Managed Volatility Is Key Focus For SEC
December 2, 2014 by Arthur D. Postal
WASHINGTON— Adding managed volatility overlays to funds that underlie variable annuities “may raise important disclosure, suitability and other concerns,” according to Norm Champ, director of the Security and Exchange Commission (SEC) Division of Investment Management.
Champ made his remarks at the 32nd annual ALI CLE 2014 Conference on Life Insurance Company Products in Washington. He noted that “if an underlying equity fund is changed to add a managed volatility component after a contract owner has allocated contract value to that fund, the [SEC] staff generally believes that insurers should consider whether adding downside protection is redundant with the living benefits contract owners may have already purchased and/or suppresses the potential for gains that may have motivated the original equity investments.”
Champ’s remarks echo similar concerns expressed by the New York Department of Financial Services (NYDFS) earlier this year. On March 17, the NYDFS fined AXA Equitable $20 million. The fine was part of a consent order that alleged that AXA filed plan of operations amendments that did not adequately discuss the significance of implementing a managed volatility strategy, called the AXA Tactical Manager Strategy or “ATM Strategy,” to underlying funds that “substantially changed its variable annuity products.”
According to the consent order, the ATM Strategy “may have the effect of suppressing the value of certain guarantee benefits” that are available when the policyholder’s account value rises. The consent order goes on to note that if the NYDFS “had been aware of the extent of the changes, it may have required that the existing policyholders affirmatively opt in to the ATM Strategy.”
Similarly, Champ stated that that use of managed volatility strategies at the fund level in connection with contracts that provide living benefits may, in some cases, “result in limited benefits to contract owners who have already paid for protections against market loss, particularly to the extent that they limit upside earning potential.”
However, according to Richard T. Choi, a lawyer with Carlton Fields Jorden Burt in Washington and co-chair of the conference, managing volatility “does not necessarily equate to lower overall long-term performance.” To the contrary, “managing volatility may result in superior long-term performance since the dips are not as severe, which means less ground has to be made up to recover from losses,” Choi said. “It’s an appropriate strategy for variable annuities, which are long-term investments.”
Choi added that the NYDFS threat of imposing a requirement that a policyholder affirmatively opt in to a variable annuity underlying fund change involving a managed volatility overlay would contradict the federal securities laws. “Congress preempted state regulation of mutual funds in 1996,” Choi said, “and such a requirement would effectively enable New York to prevent a fund from implementing investment strategy changes approved by the fund’s independent board acting in the best interests of the fund’s shareholders. This is not what Congress had in mind.”
In addition, the NYDFS position could create mischief in the area of fund substitutions approved by the SEC. “In 1970, Congress mandated that the SEC exercise its judgment in approving substitutions on behalf of investors on grounds that investors are seldom in a position to judge the merits of the substituted security,” Choi said. “Requiring policyholders to opt in would, in effect, turn this congressional policy on its head and for no good reason since VA policyholders typically have a wide range of investment options to which to transfer their assets if they so desire, both before and after a substitution.”
It remains to be seen what will come of the SEC’s review of this area, and how the SEC will react to the positions expressed by the NYDFS.
