The SEC settled public administrative and cease and desist proceedings against a mutual life insurance company (“Respondent”) related to findings that the prospectuses and sales literature for certain of Respondent’s variable annuity products failed to sufficiently disclose key aspects of those products. This article summarizes the SEC’s findings, which Respondent has neither admitted nor denied.
Background. From 2007-2009, the Respondent offered a guaranteed minimum income benefit (“GMIB”) rider as an optional feature in connection with certain variable annuity products. These variable annuity products and the GMIB riders were described in prospectuses filed with the SEC under the Securities Act of 1933 and the Investment Company Act of 1940 and in sales literature filed with FINRA (the prospectuses and the sales literature together, the “Disclosure Documents”). According to the SEC, the aggregate investment in the GMIB riders by July 2009 was approximately $2.5 billion.
GMIB Rider. Under the terms of the GMIB rider, the GMIB value earned interest annually subject to a cap on the maximum value and, subject to certain conditions, investors had the flexibility to make withdrawals during the accumulation phase of the annuity. The Disclosure Documents described this withdrawal feature in detail. The SEC’s investigation focused on the disclosures regarding the impact of withdrawals once the GMIB value reached its maximum value, or “cap.” Specifically, the SEC found that the Disclosure Documents did not sufficiently explain that once the GMIB cap was reached the GMIB value would cease to earn interest and any subsequent withdrawals would reduce the GMIB value on a pro-rata basis. The SEC found that the Disclosure Documents implied the opposite, that interest would continue to accrue once the cap was reached and dollar-for-dollar withdrawals would still be available.
As a result of its investigation, the SEC found that a number of sales agents and others responsible for selling the GMIB riders did not understand the impact of making withdrawals after the cap was reached and some sales agents believed that investors could maximize their benefit by continuing to make annual withdrawals after the cap was reached. The SEC found that investors engaging in this practice could have suffered significant long term consequences, including losing all the value of their future income stream.
The SEC cited several instances of emails from supervisory sales personnel and sales agents acknowledging confusion over the impact of withdrawals once the cap was reached and the disclosures regarding this feature.
Respondent’s Remedial Efforts. By March 2009, Respondent had ceased offering the riders, and by May 2009 it had revised the explanation in the relevant prospectuses of the consequences of taking withdrawals after the GMIB value reaches the cap. Following the SEC’s investigation, Respondent removed the cap entirely from these riders so that no investor would ever reach the cap.
Violations. The SEC determined that the Respondent had willfully violated Section 34(b) of the Investment Company Act of 1940, which prohibits materially false or misleading statements in documents filed with the SEC. In so finding, the SEC noted that “[p]rospectus disclosures that do not go far enough in explaining the features of a product violate Investment Company Act Section 34(b). In re Fundamental Portfolio Advisors, Inc., 56 SEC 651, 675 (2003) (‘prospectus disclosures, while accurate, do not go far enough’).”
Sanctions. The Respondent agreed to cease and desist from violations of Section 34(b) and to pay a $1.625 million civil penalty. In determining the amount of the penalty, the SEC took into account Respondent’s remedial efforts.
SEC Focus on Investor Communications. With reference to this settlement, it is also worth noting remarks made by Norm Champ, Director of the SEC’s Division of Investment Management, in a speech delivered at the ALI CLE 2012 Conference on Life Insurance Company Products shortly before the settlement agreement was announced. Mr. Champ’s speech highlighted a number of key themes on which the staff is currently focusing, key among them, effective investor communications. Among other things, Mr. Champ urged the insurance industry to be proactive in considering how best to inform investors about contract risks. He noted recent decisions by companies to stop accepting additional purchase payments on outstanding contracts and to make exchange offers to terminate benefits on variable annuities. He encouraged careful consideration of product design and disclosure going forward.