In adopting Rule 151A under the Securities Act of 1933, the Securities and Exchange Commission did more than change the status of equity indexed annuities. It also threw into a complete state of confusion the question of how another indexed insurance policy–indexed universal life–should be analyzed under the federal securities laws.

The result could be that only registered representatives of broker-dealers using a prospectus filed with the SEC will be allowed to sell IUL policies.

As we shall see, this question appears in a single sentence of the 155-page Adopting Release.

First, let’s look at IUL’s traditional status. Before the 151A Adopting Release, most practitioners would probably have agreed on the criteria to be considered in determining whether an IUL policy is a security. They would have cited as appropriate the criteria referred to in Rule 151′s 1986 Adopting Release, though there would have been differences in how to evaluate and how much weight to give to each factor.

In addition to judicial interpretations of Section 3(a)(8) of the 1933 Act, the criteria would have included the “principles discussed in Rule 151″ which are those underlying these 3 elements of Rule 151:

1) The policy issuer must be subject to the supervision of the insurance commissioner, bank commissioner, or any agency or officer performing like functions;

2) The insurance company must assume the investment risk under the policy; and

3) The policy must not be marketed primarily as an investment.

Another factor which would have been considered is the extent to which the insurance company is bearing mortality risk under its policies–a factor of greater significance to issuers of life policies than annuity issuers.

In discussing IUL, the 151A Adopting Release repeats a statement from the 151A Proposing Release–that Rule 151A will not apply to life policies. It goes on:

“The status of an indexed life insurance policy under the federal securities laws will continue to be a facts and circumstances determination, undertaken by reference to the factors and analysis that have been articulated by the Supreme Court and the Commission. We note, however, that the considerations that form the basis for rule 151A are also relevant in analyzing indexed life insurance because indexed life insurance and indexed annuities share certain features (e.g., securities-linked returns).”

It is the second sentence above which has created uncertainty at several levels.

One approach would be to measure an IUL policy against the 3-factor test of Rule 151, supplemented by assumption of mortality risk.

Presumably, the investment risk test of Rule 151 would be replaced by the test in Rule 151A(a)(2) (the “Amount Payable Test”). The Amount Payable Test makes an EIA a security requiring SEC registration if: Amounts payable by the issuer under the contract are more likely than not to exceed the amounts guaranteed under the contract.

The 151A Proposing Release acknowledged the importance of marketing in determining whether an insurance contract must be SEC registered.

Even so, and despite commenters who questioned the absence of an explicit marketing test, the SEC Adopting Release concluded that a separate marketing test was unnecessary because EIA marketing would always run afoul of the SEC’s limits on the marketing of an unregistered insurance contract.

Similarly, the SEC did not change Rule 151A in response to commenters who suggested including a mortality risk test.

In light of these omissions, the question exists whether these factors would continue to be relevant in a facts and circumstances analysis of an IUL policy.

Whether or not policy marketing and mortality risk assumptions are relevant tests, it is not completely clear how the “Amounts Payable Test” should be applied to an IUL. What are the amounts payable and the amounts guaranteed under an IUL? Do the amounts payable include death benefits?

Because the application of the Amounts Payable Test to an IUL was not raised in the 151A Proposing Release, there were no public comments or statements in the Adopting Release on these points. There is, however, a footnote in the SEC’s Adopting Release which suggests that death benefits should be considered as amounts payable.

This footnote (114) states that, “For simplicity, we are referring to payments to the purchaser. The rule, however, references payments by the insurer without reference to a specified payee. In performing the analysis, payments to any payee, including the purchaser, annuitant, and beneficiaries, must be included.”

Of course, death benefits would be payments to beneficiaries as referenced in the footnote, but there is nothing specifically tying the footnote’s language to the earlier discussion of how an IUL should be analyzed.

In sum, the 151A Adopting Release has left a number of unanswered questions concerning the need to register IUL with the SEC as a security, which in turn would only permit IUL to be sold by representatives registered with the Financial Industry Regulatory Authority.

Having created the confusion with a single sentence, the SEC should provide some clarification before Rule 151A becomes effective on January 12, 2011. This assumes the SEC’s adoption of Rule 151A survives the current court challenge.

Michael Berenson, Esq., is an attorney with Morgan, Lewis & Bockius, LLP, Washington, D.C. His e-mail address is mberenson@morganlewis.com