Rule 151A is Over - Now What?

Two years ago, the Securities and Exchange Commission (SEC) proposed Rule 151A, which would have regulated indexed annuities as securities rather than insurance products. After a long battle, however, indexed annuities have secured their fixed insurance status of thanks to two final actions:

1. The District of Columbia U.S. Court of Appeals vacated Rule 151A
2. Iowa Sen. Tom Harkin added an amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act, which would ensure state regulation of the index-linked annuities.

Now that the dust has settled, what have we learned?

The real issue

Indexed annuities are products that provide a guaranteed income that one cannot outlive, while providing a minimum guarantee, protection from market losses, and the opportunity for gains based on the performance of an outside stock market index. These products first made their way onto the insurance scene on Feb. 5, 1995 when Keyport Life (now Sun Life) introduced their novel idea of combining the best features of both fixed and variable annuities.

At the time, it seemed logical to everyone that the products be regulated as insurance rather than securities. After all, the purchaser’s principal and gains were protected from any losses that were due to stock market volatility. In addition, indexed annuities met the three criteria for the SEC’s Section 3(a)(8) exemption from securities regulation in the Securities Exchange Act of 1934. This exemption was determined eight years before indexed annuities were ever introduced, and indicated that a product was not subject to SEC regulation if:

1. The annuity contract was subject to supervision by the state insurance commissioner;
2. The insurer assumes the investment risk under the annuity (as opposed to the purchaser)
3. The annuity is not marketed primarily as an investment.

So, it seemed clear that indexed annuities were fixed insurance products, and not securities – at least based on the SEC’s own words in 1987.

More than a decade later, the SEC’s proposed Rule 151A created a new definition of what could and could not be deemed an “annuity contract.” The new rule said an annuity was not a fixed insurance contract, and was thereby subject to SEC regulation, if:

1. The crediting method is based on the performance of a security or index
2. The amount credited is more likely than not to exceed the minimum guarantee on the contract.

Interestingly, indexed life insurance products (IUL) met the SEC’s new definition, and yet IUL was expressly excluded from SEC regulation in Rule 151A. To many, it appeared that the SEC was intentionally targeting the indexed annuity for SEC regulation. Unfortunately, the definition was so vague that it was subject to wide interpretation – would whole life products with indexed-linked benefits then meet the definition of a security?

In light of all of this redefining, the securities regulators’ actions began to be viewed as a power grab and an opportunity for job security. After all, what business did securities regulators have in regulating a product that they themselves had previously defined as insurance? The issue suddenly became a fight for state regulation of insurance products, rather than a fight for indexed annuities.

An industry effort

There was an instant need for support from even those who were disinterested in the indexed annuity market. The insurance industry wanted to send a message that it was not OK for securities regulators to have jurisdiction over fixed insurance products.