When the Securities and Exchange Commission adopted Rule 151A on December 17, 2008, the landscape of insurance regulation undeniably changed significantly. Arguably, that Rule sets the stage for federal regulation of many more insurance products.

Although not yet officially published in final form, Rule 151A is more clearly limited in its application to index annuities than when it was first proposed in June 2008. But the analysis that formed the justification for the rule still applies to almost all life insurance and annuity products.

Section 3(a)(8) of the Securities Act of 1933 exempts from SEC regulation an “annuity contract” or an “optional annuity contract” when the contract is issued by a state-regulated insurance company. In the Proposing Release for Rule 151A, the SEC relies on U.S. Supreme Court decisions in concluding that a two-prong test determines whether the exemption applies:

–Does the purchaser or the issuer bear the investment risk?

–And is the product marketed as an investment product?

Significantly, the SEC asserts that defining the terms “insurance” and “annuity contract” is a federal, not state law, question. Where the major break with the past arises is in the determination of what constitutes bearing the investment risk.

The SEC rule requires that a determination be made whether crediting an additional amount, above the guaranteed minimum, is expected. The legal analysis states that “at the time that [an IA] is purchased, the risk for the unknown, unspecified, and fluctuating securities-linked portion of the return is primarily assumed by the purchaser.” If this expectation exists prior to issuance of the contract, the SEC finds investment risk.

In a fixed annuity, the amount credited above that minimum is also unknown and unspecified at the time the contract is purchased. Only the minimum and the first year’s current rate is typically guaranteed at the time of purchase.

The final Rule 151A reportedly looks only at contracts when crediting is based on retrospective performance of a security. All that is legally needed under the SEC’s analysis is a “link” between the performance of a security and the rate credited. Therefore, a prospective crediting rate based on the performance of insurer’s supporting securities could similarly bring the product under SEC regulation.

Rule 151A is limited to contracts with a reference to the performance of a security. However, the Rule’s supporting analysis does not require a reference, just a link to the performance of a security. Only the intent to focus on indexed annuities requires the reference. The addition in the final rule of this reference requirement does not address the fact that the legal analysis still leads to the conclusion that fixed annuities could easily be subject to the same outcome: There is a link between the performance of a security and the rate credited to the contract with both types of products. The link is explicit in an IA and implicit for FAs and other types of insurance products.

In two sentences, the SEC trivializes insurer guaranteed minimum interest/crediting rates in a way that applies to all annuities: “[T]hese provisions reduce–but do not eliminate–a purchaser’s exposure to investment risk under the contract. These contracts may to some degree be insured, but that degree may be too small to make the indexed annuity a contract of insurance.” If minimum guarantees are not sufficient to make particular products a contract of insurance, then all products issued by state-regulated companies may “to some extent be insured” but not sufficiently to be contracts of insurance. The Rule provides that if it is more likely than not that amounts payable by the insurer will exceed contractual guarantees, the exemption does not apply.

Citing Congressional intent, the SEC also found a federal interest in providing IA “investors with disclosure, antifraud, and sales practice protections.”

It is unclear why SEC regulation of many more insurance products does not result from the analysis it has put forward: The “link” to performance of underlying assets, the “more likely than not” standard and the federal interest in how insurance products are marketed, apply to most, if not all, insurance company products.

The SEC does seem content to leave solvency regulation to the states, stating that issues relating to the insurer’s financial ability to satisfy its contractual obligations are those addressed by state law. However the SEC deems nondispositive state laws addressing IA product features, so solvency regulation may also be so deemed when expedient.

For companies now offering IAs, Rule 151A will result in heavy new compliance requirements as registration becomes mandatory. But the assertion of federal jurisdiction is likely to be felt by many more companies if taken to its logical conclusion and applied to other insurance products currently regulated at the state level.

Cailie A. Currin, JD, is president and CEO of Currin Compliance Services, LLC. She can be reached via email at ccurrin@currincompliance.com