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July 27, 2005 at 08:00 PM
Agencies are examining the securities status of EIAs
This past spring, high-level officials at the National Association of Securities Dealers started making public statements, warning member firms that they may face significant risk concerning sales of equity index annuities, and advising that: If you can’t be sure whether an EIA is a security or not, you should consider assuming the worst and treating it like a security.
On Aug. 8, 2005, the NASD issued a Notice to Members setting out additional guidance for implementing this advice. Now, more quietly, the Securities and Exchange Commission also has started reexamining the securities status of equity index annuities.
To step back, EIAs are hybrid products that offer both traditional insurance features (minimum guaranteed returns) and the opportunity to participate, to some extent, in the upside potential of the equity markets. They first came to market in 1995 and have been sold, for the most part, as insurance, without SEC registration or NASD sales practice supervision.
The dividing line between “insurance” and “securities” depends on (1) whether the insurance company assumes investment risk, and (2) whether the product is marketed primarily as an investment. EIAs do not seem to fit categorically on either side.
In 1997, the SEC issued a “concept release” concerning “substantial uncertainty” about whether all equity indexed products should be properly characterized as insurance, and asking for industry comment on the structure and marketing of these products. More clarity on this subject may benefit everyone, the release said. For products that qualify as securities, investors would get the protections of the federal securities laws. For real insurance, greater clarity would reduce litigation risk for all parties.
Comments were sent in, but more guidance from the SEC was not forthcoming.
Left to apply existing legal principles on their own, manufacturers and sellers appeared to become comfortable that guaranteeing a minimum return of 90% of principal earning interest at 3% until maturity (the amount required by most state nonforfeiture laws for single premium products) would satisfy the insurance test and justify offering the products without SEC registration.
Now, in mid-2005, clarity on this score is more important than ever. EIA sales are exploding under today’s market conditions and demographics; they appeal strongly to investors nearing retirement who suffered losses in the early 2000s but still feel the allure of the stock market.
At the same time, some companies have found the 90% at 3% guarantee untenable in the persistent low interest environment, and nonforfeiture laws now permit lower, and even variable, rates. Thus, there are products now on the market that are no longer in the old comfort zone.
