OGC Op. No. 09-06-11
The Office of General Counsel issued the following opinion on June 25, 2009 representing the position of the New York State Insurance Department.
RE: Permissibility of Proposed Contingent Annuity Contracts
Is the proposed contingent annuity contract discussed below permissible under the New York Insurance Law?
No. The contingent annuity contract is not permissible under the New York Insurance Law because it constitutes an impermissible form of financial guaranty insurance.
The inquirer reports that several life insurance companies (collectively, “Companies”, or individually, the “Company”) have presented for the Department’s approval variations of a contingent annuity contract (the “Contract”), which is structured as a group or individual annuity. The inquirer further reports that the Contract typically provides for the making of small periodic payments that are determined as a percentage of amounts deposited or held in a mutual fund or brokerage account (the “Account”) of another financial institution and owned by the account holder investor (“Investor”). The Investor will be the certificate holder, although the actual covered life (“Payee”) may be another person, such as a dependent of the certificate holder.
The inquirer reports that the Investor’s choice of Account investments is limited within a range of options intended to produce predictable returns and that the Investor elects the date on which distributions for the life of the annuitant will begin from the Account. The size of the distributions must be a fixed percentage of the value of the Account at the time when distributions begin, and the percentage must fall within a range appropriate to the life expectancy of the Payee. The amount determined by initial application of the percentage to the Account is fixed as the amount to be paid for all future distributions, subject to variations in the growth or decline of the Account and/or withdrawals from the Account. The distributions will be funded by income earned in the Account or sales of assets within the Account, if the income or cash in the Account is not adequate to make the current distribution. All amounts withdrawn will be included in the income of the Payee as ordinary income, return of basis, or capital gain, using general income tax principles rather than those applicable to annuities.
If the Investor chooses to distribute less from the Account than the fixed amount, future distributions may increase. If the Investor decides to access a greater amount from the Account than the initial fixed distribution, future distributions will be reduced. In either event, the future commitment from the Company to continue the distributions also will be adjusted.
The Account may eventually be exhausted (or reduced below a certain level) due to the distributions and/or poor investment experience. In that event, the remaining balance in the Account will be transferred to the Company, which will continue a payment stream that had been previously generated by the Account to the Investor or Payee. If, however, in spite of the distributions, the Account does not fall below a specified level or is not exhausted (either because of favorable investment experience or because the Investor dies before the originally predicted life expectancy), then the Company will not make any “annuity” income payments. Further, until such time as the Account’s value drops to the specified minimum, the Investor may choose at any time to cease making the small periodic payments to the Company, and all obligations from the Company will cease.
The first part of this analysis considers whether the proposed Contract constitutes a form of financial guaranty insurance, and whether it may be offered in New York. The second part addresses arguments raised by the Companies in support of the proposed Contract’s legal validity.
A. Financial Guaranty Insurance
Based on the description of the Contract noted above, the Contract appears to be a form of financial guaranty insurance, which is defined by Insurance Law § 6901 in pertinent part as follows:
"Financial guaranty insurance" means a surety bond, insurance policy or, when issued by an insurer or any person doing an insurance business as defined in [§ 1101(b)(1)] of this chapter, an indemnity contract, and any guaranty similar to the foregoing types, under which loss is payable, upon proof of occurrence of financial loss, to an insured claimant, obligee or indemnitee as a result of any of the following events:
* * *
(D) changes in the value of specific assets or commodities, financial or commodity indices, or price levels in general; or
(E) other events which the superintendent determines are substantially similar to any of the foregoing.
Ins. L. § 6901(a)(1). Financial guaranty insurance can be issued only by a financial guaranty insurer licensed for that purpose, Ins. L. § 6904(a), and only to the extent permitted by Insurance Law § 6904(b).
The Contract comes within this definition of financial guaranty insurance because it purports to provide indemnification for “financial loss” resulting from “changes in the value of specific assets.” Ins. L. § 6901(a)(1)(D). Indeed, the Companies here are promising to continue making regular payments only in the event that the value of the covered Account declines before the annuitant dies. The Contract essentially holds the Investor harmless from declines in the value of the Account, whether such declines result from market losses or insufficient market growth relative to the amounts withdrawn. The Contract therefore meets the definition of financial guaranty insurance, in that a decline in the value of specific assets (the holdings in the Investor’s Account) is being indemnified via the continuation of payments that commence only when and if the decline in value occurs.1 Whether the indemnification is effected by the making of periodic payments over a term of years, or for the duration of the Investor’s lifetime, is immaterial to the analysis.
The broad definition of financial guaranty insurance in Insurance Law § 6901(a)(1) is subject to the provisions of Insurance Law § 6901(a)(2), which specifically exclude certain kinds of insurance and other arrangements from the definition. Insurance Law § 6901(a)(2) states in pertinent part:
Notwithstanding paragraph one of this subsection, “financial guaranty insurance” shall not include:
(A) insurance of any loss resulting from any event described in paragraph one of this subsection if the loss is payable only upon the occurrence of any of the following, as specified in a surety bond, insurance policy or indemnity contract:
(i) a fortuitous physical event;
(ii) failure of or deficiency in the operation of equipment; or
(iii) an inability to extract or recover a natural resource;
(B) fidelity and surety insurance as defined in [§1113(a)(16)] of this chapter;
(C) credit insurance as defined in [§ 1113(a)(17)]of this chapter;
(D) credit unemployment insurance as defined in [§ 1113(a)(24)] of this chapter;
(E) residual value insurance as defined in [§ 1113(a)(22)] of this chapter;
(F) mortgage guaranty insurance as defined in [§ 1113(a)(23)] of this chapter and as permitted to be written by a mortgage guaranty insurer under article sixty-five of this chapter;
(G) guaranteed investment contracts issued by life insurance companies which provide that the life insurer itself will make specified payments in exchange for specific premiums or contributions;
(H) indemnity contracts or similar guaranties, to the extent that they are not otherwise limited or proscribed by this chapter . . .
(I) guarantees of higher education loans, unless written by a financial guaranty insurance corporation;
(J) guarantees of insurance contracts, except for . . .
(K) any other form of insurance covering risks which the superintendent determines to be substantially similar to any of the foregoing.
The proposed Contract cannot be characterized as any of the kinds of insurance or other arrangements specifically excluded from the broad scope of Insurance Law § 6901(a)(1). Nor does the proposed Contract insure risks “substantially similar” to those specifically enumerated in the statute, Ins. L. § 6901(a)(2)(K), because none of the enumerated items represents the kinds of risks that are similar to the risks the proposed Contract seeks to insure – namely, market value declines of a portfolio of equities, which the insurer does not own. Thus, the Contract falls squarely within the definition of financial guaranty insurance in Insurance Law § 6901(a)(1), and is not specifically excluded from that definition by Insurance Law § 6901(a)(2).
Not only does the Contract constitute financial guaranty insurance, it also constitutes an impermissible form of financial guaranty coverage. Under New York law, financial guaranty insurance may only be written by an insurer licensed for that specific purpose and only with respect to permissible guaranties as set forth in Insurance Law § 6904(b)(1):
The superintendent shall not permit the writing of financial guaranty insurance except as defined in [§ 6901(a)(1)(A)] of this article, and a corporation may insure the timely payment of United States dollar debt instruments, or other monetary obligations, only in the following categories:
(A) municipal obligation bonds;
(B) special revenue bonds;
(C) industrial development bonds;
(D) obligations of corporations, trusts or other similar entities established under applicable law;
(E) partnership obligations;
(F) asset-backed securities, trust certificates and trust obligations other than mortgage-backed securities secured by first mortgages on real property which are insurable by a mortgage guaranty insurer authorized under [§ 1113(a)(23)] of this chapter . . .
(G) installment purchase agreements executed as a condition of sale;
(H) consumer debt obligations;
(I) utility first mortgage obligations; and
(J) any other debt instrument or financial obligation that the superintendent determines to be substantially similar to any of the foregoing or shall otherwise be approved by the superintendent.
Under the plain terms of Insurance Law §§ 6901 and 6904, the Contract, although constituting financial guaranty insurance, is not of a type that may be marketed in New York. The Contract protects against declines in the value of specific assets (thus qualifying under the broad definition of financial guaranty in Insurance Law § 6901(a)(1) and not specifically excluded by Insurance Law § 6901(a)(2)), but does not come within any of the expressly permitted kinds of financial guaranty insurance enumerated in Insurance Law § 6904(b)(1).
The characterization of the Contract as an impermissible form of financial guaranty is consistent with the Department’s prior interpretations of the statute. For example, the Department has previously characterized several proposed “excess deposit insurance” contracts, each of which purported to provide insurance to savings deposit account holders in excess of the protection provided by the Federal Deposit Insurance Corporation, as constituting impermissible financial guaranty insurance. See Office of General Counsel (“OGC”) Opinion 02-11-03 (November 12, 2002); OGC Opinion No. 90-54 (NILS, June 1, 1990); and OGC Opinion No. 90-16 (NILS, February 15, 1990). The Department also has characterized a proposed “financial property insurance” contract as impermissible financial guaranty insurance. See OGC Opinion No. 05-11-02 (November 3, 2005) (concluding that insurance intended to protect policyholders against a decline in the value of equity and/or mutual fund portfolios constitutes an impermissible form of financial guaranty under Insurance Law § 6901(a)(1)(D)).
B. The Companies’ Arguments
The Companies raise a number of arguments that challenge the conclusion that the Contract fails to comport with Article 69.
One Company contends that the Contract is not financial guaranty because (1) there is no specific sum owed to each specific Investor and (2) in the event of a loss, there is no specific asset to which the loss can be traced. These two points reflect a misunderstanding of the definition of “financial guaranty insurance” under New York law. First, nothing in Insurance Law § 6901(a)(1)(D) requires that there be a specific sum owed. Rather, the definition requires only a loss payable “upon proof of occurrence of financial loss . . . as a result of . . . changes in the value of specific assets.” Ins. L. § 6901(a)(1)(D). Second, the “specific assets,” in the case of the Contract, are the assets in the Investor’s Account, whose decline in value triggers the Contract’s obligation to pay (in the form of maintaining periodic payments as though the value of the Account had not declined).
Another Company’s reliance on the legislative history of the original financial guaranty statute is likewise misplaced. One major aim of Article 69 of the Insurance Law is to regulate the provision of guaranties on municipal bonds and other debt instruments, which are described as permissible guaranties in Insurance Law § 6904. But another overarching purpose of Article 69 is to distinguish financial guaranty from the wider universe of fidelity and surety insurance. Accordingly, Insurance Law § 6901(a)describes all of the types of risks whose coverage would constitute the provision of a financial guaranty, whether permissible or not. That list encompasses many possible transactions, including the transaction contemplated by the Contract. Indeed, one of the major concerns at the time that Article 69 was enacted was that financial guaranty insurance was a risky proposition that should not be written along with most other kinds of insurance. Because of worries that financial guaranty risks could bring down a multi‑line insurer, and thereby injure insureds seeking ordinary property or liability insurance, see Governor’s Program Bill Memorandum, Ch. 48, L. 1989; 1989 N.Y. Session Laws 2056 (McKinney) – a concern that applies with equal force to a company that writes only life insurance – the broad definition of financial guaranty insurance was written to intentionally encompass the kinds of risks and exposures that cannot be lawfully written in New York.
A third Company asserts that the Contract is not financial guaranty insurance by seeking to distinguish the Contract from the typical applications of financial guaranty insurance (e.g., as a means of improving the credit rating of debt issuers). But in so doing, the Company ignores the expansive scope of Insurance Law § 6901(a)(1). The text of the statute is not circumscribed in the way the Company contends.
Finally, one Company suggests that the factual description of the proposed contingent annuity contract outlined above is not representative of its product, which is an individual annuity contract that has been registered with the SEC and authorized in 40 states. The Company also argues that because its product does not provide guaranties for “negative market performance,” the product does not constitute financial guaranty insurance. Both arguments are unpersuasive. First, whether the product is structured as an individual or group annuity is immaterial to whether it constitutes financial guaranty insurance under Article 69. Second, while negative market performance may be one cause of the decline in the value of the Account, the application of Insurance Law § 6901(a)(1)(D) is not limited exclusively to that one cause. Rather, the provision speaks generally of “financial loss . . . as a result of . . . changes in the value of specific assets.” Thus, whether a decline in the value of the Account sufficient to trigger the Company’s obligation to pay results from negative market performance or low market growth relative to the size of the withdrawals, the Company continues to provide the Investor with a stream of payments that had been funded by the Account, even though the Account itself can no longer support that stream of payments.
Because the proposed Contract is deficient as a matter of law under the standards set forth in Article 69 of the Insurance Law, it is unnecessary to reach any other arguments raised by the Companies regarding variable annuities or synthetic GICs. For the proposed Contract to pass legal muster would require, at the very least, a legislative change to Article 42 and/or Article 69 of the Insurance Law.
For further information you may contact Senior Counsel Eugene Benger or Supervising Attorney Michael Campanelli at the New York City office.
1 While the proposed contingent annuity contract does not provide an exact dollar-for-dollar indemnification for Account losses, it nevertheless provides an economic benefit when and if the Investor’s Account experiences a reduction in value below the trigger amount.