAs in light of
the challenges our investor testing suggests investors have in
understanding these products. This way, investors will see the key
risks regardless of whether they review targeted sections of the
prospectus.
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\84\ General Instruction C.3.(a) of Form N-4.
\85\ See instruction 1(b) to Item 2 of Form N-4.
\86\ See Item 5 of Form N-4; VASP Adopting Release at text
following n.689 (``The principal risks section is designed to
provide a consolidated presentation of principal risks which can be
cross-referenced by registrants to reduce repetition that might
otherwise occur if the same principal risks are repeated in
different sections of the prospectus.'').
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The proposed overall format of the KIT is depicted below:
Table 3--Proposed Key Information Table
------------------------------------------------------------------------
------------------------------------------------------------------------
Fees and Expenses:
Are There Charges for Early
Withdrawals?
Are There Transaction Charges?
Are There Ongoing Fees and Expenses?
Risks:
Is There a Risk of Loss From Poor
Performance?
Is this a Short-Term Investment?
What are the Risks Associated with the
Investment Options?
Is There Any Chance the Insurance
Company Won't Pay Amounts Due to Me
Under the Contract?
Restrictions:
Are There Restrictions on the
Investment Options?
Are there any Restrictions on Contract
Benefits?
Taxes:
What are the Contract's Tax
Implications?
Conflicts of Interest:
How are Investment Professionals
Compensated?
Should I Exchange My Contract?
------------------------------------------------------------------------
(a) Fees and Expenses
RILA contracts typically have implicit fees, expenses, and charges
for early or mid-term withdrawals that can be confusing or surprising
to investors, as observed in our investor testing.\87\ We anticipate
that investors would benefit from tailored disclosure about certain
unique features of a RILA contract's fee and expense structure as
described below to help them make informed decisions.
---------------------------------------------------------------------------
\87\ See, e.g., OIAD Report at Section 5, Qualitative Testing,
Results from Round 1, Results from Round 2.
---------------------------------------------------------------------------
Early Withdrawal Charges. As RILAs may have surrender charges, we
propose to require RILA issuers to provide the existing KIT surrender
charge disclosure in this first line item under the ``Fees and
Expenses'' heading so that RILA investors understand how surrender
charges are assessed (e.g., that if they make a withdrawal within a
specified period after their last premium payment, they may pay a
significant surrender charge that will reduce the value of their
investment).\88\ This disclosure must include the maximum surrender
charge, the maximum number of years that a surrender charge may be
assessed, and an example of the maximum surrender charge an investor
could pay in dollars based on a $100,000 investment. In a change to the
current form requirements, we also are proposing to require that
offerings of both variable annuities and RILAs disclose that this loss
will be greater if there is a negative contract adjustment, taxes, or
tax penalties, to make clear that an investor may lose more than just
the surrender charge upon an early withdrawal.
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\88\ Proposed instruction 2(a) to Item 3 of Form N-4.
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We also are proposing to require specific disclosure on contract
adjustments, which can result in investor losses if the investor
withdraws
[[Page 71102]]
money from an index-linked option, or withdraws money from the RILA
entirely before the end of a specified period.\89\ Specifically, if the
contract includes contract adjustments, the insurance company would be
required to include a statement that if all or a portion of account
value is removed from an index-linked option or from the contract
before the expiration of a specified period, the insurance company will
apply a contract adjustment, which may be negative. Similar to the
disclosures relating to surrender charges, this statement would include
the maximum potential loss (as a percentage of the investment)
resulting from a negative adjustment (e.g., ``[y]ou could lose up to
XX% of your investment due to the contract adjustment''). The insurance
company also would be required to provide an example of the maximum
negative adjustment that could be applied (in dollars) assuming a
$100,000 investment (e.g., ``[i]f you allocate $100,000 to an
investment option with a 3-year crediting period and later withdraw the
entire amount before the 3 years have ended, you could lose up to
$90,000 of your investment. This loss will be greater if you also have
to pay a surrender charge, taxes, and tax penalties.''). We also
propose to require the insurance company to provide a brief narrative
description of the contract transactions subject to a contract
adjustment (e.g., withdrawals, surrender, annuitization, etc.) as part
of the response to this item to make clear to investors the range of
transactions that could result in a contract adjustment.
---------------------------------------------------------------------------
\89\ As noted above, contract adjustments include adjustments
made when amounts are removed prematurely from an index-linked
option, often referred to as interim value adjustments, as well as
adjustments made when amounts are removed prematurely from the
contract, often referred to as market value adjustments. Thus, a
specified period would include index-linked option crediting periods
(which again, are typically referred to by insurance companies as
``investment terms'' or ``terms''), as well as any specified period
relating to a market value adjustment.
---------------------------------------------------------------------------
Transaction Charges. The second line item in the ``Fees and
Expenses'' section of the proposed amended KIT, ``Are there transaction
charges?,'' would require registrants to disclose that the investor may
also be charged for other transactions in addition to surrender charges
(and now contract adjustments), along with a brief narrative
description of the types of such charges (e.g., front loads, charges
for transferring cash value between investment options, etc.).\90\ This
line item is designed to provide a simple narrative description to
alert investors that surrender charges and contract adjustments are not
the only transaction charges they could pay. We are proposing to
require RILA issuers to provide this disclosure.
---------------------------------------------------------------------------
\90\ Proposed instruction 2(b) to Item 3 of Form N-4.
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Ongoing Fees and Expenses. The third line item in the ``Fees and
Expenses'' section, ``Are there ongoing fees and expenses?,'' is
designed to alert investors that they also will bear recurring fees on
an annual basis. This item currently requires the insurance company to
disclose (1) a minimum and maximum annual fee table and (2) a lowest
and highest annual cost table, both along with applicable legends.\91\
The minimum and maximum annual fee table is designed to consolidate the
more detailed information in the Fee Table that appears later in the
prospectus, in order to minimize the need for investors to perform
complex calculations to understand the fees they will pay.\92\ The
lowest and highest annual cost table is designed to provide investors
with a high-level cost illustration that will give investors a tool to
understand the basic cost framework of the contract.\93\ We are
proposing to require RILA issuers to provide this disclosure.\94\
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\91\ See instruction 2(c) to Item 2 of Form N-4. The minimum and
maximum annual fee table requires a tabular description of the fees
and expenses that an investor may pay each year, depending on the
investment options chosen. This includes minimum and maximum
percentages for: base contract fees; portfolio company fees and
expenses; and optional benefits available for an additional charge.
The lowest and highest annual cost table requires a tabular
description of the lowest and highest cost an investor could pay
each year, based on current charges and a set of standardized
assumptions (e.g., $100,000 investment and 5% annual appreciation).
\92\ See VASP Adopting Release at section II.A.1.c.ii.(i), n.144
and accompanying text; see also Item 4 of Form N-4.
\93\ See VASP Adopting Release at section II.A.1.c.ii.(i), n.147
and accompanying text.
\94\ See proposed instruction 2(c) to Item 3 of Form N-4.
---------------------------------------------------------------------------
We also are proposing to require that where a contract imposes
limits on gains on the amount an investor can earn on an index-linked
option, insurance companies disclose that they impose these limits on
gains and that they serve as an implicit ongoing fee.\95\ In other
words, as a result of limits on gains imposed under a contract, an
investor is sacrificing the potential for investment gains that exceed
the cap or other limit on upside performance. Specifically, insurance
companies would prominently state that they impose an implicit ongoing
fee on index-linked options by limiting, through the use of a cap,
participation rate, or some other rate or measure, the amount an
investor can earn on an index-linked option. Further, insurance
companies would state that imposing this limit helps the insurance
company make a profit on the index-linked option, and that, in return
for accepting this limit on index gains, an investor will receive some
protection from index losses. This disclosure would be required to
precede the minimum and maximum annual fee table. If the contract
offers an index-linked option subject to limits on gains but does not
impose any explicit ongoing fees or expenses under the contract, and
thus there would be no need to include the minimum and maximum annual
fee and lowest and highest cost tables, the insurance company would
include this disclosure in lieu of such tables.\96\ Where there are no
explicit ongoing fees, minimum and maximum annual fee and cost tables
showing zero fees could mislead investors because an index-linked
option imposing limits on gains has implicit fees inherent in limiting
upside index participation.
---------------------------------------------------------------------------
\95\ See proposed instruction 2(c)(i)(G) to Item 3 of Form N-4.
\96\ Proposed instruction 2(c)(iii) to Item 3 of Form N-4.
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Lastly in this line item, we propose to revise the last sentence in
the required legend in the lowest and highest annual cost table to
include the underlined language: ``This estimate assumes that you do
not take withdrawals from the Contract, which could add surrender
charges and negative Contract Adjustments that substantially increase
costs.'' \97\ This would further alert investors to the cost impact of
a contract adjustment if they withdraw money early.
---------------------------------------------------------------------------
\97\ See proposed Instruction 2(c)(ii)(A) to Item 3 of Form N-4.
Currently, this legend only refers to surrender charges, not
negative contract adjustments.
---------------------------------------------------------------------------
(b) Risks
Risk of Loss. Under the first line item in the amended KIT under
the heading ``Risks,'' ``Is there a risk of loss from poor
performance?,'' we would, as required by an existing instruction in the
form, require RILA issuers to state that an investor can lose money by
investing in the contract. RILAs, like variable annuities, are subject
to the risk of investment loss. We also are proposing to amend this
instruction to provide that, if an annuity contract offers an index-
linked option, the insurance company must disclose, as a percentage,
the maximum amount of loss an investor could experience from negative
index performance, after taking into account the minimum guaranteed
limit on index loss provided under the
[[Page 71103]]
contract.\98\ For example, with a guaranteed buffer of -10%, a
registrant would disclose that investors could lose up to 90% of their
investment in an index-linked option due to poor index performance even
with the loss limitation feature. This amendment is designed to make
clear to investors investing in an index-linked option that they can
still lose money even though index-linked options typically include
features designed to limit investment loss.
---------------------------------------------------------------------------
\98\ See proposed Instruction 3(a) to Item 3 of Form N-4.
---------------------------------------------------------------------------
Short-Term Investment. The second line item under the Risks
heading, ``Is this a short-term investment?,'' currently requires a
statement that the contract is not a short-term investment and is not
appropriate for an investor who needs ready access to cash along with a
brief explanation. This statement and an accompanying brief explanation
is equally applicable to RILAs and we therefore would require RILA
issuers to make the same disclosure.\99\ We also are proposing to amend
this item to require issuers of RILAs and variable annuities to state
that (1) amounts withdrawn from the contract may result in surrender
charges, taxes, and tax penalties; and (2) if applicable, that amounts
removed from an index-linked option or the contract before a specified
period may also result in a negative contract adjustment and loss of
positive index performance. These disclosures are designed to make
clear to investors some of the key reasons why these investments are
not short-term investments. These disclosures are particularly
important for an investor considering a RILA in light of the potential
negative consequences if the investor withdraws money early from a
particular index-linked option or the contract. We are not limiting
these disclosures to contracts with index-linked options, however,
because these disclosures may be equally material for a variable
annuity. To further illustrate that index-linked options are not short-
term investments even though they may have a short crediting period, we
also propose new risk disclosure for index-linked options that would
require issuers offering such investment options to state that contract
value will be reallocated at the end of the crediting period according
to the investor's instructions, and to disclose the default
reallocation in the absence of such instructions.
---------------------------------------------------------------------------
\99\ See proposed instruction 3(b) to Item 3 of Form N-4.
---------------------------------------------------------------------------
Risks Associated with Investment Options. The third line item under
the Risk heading, ``What are the risks associated with the investment
options?,'' is intended to focus on the general risk of poor investment
performance.\100\ Currently, the KIT therefore requires the insurance
company to state that: (1) an investment in the contract is subject to
the risk of poor investment performance and can vary depending on the
performance of the investment options available under the contract; (2)
each investment option will have unique risks; and (3) the investor
should review these investment options before making an investment
decision. We are proposing conforming changes to the required statement
to refer to index-linked options now that RILAs are included on Form N-
4.\101\
---------------------------------------------------------------------------
\100\ VASP Adopting Release at the text accompanying n.170.
\101\ See proposed instruction 3(c) to Item 3 of Form N-4.
---------------------------------------------------------------------------
We also are proposing to require the insurance company to provide
additional information about any index-linked options offered under the
contract to highlight how the insurance company limits the investor's
participation in gains and losses of the index. For the risk of limited
upside, the insurance company would be required to (1) state that the
cap, participation rate, or some other rate or measure, as applicable,
will limit positive index returns (e.g., limited upside), (2) provide
an example for each type of limit imposed under the contract (e.g., if
the index return is 12% and the cap rate is 4%, the insurance company
will credit the investor 4% in interest at the end of the term), and
(3) prominently state that this may result in the investor earning less
than the index's return.\102\
---------------------------------------------------------------------------
\102\ See proposed instruction 3(c)(A) to Item 3 of Form N-4.
---------------------------------------------------------------------------
For the risk of limited protection in the case of market decline,
the insurance company would be required to (1) state that the floor,
buffer, or some other rate or measure, as applicable, will limit
negative index returns (e.g., limited protection in the case of market
decline), (2) provide an example for each type of limit imposed under
the contract (e.g., ``if the Index return is -25% and the buffer rate
is -10%, we will credit -15% (the amount that exceeds the buffer rate)
at the end of the crediting period''), and (3) prominently state that
even after limiting a negative index return, investors could still lose
up to XX% of their investment.\103\ The disclosure in this row of the
KIT is designed to highlight that each investment option, including an
index-linked option, will have unique risks. The proposed disclosure on
index-linked options would highlight one of the central economic
tradeoffs index-linked options present: that an investor will sacrifice
the potential for returns if the index goes up in exchange for some
protection from loss if the index goes down.
---------------------------------------------------------------------------
\103\ See proposed instruction 3(c)(B) to Item 3 of Form N-4.
---------------------------------------------------------------------------
Insurance Company Risks. The fourth line item under the Risk
heading, ``Is there any chance the insurance company won't pay amounts
due to me under the contract?,'' is meant to alert investors that any
obligations, guarantees, or benefits under the contract that may be
subject to the claims-paying ability of the insurance company will
depend on the financial solvency of the insurance company.\104\ Form N-
4 therefore currently requires the insurance company to include a
statement to this effect in this row of the KIT and either to provide
the insurance company's financial strength ratings or state, if
applicable, that they are available upon request. We propose to require
a RILA issuer to provide the same statement, with a conforming change
to include index-linked options as an obligation of the insurance
company.\105\
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\104\ See VASP Adopting Release at section II.A.1.c.ii.(ii); see
also proposed Instruction 3(d) to Item 2 of Form N-4 (``State that
an investment in the Contract is subject to the risks related to the
Insurance Company, including that any obligations (including under
any Fixed Options and Index-Linked Options), guarantees, or benefits
are subject to the claims-paying ability of the Insurance
Company.'').
\105\ See proposed instruction 3(d); see also infra section
II.B.7(b) (discussing changes of Form N-4's defined terms, including
replacing ``depositor'' with ``insurance company,'' to facilitate
inclusion of RILAs on the form).
---------------------------------------------------------------------------
(c) Restrictions
Investments. We propose to require RILA issuers to include the
disclosure required by the first line item under the heading
``Restrictions,'' ``Are there limits on the Investment Options?'' This
current item would be modified to require the insurance company to
state whether there are any restrictions that may limit the investment
options that an investor may choose, as well as any limitations on the
transfer of contract value among investment options.\106\ As these
limitations can exist for RILAs, we propose to require RILA issuers to
make
[[Page 71104]]
this disclosure so that investors can assess that disclosure in
determining whether the RILA is an appropriate investment for them.
---------------------------------------------------------------------------
\106\ See proposed instruction 4(a) to Item 3 of Form N-4. The
current item requires the insurance company to state whether there
are any restrictions that may limit the investments that an investor
may choose, as well as any limitations on the transfer of contract
value among portfolio companies. Consistent with the corresponding
changes made to defined terms, we would also clarify that this item
applies to any investment option, not just the portfolio companies
available as investment options under a variable option. See infra
section II.B.7.
---------------------------------------------------------------------------
Currently, the form also generally requires the insurance company
to state that it reserves the right to remove or substitute portfolio
companies as investment options, if applicable. Insurance companies
typically reserve the right to change the index-linked options that are
available under a contract as well as key features of available index-
linked options. To alert investors that the available index-linked
options and key terms of those index-linked options may change in the
future we are proposing to require the insurance company to state any
reservation of its rights under the contract, including, if applicable,
the right to (1) add or remove index-linked options, (2) change the
features of an index-linked option from one crediting period to the
next, including the changes to the index and the current limits on
gains and limits on index losses (subject to contractual minimum
guarantees), and (3) substitute the index of an index-linked option
during its crediting period. We are also proposing to require that
insurance companies disclose any right to stop accepting additional
purchase payments, which may be significant to investors given the
impact this reservation can have on investors' ability to accumulate
contract value for retirement, grow the death benefit, and increase
optional benefit values.
Contract Benefits. The second line item under ``Restrictions,''
``Are there any restrictions on contract benefits?'' requires a
statement about whether there are any restrictions or limitations
relating to benefits offered under the contract, and/or whether a
benefit may be modified or terminated by the insurance company. It also
requires a statement that withdrawals that exceed limits specified by
the terms of a contract benefit may affect the availability of the
benefit by reducing the benefit by an amount greater than the value
withdrawn and/or could terminate the benefit. We are proposing that
this item be broadened to include disclosure on restrictions or
limitations relating to any benefit under the contract, not just
optional benefits (as currently required). While a benefit under the
contract might be characterized as standard, it could have restrictions
that should be disclosed in the KIT because of the benefit's importance
to the investor's rights under the contract, such as a proportionate
withdrawal calculation under a standard death benefit.\107\ We propose
to require RILA issuers to include this disclosure, as such disclosure
is equally applicable to RILAs as it is to variable annuities.
---------------------------------------------------------------------------
\107\ See proposed instruction 4(b) to Item 3 of Form N-4.
Similarly, we are proposing a change to the discussion in the
overview of the contract item about contract features that would
broaden that discussion to cover both optional and standard contract
benefits. See proposed Item 2(c) of Form N-4.
---------------------------------------------------------------------------
(d) Taxes
We also propose to require RILA issuers to include the line item
under the heading ``Taxes,'' ``What are the Contract's tax
implications?'' \108\ This line item is designed to alert investors to
the tax implications of variable contracts and, as we propose to amend
this item, of RILAs. It currently requires a statement that an investor
should consult with a tax professional to determine the tax
implications of an investment in, and purchase payments received under,
the contract. The insurance company must also state that there is no
additional tax benefit to the investor if the contract is purchased
through a tax-qualified plan or individual retirement account
(``IRA''), and that withdrawals will be subject to ordinary income tax
and may be subject to tax penalties. We propose to subject RILAs to
this requirement because the same tax considerations apply.
---------------------------------------------------------------------------
\108\ See proposed instruction 5 to Item 3 of Form N-4.
---------------------------------------------------------------------------
(e) Conflicts of Interest
Investment Professional Compensation. We propose to require RILA
issuers to include the first line item under the heading ``Conflicts of
Interest,'' ``How are investment professionals compensated?'' \109\
This current line item for variable contracts is designed to alert
investors to the existence of compensation arrangements for investment
professionals and the potential conflicts of interest arising from
these arrangements.\110\ It requires issuers to disclose that an
investment professional may be paid for selling the contract to
investors. An issuer must describe the basis upon which such
compensation is typically paid (e.g., commissions, revenue sharing,
compensation from affiliates and third parties). An issuer providing
the required disclosure also must state that investment professionals
may have a financial incentive to offer or recommend the contract over
another investment. The same compensation arrangements and potential
conflicts are relevant for RILAs, and we therefore are proposing to
require an insurance company registering a RILA to provide the same
disclosure.
---------------------------------------------------------------------------
\109\ See proposed instruction 6(a) to Item 3 of Form N-4.
\110\ See VASP Adopting Release at section II.A.1.c.ii.(v).
---------------------------------------------------------------------------
Exchanges. We propose to require RILA issuers to include the second
line item under the heading ``Conflicts of Interest,'' ``Should I
exchange my Contract?,'' with conforming changes.\111\ This current
line item for variable contracts is designed to alert investors to
potential conflicts of interest that may arise from contract sales that
stem from exchanges.\112\ It requires issuers to state that some
investment professionals may have a financial incentive to offer a new
contract in place of the one owned by the investor. An issuer must
further state that investors should only exchange their contract if
they determine, after comparing the features, fees, and risks of both
contracts, that it is preferable to purchase the new contract rather
than continue to own the existing contract. These same considerations
apply to an investor considering an exchange involving a RILA. In a
change that would apply to variable annuities and RILAs, and to put
investors on notice that there may also be costs or charges associated
with terminating an existing contract, we are also proposing that
issuers disclose in this legend that investors should consider any fees
or penalties to terminate the existing contract in considering whether
to exchange a contract.
---------------------------------------------------------------------------
\111\ See proposed instruction 6(b) to Item 3 of Form N-4; see
also infra section II.B.7.
\112\ See VASP Adopting Release at section II.A.1.c.ii.(v).
---------------------------------------------------------------------------
(f) Requests for Comment on Key Information Table
We request comment generally on the proposed amendments to the KIT,
and specifically on the following issues.
14. Should we require all issuers to provide the ``Overview of the
Contract'' disclosure before the KIT, as proposed? Would this provide
relevant context for an investor to help understand the KIT disclosure
or, conversely, would it detract from the KIT's efficacy in conveying
key information about the contract up front in a consistent format? Are
there other reasons to precede the KIT disclosure with the current
``Overview of the Contract'' disclosure? Alternatively, should we allow
issuers to maintain the current order of disclosure and include new
rows in the KIT to provide contract overview disclosure to investors?
Would this be a more effective way to provide context for investor to
understand the KIT, or
[[Page 71105]]
would it lead to disclosure that is too lengthy for the KIT format and
potentially duplicate disclosure in the Overview of the Contract
section of the prospectus? Alternatively, should we require the
Overview of the Contract to precede the KIT only in prospectuses
offering annuity contracts with index-linked options, rather than for
all issuers?
15. Should we add disclosure to the KIT regarding whether index-
linked options offered under the contract are based on a price return
index (i.e., an index that only reflects price movements of the
security) or a total return index (i.e., one that includes additionally
factors like dividends), so that, where appropriate, investors
understand whether or not they can expect their account value to
increase as a result of dividends?
16. Should we add any additional headings and sub-headings to the
KIT, for example, a new heading ``Contract Overview,'' with related
line items or sub-headings ``What is the purpose of the contract?,''
``What is the time period for measuring growth (or loss) on my contract
value?,'' and/or ``Who may the contract be appropriate for?''? Would
this information be helpful to an investor in providing context for the
KIT disclosure or, conversely, would these requirements lead to lengthy
disclosure that makes the KIT less investor friendly?
17. Would rephrasing the topics of the KIT line items in a question
format and requiring the descriptions in the right-hand column of the
KIT to be presented in an answer format, as proposed, be helpful for
investors making an initial purchase of an annuity contract? Should we
make the Q&A format mandatory for all issuers that use Form N-4? Or
should we instead require that issuers state the line items in the
left-hand column as brief descriptions of the topics to be detailed in
the right-hand column of the KIT, as is currently required? Should any
of the required line items or sub-headings be worded in a different
way, or using different terminology, than the proposal would require?
18. Should we allow issuers to change the wording of the line item
questions in circumstances where the changes would not impede investor
comprehension and clear, consistent disclosure? Could this undermine
standardized disclosures and investors' ability to make comparisons of
certain disclosure topics among RILA and variable annuity prospectuses,
or would issuers' ability to customize the disclosure lead to more
informed investor decisions about that particular RILA?
19. Should we require issuers to add a new column in the KIT
labeled ``Location in the Prospectus'' or similar caption, and place it
next to the relevant disclosure presented in the table to provide
hyperlinked cross-references directly to the location in the statutory
prospectus where the investor can find more detailed information about
the subject matter or should we, as proposed, continue to permit
issuers to provide cross-references either within the table row or
presented as an additional column? Are there any particular sub-
headings or captions that would help investors identify where to find
information?
20. Should we mandate particular examples or illustrations in the
KIT? For example, should we require a chart of historical index
performance with the guaranteed minimum cap overlaid? Should we require
a table showing examples of the dollar amounts of losses and gains,
without fees, an investor would face in a variable annuity as compared
to RILAs with various floors, buffers, and caps over a four-year period
assuming various index movements? \113\ Are there other useful examples
or illustrations currently provided by RILAs that help to illustrate
their structure effectively to investors that we should include in the
KIT? For example, should we require a graphic in the KIT to illustrate
surrender charges and contract adjustments during different time
periods of the contract? If so, what should the requirements for these
graphics or illustrations be? Should we require illustrations in the
KIT showing how caps, floors, and/or buffers could affect an investor's
returns across different market scenarios? If so, what should these
scenarios be? As another example, we request comment below on requiring
insurance companies to disclose the difference between a hypothetical
$100,000 investment in an index-linked option and the value, or the
cost to assemble, the economic components underlying the index-linked
option.\114\ Should that disclosure be required in the KIT?
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\113\ See N.Y. Comp. Codes R. & Regs. tit. 11, App. 28.8 (2023).
\114\ See Section II.B.3.b.
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21. We have proposed that insurance companies include disclosures
in the KIT regarding any limits on gains the RILA imposes, including an
illustrative example demonstrating the operation of those limits. Would
this disclosure be improved by requiring that the example conform to
any specific parameters? Would other examples be helpful? For example,
should we require that the example use the most common limit on gains
offered under the RILA for the previous year? Should we require that
the example disclose the amount of gains an investor would have given
up due to the limit over the prior ten years, based on the index's
performance during that time and assuming the limit on gains discussed
in the example applied during each of those ten years? Should we
require that the example use only round numbers?
22. Should we allow or require issuers to provide cross-references
to charts or other graphics designed to facilitate investor
understanding of RILAs, including, e.g., educational resources designed
by the Commission staff? Should we require issuers to provide these
hyperlinked cross-references in the current right-hand column of the
KIT directly after the relevant sentence of disclosure? Would the KIT
be more succinct and easier to read if the hyperlinked cross-references
were placed on the cover page of the prospectus instead of the KIT?
Would requiring the registrant to state ``More information can be found
at:'' before or after these cross-references help investors easily find
the information they may need to make an informed investment decision?
Should we require cross-references to other prospectus sections to
include a specific page number in the prospectus where an investor
could find the information?
23. Besides hyperlinks, are there other technological tools that
would help an investor find information that is cross-referenced in the
KIT or on the cover page of the prospectus, such as QR codes or other
technological tools?
24. Is the level of detail of the disclosure that we propose in
each line item of the KIT appropriate? Does it strike the right balance
between providing enough information to alert an investor to the most
salient facts (including ongoing implicit fees, expenses, risks, and
conflicts) of the RILA contract, but not too much, or too detailed
information? If not, how should we modify the table and/or the
instructions? Are there other key features of RILA contracts that RILA
issuers should disclose in the KIT to help investors make an informed
investment decision?
25. RILAs are frequently marketed as a way to protect against
investment losses through loss-limiting features such as buffers and
floors. Should we require RILA issuers to provide more detailed
disclosures about how these loss-limiting features have affected RILA
investors historically? For example, would investors be better
positioned to
[[Page 71106]]
make informed decisions if we were to require RILA issuers to disclose:
(a) the total number of investor crediting periods (across all
investors and index-linked options) that utilized a loss-limiting
feature for a certain historical period (e.g., the past five years);
(b) the percentage of those investor crediting periods where an
investor's contract value benefited from a loss-limiting feature
(because the feature eliminated or reduced a negative credit resulting
from the performance of the index-linked option); and (c) the
percentage of those investor crediting periods where an investor's
contract value was not impacted by a loss-limiting feature. Should a
RILA issuer have experience with a certain minimum number of crediting
periods in order to be subject to this disclosure? What should a RILA
issuer disclose if their experience with loss-limiting features does
not meet the minimum threshold? Where in the prospectus would be the
appropriate location for this information? For example, if we require
this disclosure, do commenters feel it would be best positioned as part
of the KIT, in Item 6 (in the Limits on Index Losses section), or in
the Contract Overview? Are there other disclosures that commenters
would recommend in the alternative as a way to increase investor
knowledge about the utility of loss-limiting features and their ability
to positively affect investors' contract values? Whether or not we
require more detailed disclosures about the historical effects of loss-
limiting features, should we require similar disclosure about the
historical effects of limits on gains (i.e., upper limits on an
investor's ability to participate in an index-linked option's upside
performance)? Should we require disclosure comparing the economic
effects of the limits on gains to the limits on losses? For example,
should we require disclosure of the number of periods in which each
limit would have actually limited an investor's losses or capped an
investor's gains? Should we require disclosure of the dollar value of
losses an investor would be protected against compared to gains an
investor would give up over a prescribed period of time, such as the
past 10 years?
26. Are there any particular legends that should be included in the
KIT, e.g., ``We will not return your money at the end of the crediting
period unless you tell us to,'' ``The contract adjustment applies in
addition to any surrender charge,'' ``You may earn less than the
index's return,'' and/or ``You may lose up to [X]% of your investment
if you withdraw your money before the end of a crediting period. This
loss can be greater if there is a surrender charge, taxes, and/or tax
penalties''? If so, what legends and why?
27. Is the process of what happens at the end of the crediting
period adequately highlighted in the proposed KIT? Should insurance
companies be required to provide more specific details, either in the
KIT or elsewhere in the prospectus, about how investors can choose an
investment option at the end of the crediting period and the
limitations on those choices?
28. Would the disclosure that a RILA issuer would provide in
response to the proposed ``Fees and Expenses'' line items convey the
appropriate amount of information to investors and concisely alert
investors to the most important fees, charges, penalties, and expenses
associated with the RILA contract?
29. Should the proposed ``Fees and Expenses'' line item, ``Are
there charges for early withdrawals?,'' include disclosure both about
the surrender charges and contract adjustments, as proposed? Would this
disclosure sufficiently alert investors to the typical contract
adjustment of a contract and its impact in reducing contract value (in
addition to any surrender charge) if the investor withdraws money
before the expiration of a specified period? Alternatively, should we
sub-divide this line item into two line items, with the one focused on
surrender charges and the other titled (for example) ``Are there
penalties for mid-term withdrawals?,'' focused on contract adjustments?
Would this help an investor to understand both concepts better? Or
would sub-dividing the line item cause confusion, for example by making
it seem as if a surrender charge and a contract adjustment could not
apply simultaneously? If so, should we require an explicit disclosure
that they could apply simultaneously?
30. Would the Minimum and Maximum Annual Fee and Lowest and Highest
Cost tables assist investors in understanding the costs of their
investment and help them compare the costs of different investment
options and optional benefits in the RILA context? Should we modify the
proposed disclosure or require other additional information to
accompany the tables?
31. Would the proposed disclosure that an issuer would provide
about contracts that do not impose ongoing fees and expenses adequately
convey the implicit ongoing fees of contracts with index-linked options
that have features that limit positive index return? If not, should we
modify the proposed disclosure or require additional information from
issuers?
32. Would the disclosure that a RILA issuer would provide in
response to the proposed ``Risks'' line items adequately convey an
overview of the risks of investing in a contract with an index-linked
option? Are there other risks of investing in these contracts that we
should require a registrant to disclose in the proposed KIT? For
example, should we require RILA issuers to state that an investor can
lose money by investing in these contracts including a loss of
principal? Alternatively, should we require all issuers to state this,
not just RILA issuers?
33. Would the disclosure that a RILA issuer would provide in
response to the proposed ``Restrictions'' line items convey the
appropriate amount of information about certain restrictions that
various contract options may entail, in light of the goals of the
proposed KIT and the unique nature of a RILA? Should an issuer be
required to disclose information about restrictions in the KIT other
than those associated with the contract's investment options and
benefits? If so, what? Instead, should we provide flexibility by
permitting issuers to disclose other restrictions at their discretion?
Do commenters agree that our proposal to require disclosure about
restrictions on contract benefits generally (as opposed to the current
requirement which is limited to optional benefits) is appropriate?
34. Is the disclosure that a RILA issuer (along with other issuers
that use Form N-4) would be required to provide in response to the
proposed ``Taxes'' line item appropriate, in light of the goals of the
proposed KIT? Given that some investors in these products may not have
the means or ability to consult a tax professional, should we require
additional disclosures in addition to the required statement that
investors should consult a tax professional? For example, should a RILA
issuer be required to consider which tax consequences are most likely
be faced by retail investors and to provide general information
regarding those consequences? For example, should an issuer be required
to emphasize more prominently that withdrawals will be subject to
ordinary income tax, and not the capital gains rates? Should the line
item require disclosure of the specific tax penalties and requirements
that investors in annuity contracts may incur (e.g., penalties for
withdrawal before age 59\1/2\, or that purchases through a tax-
qualified plan may be subject to required minimum distribution each
year beginning at age 70\1/2\)?
[[Page 71107]]
35. Are the disclosures that a RILA issuer (along with other
issuers that use Form N-4) would be required to provide in response to
the proposed ``Conflicts of Interest'' line items appropriate, in light
of the goals of the proposed KIT? Would these disclosures adequately
apprise investors of the potential conflicts that arise when their
investment professional is compensated for recommending an investment
into a new, or an exchange from, an existing RILA contract or variable
annuity contract? Should we revise these proposed disclosure
requirements, and if so, how?
36. Do the instructions associated with each of the proposed line
items clearly explain what an issuer would be required to disclose? In
keeping with the structured format of a tabular presentation, we sought
to promote concise disclosure by largely directing issuers to state,
rather than to explain, certain information in response to the required
line items. Should the instructions prescribe specific language or
should issuers have flexibility in drafting their responses? Are there
any particular instructions that we should include or modify in any
way, for clarity or for any other reason?
37. Should we require particular terms in the KIT (e.g., those that
are defined in a related glossary or list of definitions that the
insurance company chooses to include) to be formatted in a way that
will emphasize them, or indicate that they are defined elsewhere in the
prospectus, for example by using bold and/or italic font?
38. Should we apply the structural changes we are proposing to the
KIT in other variable insurance contract registration forms, that is,
Forms N-3 and N-6? The principles we outlined above regarding the
potential efficacy of these changes could be just as applicable in the
context of those forms as in the context of Form N-4. For example,
should we apply the proposed requirements for Forms N-3 and N-6 issuers
to present all disclosures in the KIT in a Q&A format and to begin each
response with a ``yes'' or ``no'' in bold text when answering a
question presented in a given row of the KIT, unless the context
otherwise requires? Similarly, should we require in those forms that
issuers include in their required legends on contract exchanges that
investors consider any fees or penalties to terminate the existing
contract before exchanging their contracts?
3. Principal Disclosure Regarding RILAs (Items 2, 6, and 17)
We are proposing amendments to Form N-4 to provide investors with
the principal disclosures regarding RILAs and the index-linked options
available under the contract in three items of the form. First,
investors would receive a concise description of the basic information
about any index-linked option available under the contract as well as
any contract adjustments in Item 2 (Overview of the Contract), which,
as discussed above, would appear before the KIT.\115\ Second, investors
would be provided with detailed information about the index-linked
options available under the contract in Item 6 (Description of the
Insurance Company, Registered Separate Account, and Investment
Options). Lastly, investors would be provided with a summary
information table, with legends highlighting risks, that outlines the
available index-linked options in Item 17 (Investment Options Available
Under the Contract). These amendments build on the existing disclosure
requirements in each item to help ensure that investors have key
information about the annuity contract and available investment
options, regardless of whether the contract is a variable annuity, a
RILA, or combination contract offering both variable and index-linked
options.
---------------------------------------------------------------------------
\115\ Because we propose to require the KIT to appear before the
Overview of the Contract, current Item 3 (Overview of the Contract)
would be renumbered as Item 2.
---------------------------------------------------------------------------
(a) Overview of the Contract (Item 2)
We are proposing to amend Item 2 (Overview of the Contract) to
include information about RILAs generally and require the insurance
company to provide an overview of certain key elements of any index-
linked options offered under the contract and to highlight any contract
adjustments. This item is designed to describe certain basic and
introductory information about the contract and its benefits.\116\ It
currently requires a concise description of the contract. This
description must include information about (1) the contract's purpose
(e.g., to help the investor accumulate assets through an investment
portfolio), (2) the phases of the contract (the accumulation (savings)
and annuity (income) phases) including a discussion of the investment
options available under the contract, and (3) the primary features of
the contract (such as death benefits).
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\116\ See VASP Adopting Release at text accompanying n.207.
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We would require insurance companies to provide this existing
disclosure when registering RILA offerings, adjusted to account for the
specifics of RILAs, because it is equally relevant for these types of
annuity contracts. In particular, in addition to the general
information about the contract already required by Form N-4, the
following information would be required with respect to any index-
linked option offered under the contract:
<bullet> A statement that the insurance company will credit
positive or negative interest at the end of a crediting period to
amounts allocated to an index-linked option based, in part, on the
performance of the index;
<bullet> A statement that an investor could lose a significant
amount of money if the index declines in value and prominent disclosure
of the maximum amount of loss (as a percentage) an investor could
experience from negative index performance, after taking into account
the minimum guaranteed limit on index loss provided under the contract;
and
<bullet> An explanation that the insurance company limits the
negative or positive index returns used in calculating interest
credited to an index-linked option at the end of its crediting period,
accompanied by a brief description of the manner in which such returns
may be limited, along with an example and disclosure of the minimum
limit on index losses guaranteed for the life of the contract for any
index-linked option.\117\
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\117\ See proposed Item 2(b)(2)(i) through(iv) of Form N-4.
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We also are proposing to require the insurance company to state, if
applicable, that an investor could lose a significant amount of money
due to the contract adjustment if amounts are removed from an index-
linked option or from the contract prior to the end of a specified
period.\118\ The issuer would also provide a brief description of the
transactions subject to a contract adjustment. We would require a
prominent statement, as a percentage, of the maximum amount of loss an
investor could experience from a negative contract adjustment and that
this loss could be greater due to surrender charges and tax
consequences.
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\118\ See proposed Item 2(d) of Form N-4.
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These disclosures, together, are designed to highlight upfront some
of the key elements of a RILA. The required disclosure about any index-
linked option offered under the contract would highlight for investors
the key
[[Page 71108]]
features of these investment options in general: that returns are based
in part on an index, that investors could still lose a significant
amount of money under the contract, and that there are limits on both
positive and negative index performance. The required disclosure on
contract adjustments would highlight a separate but important
consideration for an investor considering investing in a RILA: that in
addition to any losses from poor index performance, the investor also
can lose a significant amount of money if the investor takes money out
of an index-linked option or the contract early. These disclosures
collectively also would provide context for the KIT, which immediately
follows this item under the proposal, as well as context for more
detailed disclosures that would appear elsewhere in the prospectus.
In addition to these items that are specific to RILAs, we also are
proposing to expand the current requirements for disclosures regarding
optional benefits in Form N-4. Currently, when summarizing a contract's
primary features, the form requires a discussion of any optional
benefits.\119\ A benefit under the contract, such as a non-optional
guaranteed living benefit, might be characterized as a standard (i.e.,
not optional) benefit but nonetheless be a key feature of the contract
that should be highlighted for investors in the overview section of the
prospectus. We are therefore proposing to require that the discussion
of benefits cover all of the primary contract benefits, not just
optional benefits.\120\ This requirement would apply to all contracts
registered on the form.
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\119\ See current Item 3(c) of Form N-4.
\120\ See proposed Item 2(c) of Form N-4; see also supra
footnote 107 and accompanying text.
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We request comment on the proposed summary disclosures contained in
Item 2.
39. Is the proposed information on index-linked options and
contract adjustments appropriate? Is there other or different
information we should require? For example, we are proposing to require
RILA issuers to include examples of how limits on gains and downside
protection operate but do not mandate a form of presentation. Should we
require these examples be provided in a graphical presentation, or
require only a narrative example? Should we require the examples be
converted into a dollar amount? Would investors understand the examples
more readily if we did this? As another example, should we require RILA
issuers to briefly summarize the index crediting methodologies
available under the contract?
40. Should we require the proposed disclosures for index-linked
options and contract adjustments in Item 2, including the existing
disclosure to be provided in the context of a RILA? Is this information
necessary for investors to understand the other disclosures in the
prospectus?
41. Should we, as proposed, broaden the current discussion of the
primary contract features to include a discussion of contract benefits
generally, not just optional benefits (the current focus of the
disclosure requirement)?
(b) Description of Insurance Company, Registered Separate Account, and
Investment Options (Item 6)
We propose to amend Item 6 of Form N-4 to modify certain existing
disclosure requirements and to expand the item to include new
disclosures for RILAs. Proposed Item 6(d), discussed further below,
would set forth most of the substantive new disclosure requirements for
contracts that include index-linked options. We would also include new
disclosures for any fixed options provided as part of the contract. The
information that would be required by the proposed amendments is
designed to convey key aspects of each index-linked option offered
under the contract to investors.
As an initial matter, the proposed amendments to Item 6 would
largely retain the existing requirement to provide a concise discussion
about the insurance company, registered separate account, and variable
options, subject to certain modifications in nomenclature to implement
definitional changes and minor restructuring to accommodate the
addition of RILAs to the form.\121\ Specifically, these changes would
incorporate the proposed changes to certain defined terms and revise
existing disclosures to clarify the entities that should be associated
with certain disclosures (e.g., because the insurance company would be
obligated to pay all amounts promised to investors under the contracts
subject to its financial strength and claims-paying ability, we would
require disclosure about this topic to be framed in terms of the
insurance company, not the registered separate account, as the
requirement is currently worded).\122\
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\121\ See proposed Item 6(a) through (c) of Form N-4.
\122\ We also propose to add an instruction requiring the
insurance company to indicate whether it is relying upon the
exemption provided by 17 CFR 240.12h-7 (``rule 12h-7''), consistent
with the requirements of that rule. See proposed Instruction to Item
6(a) of Form N-4; see also rule 12h-7(f) (requiring issuers of
securities subject to insurance regulation that rely on the
exemption from the duty to file section 13(a) reports with respect
to securities registered under the Securities Act to provide a
statement indicating that fact in the relevant prospectus).
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We are proposing to require one new disclosure item for contracts
that offer variable options, which would be similar to a proposed
disclosure for index-linked options, discussed below. Specifically, the
prospectus for such contracts would be required to include a statement
indicating that ``contract value allocated to a Variable Option will
vary based on the investment experience of the corresponding Portfolio
Company in which the Variable Option invests,'' and ``there is a risk
of loss of the entire amount invested.'' \123\ The risk of loss
inherent in a variable annuity is currently disclosed in the form's
``Key Information Table,'' and we are proposing to mandate this
disclosure in Item 6 as well to warn that an investor can lose the
entire amount invested in a variable option. In addition to informing
investors about investment risks in a variable option generally, where
an annuity contract offers both variable and index-linked options, this
disclosure also would help to explain the different nature of the
investment risks posed by each kind of investment option. In that case
the prospectus would disclose the maximum loss associated with the
index-linked options while also disclosing that, for the variable
options, the investor could lose the entire amount invested.
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\123\ See proposed Item 6(c)(1) of Form N-4.
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Description of Index-Linked Options
We are proposing to require the insurance company to disclose
information about the key features of the index-linked options
currently offered under the contract.\124\ These proposed disclosures
are designed to complement other proposed disclosures in the prospectus
about index-linked options generally by providing investors specific
information about each index-linked option's features and risks, akin
to the information that is currently available to investors about
variable options in the prospectuses for the mutual funds underlying
those options. Specifically, the insurance company would be required to
describe the index-linked options currently offered under the contract
as well as information about how interest is calculated and credited
for each index-linked option, specifically: (1) limits on index losses;
(2) limits on index gains; (3) crediting period; (4) crediting
methodology and
[[Page 71109]]
examples; (5) relevant indexes; (6) maturity; and (7) other material
features of the index-linked option. These disclosures are intended in
part to address points that investors found to be confusing in investor
testing.\125\ Further, some investors in the qualitative interviews
indicated that they would prefer more information about these points
relative to the KIT disclosures.\126\
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\124\ See proposed Item 6(d) of Form N-4.
\125\ See OIAD Study at Section 7, Conclusions, Summary of
Findings and Discussion.
\126\ See OIAD Study at Section 5, Qualitative Testing, Summary
of Qualitative Testing.
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Description of the Index-Linked Options Currently Offered
Under the proposed amendments, RILA issuers would be required to
describe the index-linked options currently offered under the contract,
including statements indicating that the insurance company will credit
positive or negative interest at the end of a crediting period to
amounts allocated to an index-linked option based, in part, on the
performance of the index.\127\ To dispel potential investor confusion
relating to the reference to an index, we are proposing to require RILA
issuers to state that an investment in an index-linked option is not an
investment in the index or in any index fund.
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\127\ See proposed Item 6(d)(1) of Form N-4.
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Other cautionary statements regarding the index-linked options
offered would include that the potential for investment loss could be
significantly greater than the potential for investment gain, and that
an investor could lose a significant amount of money if the index
declines in value. To illustrate the potential scope of such a loss,
RILA issuers would have to prominently state (as a percentage) the
maximum amount of loss an investor could experience from negative index
performance over a crediting period, after taking into account the
minimum guaranteed limit on index loss provided under the contract.
Because index-linked options are often marketed as a way to limit
investment losses, this disclosure is designed to convey to investors
that they could still lose a significant amount on an index-linked
option, despite having a floor or buffer.
To emphasize the substantial risks associated with an early
withdrawal from an index-linked option, RILA issuers would be required
to state that an investor could lose a significant amount of money due
to the contract adjustment if amounts are removed from an index-linked
option prior to the end of its crediting period. To further underscore
the risk, RILA issuers would also prominently state (as a percentage)
the maximum amount of loss an investor could experience from a negative
contract adjustment, and that this loss could be greater due to
surrender charges and tax consequences.
To inform investors of the possibility that their investment
options could be unilaterally changed without action on their part, the
insurance company would be required to state, if applicable, that it
can add or remove index-linked options and change the features of an
index-linked options from one crediting period to the next, including
the index and current limits on gains and limits on index losses,
subject to contractual minimum guarantees.
Similar to the current requirement for prospectuses for contracts
that offer variable options, the insurance company would be required to
state that certain information regarding the features of each currently
offered index-linked option is available in an appendix to the
prospectus,\128\ and to provide a cross-reference to that appendix. An
instruction would permit this statement to be modified if needed to
conform to the corresponding table in the appendix.\129\ As described
further below, the appendix would also be amended to include a table
listing the index-linked options currently available under the
contract.\130\
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\128\ See proposed Item 17 of Form N-4.
\129\ See infra footnote 164 and accompanying text.
\130\ See infra at section II.B.3(b) (describing proposed
amendments to Item 17 (Portfolio Companies Available Under the
Contract) to include parallel provisions for RILAs).
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How Interest Is Calculated and Credited
To aid investors in making informed investment decisions, we
propose to require RILA issuers to describe how interest is calculated
and credited for each index-linked option.\131\ As part of this
description, the insurance company would be required to disclose any
limits on index losses and/or index gains, the crediting periods
available under the contract (e.g., 1, 3, and 6 years), a description
of an index-linked option's index crediting methodology, information
about each index, what happens when an index-linked option matures, and
any other material features associated with index-linked options. We
discuss each of these requirements in turn.
---------------------------------------------------------------------------
\131\ See proposed Item 6(d)(2) of Form N-4.
---------------------------------------------------------------------------
How Interest Is Calculated and Credited--Limits on Index Losses and
Gains
We are proposing to require the insurance company to describe, as a
primary element of a RILA contract, the limits on index losses and
gains for each index-linked option.\132\ In each case, and as
applicable, the insurance company would be required to state that such
limits apply and describe how index losses and gains would be limited
(for example, through the use of a floor or buffer to limit losses, or
a cap or participation rate to limit gains). We also are proposing to
require the insurance company to provide examples to help investors
understand how these limits work in practice. To illustrate the limits
on index losses, the prospectus would include an example showing how
the limit on index losses could operate to limit a negative return
(e.g., if the index return is -25% and the buffer is -10%, the
insurance company will credit -15% (the amount that exceeds the buffer)
at the end of the term, meaning the investor's contract value will
decrease by 15%). The prospectus similarly would include an example of
how the limit on gains could operate to limit a positive return (e.g.,
if the index return is 12% and the cap rate is 4%, the insurance
company will credit 4% in interest at the end of the term, meaning the
investor's contract value will increase by 4%).
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\132\ See proposed Item 6(d)(2)(i) and (ii) of Form N-4.
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We also propose to require the insurance company to disclose, for
each index-linked option, current limits on index losses and gains, as
well as the minimum limits on losses and gains that are guaranteed for
the life of the contract.\133\ The guaranteed minimum limits tend to be
lower than those currently provided for in the contract but will not
change for the life of the contract, whereas the actual limits for an
index-linked option will vary from crediting period to crediting
period. However, at no point will these limits be lower than the
guaranteed minimums. Both pieces of information are important to
understanding the potential returns of an index-linked option because
one of the central economic tradeoffs a RILA presents is an investor's
consideration of whether to sacrifice potential gains in exchange for
protection against potential losses. An investor therefore will not
only need to consider the guaranteed limits, but also understand that
the actual limits can vary over the life of the contract.\134\
[[Page 71110]]
We also propose to require the insurance company to state that current
limits on gains and limits on index losses will not change during the
index-linked option's crediting period. This would help investors
understand that although the current limits on gains and limits on
losses--unlike the minimum guaranteed limits--can change from crediting
period to crediting period, they will not change during any given
crediting period.
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\133\ Proposed Items 6(d)(2)(i)(B) and 6(d)(2)(ii)(B) of Form N-
4.
\134\ This information about minimum guaranteed index gain
limits is also set forth in the appendix, which is part of the
summary prospectus. See proposed Instruction 7 to Item 17(b);
proposed rule 498A(b)(5)(ix). We are also proposing to require RILAs
to publish online limits on gains. See infra section II.B.3.c.
Although changes to an index-linked option, including current limits
on gains, are material, we recognize that these limits in particular
can change from time to time. Therefore, insurance companies may
update current limits on gains using a prospectus supplement filed
pursuant to rule 497 under the Securities Act. See infra section
II.E.2.
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Because an insurer can generally set rates at its discretion and
may take into account a number of factors in setting those rates, we
are proposing that the insurance company explain how it selects rates
for limiting index losses and gains to help investors understand how
the features of a particular index-linked option will impact that
option's risk/return profile. In particular, we are proposing to
require the insurance company to describe the factors it considers in
determining the current limits on losses and gains for an index-linked
option (e.g., long-term interest rates, market volatility, the cost of
option contracts supporting the index-linked option guarantees,
etc.),\135\ and how that choice may impact other features of the option
set by the insurance company.
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\135\ Similar disclosure has been required in other contexts.
See, e.g., Item 9(a) of Form N-4 (requiring disclosure of material
factors that determine the level of annuity benefits); see also
Instruction 2 to Item 7(a) of Form N-6 (requiring the identification
of factors that determine the applicable cost of insurance rate).
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Giving investors information about the factors the insurer
considers in determining current limits--which are key features of an
index-linked option--may help manage their expectations regarding how
the product operates. If an investor sees that last year's cap on an
index-linked option was 22% and this year the cap is 17%, the proposed
disclosure may help them understand why the insurer's rates have
changed.\136\ If an insurer discloses that it takes various specified
factors into consideration, but ultimately sets rates at its own
discretion, the investor should know that as well.
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\136\ For example, an insurer might disclose that caps and
participation rates may vary depending on factors such as market
volatility, hedging strategies and investment performance, the
investor's index effective date, or interest rates, among others.
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The proposed disclosure about how the current limits on index gains
or losses may impact other aspects of the index-linked option is
designed to explain the inverse relationship between various features
of the index-linked option. For example, the insurance company could
include an explanation regarding how the limit on index losses for an
index-linked option could impact the current limit on index gains. This
could help an investor understand, for example, that if the insurance
company determines to increase the extent to which the index-linked
option will protect against loss, the insurance company may then reduce
the amount of upside index participation the investor could receive.
The prospectus would also require an explanation of the factors an
investor should consider regarding limits on index losses or gains
before selecting an index-linked option for investment. This disclosure
should assist an investor in choosing among the index-linked options
available under the contract, such as by explaining the difference
between a floor and a buffer, or by highlighting index-linked options
with features that assume more risk in return for higher potential
return, or vice versa.
How Interest Is Calculated and Credited--Crediting Period
We are proposing to require the insurance company to generally
describe the crediting periods of the index-linked options available
under the contract (e.g., 1, 3, and 6 years), along with the factors an
investor should consider regarding different crediting period lengths
before selecting an index-linked option.\137\ An example of one such
factor an insurance company could include as part of this disclosure
would be that crediting periods introduce timing risk that forces
investors to take losses at the end of a crediting period, and shorter
crediting periods might increase this risk.\138\ The insurance company
also would be required to prominently state that amounts must remain in
an index-linked option until the end of its crediting period to be
credited with all or partial interest, as applicable, and to avoid a
possible contract adjustment in addition to potential surrender charges
and tax consequences. This discussion would also include a description
of the transactions subject to a contract adjustment (e.g., living
benefits), with appropriate cross-references to related disclosures in
the prospectus. These disclosures collectively are designed to help an
investor make an informed investment decision when selecting an index-
linked option, taking into account that withdrawing money before the
end of the applicable crediting period can have adverse consequences.
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\137\ See proposed Item 6(d)(2)(iii) of Form N-4.
\138\ See OIAD Report at Section 2, RILAs: Structure of
Contracts and Investment Options, Investment Terms (``The role of
[crediting periods] also creates a situation that may be unique for
RILA purchasers relative to other investments they hold. In
particular, RILA investors periodically realize gains or losses at
the end of each [crediting period]. In contrast, a mutual fund
investor (for example) could wait to sell the fund during down
markets, avoiding realizing those losses. Thus, the [crediting
period] feature adds a 'timing risk` for RILA investors relative to
certain other investments.'').
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How Interest Is Calculated and Credited--Methodology and Examples
Each index-linked option has an ``index crediting methodology''
that explains how interest is calculated and credited to the contract.
For example, one index crediting methodology is ``point-to-point,''
that is, the amount credited to the contract is based upon a comparison
of the index's performance at two points in time (such as at the
beginning and end of the crediting period). We- propose to require
insurance companies to explain the index crediting methodologies used
in the index-linked options available under the RILA contract, along
with numerical examples about how these methodologies work. We further
propose to require insurance companies to provide a bar chart that
illustrates the annual total return of each index along with
hypothetical examples of index return after applying standardized
limitations on index gains and losses.
Specifically, insurance companies would be required to describe,
for each index crediting methodology,\139\ how interest is calculated
and credited at the end of a crediting period based on the interest
crediting formula or performance measure.\140\ Form N-4, as we propose
to amend it, would provide examples of common crediting methods that
the insurance company would describe if applicable, such as point-to-
point, step-up calculations, and enhanced performance.\141\ To help
[[Page 71111]]
investors understand how these crediting methods work, we also are
proposing to require the insurance company to include a numeric example
to illustrate the mechanics of each index crediting methodology.\142\
The examples would be required to show, in a clear, concise, and
understandable manner, how each crediting method functions when the
index has positive returns as well as negative returns to help
investors understand how the crediting method functions in both
circumstances.
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\139\ We understand that many index-linked options use the same
crediting methodology. If all index-linked options offered by a RILA
contract use the same crediting methodology, the prospectus would
only include one example of that crediting methodology. If, however,
the index-linked options in a RILA contract offer more than one
crediting method, or if different index-linked options in a RILA
contract offer different crediting methods, this would affect the
number of examples to be provided. The number of examples to be
provided depends on the number of crediting methodologies, not the
number of index-linked options.
\140\ See proposed Item 6(d)(2)(iv)(A) of Form N-4.
\141\ As noted above, a point-to-point crediting methodology
compares the index's performance at two points in time (such as at
the beginning and end of the crediting period). Step-up calculations
guarantee a given rate if the index's returns are positive,
regardless of the index's actual performance, subject to certain
conditions. ``Enhanced performance'' increases a positive index
return, such as by offering a participation rate of more than 100%.
\142\ See proposed Item 6(d)(2)(iv)(C) of Form N-4.
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Specifically, we would require numeric examples that reflect a
positive return above the limit on index gains, and a negative return
below the limit on index losses for each methodology. The examples also
would be required to assume hypothetical returns and limits that are
reasonable based on current and anticipated market conditions and sales
of the contract, and to reflect any charges subtracted from interest
credited to or deducted from contract value in the index-linked option
to allow investors to understand the impact of these charges on their
return. Additional examples, charts, graphs, or other presentations
would be permitted if they are clear, concise, understandable. Any
additional presentations that assume hypothetical returns and limits
also should assume hypothetical returns and limits that are reasonable
based on current and anticipated market conditions and sales of the
contract. We would also require insurance companies to include a
legend, in the format specified in the form, that (1) these examples
illustrate how the insurance company calculates and credits interest
under each index crediting methodology assuming hypothetical index
returns and hypothetical limits on index gains and losses and (2) the
examples assume no withdrawals.
We also are proposing to require a bar chart for each index
available under the currently-offered index-linked options showing the
index's annual return for the last 10 calendar years (or for the life
of the index, if less than 10 years), with the corresponding numerical
performance adjacent to each bar.\143\ Further, insurance companies
would be required to provide a hypothetical example alongside each
index return that reflects the return after applying a 5% cap and a -
10% buffer. If there are no caps or buffers offered under the contract
(if, for example, the contract includes a floor rather than a buffer),
insurance companies would be permitted to reflect a rate or measure
used to limit index gains or losses under the contract that is
comparable. Insurance companies would not be permitted to include
additional performance presentations, or historical index performance
that precedes the inception of the index. Further, insurance companies
would be required to provide two footnotes to this table, if
applicable, that disclose (1) that the index return does not reflect
dividends paid on the assets in the index, and (2) that the index
provider deducts fees and costs when calculating index return.
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\143\ See proposed Item 6(d)(2)(iv)(B) of Form N-4.
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These bar charts would also be accompanied by the following legend
in the format specified in the form:
The bar chart shown below provides the Index's annual returns
for the last 10 calendar years (or for the life of the Index if less
than 10 years), as well as the Index returns after applying a
hypothetical 5% cap and a hypothetical -10% buffer. The chart
illustrates the variability of the returns from year to year and
shows how hypothetical limits on Index gains and losses may affect
these returns. Past performance is not necessarily an indication of
future performance.
The performance below is NOT the performance of any Index-Linked
Option. Your performance under the Contract will differ, perhaps
significantly. The performance below may reflect a different return
calculation, time period, and limit on Index gains and losses than
the Index-Linked Options, and does not reflect Contract fees and
charges, including surrender charges and the Contract Adjustment,
which reduce performance.
This information is intended to provide context for the index-
linked options that the RILA contract offers and would better inform an
investor when deciding whether to invest in a RILA. For example, if an
index-linked option provides that the investor will experience at least
5% of the upside performance of an index, investors may view the
tradeoffs of this investment differently if the index historically has
returned, for example, 10% per year (thus capping gains at 5% during
those past periods) or 1% per year. Similarly, if an index-linked
option offers a -10% buffer, the investor could compare that against
the index performance in the bar chart and assess the extent to which
the buffer would have provided downside protection against market
losses in negative return years.
We appreciate, however, that historical index presentation alone,
without the addition of hypothetical caps and buffers, may mislead
investors into thinking that these historical rates of index
performance are what investors would have received under the contract
if they invested in a particular index-linked option. As we discuss in
more detail below, we are concerned that presenting historical RILA
performance without additional context can be potentially misleading
given that investors cannot access the same RILA terms as were
available historically. Relatedly, we are concerned that statements in
RILA advertise
[…truncated; see source link]Indexed from Federal Register on October 13, 2023.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.