There was a Hollywood movie star who said: “I don’t care what you say about me, just spell my name right.”

Indexed annuities may not share that sentiment, but they certainly are getting a lot said about them at conferences and in print. In particular, a great deal has been written about National Association of Securities Dealers’ controversial Notice to Members 05-50 and the Securities and Exchange Commission staff’s August 2005 inquiry letter to index annuity insurers.

This article seeks to harvest something relevant about indexed annuities from all the swirling dialogue.

The question comes down to this: What is both the best thing about indexed annuities and the worst, or their biggest potential problem?

The best thing about them is the guarantee of a minimum rate of interest. As a retirement planning tool for the unsophisticated purchaser, the minimum guarantee provides a predictable minimum of future assets to fund the future liabilities of one’s retirement years.

Assuming the issuer is a financially stable entity, the number is a sure thing.

This floor is coupled with the potential for additional credited interest based on increases in an index that provide additional assets available to fund an improved lifestyle.

The biggest inherent problem in indexed annuities is their minimum rate of interest. The model minimum standard nonforfeiture rate (MSNFR) was changed by the National Association of Insurance Commissioners and adopted by the states. It no longer is 3%.

The 3% measure is the rate the SEC implicitly found to be sufficient as a safe harbor for permissible investment risk shifting for declared-rate fixed annuities when the SEC promulgated Rule 151 under Section 3(a)(8) of the Securities Act of 1933.

Although Rule 151 may not be relied on by indexed products, its analysis is relevant to any unregistered insurance product.

As the entire insurance product world knows, the relatively new MSNFR can be as low as 1%. When Rule 151 was adopted, few people dreamed that both short- and long-term interest rates would decline as they did. Not even Alan Greenspan anticipated that.

One thing that has not changed are the words and thoughts contained in the important Supreme Court cases, including SEC v. United Benefit Life Insurance Co. 359 U.S. 65 (1959), that address when insurance contracts are eligible for exclusion from status as securities.

In fashioning Rule 151, the SEC strove to distill the existing case law in its various provisions. The key concept this article focuses on is investment risk shifting–or put more colloquially, when, if ever, are purchasers made whole?

It is the foundation of the provision of the Rule that stipulates the crediting of a specified rate of interest for the life of the contract that is no less than the MSNF rate.

‘Made whole’ means getting back the premium or principal the purchaser originally paid. Is there a risk that they won’t get their principal back? When, if guaranteed, do purchasers get back their principal?

The new minimum standard nonforfeiture law has the potential for permitting a rate that could run afoul of the SEC’s reading of the United Benefit opinion. While the words of the opinion haven’t changed, the issue is whether the SEC’s thinking has.

The United Benefit opinion has been regarded as standing for the proposition that the 10 years the contract at issue took before the contract owner attained a “return of principal” was too long. The SEC could regard the application of the new minimum floating nonforfeiture rate even to 90% of premium as not being consistent with the implicit timeline of the United Benefit opinion, notwithstanding the literal words of Rule 151.

The reference to 90% of premium comes from the standard applied administratively, albeit not stated in Rule 151, by the SEC staff in applying Rule 151 and evaluating unregistered annuity contracts.

It is interesting to note that the August 2005 inquiry letter that the SEC sent to a variety of indexed annuity issuers contains a request for information about: “Any unregistered equity-index annuity contracts sold by the company where the payout at any point in the life of the contract, net of all surrender and other charges, may be less than 90% of premiums paid.”

This quotation highlights the 90% standard, as well as the fact the minimum rate is the only portion of the MSNFR to which the Rule and the SEC staff refer.

The other important concept, of which many issuers and actuarial and legal advisors are unaware, is that the Rule only speaks about the credited rate; it doesn’t import the entire state nonforfeiture laws’ permissible bases. Applying those bases, not even 10 years for a return of principal would be guaranteed.

Thus, the best thing about indexed annuities is their predictable and guaranteed return of principal.

The worst thing about them may be that the guarantee may not be sufficient to meet the SEC’s current view of the words of the controlling court cases, because neither the court cases nor most anyone else ever anticipated that financial structures and economic conditions would change so dramatically.

Of course, as many a stock market investor has expressed after the tech bubble burst: Getting my money back with 1% interest would have been more than fine with me. Let’s hope the SEC staff has the perspective of the tech investors.

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