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SEC's 151A Decision Provokes

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The U.S. Securities and Exchange Commission voted on Dec. 17 to regulate many kinds of indexed annuities.

Commissioners voted 4-1 to treat indexed annuities as securities when the contracts are set up in such a way that the amounts payable by the insurer under the contract “are more likely than not” to exceed the amount guaranteed under the contract.

However, in response to strong insurance agent and carrier opposition to the decision, the commissioners voted to impose the rule only for contracts sold after Jan. 12, 2011.

SEC staffers also added language to the new rule, Rule 151A under the Securities Act of 1933, that clarified that only indexed annuities, and not other insurance products, such as fixed annuities, would be affected by the new rule, and that underwriters and sellers of indexed annuities issued before Jan. 12, 2011, would not be subject to additional legal responsibilities even after the new rule becomes effective.

The rule also addresses the way in which a determination will be made about whether amounts payable by an insurer under a contract are likely to exceed the amounts guaranteed under the contract.

The SEC staffers said the rule would be “principles-based,” meaning that the insurer’s determination at the time it issues a contract would be conclusive, “if, among other things, both the insurer’s methodology and the insurer’s economic, actuarial and other assumptions are reasonable.”

SEC Chairman Christopher Cox said the SEC was acting because improving regulation of indexed annuities is a matter of great interest to senior investors.

Commissioner Kathleen Casey, who also voted for the change, said it will end a long period of uncertainty as to whether indexed annuities are insurance products or securities.

The current state regulatory approach provides insufficient protection for investors, Casey said.

Casey said the current market downturn has added urgency to the need for the rule because, she said, investors seeking to recoup losses will turn to “hybrid products,” such as indexed annuities.

However, Iowa Insurance Commissioner Susan Voss, the vice president of the National Association of Insurance Commissioners, Kansas City, Mo., said she and her colleagues are disappointed by the SEC’s decision.

“We are very dismayed the SEC chose to ignore thousands of comment letters opposing this rule,” Voss said. “As insurance products, equity-indexed annuities are subject to extensive and ongoing regulatory initiatives taken by insurance regulators and numerous state insurance laws. The states have a demonstrated record of consumer protection, and we do not believe this rule is in the best interest of insurance consumers.”

The SEC’s indexed annuities decision means that insurers and agents who sell indexed annuities will be subject to federal securities laws concerning reporting rules, suitability rules and securities license rules, and they also will be subject to the fraud provisions of the federal securities laws, according to Gary Sanders, a vice president at the National Association of Insurance and Financial Advisors, Falls Church, Va.

Commissioner Troy Paredes voted to reject the rule, saying he believed the 1933 securities law exempted indexed annuities from SEC regulation. “I believe the SEC will be entering a realm that Congress prohibited us from entering” when it passed the law, he said.

He said the rule would have a potential impact on small businesses that sell indexed annuities.

A “range of state insurance laws govern indexed annuities,” Paredes said. “I am disappointed that the rule and adopting release make an implicit judgment that state insurance regulators are inadequate to regulate these products. Such a judgment is beyond our mandate or our expertise.”

Section 3(a)(8), the provision of the Securities Act of 1933 that governs the insurance exemption, “does not call upon the commission to determine whether state insurance regulators are up to the task; rather, the section exempts annuity contracts subject to state insurance regulation.”

Moreover, Paredes said, “as a result of Rule 151A, insurers will have to bear various costs and burdens, which, importantly, could disproportionately impact small businesses. Some even have predicted that companies may be forced out of business if Rule 151A is adopted.”

NAIFA President Cliff Wilson said, “We are disappointed” by the SEC’s decision.

“We strongly believe that while any unscrupulous sales practices should be prosecuted, we do not believe the index annuities fit the definition of a ‘security,’” Wilson said. NAIFA is “encouraged that the agency is going to look into some clarifications as to how far-reaching the ruling is, and we are encouraged by that.”

At this point, Wilson said, “NAIFA will closely evaluate the text of the final rule and has not yet determined what action, if any, it will take in response to the adoption of Rule 151A by the SEC.”

David Stertzer, CEO of the Association for Advanced Life Underwriting, Falls Church, Va., said in a note to members that it appears the SEC has agreed with an AALU request that the new rule not apply to general account insurance products and traditional fixed annuities not linked to an equity index.

“During its meeting … to consider adoption of rules based on proposed Rule 151A, there were comments by SEC officials indicating that among the changes to be made would be to provide clarification of this nature,” Stertzer said.

Stertzer warned “that the devil is in the details and we will need additional information to have a clear sense about such clarification and other ramifications of the SEC action.”

The rule also addresses the manner in which a determination will be made regarding whether amounts payable by the insurance company under a contract are more likely than not to exceed the amounts guaranteed under the contract.

In a bulletin to its members, the AALU said the new SEC rule subjecting equity indexed annuities to federal oversight appears to apply only to annuities, but as a practical matter, it could also have an impact on indexed life insurance products.

The impact could be felt on those indexed life products that calculate and credit interest similar to the manner in which interest is credited on EIAs, AALU is telling its members.

In an analysis based on comments by its lawyers and other advisors, the AALU is also telling its members that there is a “distinct possibility” that industry interests may challenge the ruling in court.

At the same time, the AALU said in the bulletin, “the final rule will be narrower in scope than the proposed rule,” something the AALU fought to do, although it is unclear when the final rule will be published.

In its note to members, the AALU said the opponents of federal regulation of EIAs may argue in court that through the new rule the SEC has exceeded its jurisdiction in treating a class of fixed insurance products as securities where those products place significant investment risks on insurers, comply with state non-forfeiture laws and are not marketed primarily as investments.

“Any such challenge would contend that the rule is not consistent with established Supreme Court precedent and also represents a significant departure from prior SEC interpretations of Section 3(a)(8) of the 1933 securities law,” the AALU said in its note to members issued today.

The Section 3(a)(8) exempts from federal oversight annuity or optional annuity contracts that are regulated by the states.

The AALU bulletin said its interpretation of the new rule is that typical indexed annuity contracts will fall within the scope of the rule and be regulated as securities, but contracts declaring discretionary excess interest in advance generally would appear to fall outside the rule.

“Based upon the discussion at the open-meeting, however, it appears that, while the terms of the rule would encompass only contracts contractually providing for the crediting of interest retrospectively, the rule may not be limited in scope to contracts tied to equity indexes,” the AALU note cautioned.

Brian Cartwright, the general counsel of the U.S. Securities and Exchange Commission, said he is “very confident” about the strength of the SEC’s position on its ability to regulate indexed annuities.

Cartwright expressed that view in response to a suggestion by Commissioner Luis Aguilar that insurers might sue to overturn SEC efforts to participate in regulation of many indexed annuities.

Cartwright said he had heard some “saber rattling” from the industry regarding the rule.

But he said the SEC’s approach is consistent with a “couple of” Supreme Court cases. Cartwright said, however, that the cases are “fairly old” and do not directly address indexed annuities.

Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, expressed concern about the SEC’s lame-duck status.

“I regret the fact that the SEC has moved ahead in the very last days of an outgoing administration on something this controversial,” Frank said. “The president has earlier said he was going to urge that last minute rules of this sort will not go forward, and it is a disservice to the important interests involved here to issue a midnight ruling of this sort.”

Frank said he had earlier urged SEC Chairman Chris Cox to hold up action on the rule.

“I am very sorry that he did not respond to a large number of requests to defer action until a new administration can deal with it,” Frank said.

At a press conference after the rule was adopted, Cox confirmed that he would be stepping down when the new administration takes office Jan. 20, 2009. He said he had been working closely with the transition team appointed by President-elect Barack Obama to prepare the agency for takeover by the new administration.


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