oversight

Retirement Security: Annuities with Guaranteed Lifetime Withdrawals Have Both Benefits and Risks, but Regulation Varies across States

Published by the Government Accountability Office on 2012-12-10.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                United States Government Accountability Office

GAO             Report to Congressional Requesters




                RETIREMENT
December 2012



                SECURITY

                Annuities with
                Guaranteed Lifetime
                Withdrawals Have
                Both Benefits and
                Risks, but Regulation
                Varies across States




GAO-13-75
                                              December 2012

                                              RETIREMENT SECURITY
                                              Annuities with Guaranteed Lifetime Withdrawals
                                              Have Both Benefits and Risks, but Regulation Varies
                                              across States
Highlights of GAO-13-75, a report to
congressional requesters




Why GAO Did This Study                        What GAO Found
As older Americans retire, they may           Annuities with guaranteed lifetime withdrawals can help older Americans ensure
face rising health care costs, inflation,     they do not outlive their assets, but do present some risks to consumers. Two
and the risk of outliving their assets.       such products, variable annuities with guaranteed lifetime withdrawal benefits
Those entering retirement today               (VA/GLWB) and contingent deferred annuities (CDA), share a number of features
typically face greater responsibility for     but have some important structural differences. For example, both provide
managing their retirement savings than        consumers with access to investment assets and the guarantee of lifetime
those who retired in the past. Lifetime       income, but while VA/GLWB assets are held in a separate account of the insurer
income products can help older                for the benefit of the annuity purchaser, the assets covered by a CDA are
Americans ensure they have income
                                              generally held in an investment account owned by the CDA purchaser.
throughout their retirement. VA/GLWBs
                                              Consumers can benefit from these products by having a steady stream of income
and CDAs, two such products, may
provide unique benefits to consumers.
                                              regardless of how their investment assets perform or how long they live, while at
According to industry participants,           the same time maintaining access to their assets for unexpected or other
while annuities with GLWBs have been          expenses. VA/GLWBs and CDAs are complex products that present some risks
sold for a number of years, CDAs are          to consumers and require them to make multiple important decisions. For
relatively new and are not widely             example, consumers might purchase an unsuitable product or make withdrawal
available. GAO was asked to review            decisions that could negatively affect their potential benefits. Several insurers
issues relating to these financial            and regulators GAO spoke to said it was important for consumers to obtain
products. This report (1) compares the        professional financial advice before purchasing these products and making key
features of VA/GLWBs and CDAs and             decisions. These products can also create risks for insurers which, if not
examines potential benefits and risks         addressed, could ultimately affect insurers’ ability to provide promised benefits to
to consumers and potential risks to           consumers.
insurers, and (2) examines the
regulation of these products and the          VA/GLWBs are considered to be both securities and insurance products, and are
extent to which regulations address           therefore covered by both federal securities regulations and state insurance
risks to consumers. GAO analyzed              regulations. For CDAs, the National Association of Insurance Commissioners
insurance company product                     committee responsible for life insurance and annuities products has determined
information, proposed and final rules         CDAs to be life insurance products subject to state law and regulation for
and regulations, and studies and data         annuities. According to SEC officials, existing CDAs have been registered as
related to retirement and product sales.      securities with SEC, and therefore are covered by both federal securities laws
GAO also interviewed federal and state        and regulations, and state insurance regulations. At the state level, NAIC has
regulators and selected insurers,             developed state disclosure and suitability regulations for annuity products.
consumer advocates, and industry              However, states differ on the extent to which they have adopted these annuity
organizations.                                regulations, and some do not have protections at all. As a result, consumers in
GAO provided a draft of this report to        states that have adopted different regulations may benefit from different levels of
NAIC and SEC. Both provided                   protection. NAIC and state regulators told GAO that they are currently reviewing
technical comments, which have been           the regulations of CDAs. In March 2012, NAIC began reviewing existing annuity
addressed in the report, as                   regulations to determine whether any changes are needed to address the unique
appropriate.                                  product design features of CDAs, including potential modifications to annuity
                                              disclosure and suitability standards. It is also reviewing what kinds of capital and
                                              reserving requirements may be needed to help insurers manage product risk. In
                                              addition, NAIC and the National Organization of Life and Health Guaranty
                                              Associations are each working to determine whether state insurance guaranty
                                              funds, which protect consumers in the event insurers become insolvent, cover
                                              CDA products. Both agree that each state will have to reach its own conclusion
                                              about whether their particular state guaranty fund laws allow for CDA coverage.
View GAO-13-75. For more information,         Until these regulatory issues are resolved, consumers may not be fully protected.
contact Alicia Puente Cackley at (202) 512-
8678 or cackleya@gao.gov.

                                                                                       United States Government Accountability Office
Contents


Letter                                                                                      1
              Background                                                                    3
              Features of VA/GLWBs and CDAs May Benefit Consumers but also
                Pose Risks to Consumers and Insurers                                        7
              Federal and State Oversight Varies by Type of Product and Is
                Currently under Industry Review                                           19
              Agency Comments                                                             29

Appendix I    Objectives, Scope, and Methodology                                          30



Appendix II   GAO Contact and Staff Acknowledgments                                       32



Table
              Table 1: CDA Consumer Regulations in Sample States, as of
                       October 2012                                                       27


Figures
              Figure 1: Accumulation, Withdrawal, and Insured Phases of a
                       VA/GLWB or CDA                                                       8
              Figure 2: State Adoption of Suitability Regulations as of October
                       2012                                                               25




              Page i                                    GAO-13-75 Lifetime Withdrawal Products
Abbreviations
CDA             contingent deferred annuities
FINRA           Financial Industry Regulatory Authority
IRA             individual retirement account
NAIC            National Association of Insurance Commissioners
NASD            National Association of Securities Dealers
NOLHGA          National Organization for life and Health Guaranty
                Associations
SEC             Securities and Exchange Commission
VA              variable annuities
VA/GLWB         variable annuities with guaranteed lifetime withdrawal
                benefits

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Page ii                                            GAO-13-75 Lifetime Withdrawal Products
United States Government Accountability Office
Washington, DC 20548




                                   December 10, 2012

                                   The Honorable Herb Kohl
                                   Chairman
                                   Special Committee on Aging
                                   United States Senate

                                   The Honorable George Miller
                                   Ranking Member
                                   Committee on Education
                                     and the Workforce
                                   House of Representatives

                                   Longevity risk, or the potential for outliving one’s financial resources in
                                   retirement, is a critical issue for today’s older Americans. Life expectancy
                                   for many older Americans grew significantly from 1980 to 2010, and
                                   today’s retirees may face a greater number of years than earlier
                                   generations for which they will require income. They also face the risks of
                                   inflation and rising health care costs. Because of a decrease in defined
                                   benefit retirement plans that guarantee retirees a certain level of income
                                   for life, workers entering retirement today also typically have more
                                   responsibility for managing their retirement savings than previous retirees
                                   and must make difficult investment and withdrawal decisions.

                                   Recent market turbulence has also sparked questions about retirement
                                   account values and longevity risk, and many Americans already retire
                                   without sufficient savings to sustain them throughout a lengthy retirement.
                                   For example, a recent study showed that only 42 percent of those
                                   surveyed had calculated how much in savings they would need for
                                   retirement, and the percentage of Americans saving for retirement had
                                   declined by 9 percent from 2009 to 2012. 1 Products with guaranteed
                                   lifetime withdrawals, such as variable annuities with a guaranteed lifetime
                                   withdrawal benefits rider (VA/GLWB) and contingent deferred annuities
                                   (CDA) can potentially help older Americans plan for retirement and
                                   address longevity and market risks by providing guaranteed income even
                                   after retirement assets are depleted. However, some industry participants



                                   1
                                    The Employee Benefits Retirement Institute and Matthew Greenwald and Associates,
                                   2012 Retirement Confidence Survey (Washington, D.C.: March 2012).




                                   Page 1                                         GAO-13-75 Lifetime Withdrawal Products
suggest that VA/GLWBs and CDAs are complex products which involve
potential risks for both consumers and insurers.

In response to questions you have raised about annuities with guaranteed
lifetime withdrawals, this report:

•   compares the features of VA/GLWBs and CDAs, and examines the
    potential benefits and risks to consumers and potential risks to
    insurers of these products; and

•   examines the regulation of these products and the extent to which
    regulation addresses any identified risks to consumers.

To compare the features of VA/GLWBs and CDAs, we analyzed specific
insurance company products to obtain information on how the products
function, including how investment gains and losses are treated, how
withdrawal amounts are determined, and what happens when a
consumer’s investment account is depleted. We also interviewed
insurance company officials to verify our understanding of their products
and VA/GLWBs and CDAs in general. To identify potential benefits and
risks to consumers, we analyzed the product information we obtained and
also interviewed insurers, consumer advocates, and state insurance
regulators. To understand the potential risks these products pose to
insurers and how they manage these risks, we also interviewed NAIC
officials and reviewed information from insurers and stakeholder groups.
We also obtained data from industry organizations on the sale of annuity
products with guaranteed lifetime withdrawals. We discussed the sources
and reliability of the data with officials from these organizations and found
the data sufficiently reliable for the purposes of this report.

To determine how VA/GLWBs and CDAs are regulated and the extent to
which regulation addresses identified concerns, we identified regulations
and processes used by federal and state regulators, as well as any
proposed regulations, and compared them with the risks to consumers
that we identified as part of the work under the previous objective. We
reviewed model laws developed by NAIC, specific state regulations, and
SEC and FINRA rules. We also interviewed NAIC, state, SEC and FINRA
officials to determine how VA/GLWBs and CDAs are regulated. We also
interviewed other stakeholder groups, such as consumer advocates and
industry organizations, to gain their perspective on issues related to
regulation of lifetime income products considered in our review. Appendix
I contains additional information on our scope and methodology.




Page 2                                     GAO-13-75 Lifetime Withdrawal Products
             We conducted this performance audit from February 2012 to November
             2012 in accordance with generally accepted government auditing
             standards. Those standards require that we plan and perform the audit to
             obtain sufficient, appropriate evidence to provide a reasonable basis for
             our findings and conclusions based on our audit objectives. We believe
             that the evidence obtained provides a reasonable basis for our findings
             and conclusions based on our audit objectives.



Background

Annuities    An annuity is an insurance agreement or contract that comes in a number
             of different forms and can help individuals accumulate money for
             retirement through tax-deferred savings, provide them with monthly
             income that can be guaranteed to last for as long as they live, or both. A
             variable annuity is an insurance contract in which a consumer makes
             payments that are held in a separate account of the insurer. While the
             insurance company is the owner of the separate account assets, the
             assets are held for the benefit of consumers. In return, the insurer agrees
             to make periodic payments beginning immediately or at some future date.
             The purchaser’s payments can be directed into a range of investment
             options, typically mutual funds, which the insurer makes available in a
             separate account for the benefit of consumers. Purchasers may withdraw
             assets from their contracts at any time prior to annuitizing—that is, to
             convert the account into some form of lifetime payments.

             VA/GLWBs protect consumers against outliving their retirement assets
             and the effects that market losses on those assets can have on lifetime
             income by allowing them to withdraw a certain percentage each year until
             death. If the market performs well, the consumer may receive larger
             withdrawals, but if the market performs poorly, the consumer still receives
             the set withdrawal amount.

             VA/GLWB sales have grown in recent years. Data from LIMRA show that
             from 2008 to 2011, the number of VA/GLWB contracts in force rose from
             1.5 million to 2.8 million and that average annual sales were around $58
             billion. 2 During that same period, total VA/GLWB assets held in insurers’


             2
              LIMRA is a financial research firm that provides consulting and research services to its
             over 850 member financial services firms.




             Page 3                                             GAO-13-75 Lifetime Withdrawal Products
accounts increased from $133 billion to $323 billion. According to the
Insured Retirement Institute, states with the highest sales of variable
annuities in 2010 were California, New York, Florida, Texas,
Pennsylvania, and New Jersey. 3 In addition, LIMRA data on the
demographics of VA/GLWB consumers show that in 2010 the average
age of the consumer purchasing a VA/GLWB was 61 and the average
age at first withdrawal was 68. Typically, the average annual withdrawal
has been around $5,500. Also according to LIMRA, the average amount
of a VA/GLWB contract sale from 2007 through 2010 was around
$106,000.

Like a GLWB rider, a CDA is an insurance contract that provides
guaranteed lifetime income payments if a consumer’s investment account
is exhausted, whether through withdrawals or poor market performance.
In this case, the investment account contains the “covered assets”—
typically mutual funds or managed accounts. However, the insurance
company does not have ownership of the assets underlying the CDA,
which are typically held in brokerage or investment advisory accounts
owned by the CDA purchaser. Similar to a VA/GWLB, a CDA contract
defines how much a consumer is able to withdraw—for example, 5
percent of the benefit base annually. Even if the value of the covered
assets drops to zero, the insurance company has guaranteed the 5
percent withdrawal benefit (based on the benefit base value when lifetime
withdrawals began) and continues making the annual payments to the
consumer. Whether or not a policyholder receives payment from the
insurance company selling the CDA is contingent upon the covered
assets dropping to zero. On the basis of the products we reviewed, fees
on CDAs are calculated as a set percentage of the investment assets or
benefit base per year. These fees do not include any fees the consumer
might pay related to the underlying investment that is covered by the
CDA. Such investment management fees are paid to the investment
company, not the insurer.




3
 The Insured Retirement Institute is a trade association that provides research and
information to its members, including financial firms and advisors.




Page 4                                            GAO-13-75 Lifetime Withdrawal Products
Regulation   State insurance regulators are responsible for overseeing insurance
             products, while SEC and FINRA are responsible for the oversight of
             securities. Federal and state regulators consider variable annuities to be
             both insurance and securities products, and GLWB riders that are
             attached to variable annuities to be an additional insurance benefit. The
             National Association of Insurance Commissioners committee responsible
             for life insurance and annuities products has determined CDAs to be life
             insurance products subject to state law and regulation for annuities.
             According to SEC officials, existing CDAs have been registered as
             securities with SEC, and therefore are covered by both federal securities
             laws and regulations, and state insurance regulations.

             Insurance is unique among financial services in the United States in that it
             is largely regulated by the states. State insurance regulators are
             responsible for enforcing state insurance laws and regulations, including
             those covering the licensing of agents, reviewing insurance products
             (including variable annuities) and their rates, and examining insurers’
             financial solvency and market conduct. State regulators typically perform
             financial solvency examinations every 3 to 5 years, and they generally
             undertake market conduct examinations in response to specific consumer
             complaints or regulatory concerns. 4 State regulators also monitor the
             resolution of consumer complaints against insurers. State insurance laws
             focus on solvency, market regulation, and consumer protection. In
             addition to state insurance regulators, NAIC—a voluntary association of
             the heads of insurance departments from the 50 states, the District of
             Columbia, and five U.S. territories—plays a role in insurance regulation.
             While NAIC is not a regulator, it provides guidance and services designed
             to more efficiently coordinate interactions between insurers and state
             regulators. These services include providing detailed insurance data to
             help regulators understand insurance sales and practices; maintaining a
             range of databases useful to regulators; and coordinating regulatory
             efforts by providing guidance, model laws and regulations, and
             information-sharing tools.

             Federal securities laws and SEC rules govern the securities industry in
             the United States. SEC’s mission is to protect investors; maintain fair,


             4
              State regulators periodically perform financial examinations of insurance companies to
             investigate their accounting methods, procedures, and financial statement presentation.
             Market conduct exams by state regulators help ensure fair and reasonable insurance
             prices, products, and trade practices to protect consumers.




             Page 5                                            GAO-13-75 Lifetime Withdrawal Products
orderly, and efficient markets; and facilitate capital formation. SEC
oversees key participants in the securities markets, including securities
exchanges, securities brokers and dealers, investment advisers, and
mutual funds. The Securities Act of 1933 (1933 Act) regulates public
offerings of securities, requiring that issuers register securities with SEC
and provide certain disclosures, including a prospectus, to investors at
the time of sale. 5 Investors may rely on broker-dealers and investment
advisers for information or advice about securities, including insurance
products such as VA/GLWBs and CDAs. Money managers, investment
counselors, and financial planners who, for compensation, engage in the
business of providing advice to others about securities, including asset
allocation advice, are subject to the antifraud provisions of the Investment
Advisers Act of 1940. 6 Large investment advisers, those with $100
million or more of assets under management, generally are subject to
SEC registration and regulation under the Investment Advisers Act and
accompanying rules. Investment advisers with assets under
management of less than $100 million generally are regulated by the
states. 7 Securities, including annuities that are securities, are subject to
registration and disclosure requirements under the 1933 Act, and large
investment advisers providing advice about securities must be registered
with SEC. Broker-dealers that are engaged in the business of buying and
selling securities generally are subject to broker-dealer regulation at the
federal and state levels. FINRA is the largest regulator of securities firms
doing business with the public in the United States. All registered
securities broker-dealers who do business with the public must be
members of FINRA and their personnel must be licensed with FINRA.
FINRA oversees almost 4,500 brokerage firms and approximately
630,000 registered securities representatives.




5
 Securities Act of 1933, 48 Stat. 74 (1933) (codified as amended at 15 U.S.C. §§ 77a et
seq.).
6
 Investment Advisers Act of 1940, 54 Stat. 847 (1940) (codified as amended at 15 U.S.C.
§§ 80b-1 et seq.).
7
 The Investment Advisers Act of 1940 was amended by the Dodd-Frank Wall Street
Reform and Consumer Protection Act (Dodd-Frank) to provide that midsized investment
advisers, those managing assets between $25 million and $100 million, generally be
exempt from federal registration requirements and subject to state regulation. Small
investment advisers managing assets under $25 million were already exempt from federal
registration requirements under the Investment Advisers Act prior to Dodd-Frank.




Page 6                                            GAO-13-75 Lifetime Withdrawal Products
                      VA/GLWBs and CDAs share a number of features, but they also have
Features of           some important structural differences. For example, both provide
VA/GLWBs and CDAs     consumers with access to investment assets and the guarantee of lifetime
                      income, but while VA/GLWB assets are held in a separate account of the
May Benefit           insurer for the benefit of the annuity purchaser, the assets covered by a
Consumers but also    CDA are generally held in an investment account owned by the CDA
                      purchaser. In part because of their shared features, these products can
Pose Risks to         provide similar benefits to consumers. Yet as complex instruments that
Consumers and         require consumers to make multiple important decisions, they also
                      present certain risks to consumers. VA/GLWBs and CDAs may also
Insurers              involve risks for insurers, who must manage these risks in order to make
                      promised payments to consumers.


VA/GLWBs and CDAs     VA/GLWBs and CDAs share a number of product features. In general,
Share Some Features   both allow consumers to take lifetime withdrawals from their assets at a
                      rate that the insurance company guarantees even if such withdrawals and
                      investment losses deplete the consumer’s assets. VA/GLWBs and CDAs
                      generally have three distinct phases of ownership: an accumulation
                      phase, a withdrawal phase, and an insured phase (see fig. 1). 8




                      8
                       One insurance company whose products we reviewed referred to the insured phase as
                      the “settlement phase.” The American Council of Life Insurers and the Insured Retirement
                      Institute refer to it as the “annuity payments phase.”




                      Page 7                                           GAO-13-75 Lifetime Withdrawal Products
Figure 1: Accumulation, Withdrawal, and Insured Phases of a VA/GLWB or CDA




                                       Note: This figure is a hypothetical illustration of the phases and features of a VA/GLWB or CDA and
                                       may not represent the actual results of any product we reviewed. The actual results for each
                                       consumer will depend on the particular product’s features and costs, as well as factors such as the
                                       amount invested, the consumer’s age when the guarantee was purchased, the actual return on
                                       investments, the timing and amount of withdrawals, and how long the consumer lives.


Accumulation Phase                     The accumulation phase begins when a consumer purchases a
                                       VA/GLWB or CDA contract. 9 The initial premium paid under a VA contract
                                       with a GLWB rider or the value of assets covered by a CDA contract
                                       establishes the initial withdrawal value, or benefit base, on which the




                                       9
                                         The VA/GLWBs we reviewed are allowed to be added either when annuity contracts are
                                       first purchased, on a contract’s first anniversary, or anytime after the contract’s issue date
                                       subject to availability and the consumer’s eligibility. The CDAs we reviewed can be
                                       purchased when eligible investment funds are purchased. While some products we
                                       reviewed had no minimum eligibility age for purchasing the VA/GLWB or CDA, others had
                                       established minimums that ranged from ages 35 to 50. According to LIMRA, consumers
                                       initially purchase VA/GLWB contracts at about age 61.




                                       Page 8                                                  GAO-13-75 Lifetime Withdrawal Products
amount of lifetime withdrawals are based. 10 This benefit base is not a
cash value that can be withdrawn, but rather is the amount to which
lifetime withdrawal percentages will be applied during the withdrawal
phase. The investment account value, on the other hand, represents the
total value of the consumer’s investments, which is increased by
investment gains and decreased by fees, withdrawals, and any
investment losses. 11 During this phase the consumer decides how to
allocate investment assets among various options, including funds made
available by an insurance company for investment under its VA/GLWB
products and funds that an insurance company has agreed to cover
under its CDA products. 12 Also during this phase, the insurance company
monitors each consumer’s account value and automatically adjusts the
benefit base periodically should investment gains increase the value of
this account. This feature, which exists for the VA/GLWBs and CDAs we
reviewed, is referred to as a step-up or ratchet. 13 Once a consumer’s
benefit base is stepped up, it cannot later decline because of investment
losses that reduce the consumer’s investment account value.

Some VA/GLWBs have an additional feature that guarantees that, no
matter how the investments perform, the benefit base will grow each year
by a set percentage. This guaranteed percentage, alternatively referred to
as a roll-up rate, growth credit, or bonus, is added to the benefit base, as
adjusted for any prior step-ups. For example, some of the VA/GLWBs we
reviewed included annual roll-up rates that ranged from 5 to 7 percent.
The amount of the roll-up rate and the frequency, duration, and manner of


10
  The minimum initial premium or investment in the VA/GLWBs and CDAs we reviewed
ranged from no minimum to $100,000 with maximums that ranged from $500,000 to $5
million. According to LIMRA, the average initial premium paid for a variable annuity with a
GLWB rider is about $100,000.
11
 The investment account value may be greater or less than the benefit base.
12
  The number of investment options available under the VA/GLWBs and CDAs we
reviewed ranged from 1 to over 100 different funds.
13
  The VA/GLWBs and CDAs we reviewed stepped up benefit base values to either the
highest daily, monthly, or annual account value. For example, on each contract
anniversary an insurer may compare the benefit base to the account value at the end of
each of the past 12 months and step up the benefit base to the highest of those 12 values.
A more frequent step-up may increase the chances of locking in investment gains, but the
level of these gains, and thus the value of a more frequent step-up, may be affected by
the nature of the funds and any investment limitations, restrictions, and nondiscretionary
asset reallocation formulas used by the insurance company to manage market risks and
volatility.




Page 9                                             GAO-13-75 Lifetime Withdrawal Products
                   calculation can affect the value of a consumer’s benefit base and thus the
                   amount that can be taken as lifetime withdrawals. While such features
                   can increase a consumer’s benefit base on which lifetime withdrawals are
                   determined, annuities with higher roll-up rates can have higher fees.

Withdrawal Phase   The withdrawal phase starts when a consumer begins taking annual
                   lifetime withdrawals. The maximum amount of lifetime withdrawals that a
                   consumer can take each year (without incurring a reduction in their
                   benefit base) is calculated as a percentage of the consumer’s benefit
                   base at the time of the first lifetime withdrawal. The VA/GLWBs and CDAs
                   we reviewed had withdrawal percentages for a single life that ranged from
                   3 percent to over 8 percent of the benefit base, and the percentages were
                   generally lower for younger consumers and higher for older consumers. 14
                   Some products also have a joint life option where, if the consumer dies,
                   the guarantee of lifetime income passes to their spouse. When such an
                   option is elected, withdrawal amounts are typically one-half a percent less
                   than they would be otherwise. 15

                   Step-ups, like those during the accumulation phase, can increase the
                   benefit base after lifetime withdrawals have begun, increasing the amount
                   of annual lifetime withdrawals. Typically, the insurance company will
                   increase the benefit base if a consumer’s account value, net of
                   withdrawals and fees, has increased above this amount. After a step-up
                   during the withdrawal phase, the base and the lifetime maximum
                   withdrawals cannot decline because of investment losses that reduce the
                   consumer’s account value. Step-ups that occur after lifetime withdrawals




                   14
                     Two products we reviewed (one VA/GLWB and a CDA) set withdrawal rates based on a
                   combination of age and the 10-year Treasury bond yield at the time of the owner’s first
                   withdrawal. The older the owner and the higher the 10-year bond yield results, the higher
                   the withdrawal rates.
                   15
                     The joint life withdrawal rates for one of the VA/GLWB products we reviewed were the
                   same as for a single life, except that the withdrawal percentage was based on the younger
                   of the two lives. Another VA/GLWB product we reviewed, whose withdrawal rates were
                   based on the 10-year Treasury bond yield, set the joint life withdrawal rates at 90 percent
                   of the single life rates.




                   Page 10                                            GAO-13-75 Lifetime Withdrawal Products
                         begin allow consumers to benefit from investment gains that can offset
                         the effects of inflation. 16

Insured Phase            A consumer enters the insured phase only if their investment account
                         value has been reduced to zero as a result of lifetime withdrawals;
                         investment losses; or any expenses, fees, or other charges. In such
                         cases, the consumer’s benefit base on which lifetime withdrawals are
                         determined (the amount to which the withdrawal percentage is applied)
                         remains unchanged but the consumer’s investment account value, which
                         was the source for the funds previously withdrawn, is zero. Consequently,
                         the funds needed to continue paying the same level of benefits to the
                         consumer (and spouse, if a joint life option is elected) would then come
                         from the insurance company’s own assets, and consumers receive
                         payments from the insurance company that are equal to their prior lifetime
                         withdrawal amount. Once the insurance company begins paying the
                         agreed-upon withdrawal payment, the fees that the consumer had been
                         paying for that protection would cease, as would any investment
                         management and other fees paid for other benefits. Once the insured
                         phase begins, all rights and benefits under a VA/GLWB or CDA contract,
                         except those related to continuing benefits, terminate. 17 In addition, all
                         lifetime withdrawal benefits will continue to be paid to the consumer on
                         the established schedule and generally cannot be changed.


Structural Differences   Although VA/GLWBs and CDAs have some common features and
Exist between VA/GLWBs   function in similar ways, the contractual, product, and cost structures
and CDAs                 differ in terms of where the underlying investment assets are held and
                         what benefits are offered, and the amount of fees charged for those
                         benefits. With variable annuity contracts, including those with GLWB
                         riders, consumers can direct premium payments into a range of
                         investment options, typically mutual funds made available by and held in


                         16
                           The withdrawal percentages for some VA/GLWB and CDA products we reviewed can
                         increase when an owner enters a new age band preceding a step-up of the benefit base.
                         VA/GLWB and CDA products that base the withdrawal percentage on the 10-year
                         Treasury bond yield and recalculate the owner’s withdrawal amount based on the current
                         bond yield potentially provide a more direct connection between increases in future
                         withdrawal amounts and long-term inflation to the extent that 10-year Treasury bond yields
                         vary with inflation or inflationary expectations.
                         17
                           For example, the right to make additional contributions and receive the benefit of future
                         step-ups in the withdrawal amount would no longer be available to an owner once the
                         account is depleted.




                         Page 11                                            GAO-13-75 Lifetime Withdrawal Products
a separate account of the insurance company. The mutual funds may be
managed by outside advisers, but the insurance company holds these
assets for the benefit of consumers. By comparison, the investment
assets covered by a CDA are held by the consumer in his or her own
brokerage or investment advisory account and invested in investment
funds, such as mutual funds, that the insurance company has agreed to
cover under a CDA. The investment assets are not owned—nominally or
otherwise—by the insurance company issuing the guarantee. Like the
investment options available under a VA/GLWB, the investment assets
covered by a CDA may or may not be managed by the insurance
company or an affiliate. In this way, consumers can accumulate
retirement assets in a personal account, such as an individual retirement
account (IRA), and obtain lifetime withdrawal guarantees without having
to transfer those assets to an insurance company.

Further, the base variable annuity contracts to which GLWB riders are
attached provide additional benefits not available under CDAs. For
example, a VA/GLWB contract permits the consumer to annuitize an
account balance in the future and receive benefit payments from the
insurance company for life at rates set forth in the annuity contract. 18
Also, with a VA/GLWB, if a consumer dies before annuitizing the account
balance or taking lifetime withdrawals, the death benefit payable to
beneficiaries is typically the greater of the sum of premiums paid or the
investment account value. 19 The additional VA/GLWB benefits come with
additional costs, however. For example, in addition to the guarantee fee,
variable annuity contracts with death benefits entail additional fees to
cover the cost to the insurer. For the CDAs we reviewed, the assets
covered by the CDA could not be annuitized in the future. The assets



18
   Guaranteed lifetime withdrawal benefits terminate upon annuitization of the base
contract’s account value. Further, the VA/GLWBs we reviewed had maximum annuity
commencement ages of either 91 or 95. At those ages, annuitants are typically required to
annuitize their remaining account balance or take a lump sum distribution. For all but one
of the products we reviewed, in cases where an owner starts taking lifetime withdrawals
and later reaches the maximum annuity commencement age, the lifetime withdrawal
payments cease and the annuity payments would be calculated as the greater of the
lifetime withdrawal amount or the annuity amount for the selected payment option under
the contract.
19
  To illustrate, if an owner who paid $200,000 in premiums had investments that had
declined in value to $190,000 at the time of their death, and had not annuitized their
account balance or begun taking lifetime withdrawals, the insurance company would pay
the owner’s beneficiaries $200,000.




Page 12                                           GAO-13-75 Lifetime Withdrawal Products
                         would first have to be sold and the proceeds used to purchase a separate
                         annuity. In addition, unlike a variable annuity contract, a CDA does not
                         have a death benefit. 20


VA/GLWBs and CDAs Can    Similar to other annuity products, VA/GLWBs and CDAs can provide
Provide Consumers with   consumers with the benefit of a guaranteed stream of income for life. That
Similar Benefits         is, for a fee, they can ensure that consumers receive a minimum annual
                         payment until they die, regardless of how long they live or how their
                         investment assets might perform. These products may also lock
                         investment gains into the benefit base on which future lifetime
                         withdrawals are determined and, in the case of variable annuities, also
                         offer other potentially beneficial features such as death benefits, which
                         pass on certain guaranteed amounts to a spouse or other beneficiaries.
                         Further, VA/GLWBs and CDAs typically offer consumers the ability to
                         invest their assets in a variety of investment funds.

                         A unique benefit of these products is that they allow consumers to receive
                         income guarantees while still maintaining ownership of and access to their
                         funds during the accumulation and withdrawal phases. With traditional
                         annuity products, in order to receive lifetime income consumers must
                         transfer assets to the insurer, who holds them in their own general account
                         and uses them to fund an annuity (they are annuitized). Consequently,
                         once these assets are annuitized the consumer does not have access to
                         these assets. With VA/GLWBs and CDAs, however, the consumers’ assets
                         are not annuitized. As a result, consumers can withdraw any or all of their
                         funds at any time. This can benefit consumers should they need funds for
                         unexpected uses, such as medical or other expenses.

                         One benefit specific to CDAs is that the guarantee of lifetime withdrawals
                         can, in certain cases, be applied to existing investment assets. That is,
                         consumers who have existing investment assets may be able to purchase
                         a CDA to cover those assets, if an insurer agrees to cover those assets
                         under a CDA. If the same consumers wanted to use those assets to
                         obtain a guaranteed stream of income through a traditional annuity, they
                         would have to first sell the investment assets and then use the proceeds
                         to purchase the annuity.


                         20
                           For the VA/GLWB and CDA products we reviewed, if the consumer elects a joint life
                         withdrawal option, upon their death during the accumulation phase surviving spouses
                         typically could elect to continue the guarantee and maintain the benefit base.




                         Page 13                                          GAO-13-75 Lifetime Withdrawal Products
Consumers Face Risks     Several insurers and regulators we spoke with said that VA/GLWBs and
When Purchasing and      CDAs are complex products, and emphasized the importance of obtaining
Withdrawing Funds from   professional financial advice before purchasing these products and
                         making key decisions. Consumers that purchase VA/GLWBs and CDAs
VA/GLWBs and CDAs        can face risks similar to those they may face with the purchase of other
                         financial products. These risks include purchasing an unsuitable product,
                         paying too much, making withdrawal decisions that decrease benefits,
                         and having an insurer become insolvent before benefits are received.

                         First, consumers face the risk of purchasing an unsuitable product if they
                         do not understand how a particular product functions and meets their own
                         needs, including how much might be appropriate to invest in a particular
                         product. Insurers with whom we spoke said that VA/GLWBs and CDAs
                         are generally attractive to middle-income consumers who want more
                         control and flexibility over the investments they are relying on to provide
                         retirement income. In addition, one insurer with whom we spoke said that
                         consumers investing in such products have generally had around
                         $500,000 in retirement savings and invested around 20 percent of that
                         amount.

                         Second, consumers may face the risk of being unable to determine if they
                         are obtaining the best price for similar benefits provided by different
                         insurers. Several insurers and regulators told us that because of the
                         uniqueness of VA/GLWB and CDA products, it would be difficult to
                         compare one insurer’s product to that of another insurer. For example,
                         products can function in slightly different ways, have different
                         combinations of features, and charge different amounts for the
                         guarantees. As a result, consumers would find it difficult to take a price
                         quoted to them from one insurer for a specific product with specific
                         features, then compare that to a product from another insurer to
                         determine if they could receive similar benefits at a lower price.

                         Third, VA/GLWBs and CDAs pose a risk that certain decisions by
                         consumers in withdrawing their assets, such as the timing and size of the
                         withdrawals, could affect them negatively. For example, these decisions
                         can reduce or even eliminate guaranteed benefits and result in additional
                         fees that further reduce their assets. The investment assets underlying
                         VA/GLWB and CDA guarantees are typically available for withdrawal
                         before guaranteed lifetime withdrawals begin, but taking withdrawals too
                         early or above certain thresholds can result in financial penalties and
                         deplete assets, as the following examples illustrate,




                         Page 14                                   GAO-13-75 Lifetime Withdrawal Products
•    Variable annuities are frequently sold without any up front sales
     charges but impose contingent deferred sales charges, or “surrender”
     charges, on withdrawals taken during the early years of the contract
     (for example, the first 7 years) that are above a “free” withdrawal
     limit. 21 Surrender charges on variable annuities are expressed as a
     series of percentages that decline over time and are applied to annual
     withdrawals that are typically greater than either accumulated
     earnings or 10 percent of premiums paid. 22 Because CDAs split
     insurance and investment elements of the guarantee, there are no
     surrender charges on the CDA contract. However, a surrender charge
     may apply when a consumer sells shares of mutual funds covered by
     the CDA contract. 23 In addition to sales charges, income taxes and an
     additional 10 percent penalty tax on withdrawals taken before age
     59½ may apply. 24

•    With some VA/GLWB products, taking withdrawals of any amount
     after reaching a minimum age can trigger the beginning of lifetime
     withdrawals (at a specified percentage) and stop all future roll-ups of
     the benefit base. 25 In addition, a consumer who takes withdrawals
     sooner than initially planned can experience a permanent reduction of
     the lifetime withdrawal amount. For example, for one of the products
     we reviewed a withdrawal at age 64 triggers the establishment of a 4
     percent lifetime withdrawal percentage, but waiting for a year would
     raise the percentage to 5 percent. Further, starting lifetime
     withdrawals during a downturn in the market can have a negative


21
  A “free” withdrawal limit is an amount below which consumers may take withdrawals
without penalty.
22
   The period during which surrender charges are assessed typically varies from 3-7 years
according to the variable annuity share class. For example, some variable annuities we
reviewed had 7-year surrender charge periods with first-year surrender charges of
between 7 and 8.5 percent that declined to 0 percent over 7 years. The free withdrawal
limit for the annuities of this type that we reviewed was either 10 percent of premiums paid
or the greater of either accumulated earnings or 10 percent of premiums paid.
23
  Surrender charges are a form of sales charges that are levied on annuities and mutual
funds and are used to pay commission expenses.
24
  Some of the products we reviewed established age 59½ as the minimum age when
guaranteed lifetime withdrawals could begin. Withdrawals made earlier than the minimum
age may reduce the benefit base on which lifetime withdrawals are calculated.
25
  Owners of the VA/GLWB and CDA products we reviewed that did not have a roll-up
feature could not trigger the lifetime withdrawal percentage merely by taking withdrawals
but had to affirmatively elect to take lifetime withdrawals before they became effective.




Page 15                                            GAO-13-75 Lifetime Withdrawal Products
    effect on lifetime income because the investment account balance will
    be that much lower than the benefit base, making the possibility of a
    step-up, and a possible increase in the withdrawal percentage and
    amount, less likely.

•   The age at which lifetime withdrawals begin can have an impact on
    the value of other benefits and guarantees. For example, withdrawals
    and the related charges can reduce the cash value and death benefits
    under a variable annuity contract, leaving fewer assets available for
    surviving spouses and other beneficiaries. On the other hand, waiting
    too long to withdraw benefits can result in not living long enough to
    benefit from the product’s guarantees or receiving enough income to
    offset the amount of fees paid. For example, a person who first
    purchases a VA/GLWB or CDA at age 60 and waits until age 85 to
    begin taking lifetime withdrawals will be able to take a higher amount,
    but likely for a shorter period of time. Further, the purchaser will have
    paid fees for 25 years to protect against outliving his assets, a
    possibility that becomes less likely over time.

In addition to deciding when to begin taking lifetime withdrawals,
consumers need to decide how much to withdraw and need to be aware
of certain product features when doing so. For example, lifetime
withdrawals above the maximum annual amount specified in the
withdrawal guarantee are permitted and are referred to as “excess
withdrawals.” However, such withdrawals typically reduce the benefit
base to which withdrawal percentages are applied, thus reducing future
annual withdrawal amounts. Further, guarantee fees and other charges
are typically not counted as withdrawals for purposes of calculating the
maximum for a given year, but some VA/GLWB and CDA products we
reviewed counted certain fees and charges or those above a certain
threshold toward the annual lifetime withdrawal maximum.

Finally, as with the purchase of any long-term insurance product,
consumers can face some level of risk that by the time the consumer
needs the benefit promised by the insurer, the insurer may not be able to
provide it. However, insurers and insurance regulators take a number of
steps to ensure that insurers remain financially solvent. In addition, in the
event of an insurer’s insolvency, state insurance guaranty funds can help
pay consumers what was promised by insurers, up to any coverage limits
of those guaranty funds. According to officials from the National
Organization for Life and Health Guaranty Associations (NOLHGA), while
promises made under GLWBs, which are distinct from the investment
portion of a variable annuity, are generally covered by state guaranty



Page 16                                    GAO-13-75 Lifetime Withdrawal Products
                            funds, such certainty does not exist with respect to CDAs. As a result, a
                            risk exists that if an insurer who sold a CDA became insolvent,
                            consumers owning those CDAs might not collect any promised benefits.


Insurers Must Also Manage   As with the sale of life insurance products in general, insurers must
Risks Associated with       manage the financial risks associated with VA/GLWBs and CDAs in order
VA/GLWBs and CDAs           to ensure their ability to make promised payments and, depending on the
                            amount of such products they sell, their financial solvency. Risks to
                            insurers can arise when investment returns, interest rates, consumer
                            longevity, and consumer behavior are different from what they expected.
                            While a number of insurers and NAIC officials said that VA/GLWBs and
                            CDAs do not pose undue risk to insurers, as we noted, at least one major
                            insurer has decided not to sell CDAs because of the potential risk
                            involved, and another insurer told us that they do not sell VA/GLWBs
                            because they do not fit with the company’s risk profile.

                            Insurance company officials with whom we spoke told us that in designing
                            their products they consider not only the features that will help to meet
                            consumer needs, but also the company’s own appetite for certain risks,
                            the methods for managing those risks, and the price charged for the
                            products’ guarantees. According to insurers with whom we spoke, ways in
                            which insurers can use product design to help manage their risk can
                            include the following.

                            •   Establishing the minimum age at which consumers can begin taking
                                withdrawals and the extent to which consumers can benefit from
                                growth in the investments protected by the guarantee.

                            •   Specifying which investments consumers may have covered by the
                                products’ guarantees. For example, one CDA product we reviewed
                                limited a consumer’s investments in equity funds to no more than 80
                                percent of the consumer’s total investment account value. Another
                                insurer that sells CDAs told us that they were only willing to cover
                                index funds for major, highly traded indices, such as the Standard and
                                Poor’s 500. 26




                            26
                              The Standard and Poor’s 500 is an index of 500 U.S. company stocks from various
                            industries that meet certain criteria for inclusion in the index, including a market
                            capitalization in excess of $4 billion.




                            Page 17                                           GAO-13-75 Lifetime Withdrawal Products
•   Determining the formulas used to rebalance consumers’ investments
    into and out of fixed-income funds to mitigate some of the financial
    risks associated with providing lifetime withdrawal guarantees. 27
    Prospectuses for these VA/GLWB products disclose that the
    automatic rebalancing feature may limit the consumer’s participation
    in future market gains and, therefore, the potential for future increases
    in their annual lifetime income.

Insurers will also price their products to ensure they have sufficient
revenue and capital to pay for the expenses they expect to incur related
to the products they sell. That is, they will charge more for products that
they deem to be more risky or on which they expect to incur greater
costs. With respect to VA/GLWBs and CDAs, for example, insurers may
charge higher fees for products with features that can result in a higher
guaranteed benefit base. Insurers also use hedging programs to help
further manage the investment risks of the assets underlying the
VA/GLWB and CDA. Hedging involves buying financial instruments, such
as options, to offset the potential loss on an investment.

To the extent that product design and hedging is not sufficient, insurers
can also manage financial risks by modifying their products after they
have been purchased by consumers to the extent permitted by their
contracts, their prior disclosure, and applicable law. For the VA/GLWB
and CDA products we reviewed, insurers sometimes reserve certain
rights, such as the right to determine which investment funds will be
covered by a GLWB rider or CDA guarantee and the conditions
surrounding the allocation of a consumer’s investment assets, change the
frequency and amount of a guarantee fee, or reject additional
contributions or transfers. Some insurers have recently raised fees on
VA/GLWB guarantees or stopped accepting additional contributions to
existing contracts in response to changing market conditions. Insurers
generally cannot change the roll-up, step-up, or withdrawal rates for
existing contract holders, but can make these changes prospectively for
new customers.



27
  There are various factors that determine the amount and timing of transfers, including
the difference between an owner’s account value and benefit base. Insurance company
officials told us that owners who invest more aggressively can expect more frequent
rebalancing than those who invest more conservatively.




Page 18                                            GAO-13-75 Lifetime Withdrawal Products
                          Federal disclosure and suitability regulations apply to the offer,
Federal and State         recommendation, and sale of securities products such as variable
Oversight Varies by       annuities, including variable annuities with GLWB riders. While it has long
                          been accepted that variable annuities constitute securities under the
Type of Product and       federal laws, because CDAs are a relatively new product, analysis under
Is Currently under        the federal securities law is less developed. However, SEC officials have
                          said that CDAs currently being offered in the retail market are being
Industry Review           registered as securities and are therefore covered by federal securities
                          law and state insurance regulations. In addition, NAIC has developed
                          annuity disclosure and suitability regulations for use at the state level, but
                          state adoption and protection levels vary, so CDA consumers may not be
                          uniformly protected. Further, questions about the adequacy of existing
                          annuity regulation and the applicability of state insurance guaranty funds
                          for CDA consumers if insurers become insolvent have prompted industry
                          oversight reviews, which were ongoing as of October 2012.


Federal Disclosure and    Federal disclosure and suitability regulations apply to the offer,
Suitability Regulations   recommendation, and sale of securities products such as variable
Apply to Registered       annuities, including variable annuities with GLWB riders. These
                          requirements aim to inform consumers about products and ensure that
Annuity Products          the products themselves are reasonably appropriate for consumers
                          before they are purchased. As previously noted, while it has long been
                          accepted that variable annuities constitute securities under federal law,
                          CDAs are a relatively new product and analysis under the federal
                          securities law is less developed. 28 To our knowledge, no court has
                          addressed the securities law treatment of CDAs, and SEC has not
                          provided written guidance with respect to the status of CDAs under the
                          federal securities laws. However, according to SEC officials, existing
                          CDAs have been registered under the Securities Act of 1933, absent
                          specific exemptions from registration such as the exemption for contracts
                          sold to certain types of tax-qualified retirement plans, and are therefore
                          covered by federal securities law and state insurance regulations.

                          The 1933 Act generally requires issuers of securities that are offered to
                          the public to register them with SEC and make certain disclosures
                          through a prospectus that has been filed with SEC. The 1940 Act



                          28
                            See SEC v. United Benefit Life Ins. Co., 387 U.S. 202 (1967); SEC v. Variable Annuity
                          Life Ins. Co., 359 U.S. 65 (1959) (variable annuities are securities).




                          Page 19                                           GAO-13-75 Lifetime Withdrawal Products
generally requires investment companies, including separate accounts
that fund variable annuities, to be registered under the Act. Pursuant to
these requirements, SEC has issued rules and standards for
prospectuses offering registered variable annuities. The purpose of these
requirements is to ensure that investors receive descriptive information on
basic product features, fees, benefits, and risks that can help inform their
investment decisions. 29 Disclosures made through prospectuses filed with
SEC under the federal securities laws are subject to the anti-fraud
provisions of the 1933 Act, which prohibit material misrepresentations or
omissions and provide a general anti-fraud remedy for purchasers and
sellers of securities. 30

Since variable annuities, including those with guaranteed benefits, are
securities, they must be offered and sold through registered broker-
dealers. On the basis of anti-fraud provisions of the federal securities
laws and FINRA rules, broker-dealers are required to deal fairly with their
customers and only recommend securities to an investor that are
appropriate for the investor based on his or her individual facts and
circumstances. The suitability obligation is part of a broker-dealer’s duty
of fair dealing. 31 SEC and FINRA rules also require communications used
with investors to promote the offer and sale of variable annuities to be fair
and balanced, not misleading, and to include certain disclosures
regarding the risks and fees associated with these products. These rules
include the following:


29
  SEC Form N-4, the form used to register variable annuities with the SEC, is filed under
the Investment Company Act of 1940 and the Securities Act of 1933 and subject to review
by SEC staff. Part A of the form, the product prospectus, must present clearly written
information about the contract and its costs, including information about annuity payments
and death benefits. Part B includes information about premiums and underwriters, as well
as insurance company and separate account financial statements. Part C contains
information about directors and officers of the insurance company and indemnification,
and a representation regarding contract fees.
30
 See §17 of the Securities Act of 1933 (15 U.S.C. §77q); §10(b) of the Securities
Exchange Act of 1934 (15 U.S.C. 78j(b)).
31
  SEC staff has recommended consideration of rulemakings that would apply a fiduciary
standard to both broker-dealers and investment advisers no less stringent than that
applied currently to investment advisers. The SEC staff also identified certain areas
where laws and regulations that apply to broker-dealers and investment advisers differ,
and recommended the Commission consider whether these areas should be harmonized
for the benefit of retail investors. SEC Staff Study on Investment Advisers and Broker-
Dealers As Required By Section 913 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (2011), (Washington, D.C. January, 2011).




Page 20                                           GAO-13-75 Lifetime Withdrawal Products
•    FINRA Rule 2090, which requires broker-dealers to ask about and
     retain essential information on each customer (“Know Your
     Customer”) and concerning the authority of each person acting on
     behalf of the customer.

•    FINRA Rule 2111, which requires broker-dealers to have a
     reasonable basis to believe that a recommended securities
     transaction or investment strategy is suitable for the customer based
     on information obtained through reasonable diligence of the broker-
     dealer or its associated person to ascertain the customer’s investment
     profile. This profile includes, but is not limited to the customer’s other
     investments, financial situation and needs, tax status, investment
     objectives, investment experience, investment time horizon, liquidity
     needs, risk tolerance, and any other information the customer may
     disclose to the broker-dealer or associated person in connection with
     the recommendation.

•    National Association of Securities Dealers (NASD) Rule 2210, which
     regulates broker-dealers’ communications with the public and applies
     to, among other things, variable annuity advertisements. Broker-
     dealers must file retail communications concerning variable annuities
     with FINRA and respond to comments provided by FINRA staff on
     such communications. 32

•    FINRA Rule 2330, specific to deferred variable annuities, which
     governs member broker-dealers’ compliance and supervisory
     responsibilities with respect to the recommendation of the initial
     purchase or exchange of deferred variable annuities, and initial
     subaccount allocations.

These requirements apply to the recommendation and sale of variable
annuity products, including those with guaranteed lifetime withdrawal
benefits. According to SEC officials, issuers of CDAs have been
registering offerings of their CDA products with SEC, and SEC is
reviewing the disclosures associated with these products. While we did
not observe and were not told of any such instances, if CDAs were sold
without being registered as securities, SEC could take action if it



32
   FINRA, which formed in 2007, is in the process of converting the older NASD rules into
its own rule book. Some rules have not yet been converted, and therefore retain the
NASD label. FINRA rule 2210 replaces NASD Rule 2210 effective February 4, 2013.




Page 21                                           GAO-13-75 Lifetime Withdrawal Products
                               determined that securities laws were being violated. If it were determined
                               that federal securities laws did not apply to CDA offerings, relevant state
                               regulations would still apply. In addition, FINRA officials said that they
                               regulate member broker-dealers that offer variable annuity products,
                               including variable annuities with GLWB riders. If a broker-dealer offers a
                               CDA that is registered under the federal securities laws, FINRA also
                               regulates the sale of such a CDA. If state insurance law issues arise in
                               connection with a firm’s sale of a CDA, FINRA staff may refer these
                               issues to relevant state insurance regulators.


NAIC Has Developed             The NAIC committee responsible for life insurance and annuities issues
Annuity Disclosure and         considers CDAs to be insurance products and has developed annuity
Suitability Regulations, but   disclosure and suitability model regulations for use by state insurance
                               regulators. NAIC has developed these model disclosure and suitability
State Adoption and             regulations for annuity products in collaboration with consumer advocates
Protection Levels Vary         and industry experts. However, unlike federal standards that are
                               consistently applied to variable annuities regardless of where consumers
                               live, state adoption of these model regulations varies, so protections may
                               be stronger in some states than in others. In 2011, NAIC developed a
                               model disclosure regulation for annuity products that serves several
                               functions for consumers and insurers, including:

                               •   helping ensure that consumers understand annuity products by
                                   explaining basic features, benefits, and fees;

                               •   suggesting that annuity products with guaranteed income or benefit
                                   provisions are intended to be longer-term investment products;

                               •   providing guidance for insurers when they choose to develop product
                                   illustrations intended to help consumers better understand how a
                                   particular annuity product works. In particular, the guidance provides
                                   illustration formats and specifies what kinds of illustration disclosures
                                   must be made when an insurer chooses to develop them; and

                               •   requiring that annuity customers be provided or referred to NAIC’s
                                   Annuity Buyer’s Guide that also contains general product information
                                   and provides answers to basic questions about risks and investing
                                   that consumers can use to decide whether these products are right for
                                   them.




                               Page 22                                    GAO-13-75 Lifetime Withdrawal Products
In addition to its model disclosure regulation, NAIC developed a model
suitability regulation in 2003 to help ensure that insurers consider the
financial needs and objectives of consumers and that these needs are
appropriately addressed at the time annuity sales or exchanges occur.
More specifically, the model suitability regulation requires insurers and
insurance agents to inquire about consumers’ suitability information and
ensure that they have reasonable grounds to believe that annuity
products would benefit consumers before recommending purchases or
exchanges. 33 In 2006, NAIC revised the model regulation to expand its
scope to consumers of all ages, and in 2010 the model regulation was
again revised to further strengthen a number of annuity suitability
protections. Among other changes, the 2010 revision requires insurers to

•    be responsible for compliance with the model regulation whether or
     not they contract suitability functions out to a third party;

•    maintain procedures for reviewing each investment recommendation
     made to consumers and helping ensure that the product is suitable for
     the particular purchaser and that the purchaser understands the
     annuity product recommended;

•    ensure that insurance agents, or producers, complete general annuity
     training before selling annuity products; and

•    provide product-specific annuity training and training materials to the
     agent or producer before an agent or producer can solicit the sale of a
     product.

In addition to these changes, NAIC adopted the revised the model
regulation to set standards and procedures for suitable annuity
recommendations and to require insurers to establish a system to
supervise recommendations so that the insurance needs and financial
objectives of consumers are appropriately addressed. The revised NAIC
model regulation includes a “safe harbor” provision that is intended to
prevent duplicative suitability standards from being applied to sales of



33
   According to NAIC’s model regulation, suitability information refers to information that is
reasonably appropriate to determine the suitability of an annuity recommendation for a
consumer, including the following: age, annual income, financial situation and needs,
financial experience and objectives, intended use of the annuity, financial time horizon,
existing assets, liquidity needs, liquid net worth, risk tolerance, and tax status.




Page 23                                              GAO-13-75 Lifetime Withdrawal Products
annuities through FINRA member broker-dealers. Annuity sales made in
compliance with FINRA requirements are deemed to comply with the
suitability requirements outlined in NAIC’s model regulation. Violations of
state law developed from the model regulation can result in remedies for
consumers and penalties for insurers and agents. Under the model
regulation, state insurance commissioners can require reasonably
appropriate corrective action for violations that have harmed consumers.

NAIC information shows that, as of October 2012, state adoption of
NAIC’s disclosure and suitability regulations varied significantly, meaning
that consumers in some states may not be protected as well as those in
other states. 34 According to NAIC, many states have adopted some form
of annuity disclosure regulation, although some states and the District of
Columbia do not have disclosure protections in place. As of October
2012, officials are working to determine which states had adopted the
revised model disclosure regulation. 35 In terms of the suitability model
regulation, 19 states plus the District of Columbia have adopted NAIC’s
most recent model regulation that incorporates the added protections
noted above, and another 29 states have adopted other suitability
protections for annuity consumers. The remaining 2 states do not have
suitability regulations in place. According to NAIC officials, model
disclosure and suitability standards are not required as part of NAIC’s
accreditation program. Figure 2 summarizes the state adoption of
suitability regulations.




34
  According to NAIC officials, NAIC has not collected nationwide data on which states
allow the sale of CDA sales, so we were unable to determine which states allow CDA
sales but have not adopted disclosure and suitability regulations.
35
  According to NAIC officials, “other suitability protection” includes but is not limited to
adopting earlier versions of the NAIC model suitability regulation, or developing legislation
or regulations derived from other sources such as bulletins and administrative rulings. For
the purpose of this study, we reviewed NAIC’s model disclosure and suitability regulations,
but did not review states’ other disclosure or suitability protections.




Page 24                                             GAO-13-75 Lifetime Withdrawal Products
Figure 2: State Adoption of Suitability Regulations as of October 2012




Whether or not states have adopted NAIC disclosure and suitability
regulation is important for CDA consumers. Unlike federal regulations that
apply to the sale of VA/GLWBs nationwide, disclosure and suitability
regulations for CDAs may depend on the actions of individual states and
the extent to which they have implemented these protections. According
to NAIC, regulatory action by states can time to occur and depends on
legislative cycles and the political environment of states. As the




Page 25                                        GAO-13-75 Lifetime Withdrawal Products
information in figure 2 shows, consumers across states are subject to
different suitability protection and in some cases to no protection at all. 36

The different regulatory approaches among the sample of seven states
we reviewed also show the variation in regulation of CDAs across states.
Although most states in our sample have not specifically approved CDA
sales, most have adopted some form of disclosure and suitability
regulation for annuity products. Among these seven states, three have
adopted NAIC’s model disclosure regulation and three have adopted
NAIC’s most recent suitability regulation. For the states that allow CDA
sales, the consumer protections found in the model regulations are
critical. Of the two states that allow CDA sales—Iowa and Ohio—both
have adopted NAIC’s model disclosure regulation, but only Iowa has
adopted its most recent model suitability regulation. Ohio, according to
NAIC information, has passed a previous version of NAIC’s model
suitability regulation, and therefore has not adopted added protections
found in the revised model regulation as outlined above. Consumers in
states that have not adopted NAIC’s model regulations may not be
benefitting from available disclosure and suitability protections. More
specifically, states that have not adopted the most recent model suitability
regulations may not be extending to consumers protections developed
through NAIC’s 2010 suitability revision. Table 1 shows the variation in
the disclosure and suitability protections across our seven sample states.




36
   In prior work that was designed to provide insights for the development of a federal
financial services regulatory framework, we highlighted the importance of, among other
things, providing consistent consumer protections for similar financial products and
services. See GAO, Financial Regulation: A Framework for Crafting and Assessing
Proposals to Modernize the Outdated U.S. Financial Regulatory System, GAO-09-216
(Washington, D.C.: Jan. 8, 2009). In a report looking at regulation of the insurance
industry, a function carried out by the states, we pointed out the importance of state
regulation supporting the goals of this framework. See GAO, Insurance Reciprocity and
Uniformity: NAIC and State Regulators Have Made Progress in Producer Licensing,
Product Approval, and Market Conduct Regulation, but Challenges Remain, GAO-09-372
(Washington, D.C.: Apr. 6, 2009).




Page 26                                          GAO-13-75 Lifetime Withdrawal Products
                           Table 1: CDA Consumer Regulations in Sample States, as of October 2012

                                                                                                  Most recent
                                                                 Model             Other             model             Other
                                                               disclosure        disclosure        suitability       suitability
                               Sample          CDA sales       regulation        protection       regulation         protection
                               state           approved         adopted           adopted           adopted           adopted
                               California                                                                X
                               Florida                                                 X                                   X
                               Iowa                 X               X                                    X
                               New Jersey                                              X
                               New York                                                X
                               Ohio                 X               X                                                      X
                                      a
                               Utah                                 X                                    X
                           Sources: GAO and NAIC.

                           Note: According to NAIC, “other disclosure protection” and “other suitability protection” used in this
                           table include but are not limited to adopting earlier versions of the NAIC model regulation, or
                           legislation or regulation derived from other sources such as bulletins and administrative rulings.
                           a
                            State insurance officials with whom we spoke from Utah were unsure whether CDAs had been sold
                           there because Utah is a “file and use” state that does not require state review of insurance products
                           before they are sold. However, Utah officials said that they did not believe that CDAs were being sold
                           in their state.


Regulatory Uncertainty     Some industry participants suggest state insurance regulation and
and Concerns about CDA     existing actuarial guidance may adequately address risks to insurers
Regulation Have Prompted   offering CDAs and to consumers. Others said that CDAs may pose
                           solvency risks for both because insurers offer consumers an income
Industry Oversight         guarantee but do not maintain the assets on which the guarantees are
Reviews                    made. One major insurer has said that CDAs pose significant enough
                           pricing and reserving challenges that it does not offer CDAs. In addition,
                           two consumer advocates with whom we spoke highlighted the solvency
                           risks CDAs pose for insurers. One advocate suggested that reasonable
                           and appropriate insurer reserving and capital requirements do not
                           currently exist for CDAs and that considerable NAIC and state regulatory
                           work would be needed to develop them. The same advocate said selling
                           CDA products before key issues concerning the regulatory framework are
                           finalized might expose consumers to risks that might result from an
                           insurer’s potential insolvency. The advocate concluded that the potential
                           for insurers to increase the marketing and sale of CDAs, given the
                           growing needs of retirees, makes having consumer and insurer
                           protections in place important.




                           Page 27                                                    GAO-13-75 Lifetime Withdrawal Products
Potential risks to CDA consumers and insurers have prompted industry
oversight reviews of these products and their regulation. Although NAIC
has determined that CDAs are a life insurance product, it is working with
state regulators, insurers, and consumer advocates through its CDA
Working Group, formed in March 2012, to build greater consensus around
the classification of CDAs and to determine whether any adjustments to
state regulation might be appropriate. In particular, NAIC is evaluating the
adequacy of existing state annuity laws and regulations for CDA sales,
including those on insurer solvency such as capital adequacy and reserve
requirements. According to NAIC officials, both NAIC and state insurance
regulators recognize the complexity of CDA products for consumers and
are also working to revise disclosure and suitability practices where
appropriate.

Another industry review by the NOHLGA, NAIC, and state insurance
regulators aims to address whether CDA consumers are protected by
state insurance guaranty funds in the event of an insurer’s insolvency.
According to NOLHGA officials, variable annuities are not covered by
guaranty funds because they are indistinguishable from equity
products. That is, they are not supported by assets in an insurer’s general
account, but by specific assets in separate accounts dedicated to the
particular fund or funds chosen for the variable annuity. However, the
officials said that guaranteed lifetime withdrawal benefits, which are now
part of most variable annuity contracts, are distinct from the equity portion
of a variable annuity and are generally covered by state guaranty
funds. The officials said that while CDAs would also appear to have an
equity portion and a guarantee portion, they have a committee studying
the extent to which CDAs might be covered by state guaranty
funds. Officials noted that even when the committee has reached a
determination on guaranty fund protections, each state will have to reach
its own conclusion about whether their particular guaranty fund laws allow
for CDA coverage.




Page 28                                    GAO-13-75 Lifetime Withdrawal Products
                  We provided a draft of the report to SEC and NAIC and relevant excerpts
Agency Comments   to FINRA. Each provided technical comments that were incorporated as
                  appropriate.


                  As agreed with your offices, unless you publicly announce the contents of
                  this report earlier, we plan no further distribution until 30 days from the
                  report date. At that time, we will send copies to the Chairman of the
                  Securities and Exchange Commission, the Chief Executive Officer of the
                  National Association of Insurance Commissioners, and other interested
                  parties. In addition, the report will be available at no charge on the GAO
                  website at http://www.gao.gov.If you or your staff have any questions
                  about this report, please contact Alicia Puente Cackley (202) 512-8678 or
                  cackleya@gao.gov. Contact points for our Offices of Congressional
                  Relations and Public Affairs may be found on the last page of this report.
                  GAO staff who made major contributions to this report are listed in
                  appendix III.




                  Alicia Puente Cackley
                  Director
                  Financial Markets
                    and Community Investment




                  Page 29                                   GAO-13-75 Lifetime Withdrawal Products
Appendix I: Objectives, Scope, and
              Appendix I: Objectives, Scope, and
              Methodology



Methodology

              To compare the features of variable annuities with guaranteed lifetime
              withdrawal benefits (VA/GLWB) and contingent deferred annuities (CDA),
              we analyzed specific insurance company products to obtain information
              on how the products function, including how investment gains and losses
              are treated, how withdrawal amounts are determined, and what happens
              when a consumer’s investment account is depleted. We also interviewed
              insurance company officials to verify our understanding of their products,
              and VA/GLWBs and CDAs in general. We judgmentally selected the
              companies based on criteria that included their market share of variable
              annuity sales and their decisions to sell or not to sell CDAs. To identify
              potential benefits and risks to consumers, we analyzed the product
              information we obtained and also interviewed insurers, consumer
              advocates, and state insurance regulators. To understand the potential
              risks these products pose to insurers and how they manage these risks,
              we also interviewed NAIC officials and reviewed information from insurers
              and stakeholder groups. We also obtained data from industry
              organizations on the sale of annuity products with guaranteed lifetime
              withdrawals. We discussed the sources and reliability of the data with
              officials from these organizations and found the data sufficiently reliable
              for the purposes of this report.

              To determine how VA/GLWBs and CDAs are regulated and the extent to
              which regulation addresses identified concerns, we identified regulations
              and processes used by federal and state regulators, as well as any
              proposed regulations, and compared them with the risks to consumers
              that we identified as part of the work under the previous objective. Our
              review of state regulation included model laws developed by the National
              Association of Insurance Commissioners (NAIC), specific state
              regulations, and Securities and Exchange Commission (SEC) and
              Financial Industry Regulatory Authority (FINRA) rules. We selected the
              sample of states for our analysis based on the volume of sales of
              VA/GLWBs and CDAs in the state, whether the state allowed the sale of
              CDAs, and the state’s population. We interviewed NAIC, state, SEC, and
              FINRA officials to determine how VA/GLWBs and CDAs are regulated.
              We also interviewed other stakeholder groups, such as consumer
              advocates and industry organizations, to gain their perspective on issues
              related to regulation of lifetime income products considered in our review.




              Page 30                                   GAO-13-75 Lifetime Withdrawal Products
Appendix I: Objectives, Scope, and
Methodology




We conducted this performance audit from February 2012 to November
2012 in accordance with generally accepted government auditing
standards. Those standards require that we plan and perform the audit to
obtain sufficient, appropriate evidence to provide a reasonable basis for
our findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objectives.




Page 31                                  GAO-13-75 Lifetime Withdrawal Products
Appendix II: GAO Contact and Staff
Acknowledgments

                  Alicia Puente Cackley, 202-512-8678 or cackleya@gao.gov
GAO Contact
                  In addition to the contact named above, Patrick A. Ward (Assistant
Staff             Director), Emily R. Chalmers, Nima Patel Edwards, Scott E. McNulty, and
Acknowledgments   Steve Ruszczyk made key contributions to this report. Also contributing to
                  this report were Pamela Davidson, Marc Molino, Patricia Moye, and
                  Frank Todisco.




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