Conflicting reports continue to trouble the fixed index annuity marketplace. Speculation concerns whether the Securities and Exchange Commission will take sufficient time to consider the thousands of comment letters that have poured into its office in opposition to proposed Rule 151A.
Unable to predict the outcome, FIA carriers and insurance agents are developing contingency plans that include strategies for operation under SEC regulation and state regulation.
Looming in the background is the question of whether the industry will be forced to file a lawsuit against the SEC to protect FIAs from securities regulation.
Certainly, adoption of Rule 151A will adversely impact FIA carriers. Some insurance companies have publicly declared they will be swift to attack the proposed rule legally, with no mercy, should adoption occur. Anticipated legal arguments will strike at the severe contradictions that exist between the SEC’s historic position on FIAs and its posture in Rule 151A.
Critical to analysis of the SEC proposal is the concept of “investment risk.”
In proposed Rule 151A, the SEC claims the consumer bears the “majority of the investment risk” based upon the “fluctuating, equity-linked portion” of the return.
This is contrary to long-standing SEC statements, including those in an amicus brief filed in a lawsuit in 1959. Since at least 1959, the SEC has declared that when a state-regulated insurance carrier assumes all of the risk by guaranteeing the consumer’s principal and a fixed rate of interest (the minimum guaranteed rate), and guarantees payment of excess interest (index-linked interest), then the insurance carrier has sufficiently “assumed the investment risk.” Accordingly, the product cannot be considered a security.
To be clear, the index-linked interest in a FIA is “excess” interest. It is paid over and above the minimum guaranteed interest promised in the contract. The SEC has not changed its position that index-linked interest is excess interest; rather, it is now contradicting itself by claiming the fluctuation in index-linked interest is somehow risky for the consumer.
A second contradiction exists by the mere proposal of federal regulation over a state insurance product. The SEC strongly expressed in another amicus brief, filed in 1981, that redundant regulation should be avoided. It acknowledged that SEC regulation was not necessary where there is a governmental regulatory scheme, like the state insurance laws, as such laws substantially eliminate the risk of loss under the financial instrument.
Yet, if enacted, Rule 151A would create federal regulation where state regulation already exists.
The most blatant contradiction, and possibly the most puzzling aspects of the SEC position, is its previous position on the Safe Harbor Rule 151. In 1986, the SEC stated “[T]he Commission [SEC] has determined that it would be appropriate to extend the rule to permit insurers to make limited use of index features in determining the excess interest rate.”
Since highlighting the Commission’s inconsistencies in certain comment letters, the SEC has sought proposals for alternative language for Rule 151A.
Some alternative proposals are reverting back to the original safe harbor language found in Rule 151 and are looking to clarify the criteria set forth. The safe harbor previously created 3 main criteria, which if met, granted the product ‘safe harbor’ from securities regulation. Index annuity carriers relied on this safe harbor and built FIAs to comply with the language.
As a refresher, those criteria generally said that, so long as 1) the FIA was issued by an insurance carrier regulated by the state insurance authority; 2) the insurance company assumes the investment risk; and 3) the FIA was not marketed as an ‘investment,’ the safe harbor applied.
Revisions to Rule 151 clarify the rule by addressing the topics shown in the accompanying box.
No clear consensus has been reached regarding any alternative language being proposed. At a minimum, the industry will continue to circulate drafts and discuss options.
In the event that the SEC adopts Rule 151A, or some version of it that attempts to bring regulation of fixed index annuities under securities regulation, litigation will very likely follow. Such litigation will certainly take many years to resolve, 8 to 10 years at the least, according to some predictions, as the industry sees too much at stake to accept the change quietly.