Guidance for Charitable Annuity Societies

Portfolio Diversification and Adoption of an Investment Strategy Statement Incorporating the Prudent Investor Standard

Department guidance to charitable annuity societies on various areas of the operation of these societies. These constitute best practice recommendations rather than statutorily mandated provisions.

Section 1409(a) of the New York Insurance Law states,

Except as more specifically provided in this chapter, no domestic insurer shall have more than ten percent of its admitted assets as shown by its last statement on file with the superintendent invested in, or loaned upon, the securities (including for this purpose certificates of deposit, partnership interests and other equity interests) of any one institution.

While charitable annuity societies are not subject to Section 1409 of the New York Insurance Law, as part of the exercise of prudent governance, it is the Department's position that each segregated gift annuity fund ("Fund") should limit its exposure in any one institution, other than investments in U.S. government securities and those specifically backed by the U.S. government, to a maximum of ten percent (10%) of its admitted assets. Limiting each Fund's exposure makes it likely that the Fund's other assets could provide a variability to offset the risks inherent in each investment in the Fund's portfolio.

A trustee using reasonable care, skill and caution should diversify the Fund's assets. A diversification is proper when it disperses the investments' risks consistent with the Investment Strategy Statement's ("ISS") risk, return, and time horizon objectives, and the various risks in the portfolio offset each other. Section 1409 of the New York Insurance Law is instructive in this regard. Limiting exposure to any assets of any one institution to ten percent of admitted assets would reasonably assure that the risks in the investment in that institution are offset by the rest of the portfolio. The Department also recognizes the desire of charitable annuity societies to purchase passive index mutual funds, collective funds or trusts, and exchange traded funds (collectively, "index funds") to take advantage of the low cost and large number of underlying securities as part of a prudent investment management strategy. However, a trustee should consider that while the use of index funds might rightly justify exceeding the 10% recommended concentration threshold, the purchase of index funds do not, by themselves, provide sufficient diversification given risks that may arise due to any discretion provided to a fund's investment managers to deviate the fund's holdings from the index and to engage in practices such as securities lending or the purchase of derivatives. If the trustee has determined that it is in the interests of the beneficiaries not to diversify, then it should memorialize the reasons for that determination in terms of the ISS's risk, return, and time horizon parameters.

It is the Department's position that each Fund adopt an Investment Strategy Statement. Such a Statement should refer to the prudent investor standard as defined in Section 11-2.3 of the Estates, Powers and Trusts Law, which standard, as specified in Section 1110(b) of the New York Insurance Law, governs the manner in which the required admitted assets of a segregated gift annuity fund shall be invested. The Fund should exercise reasonable care, skill and caution to make and implement investment and management decisions as a prudent investor would for the entire portfolio. In doing so, the Fund should take into account present and future distributions to or for the beneficiaries and create a plan to meet the needs of those distributions to establish the ISS's risk, return, and time horizon objectives.

Conflicts of Interest

It is the Department's position that charitable annuity societies should be aware of potential conflicts of interest that may impact making impartial investment decisions on their behalf. While it is fairly common for such societies to hire outside investment managers to perform the function of making investment decisions and managing a portfolio of invested assets, it has been noted that oftentimes these societies invest in mutual funds or other entities issued or sponsored by the primary investment manager. Prudent management strongly suggests that such apparent conflicts of interest should be avoided.