Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Thursday, June 26, 2008

SEC Proposes Standards for Determining When Equity-Indexed Annuities are Securities

The SEC released the text of its proposed rule that would set forth the standards for determining whether equity-indexed annuities (EIAs) are securities or insurance products.  As the SEC describes in the release, the proposed rule would prospectively define certain indexed annuities as not being “annuity contracts” or “optional annuity contracts” under the statutory insurance exemption if the amounts payable by the insurer under the contract are more likely than not to exceed the amounts guaranteed under the contract.  According to the release:

The proposed definition would hinge upon a familiar concept: the allocation of risk. 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. ...

Individuals who purchase indexed annuities are exposed to a significant investment risk – i.e., the volatility of the underlying securities index. ... Indexed annuities are attractive to purchasers because they promise to offer market-related gains. Thus, these purchasers obtain indexed annuity contracts for many of the same reasons that individuals purchase mutual funds and variable annuities, and open brokerage accounts.

The federal interest in providing investors with disclosure, antifraud, and sales practice protections arises when individuals are offered indexed annuities that expose them to securities investment risk. Individuals who purchase such indexed annuities assume many of the same risks and rewards that investors assume when investing their money in mutual funds, variable annuities, and other securities. However, a fundamental difference between these securities and indexed annuities is that – with few exceptions – indexed annuities historically have not been registered as securities. As a result, most purchasers of indexed annuities have not received the benefits of federally mandated disclosure and sales practice protections.

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As a fully credentialed actuary I find some of the statements expressed here to be blatantly false.

Individuals who purchase indexed annuities are NOT exposed to significant investment risk.

Indexed annuity purchasers receive only a limited participation in the market volatility. The most any insured can lose is the interest credit for that particular year - say 4% of their account.

Furthermore, if the market fares badly for several years, any indexed annuity will provide guarantees that the policy will not fail to gain a legally prescribed minimum amount over time.

It is precisely for these reasons that indexed annuities are NOT securities but insurance products - as they insure the policy holder from certain market risks and are guaranteed to perform at the state required minimum level.

Posted by: Matthew Coleman FSA, MAAA | Jun 27, 2008 5:50:41 PM

Is this where comments will be received by the SEC for serious consideration of the proposed rule concerning index annuities?

Please respond accordingly.

Posted by: Jerry | Jun 29, 2008 8:58:32 PM

Nonsense. This is all about a power grab by FINRA and the SEC. Not until the big wirehouses realized they are loosing money to the FIA's did anyone care about them.

A statement such as this shows the ignorance of an FIA "Individuals who purchase indexed annuities are exposed to a significant investment risk."

I spent 17 years as a Registered Representative/RIA and investment risk includes the possibility of loss. In an FIA the loss is if you cash out while there is still a surrender charge, which is not different from a traditional annuity.

Most if not all FIA's will not deduct from the surrender value in a down market. You make nothing and lose nothing, it is a zero sum return. Where is the "significant investment risk" if you can't receive a negative on the account.

If these annuities produce no return on an index the owner will receive the guaranteed interest rate.

You are pontificating an urban legend sent out by the SEC and others. I find it very disturbing when I read articles that present misrepresentations.

If the SEC can declare this a security it is not a giant leap for the SEC to declare traditional annuities and universal life insurance a security. The insurance companies my rely on the purchase of bills / bonds to pay the interest on universal life insurance and traditional annuities. The return on the above products are dependent on the economic health of the stock market and are paid out of the insurance company general fund. If I am correct, there is no segregated account on an FIA and the owner's returns are paid out of the insurance general fund.

I am preparing a paper to send to the SEC during the comment period. In the paper there are two glaring questions that I need to have be answered:

1. Why is FINRA (NASD) the only SRO available to those doing business i the securities business. When the idea of an SRO rule was developed it was assumed there would be competition among SRO's.

2. I want the SEC to explain why they will not discuss the distinction, The SEC statement: "The SEC does not discuss its views on whether there is a distinction between products linked to the performance of separate accounts and products backed by an insurer’s general account"

It is my opinion that FINRA and the SEC has not done a great job of overseeing the securities markets. Most all the major economic ills have been brought to us from Wall Street and Banks. Our current housing credit debacle happened during the watch of the SEC and FINRA, not any State Department of Insurance.

If the SEC determines that any return in an insurance company general fund, based on securities, be they bills; bonds; the S&P or whatever, the SEC will be forced to discuss its views on a distinction between other insurance products linked to the performance of the general account. If they come out and say there is no distinction an even bigger cat fight will begin. People may start to see that this is really an SEC / FINRA fight for power and not about consumer protection.

Posted by: Bob Johnson | Jul 1, 2008 10:20:46 AM

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