Registration for Index-Linked Annuities; Amendments to Form N-4 for Index-Linked and Variable Annuities
Federal RegisterOct 13, 2023
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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.
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
• Use the Commission's internet comment form (
https://www.sec.gov/rules/2023/09/rila
); or
• Send an email to
rule-comments@sec.gov.
Please include File Number S7-16-23 on the subject line.
Paper Comments
• 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 (
https://www.sec.gov/rules/2023/09/rila
). 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
www.sec.gov
to receive notifications by email.
A summary of the proposal of not more than 100 words is posted on the Commission's website (
https://www.sec.gov/rules/2023/09/rila
).
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:
1
15 U.S.C. 77a
et seq.
Commission reference
CFR citation
(17 CFR)
Securities Act of 1933 (“Securities Act”):
1
Rule 156
§ 230.156
Rule 172
§ 230.172
Rule 405
§ 230.405
Rule 415
§ 230.415
Rule 424
§ 230.424
Rule 456
§ 230.456
Rule 457
§ 230.457
Rule 485
§ 230.485
Rule 497
§ 230.497
Rule 498A
§ 230.498A
Regulation S-T:
Rule 313 of Regulation S-T
§ 232.313
Rule 405 of Regulation S-T
§ 232.405
Forms:
Form N-4
§ 239.17b and 274.11c
Form N-6
§ 239.17c and 274.11d
Form 24F-2
§ 239.66 and § 274.24
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.
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),
https://www.limra.com/en/newsroom/news-releases/2023/limra-record-annuity-sales-in-2022-expected-to-continue-into-first-quarter-2023/
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),
https://www.limra.com/en/newsroom/news-releases/2018/limra-secure-retirement-institute-total-annuity-sales-continued-to-decline-in-2017/.
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
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.
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).
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.
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.
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.
•
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.
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.
•
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.
•
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
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.
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 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.
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
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,
https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_indexedannuities.
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.
•
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.
•
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
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.
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
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.
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
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
https://www.sec.gov/files/fidelity-guaranty-031723.pdf
) (“F&G Life Letter”).
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
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”).
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.
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.
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
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”).
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.
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
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
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
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
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
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.
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
http://www.investor.gov/publications-research-studies/sec-research.
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.
•
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.
•
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.
•
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.
•
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.
•
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.
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
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 Pages
Adding new legends and other standardized disclosures applicable to all issuers
Section II.B.1.
2
Overview of the Contract
New RILA-specific disclosures; moving order of appearance up
Section II.B.3(a).
3
Key Information
New RILA-specific disclosures; changing to a question-and-answer format; moving order of appearance down; change discussion of restrictions on optional benefits to cover all benefits
Section II.B.2.
4
Fee Table
New contract adjustment disclosure
Section II.B.5.
5
Principal Risks of Investing in the Contract
Providing more detailed disclosures applicable to all issuers
Section II.B.4.
6
Description of the Insurance Company, Registered Separate Account, and Investment Options
New RILA-specific disclosures and one new item regarding variable options
Section II.B.3(a).
7
Charges
New disclosures related to contract adjustments
Section II.B.5.
8
General Description of Contracts
No substantive change
Section II.B.8(b).
9
Annuity Period
No substantive change
Section II.B.8(b).
10
Benefits Available Under the Contract
No substantive change
Section II.B.8(b).
11
Purchases and Contract Value
No substantive change
Section II.B.8(b).
12
Surrenders and Withdrawals
No substantive change
Section II.B.8(b).
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 see Item 26)
Section II.D.
17
Investment Options Available Under the Contract
New RILA-specific disclosures
Section II.B.3(b).
Statement of Additional Information (Part B)
18
Cover Page and Table of Contents
No substantive change
Section II.B.8(b).
19
General Information and History
No substantive change
Section II.B.8(c).
20
Non-Principal Risks of Investing in the Contract
No substantive change
Section II.B.8(b).
21
Services
No substantive change
Section II.B.8(b).
22
Purchase of Securities Being Offered
New disclosure of specific contract adjustment information
Section II.B.5.
23
Underwriters
No substantive change
Section II.B.8(c).
24
Calculation of Performance Data
Clarifying only applies to variable options
Section II.B.7.
25
Annuity Payments
No substantive change
Section II.B.8(b).
26
Financial Statements
Providing that RILA issuers can use the relevant instructions and adding requirements relating to changes in and disagreements with accountants for RILAs
Section II.D.
Other Information (Part C)
27
Exhibits
Adding power of attorney for all issuers and accountant letters for RILA issuers as exhibits
Section II.B.7(d).
28
Directors and Officers of the Insurance Company
No substantive change
Section II.B.8(c).
29
Persons Controlled or Under Common Control with the Insurance Company or the Registrant
No substantive change
Section II.B.8(c).
30
Indemnification
No substantive change
Section II.B.8(c).
31
Principal Underwriters
No substantive change
Section II.B.8(c).
31A
Information about contracts with Index-Linked Options
New disclosure of RILA specific information
Section II.B.6.
32
Location of Accounts and Records
No substantive change
Section II.B.7.
33
Management Services
No substantive change
Section II.B.8(b).
34
Fee Representation and Undertakings
Adding new RILA undertakings
Section II.B.7(d).
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 name
Front.
Item 1(a)(3)
Types of contracts offered (
e.g.,
group, individual, etc.)
Front.
Item 1(a)(4)
Name and class of contract
Front.
Item 1(a)(9)
Date of prospectus
Front.
Item 1(b)(4)
EDGAR identifier number
Back.
Legends
Item 1(a)(10)
Statement that the 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))
Front.
Item 1(a)(11)
Statement that additional information about the contract is available on
Investor.gov
Front.
Item 1(a)(12)
A legend that states 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
Front.
Other Information
Item 1(b)(1)
Statement that the SAI contains additional information, that it is available to investors, and how investors may obtain the SAI or make inquiries about their contracts
Back.
Item 1(b)(2)
Statement about whether and from where information is incorporated by reference
Back.
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?
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 https://www.sec.gov/about/offices/investorad/investor-testing-form-crs-relationship-summary.pdf,
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 https://www.sec.gov/comments/s7-07-18/s70718-4729850-176771.pdf,
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 https://www.sec.gov/spotlight/investor-advisory-committee-2012/iac061418-slides-by-susan-kleimann.pdf
(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.”).
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
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.
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.
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.
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.”).
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.
88
Proposed instruction 2(a) to Item 3 of Form N-4.
We also are proposing to require specific disclosure on contract adjustments, which can result in investor losses if the investor withdraws
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.
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
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.
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
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
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
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
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?
113
See
N.Y. Comp. Codes R. & Regs. tit. 11, App. 28.8 (2023).
114
See
Section II.B.3.b.
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
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
)?
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).
116
See
VASP Adopting Release at text accompanying n.207.
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:
• 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;
• 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
• 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
117
See
proposed Item 2(b)(2)(i) through(iv) of Form N-4.
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.
118
See
proposed Item 2(d) of Form N-4.
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
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.
119
See
current Item 3(c) of Form N-4.
120
See
proposed Item 2(c) of Form N-4; s
ee also supra
footnote 107 and accompanying text.
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.
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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
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).
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.”
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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.
123
See
proposed Item 6(c)(1) of Form N-4.
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.
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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
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.
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Further, some investors in the qualitative interviews indicated that they would prefer more information about these points relative to the KIT disclosures.
126
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.
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.
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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.
127
See
proposed Item 6(d)(1) of Form N-4.
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,
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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
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).
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.
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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.
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See
proposed Item
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