Staffers at the U.S. Securities and Exchange Commission say the benefits of putting indexed annuities under SEC jurisdiction would far outweigh the costs to product manufacturers and distributors.

The SEC put a copy of the final version of Rule 151A, which would classify most indexed annuities as securities, on its Web site today.

The final rule, which is set to take effect Jan. 12, 2011, comes with more than 100 pages of SEC staff discussion of the 4,800 public comments submitted in response to a draft of the rule released in June 2008.

The final rule, which was approved by the SEC in December 2008, would classify an indexed annuity as a security “if the amounts payable by the insurer under the contract are more likely than not to exceed the amounts guaranteed under the contract,” SEC staffers write in a preamble to the final rule.

“The definition hinges upon a familiar concept: the allocation of risk,” officials write in the preamble. “Insurance provides protection against risk, and the courts have held that the allocation of investment risk is a significant factor in distinguishing a security from a contract of insurance. The Commission has also recognized that the allocation of investment risk is significant in determining whether a particular contract that is regulated as insurance under state law is insurance for purposes of the federal securities laws.

“Individuals who purchase indexed annuities are exposed to a significant investment risk – i.e., the volatility of the underlying securities index. Insurance companies have successfully utilized this investment feature, which appeals to purchasers not on the usual insurance basis of stability and security, but on the

SEC staffers reject the idea that Rule 151A exists because of a perception that there are widespread abuses in indexed annuity marketplace.

“Rather, the rule is intended to address an uncertain area of the law, which, because of the growth of the indexed annuity market and allegations of sales practice abuses, has become of pressing importance,” officials write. “We do not believe the states’ regulatory efforts, no matter how strong, can substitute for our responsibility to identify securities covered by the federal securities laws and the protections Congress intended to apply.”

Insurers have made commendable efforts to improve annuity sales practices, and the states also have tackled the issue, but “state insurance laws, enforced by multiple regulators whose primary charge is the solvency of the issuing insurance company, cannot serve as an adequate substitute for uniform, enforceable investor protections provided by the federal securities laws,” officials write.

Moreover, although the insurer guarantees that it will protect the indexed annuity purchasers’ principal, the purchasers clearly assume investment risk linked to the fluctuations of the securities markets, officials write.

SEC staffers say they received comments citing estimates that the new rule could force indexed annuity distributors to pay $250,000 to $3 million to establish a registered broker-dealer or form a networking arrangement with a registered broker-dealer, and that a typical insurance agent might have to pay about $3,100 in initial state registration fees and about $3,000 per year in ongoing state securities fees to qualify to sell indexed annuities under the new rule.

Several commenters cited an estimate by Jack Marrion, an indexed annuity expert, that the rule could cost indexed annuity distributors about $800 million in income and agents about $200 million, SEC staffers write.

Distributor registration costs “are not unique to indexed annuities,” SEC staffers write. “For example, issuers of insurance products registered as securities, such as variable annuities, may incur networking costs, as do banks involved in networking arrangements.”

Agents may incur higher costs, but “those fees are paid by all sellers of securities and are not unique to those selling indexed annuities,” officials write. “The fees are a product of the regulatory structure mandated by Congress under the federal securities laws.”

Moreover, although revenue from indexed annuities at a marketing organization may drop, “it would have opportunities to sell other types of securities, and may be able to compensate for any declines in sales of indexed annuities that may occur,” officials write. “We believe that even at the high end of costs suggested by commenters, given the imperative of the federal securities laws and size of the industry, these costs are nonetheless justified.”