Retirement planners and insurance professionals are finding that the needs of very high-net-worth clients simply cannot be satisfied through traditional retirement planning vehicles. Traditional tax-preferred planning vehicles create undesirable limits for these so-called “ultra-wealthy” clients, who have plentiful funds and, therefore, seek high-performing investment vehicles. Private placement variable annuity investments may be the right choice for these extremely wealthy clients, as tax benefits and investment control are attractive aspects of those products. Distributors of the products, however, must exercise caution—particularly where a variety of services are needed to manage the products. A clear understanding of the product is necessary to fully comprehend the underlying issues.
What Is a Private Placement Variable Annuity?
A Private Placement Variable Annuity (PPVA) is an annuity that is available only to high-net-worth clients who qualify as “accredited investors” (and, practically speaking, “qualified purchasers”), meaning that they meet certain requirements as to net worth and investment sophistication. It is an annuity in that it is treated as such for tax purposes but is very different from the traditional retail annuities familiar to consumers. PPVA investments do not offer the types of income guarantee riders and protection against market risks that more traditional retail annuities make available. However, the PPVA is an attractive tool because it is flexible and allows tax-deferred growth, allowing the purchaser the discretion to make additional deposits into the annuity contract and change investment allocations based on investment options, including hedge funds and private equity investments which provide the potential for significant financial returns.
Taxes on account growth are deferred until the contract holder begins taking annuity payouts (a 10% penalty charge applies if distributions begin before the holder reaches age 59½). To qualify for this favorable tax treatment, the PPVA investment must offer investment options that are available solely to qualified insurance companies. Additionally, the underlying asset allocations must meet certain investment diversification requirements—for example, no more than 55%of the holder’s assets may be allocated to any single investment and no more than 70% may be allocated to any two investments. The contract holder has control over investment allocations but cannot have control over the investment choices that are offered within the PPVA investment, as an independent investment manager must have discretion to choose the investments that will be made available to the contract holder.
The attributes of these products, while attractive to the wealthy, make for a sophisticated product, requiring careful product disclosures by the sales force. As noted above, for example, an independent investment manager must have discretion to choose the investments that will be made available to the contract holder. If that independent manager is associated with an affiliate of the distributor for which the selling agent produces, disclosures that the affiliate will receive investment management fees are required under applicable law. Further, because the PPVA products are manuscript products, often designed to meet the customer’s particular needs, fees associated with the sales are often subject to negotiation, meaning fees charged to similarly situated contract holders could be widely disparate. This may implicate state insurance anti-rebating laws and compensation disclosure rules as more fully discussed below.
Disclosure Requirements
The SEC is clear that under both federal and state law, an investment adviser is a fiduciary and: must make full disclosure to your clients of all material facts relating to the advisory relationship. As a fiduciary, you also must seek to avoid conflicts of interest with your clients, and, at a minimum, make full disclosure of all material conflicts of interest between you and your clients that could affect the advisory relationship. This obligation requires that you provide the client with sufficiently specific facts so that the client is able to understand the conflicts of interest you have and the business practices in which you engage and can give informed consent to such conflicts or practices or reject them.
Form ADV, Part 2, 3—Disclosure Obligations as a Fiduciary. “Under rule 17a-14 under the Securities Exchange Act of1934 and rule 204-5 under the Investment Advisers Act of 1940, broker-dealers registered under section 15 of the Exchange Act and investment advisers registered under section 203 of the Advisers Act are required to deliver to retail investors a relationship summary disclosing certain information about the firm.” Form CRS, USSEC,
//www.sec.gov/files/formcrs.pdf.
With a few notable exceptions, such as Florida, most states’ insurance laws require written compensation disclosures to be made to the insured in some form and with varying content requirements. Additionally, the sales force will be required to disclose its advisory fee bank arrangement (assuming the banker is an affiliate of the distributor), especially in certain states such as Texas and New York, as those laws are broad enough to encompass affiliated arrangement as are common in the sale of PPVA investments.
In New York, compensation disclosure transcends affiliation as “no person licensed as an insurance agent, broker, or consultant may receive” any fee or compensation unless there is “a written memorandum, signed by the party to be charged, and specifying or clearly defining the amount or extent of such compensation.” See, N.Y. Ins. Law Section2119. “All compensation arrangements between an insurer and a broker should be reduced to writing and agreed to by both parties.” see NYSDFS, Circular Letter No. 1998.22. Under Reg 194, upfront disclosures include: a description of the role of the insurance producer in the sale:
- whether the insurance producer will receive compensation from the selling insurer or other third partybased in whole or in part on the insurance contract the producer sells.
- that the compensation paid to the insurance producer may vary depending on a number of factors.
- that the purchaser may obtain information about the compensation expected to be received by theproducer based in whole or in part on the sale, and the compensation expected to be received based inwhole or in part on any alternative quotes presented by the producer, by requesting such information fromthe producer.
The purchaser can request more information, in which case the producer must disclose additional detail.
Anti-Rebating Restrictions
If product distributors expect to charge fees on a client-by-client basis, the compensation scheme could be subject tostrict regulatory scrutiny but likely would not run afoul of anti-rebating restrictions. For example, New York’s anti-rebatinglaw, N.Y. Ins Law 4224, states:
(c) … no licensed insurance broker and no employee or other representative of any such insurer, agent or broker, shall pay, allow or give, or offer to pay, allow or give, directly or indirectly, as an inducement to any person to insure, or shall give, sell or purchase, or offer to give, sell or purchase, as such inducement, or interdependent with any policy of life insurance or annuity contract or policy of accident and health insurance, any stocks, bonds, or other securities, or any dividends or profits accruing or to accrue thereon, or any valuable consideration or inducement whatever not specified in such policy or contract other than any valuable consideration …
This echoes similar language in the National Association of Insurance Commissioners (NAIC) Model Unfair Trade Practices Law, MDL 880-1.
New York has issued numerous Office of General Counsel opinions opining those rebates, via a waiver or otherwisereduced commission, are inappropriate because any rebate or inducement must be “specified in the policy.” See, e.g.,OGC Opinion No. 10-09-13; OGC Opinion No. 07-07-25; OGC Opinion No. 08-09-07.
While variable fee structures likely would not be permitted for traditional insurance products which have rates and forms filed with the various states, the nature of the PPVA products generally changes this analysis since PPVA products are manuscript—bespoke and specific to the insured. Whereas a producer would not be able to adjust commissions for a traditional life insurance product between insureds, for the PPVA any compensation could be tailored to the insured and written directly into the product itself. Careful contract drafting and a tightly controlled sales force will be necessary if PPVA investments are to be sold on a compliant basis.
Reprinted with permission from the May 5, 2023 edition of The Legal Intelligencer © 2023 ALM Global Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-256-2472 or reprints@alm.com.