RILA Modernization

On July 1, 2024, the Securities and Exchange Commission ("SEC") adopted rule and form amendments that require issuers of registered index-linked annuities ("RILAs") to exclusively register their offerings on Form N-4.¹ The final amendments ("RILA Amendments") are focused on increasing and simplifying disclosure to RILA investors. Under the RILA Amendments, Forms S-1 and S-3 under the Securities Act of 1933 ("Securities Act") and Rule 424 under the Securities Act are no longer available for RILA offerings.

The RILA Amendments mostly adopt, unchanged, the modifications discussed in the original proposal (the "RILA Proposal").² The RILA Amendments will become effective 60 days after date of their publication in the Federal Register.

The RILA Amendments were adopted in response to Division AA, Title 1 of the Consolidated Appropriations Act ("RILA Act"). The RILA Act requires the SEC to adopt a new registration form for RILAs, which must be designed "to ensure that a purchaser using the form receives the information necessary to make knowledgeable decisions, taking into account (1) the availability of information; (2) the knowledge and sophistication of that class of purchasers; (3) the complexity of the RILA; and (4) any other factor the Commission determines appropriate."³ The RILA Act also directed the SEC to engage in investor testing in order to inform the design of the new form.⁴

This article summarizes key parts of the RILA Amendments.

The RILA Amendments make the following changes to RILA offerings, among others:

• RILA issuers will be required to use Form N-4 (the form historically used to register variable annuity products);
  • The Form N-4 Key Information Table is amended to highlight particular features of RILAs and to allow the use of financial statements presented in accordance with statutory accounting principles ("SAP");
• Form N-4 is amended for issuers of variable annuities to switch the order of the Key Information Table and the Overview of the Contract items so that investors are introduced earlier to the meaning of terms that the SEC has found to be confusing to investors;
• RILA issuers are permitted to use a summary prospectus;
• RILA issuers will pay registration fees in arrears, using Form 24F-2 (as opposed to paying in advance, as with Form S-1 or S-3);⁵ and
• RILA issuers' sales literature will be required to comply with Rule 156 under the Securities Act.⁶

CHARACTERISTICS OF RILAs

RILAs are annuity contracts, the payout of which is linked to the performance of an underlier, such as an equity index. An annuity contract ("annuity" or "contract") is a type of insurance product in which an investor makes a lump-sum payment or series of payments in return for future payments from the issuing insurance company. Investors purchase annuities in order to meet retirement and other long-term financial objectives. An investor in a RILA allocates purchase payments to one or more investment options under which the investor's returns (both gains and losses) are based, at least in part, on the performance of an index or other benchmark (collectively, "indexes"), over a set period of time ("crediting period"). In some cases, insurance companies offer RILAs with various index-linked investment options ("index-linked options") for investors to choose from.⁷

The Final Release summarizes certain features of RILAs, which, together, may be confusing to investors and should be considered by financial professionals when recommending RILAs to investors:

• "Bounded Return" structure – much like structured notes, RILAs have features that cause them not to have a 1:1 relationship with the performance of the underlying index, such as buffers, caps, and upside participation rates that are generally less than 1:1;
• "Fees and Expenses" – while a RILA investor pays no direct or explicit ongoing fees and expenses under a RILA, the SEC views limitations on the upside performance (leverage ratios of less than 1:1 and caps) as the equivalent of fees and expenses (a viewpoint not expressed by the SEC in the context of structured notes); and
• Early withdrawal penalties, changes by the insurer to the features of the RILA during the life of the RILA and taxes.⁸

HOW RILAS ARE CURRENTLY REGISTERED

RILAs are securities for purposes of the Securities Act. Offerings of RILAs are currently registered with the SEC on Form S-1 or S-3. Because U.S. insurance companies are required for state insurance regulatory purposes to prepare their financial statements in accordance with SAP, the usual approach for S-1 RILA issuers has been to obtain a no-action letter from the SEC staff, under which the issuer's financial statements are presented in SAP, rather than US GAAP (as required by Form S-1).

Under Section 15(d) of the Securities Exchange Act of 1934 ("Exchange Act"), any issuer that has had a registration statement declared effective under the Securities Act must file reports under the Exchange Act. Under the Securities Act and the Exchange Act, the financial statements of domestic issuers in these reports must be prepared in accordance with US GAAP. Exchange Act periodic reports also require that the issuer's chief executive officer and chief financial officer complete and file Sarbanes-Oxley certifications.

To avoid overburdening an insurance company issuer that is already required under state insurance regulations to report its financial condition under SAP, Rule 12h-7 under the Exchange Act exempts insurance company issuers from the Section 15(d) reporting requirement. Rule 12h-7, in brief, exempts an insurance company that is state-regulated and also files an annual statement of its financial condition with, and is supervised and its financial condition is examined periodically by, the state insurance commissioner or equivalent official, among other requirements.

The SEC states in the RILA Proposal that, because Forms S-1 and S-3 are designed to accommodate a wide range of equity and debt securities, these forms "do not include specific line-item requirements addressing disclosures about RILAs and their complex features."⁹ The SEC also noted that these forms require issuers to disclose information about the offering itself as well as extensive information about the registrant issuing the securities that a RILA investor may view as less important than information about the features of the RILA.¹⁰

INVESTOR CONFUSION ABOUT RILAS

The SEC's Office of the Investor Advocate ("OIA") conducted investor testing to determine the level of investor understanding about RILAs. Through interviews, the SEC sought to identify specific items that could appear in the Key Information Table in RILA registration statements, and to determine whether those line items could confuse investors. The results of the research showed that investors had significant confusion about the structure and timing of RILAs.¹¹ After a second round of interviews, in which investors were shown tables and graphics explaining RILA payoffs, participants "demonstrated modestly improved comprehension in certain limited areas."¹²

Testing "reviewed overall comprehension of participants as well as whether participants were able to assess four sub-scores: (1) appropriateness of RILAs for investors based on their characteristics, (2) how a RILA works, (3) how the charges and penalties associated with RILAs affect liquidity, and (4) the insurance protections offered by RILAs. Across all participants, the average percentage of questions scored correct was 58%, which, while higher than the expected score for people randomly guessing (50%), was lower relative to what might be considered a well-informed purchaser of a RILA product."¹³ Although the SEC did not conclude that the OIA's testing was largely successful in identifying areas of investor confusion, the testing did not point to specific disclosures that would mitigate confusion. The SEC incorporated the OIA's testing results into its amendments to Form N-4, with the aim of reducing areas of confusion exposed by the OIA's testing while working off of existing disclosure requirements.¹⁴

Footnotes

1. Registration for Index-Linked Annuities and Registered Market Value Adjustment Annuities; Amendments to Form N-4 for Index-Linked Annuities, Registered Market Value Adjustment Annuities, and Variable Annuities; Other Technical Amendments Securities Act Release No. 33-11294 (July 1, 2024), available at: https://www.sec.gov/files/rules/final/2024/33-11294.pdf (the "Final Release").

2. Registration for Index-Linked Annuities; Amendments to Form N-4 for Index-Linked and Variable Annuities, Securities Act Release No. 11250 (Sept. 29. 2023), available at: https://www.sec.gov/files/rules/proposed/2023/33-11250.pdf.

4. The investor testing was performed by the SEC's Office of the Investor Advocate ("OIA") and is available at: https://www.sec.gov/files/rila-report-092023.pdf.

5. The SEC noted that it is not aware of any RILA issuers that are "well known seasoned issuers" eligible to use Form S-3ASR, the automatic shelf registration form, which also allows for "pay-as you-go" of registration fees. See the Final Release at II.F.1, n. 598 (citing also the RILA Proposal).

6. Final Release at II.G.

7. RILA Proposal at pp. 5-6; Final Release at pp. 8-9.

8. Final Release at I.A.

9. Final Release at p. 14. We note that, in the absence of these line item requirements, material disclosure about characteristics such as limits on gains are fully disclosed by S-3 issuers of structured notes.

10. Final Release at pp. 14-15.

11. See generally the Final Release at I.D. Although certain characteristics of RILA are familiar to investors in structured notes (buffers, leverage, caps), it is understandable that the additional complexities of RILAs– such as crediting periods, early withdrawal penalties, etc.– create opportunities for confusion.

12. RILA Proposal at p. 22.

13. Id. at pp. 24-25.

14. Final Release at pp. 17-18.

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