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John Selden, a 17th century writer said, “Equity is a roguish thing.”

He was speaking about the English Chancery system of law by that name–not justice or fairness, and certainly not about risk interest or ownership rights in property, or common stock of corporations.

The interpretation does apply, however, to each of the other meanings. Just look at the stock market over the last three years, or three months, or at what forecasters are predicting for the rest 2003. Have common stock prices been fair to investors?

Another question: Have equity indexed products been treated fairly? Lets see.

The National Association of Securities Dealers recently indicated it intends to scrutinize practices used in sales of equity indexed products to seniors. The NASD appears to anticipate significant sales activity of such products to seniors. This heightened scrutiny has implications for marketers of equity index annuities.

But this article addresses a less obvious spotlighting of equity indexed products–namely, the impact on annuities of the floating rate model nonforfeiture law recently adopted by National Association of Insurance Commissioners. As this was being written in late July 2003, approximately a dozen states had already adopted the model.

The model replaces the prior 3% guaranteed minimum interest rate requirement for fixed annuities. Since its adoption, the model has provoked what I consider to be a disproportionate focus on equity indexed annuities. Specifically, the marketplace is abuzz with questions about what this means for the status of equity indexed annuities under the federal securities laws.

However, few people seem to be actively concerned about the models impact on more traditional declared rate fixed annuities. Nor do they seem to realize that traditional fixed annuities are not immune from scrutiny under the same securities laws.

There is no question that this new model poses significant issues concerning the status of equity indexed products under the federal securities laws. Those of us who analyze, and opine on, these products are keenly aware of this.

Yet the industry should be aware that the model does pose the same issues for any declared rate fixed annuity. This is because much of the precedent–including formal articulations by the Securities and Exchange Commission and its staff–has been in terms of the guaranteed return of 90% of premium at 3% interest. “Ninety at three” has been the underlying mantra of Rule 151 under the Securities Act of 1933 that provides a “safe-harbor” for fixed annuity contracts.

Of course, Rule 151 says what it says, and it only references the state or NAIC prescribed rate, not any specified rate of 3%. If a literal reading (i.e., it says what it says) prevails, this reading will be equally applicable to equity indexed products.

Indexed products are not expressly covered by the Safe Harbor rule. However, any analysis of the status of an equity indexed product starts with the extent to which it complies with Rule 151s standards. Then it extends to its consistency with the case law under the controlling statutory provision, Section 3(a) (8) of the 1933 Act.

Thus, the specified rate of interest credited and guaranteed to be part of the owners minimum withdrawal value is not one of the differences that distinguishes the analysis of equity indexed products from other fixed products.

On the other hand, what happens if the SEC or a court takes another look at Rule 151 and determines that it was adopted when no one dreamed that interest rates would ever fall so low? What if the official body therefore decides Rule 151 needs revising or reinterpreting?

That will impact not just equity indexed products but all future declared rate products that only guarantee the new applicable floating rate.

It seems incredible that such a turn of events would happen. However, recall that in 1986, many observers thought the decision in Otto v. Variable Annuity Life Insurance Co. [814 F.2d 1127 (7th Cir. 1986)] posed a significant threat to fixed annuities. As you will recall, this case found that the fixed annuity portion of a variable contract was itself a security.

There is not necessarily any reason to believe that the SEC is contemplating any revisit of Rule 151. Even at the time of its renewed interest in equity indexed products in late 2002, the then-pending nonforfeiture rate reductions did not evoke any expressions of grave concern during informal discussions with the SEC senior staff. Of course, that was then and this is now, and the new floating rate is a reality.

For the moment, annuity insurers are more occupied with figuring out transition procedures. They are focused on installing the new rates and the related reserving requirements in the face of the disparities between the requirements of the old law and new law states.

Even so, they should not lose sight of the need to evaluate carefully the impact of the new model law on product design. It is not only equity that is a roguish thing.

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Joan E. Boros, Esq., is a partner in the Jorden Burt LLP law firm in Washington, D.C. Her e-mail address is

JEB@ jordenusa.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, August 11, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.