On June 25, the Securities and Exchange Commission proposed Rule 151A, which would reclassify equity indexed annuities as securities rather than simply insurance products. It is particularly troubling that the language of the new Rule 151A could apply equally to all deferred annuities, including traditional declared rate annuities and perhaps even to equity indexed life insurance policies.
In 1987, the SEC adopted Rule 151, known as the “safe harbor” rule for exempting certain types of annuities from securities laws. The safe harbor rule is based on Section 3(a)(8) of the federal Securities Act, which provides exemption from regulation under the federal Securities Act “any insurance or endowment policy or annuity contract or optional contract issued by a corporation subject to supervision of the appropriate insurance regulatory of any state.”
To qualify under the safe harbor of Rule 151: (1) the annuity contract must be subject to supervision by the state insurance commissioner and satisfy minimum state nonforfeiture requirements; (2) the insurer must assume the investment risk under the annuity; and (3) the annuity must not be marketed primarily as an investment.
If adopted, Rule 151A would eliminate the safe harbor by imposing in its place a broad standard called the more-likely-than-not test. The proposed rule states that if both (1) amounts payable by the insurance company are calculated by reference to the performance of a security or a group or an index of securities; and (2) amounts payable under the contract are more likely than not to exceed the amounts guaranteed under the contract, then the annuity will be regulated as a security.
Although the SEC refers to equity indexed annuities, the expansive language of the new Rule on its face applies to any annuity product, including traditional declared rate annuities, if the annuity meets both parts of the test. Nearly all annuities will satisfy the more-likely-than-not test because fixed annuities are generally designed to exceed the legal guaranteed minimum rates.
Although the SEC has expressed concern regarding an equity indexed annuity’s effect of shifting “investment risk” to buyers, it has placed particular focus on alleged abusive sales practices towards senior citizens. However, the proposed Rule does not address these perceived marketing problems, and in juxtaposition eliminates the third prong in the current Rule 151–the annuity contract may not be marketed primarily as an investment.
The SEC’s apparent rationale for proposing Rule 151A is that the insurance regulatory oversight of equity indexed annuities does not adequately protect consumers. According to the SEC, it is because when amounts payable by the buyer to the insurer under the contract are more likely than not to exceed the amounts guaranteed by the insurer under the contract, the buyers assume the investment risk, which risk is more likely than not to fluctuate and move with changes in the securities markets.