SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 230
[Release No. 33-7438; File No. S7-22-97]
RIN: 3235-AH23
Equity Index Insurance Products
AGENCY: Securities and Exchange Commission
ACTION: Concept release; request for comments.
SUMMARY: The Securities and Exchange Commission is requesting comments on
the structure of equity index insurance products, the manner in which they
are marketed, and any other matters the Commission should consider in
addressing federal securities law issues raised by equity index insurance
products.
DATES: Comments must be received on or before November 20, 1997.
ADDRESSES: Comments should be submitted in triplicate to Jonathan G. Katz,
Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W.,
Washington, D.C. 20549-6009. Comments also may be submitted electronically
at the following E-mail address: rule-comments@sec.gov. All comment
letters should refer to File No. S7-22-97; this file number should be
included on the subject line if E-mail is used. All comments received will
be available for public inspection and copying in the Commission's Public
Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549-6009.
Electronically submitted comments will also be posted on the Commission's
Internet site (http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT: Megan L. Dunphy, Attorney, Mark C.
Amorosi, Branch Chief, or Susan Nash, Assistant Director, (202) 942-0670,
Office of Insurance Products, Division of Investment Management, Securities
and Exchange Commission, 450 Fifth Street, N.W., Mail Stop 10-6,
Washington, D.C. 20549-6009.
SUPPLEMENTARY INFORMATION: The Securities Act of 1933 (the "Securities
Act") includes an "insurance exemption" that exempts "insurance policies"
and "annuity contracts" from the Act's registration requirements. Equity
index insurance products, recently introduced by the insurance industry,
combine features of traditional insurance products and traditional
securities. The Commission requests information about the structure of
equity index insurance products and the manner in which they are marketed.
The Commission also requests comment on any other matters the Commission
should consider in addressing federal securities law issues raised by
equity index insurance products.
TABLE OF CONTENTS
Page
I. BACKGROUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
II. DESCRIPTION OF EQUITY INDEX INSURANCE PRODUCTS . . . . . . . . . . . .
A. Equity Index Annuities . . . . . . . . . . . . . . . . . . . .
1. Product Features . . . . . . . . . . . . . . . . . . . . .
2. Funding of Insurer's Obligation . . . . . . . . . . . . .
3. Distribution Channels . . . . . . . . . . . . . . . . . .
B. Equity Index Life Insurance . . . . . . . . . . . . . . . . . .
III. APPLICABILITY OF THE FEDERAL SECURITIES LAWS TO EQUITY INDEX
INSURANCE PRODUCTS . . . . . . . . . . . . . . . . . . . . . . . . .
A. Applicability of State Insurance Regulation . . . . . . . . . .
B. Investment Risk . . . . . . . . . . . . . . . . . . . . . . . .
1. Case Law . . . . . . . . . . . . . . . . . . . . . . . . .
2. Rule 151 . . . . . . . . . . . . . . . . . . . . . . . . .
a. Contract Value not Tied to Separate Account . . . . .
b. Guarantee of Purchase Payments and Credited
Interest . . . . . . . . . . . . . . . . . . . . . .
c. Specified Rate of Interest . . . . . . . . . . . . .
d. Excess Interest . . . . . . . . . . . . . . . . . . .
C. Marketing . . . . . . . . . . . . . . . . . . . . . . . . . . .
D. Mortality Risk . . . . . . . . . . . . . . . . . . . . . . . .
IV. REQUEST FOR COMMENTS . . . . . . . . . . . . . . . . . . . . . . . .
======END OF PAGE 2======
V. CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
I. BACKGROUND
The Commission is considering the status of equity index annuities and
other equity index insurance products under the federal securities laws.
Today the Commission is requesting public comment regarding these products.
An equity index annuity is a contract issued by a life insurance
company that generally provides for accumulation of the contract owner's
payments, followed by payment of the accumulated value to the contract
owner in a lump sum or series of payments. During the accumulation period,
the insurer credits the contract owner with a return that is based on
changes in an equity index, such as the Standard & Poor's Composite Index
of 500 Stocks ("S&P 500 Index"). The insurer also guarantees a minimum
return to the contract owner if the contract is held to maturity.
Equity index annuities are designed to appeal to risk averse consumers
who desire to participate in market increases, without sacrificing the
guarantees of principal and minimum return offered in traditional fixed
annuities. Other consumers may be seeking to lock in prior gains from
stock market investments while retaining some exposure to the
market.<(1)>
The first equity index annuities were introduced in 1995.<(2)>
By the end of 1995, there were four insurers marketing equity index
annuities; and, by the end of 1996, over 30 equity index annuities were
<(1)> See, e.g., Bill Harris, "Tips For Selling Indexed
Annuities," National Underwriter, Aug. 5, 1996, at 12.
<(2)> See, e.g., Linda Koco, "3 More Equity Index Annuities
Make Mkt. Debuts," National Underwriter, Dec. 23, 1996,
at 11.
======END OF PAGE 3======
available.<(3)> In 1997, this expansion is expected to continue with
as many as 40 insurers issuing an estimated 50 equity index annuity
contracts.<(4)> Equity index annuity sales reached $2 billion in
1996, with 1997 sales projected to be as much as $10 billion.<(5)>
Recently, the types of equity index insurance products have proliferated,
with single premium deferred annuities joined by flexible premium deferred
annuities, immediate annuities, and life insurance policies.<(6)>
Equity index insurance products combine features of traditional
insurance products (guaranteed minimum return) and traditional securities
(return linked to equity markets). Depending upon the mix of features in
any insurance product, including an equity index insurance product, the
product may or may not be entitled to exemption from registration under the
Securities Act as an "insurance policy" or "annuity contract." To date,
most equity index annuities have not been registered under the Securities
Act, although commentators have acknowledged that substantial uncertainty
exists whether all of these products are entitled to exemption from
<(3)> See, e.g., "More Insurers Expected To Jump On Indexed
Bandwagon," Bank Investment Product News, Feb. 3, 1997,
at 11 [hereinafter "Bank Investment Product News"];
James B. Smith, Jr., "Survey Shows Strong Interest in
Offering EIAs," National Underwriter, Jan. 20, 1997, at
14 [hereinafter "Survey"].
<(4)> See, e.g., Bank Investment Product News, supra note 3.
<(5)> See, e.g., Bridget O'Brian and Leslie Scism, "Equity-
Indexed Annuities Score Big Hit, But They Put a High
Price on Protection," Wall Street Journal, May 30,
1997, at C1.
<(6)> See, e.g., Linda Koco, "Some Index Annuity Products Are
Going Optional," National Underwriter, Oct. 21, 1996,
at 21 [hereinafter "Going Optional"].
======END OF PAGE 4======
registration.<(7)>
The Commission believes that both purchasers and insurers may benefit
from greater clarity in this area. With respect to products that are not
covered by the insurance exemption, investors are entitled to the
protections afforded by the federal securities laws -- full disclosure
concerning the issuer and the product and marketing through registered
broker-dealers that are subject to the Commission's oversight. With
respect to products that are covered by the insurance exemption, greater
certainty would reduce the risk to all parties of expensive and time-
consuming litigation.
The Commission is considering the issues raised by equity index
insurance products. As part of its consideration, the Commission today
seeks public comment on the structure of these products, the manner in
which they are marketed, and any other matters the Commission should
consider in addressing federal securities law issues raised by equity index
<(7)> See, e.g., Jeffrey S. Puretz and Christopher M.
Gregory, "Should Equity Index Annuities Be
Registered?," National Underwriter, Jan. 20, 1997, at
22; Stephen E. Roth and Kimberly J. Smith, "Emerging
Developments Relating to Fixed Insurance Products Under
the Federal Securities Laws," ALI-ABA Conference on
Life Insurance Company Products 45, 65-95 (1996). The
equity index annuities that have been registered
contain features that could reduce amounts received by
contract owners below the floor typically guaranteed by
equity index annuities. See, e.g., Pre-Effective
Amendment No. 1 to Registration Statement on Form S-1
of Keyport Life Insurance Company (File No. 333-13609)
(filed Feb. 7, 1997); Pre-Effective Amendment No. 1 to
Registration Statement of Valley Forge Life Insurance
Company (File No. 333-02093) (filed Oct. 17, 1996).
======END OF PAGE 5======
insurance products.<(8)>
II. DESCRIPTION OF EQUITY INDEX INSURANCE PRODUCTS
A. Equity Index Annuities
1. Product Features
Equity index annuity contracts generally share two characteristics:
(i) a return based on changes in an equity index, and (ii) a guaranteed
minimum return if the contract is held to maturity. Other features of
equity index annuity contracts vary from product to product.
Premium Payments. To date, the majority of products on the market are
single premium deferred annuities, with the purchaser making one premium
payment that is accumulated for some period prior to pay-out.<(9)>
Some insurers offer flexible premium deferred annuities, permitting
multiple premium payments in amounts determined by the purchaser, and
immediate annuities, providing for immediate commencement of the pay-out
period.<(10)>
Floor Guarantee. The guaranteed minimum return for a single premium
product typically is 90% of premium accumulated at a 3% annual rate of
interest, an amount that is generally required by applicable state
<(8)> The Commission's consideration of whether equity index
insurance products are exempt from registration as
"insurance products" or "annuity contracts" does not
relate to the status under the federal securities laws
of index products issued by non-insurers to which the
insurance exemption is inapplicable.
<(9)> See, e.g., Survey, supra note 3.
<(10)> See, e.g., Going Optional, supra note 6.
======END OF PAGE 6======
insurance laws.<(11)>
Computation of Index-Based Return. The index-based return depends on
the particular combination of indexing features specified in the contract.
The most common indexing features are described below.<(12)>
* Index. The return of equity index annuities is typically based
on the S&P 500 Index, but other domestic and international
indices are also used. Some products permit the contract owner
to select one or more indices from a specified group of indices.
* Determining Change in Index. Index growth generally is computed
without regard to dividends. There are several methods for
determining the change in the relevant index over the period of
the contract. The "point-to-point" method compares the level of
the index at two discrete points in time, such as the beginning
and ending dates of the contract term. The "high water mark" or
"look-back" method compares the highest index level reached on
specified dates throughout the term of the contract (e.g.,
contract anniversaries) to the index level at the beginning of
the contract term. The "annual reset," "cliquet," or "lock-in"
method compares the index level at the end of each contract year
<(11)> See, e.g., Michelle Clayton, "How Product Marketers
Stylize Equity Indexed Annuities," Bank Mutual Fund
Report, Mar. 10, 1997, at 1.
<(12)> See, e.g., Thomas F. Streiff, "Three Basic Ways of
Achieving Equity Indexing," National Underwriter, Nov.
4, 1996, at 18; William Harris, "A Selling Perspective
on Equity Indexed Annuities," National Underwriter,
Nov. 4, 1996, at 16; Going Optional, supra note 6;
Albert B. Crenshaw, "A Rising Investment Star: Equity-
Indexed Annuities," Washington Post, Oct. 20, 1996, at
H1.
======END OF PAGE 7======
to the index level at the beginning of that year, with the gain
for each year "locked in" even if the index declines in the
following year. Averaging techniques may be used with these
formulas to dampen the volatility of index changes. For example,
in the point-to-point method, the ending index value could be
computed by averaging index values on each of the final 90 days
of the contract term.
* Participation Rate or Spread. Two methods typically are used to
compute the extent to which a contract owner is credited with
index growth. In some contracts, the participation rate,
frequently between 75% and 90%, is multiplied by index growth to
determine the applicable share of index appreciation to be
credited. The participation rate is typically set at the time
the annuity is purchased and may be reset either annually or at
the start of the next contract term. Other contracts specify a
percentage, called the "margin" or "spread," that is subtracted
from index growth to determine the applicable share of index
appreciation to be credited.
* Caps and Floors. Some contracts limit the maximum ("cap") and
minimum ("floor") index-based returns that may be credited to a
contract. Caps and floors are generally guaranteed for the
entire contract term, although a few equity index annuities
provide for annual reset of the cap and floor.
Computation of Contractual Benefits. Equity index annuities provide a
variety of benefits, including surrender values, annuitization benefits,
and death benefits, each of which may be computed in a different manner.
======END OF PAGE 8======
Term of Product. Equity index annuities are issued for varying terms,
including terms of three, five, seven, or nine years.
Surrender Charges. Surrender charges are commonly deducted from
withdrawals, but these charges often are eliminated for a 30 to 45 day
window at the end of each index term. There may also be a limited free
withdrawal privilege.
Vesting. Vesting schedules are often implemented to deter early
surrenders of contracts that credit the index-based return periodically
throughout the term of the contract. Typically, a small percentage of the
index-based return is available for withdrawal in the first year, with the
percentage increasing over time until the entire return is available at the
end of the term.
2. Funding of Insurer's Obligation
Equity index annuities typically are backed by assets held in the
insurance company s general account. A portion of the general account
assets is invested in fixed income instruments to support the minimum
return guarantee. Insurance companies typically purchase derivatives to
hedge their indexed-based return obligations, although insurers vary in the
degree to which they hedge these obligations.
3. Distribution Channels
The most frequently used channels of distribution for equity index
annuities have been banks and insurance agents who are not licensed as
registered representatives of a broker-dealer. To date, broker-dealers
have played a less significant role.<(13)>
<(13)> See, e.g., Survey, supra note 3; Cerulli Associates,
Inc. and Lipper Analytical Services, Inc., The Cerulli-
(continued...)
======END OF PAGE 9======
B. Equity Index Life Insurance
Equity index life insurance policies have been introduced
recently.<(14)> The available policies are universal life insurance
policies that permit the holder to vary the amount and timing of premium
payments and change the death benefit. The cash value of an equity index
life insurance policy is credited with a return that is based on changes in
an equity index. As with equity index annuities, the insurer also
guarantees a minimum return on the policy's cash value. Equity index life
insurance policies typically offer annual crediting of index-based interest
and index participation rates that are reset annually and are generally
lower than those for equity index annuities.<(15)> At least two
companies currently offer equity index life insurance policies, and it is
estimated that as many as 25 companies are developing these
products.<(16)>
III. APPLICABILITY OF THE FEDERAL SECURITIES LAWS TO EQUITY INDEX INSURANCE
PRODUCTS
Section 3(a)(8) of the Securities Act exempts from the registration
requirements of the Act any "insurance policy" or "annuity contract" issued
<(13)>(...continued)
Lipper Analytical Report: The State of the Variable
Annuity and Variable Insurance Markets 37-40 (1996).
<(14)> See, e.g., Linda Koco, "Transamerica Occidental Unveils
Equity-Indexed UL," National Underwriter, Jan. 6, 1997,
at 25 [hereinafter "Transamerica Occidental"]; Linda
Koco, "Two More Index UL Policies Make Their Debuts,"
National Underwriter, Mar. 10, 1997, at 9.
<(15)> See, e.g., "Transamerica Occidental," supra note 14.
<(16)> See, e.g., Linda Koco, "Equity Index Market Shows Signs
of Fierce Competition," National Underwriter, Jan. 27,
1997, at 9.
======END OF PAGE 10======
by a corporation subject to the supervision of the insurance commissioner,
bank commissioner, or similar state regulatory authority.<(17)> The
exemption, however, is not available to all products labelled "insurance
policies" or "annuity contracts." For example, "variable annuities," which
pass through to the contract owner the investment performance of a pool of
assets, are securities rather than exempt annuity contracts.<(18)>
The Commission and the courts have addressed the insurance exemption
on a number of occasions. Under existing case law, factors that are
important to a determination of a contract's status under Section 3(a)(8)
include (1) the allocation of investment risk between insurer and contract
owner and (2) the manner in which the contract is marketed.
In 1986, faced with the proliferation of annuity contracts commonly
known as "guaranteed investment contracts," the Commission adopted Rule 151
under the Securities Act to establish a safe harbor for certain annuity
contracts that will not be deemed subject to the federal securities
laws.<(19)> The factors that determine an annuity contract's
<(17)> The Commission has previously stated its view that
Congress intended any insurance contract falling within
Section 3(a)(8) to be excluded from all provisions of
the Securities Act notwithstanding the language of the
Act indicating that Section 3(a)(8) is an exemption
from the registration but not the antifraud provisions.
Definition of "Annuity Contract or Optional Annuity
Contract," Securities Act Rel. No. 6558 (Nov. 21, 1984)
[49 FR 46750, 46753 (Nov. 28, 1984)] [hereinafter
"Proposing Release"].
<(18)> SEC v. Variable Annuity Life Ins. Co., 359 U.S. 65
(1959); SEC v. United Benefit Life Ins. Co., 387 U.S.
202 (1967).
<(19)> 17 CFR 230.151; Definition of Annuity Contract or
Optional Annuity Contract, Securities Act Rel. No. 6645
(May 29, 1986) [51 FR 20254 (June 4, 1986)]
(continued...)
======END OF PAGE 11======
eligibility for the safe harbor include the applicability of state
insurance regulation, the assumption of investment risk by the insurer, and
the manner of marketing the contract. In situations when the Rule 151 safe
harbor is not applicable, the status of a contract may be analyzed by
reference to the principles discussed in Rule 151 and the accompanying
releases and to judicial precedents construing Section 3(a)(8).<(20)>
This would include, for example, an annuity that does not fall within the
safe harbor or a life insurance policy.
This section discusses the factors that have been used by the
Commission and courts to determine whether a product is entitled to the
insurance exemption, and the manner in which those factors may apply to
equity index insurance products. Commenters are asked to provide detailed
information on the structure, operation, and marketing of equity index
insurance products. Commenters should specifically discuss the application
to equity index insurance products of the factors that have been used by
the Commission and the courts to determine whether a product is entitled to
the insurance exemption.
A. Applicability of State Insurance Regulation
To gain the benefit of the Rule 151 safe harbor, an annuity contract
is required to be issued by a corporation subject to the supervision of a
<(19)>(...continued)
[hereinafter "Adopting Release"]. A guaranteed
investment contract is a deferred annuity contract
under which the insurer pays interest on the
purchaser's payments at a guaranteed rate for the term
of the contract. In some cases, the insurer also pays
discretionary interest in excess of the guaranteed
rate.
<(20)> Adopting Release, supra note 19, 51 FR at 20255 n.4,
20261.
======END OF PAGE 12======
state insurance commissioner, bank commissioner, or similar state
regulator.<(21)> In addition, the contract itself is required to be
subject to state regulation as an annuity or insurance.<(22)> Equity
index insurance products on the market today generally are issued by
companies subject to state insurance regulation, thereby appearing to meet
this threshold requirement for insurance status.
Commenters are requested to address the status under state law of
equity index insurance products. Are all of these contracts regulated as
annuities or insurance? For contracts that are regulated as annuities or
insurance, commenters are asked to describe the provisions of state law
that apply, e.g., regulation of reserves, investment restrictions, approval
of contract forms, illustration requirements, market conduct standards,
applicability of state insurance guaranty laws. How does the applicability
of state insurance regulation to equity index insurance products affect the
need for federal securities regulation of these products?
B. Investment Risk
1. Case Law
Under existing case law, the allocation of investment risk between
insurer and contract owner is significant in determining whether a
particular contract is insurance for purposes of the federal securities
laws. In SEC v. Variable Annuity Life Insurance Co. (hereinafter "VALIC"),
the Supreme Court determined that absent some element of fixed return,
i.e.,"some investment risk-taking on the part of the company," an annuity
<(21)> 17 CFR 230.151(a)(1). This requirement is parallel to
the language of Section 3(a)(8).
<(22)> Adopting Release, supra note 19, 51 FR at 20255.
======END OF PAGE 13======
contract is outside the scope of Section 3(a)(8).<(23)> The VALIC
court found a variable annuity contract to be a security, not insurance,
when the insurer invested premiums in a pool of common stocks and other
equities and the value of the contract owner's benefit payments varied
directly with the success of the underlying investments.
The Supreme Court subsequently clarified that a contract could provide
for some assumption of investment risk by the insurer, but nonetheless be a
security. In SEC v. United Benefit Life Ins. Co. (hereinafter "United
Benefit"), the insurer guaranteed that the cash value of its variable
annuity contract would never be less than 50% of purchase payments made and
that, after ten years, the value would be no less than 100% of
payments.<(24)> The Court determined that this contract, under which
the insurer did assume some investment risk through minimum guarantees, was
a security. In making this determination, the Court distinguished a
contract which to some degree is insured from a contract of
insurance. <(25)>
Commenters are requested to discuss generally how investment risk is
allocated between insurer and contract owner in equity index insurance
products. Commenters should also compare this allocation of risk to other
insurance products and discuss how this allocation of investment risk
affects the application of the federal securities laws to equity index
insurance products.
2. Rule 151
<(23)> 359 U.S. 65, 71 (1959).
<(24)> 387 U.S. 202, 205 (1962).
<(25)> Id. at 211.
======END OF PAGE 14======
To gain the benefit of the Rule 151 safe harbor, an insurer is
required to assume the investment risk under the contract.<(26)> For
purposes of the safe harbor, an insurer is deemed to assume the investment
risk if the following conditions are satisfied.
a. Contract Value not Tied to Separate Account
The safe harbor requires that the value of the contract not vary
according to the investment experience of a separate account, a separately
managed pool of assets operating independently of the investment experience
of the insurer's general account.<(27)> Equity index annuities
typically are general account products, whose value does not vary according
to the investment experience of a separate account. These products
therefore appear to satisfy the first condition of the Rule 151 investment
risk test.
Commenters are requested to describe the investments used by an
insurer to support its obligations under an equity index insurance product.
Commenters should also address how the nature of these investments affects
the analysis of equity index insurance products under the federal
securities laws. For example, should the relative levels of a contract
owner's purchase payment allocated to the floor guarantee and the index-
based benefit affect the status of a contract as insurance under the
federal securities laws? Is the status of an equity index insurance
product affected by whether, or the degree to which, an insurer hedges its
obligations to pay the index-based benefit? To the extent an insurer's
obligations are hedged, does it bear investment risk with respect to those
<(26)> 17 CFR 230.151(a)(2).
<(27)> 17 CFR 230.151(b)(1).
======END OF PAGE 15======
obligations? In the alternative, is there, in essence, a pass-through of
performance from insurer to contract owner, with the contract owner
experiencing the performance of the hedging instruments that the insurer
purchased to hedge the contract?
b. Guarantee of Purchase Payments and Credited Interest
The safe harbor requires that the insurer, for the life of the
contract, guarantee the principal amount of purchase payments and credited
interest, less any deduction for sales, administrative, or other expenses
or charges.<(28)> For equity index annuities, insurers generally
guarantee 90% of purchase payments and annual interest of 3%. Commenters
should address whether the typical floor guarantee for equity index
annuities, by itself, satisfies the investment risk requirement, or whether
there must be some additional guarantee. Commenters are requested to
address whether, and under what circumstances, the typical 10% deduction
from purchase payments is attributable to sales, administrative, or other
expenses or charges and therefore falls within the rule's parameters.
Commenters should also address whether there are equity index annuities
that reduce the floor guarantee by charges of any type, and how any such
charges affect the investment risk analysis.<(29)> Commenters should
also discuss any floor guarantees in equity index annuities that are
different from 90% of purchase payments with annual interest of 3%.
Commenters should address how the different floor guarantees affect the
<(28)> 17 CFR 230.151(b)(2)(i).
<(29)> See Registration Statement of Valley Forge Life
Insurance Company (File No. 333-02093) (filed Mar. 29,
1996) (minimum guaranteed value of registered equity
index annuity reduced by rider charge for equity index
feature).
======END OF PAGE 16======
investment risk analysis.
Commenters should describe any floor guarantees provided by equity
index life insurance products and how the guarantees affect their status
under the federal securities laws. Commenters should address whether an
equity index life insurance policyholder is dependent on cash value growth
in excess of guaranteed minimums to gain the anticipated benefits under the
policy.
c. Specified Rate of Interest
The safe harbor requires that the insurer credit a specified rate of
interest, in an amount at least equal to the minimum rate required by
applicable state law.<(30)> Equity index annuities typically appear
to satisfy this condition by guaranteeing a minimum interest rate of 3%,
which is generally equal to the minimum rate required by state law.
Commenters should describe the minimum guaranteed rate on various equity
index insurance products. Do the guaranteed rates satisfy this condition
of the safe harbor?
d. Excess Interest
The safe harbor requires that the insurer guarantee that the rate of
any interest to be credited in excess of the guaranteed minimum rate not be
modified more frequently than once per year.<(31)> Rule 151, as
originally proposed, would have excluded from the safe harbor any annuity
that linked excess interest to an index. The Commission reasoned that an
insurer that uses an index feature externalizes its discretionary excess
interest rate, shifting to the contract owner all of the investment risk
<(30)> 17 CFR 230.151(b)(2)(ii) and (c).
<(31)> 17 CFR 230.151(b)(3).
======END OF PAGE 17======
regarding fluctuations in that rate.<(32)> In adopting Rule 151, the
Commission extended the rule's coverage to permit insurers to make limited
use of index features in determining the excess interest rate, so long as
the excess rate is not modified more frequently than annually.<(33)>
Specifically, the insurer could specify an index to which it would refer,
no more often than annually, to determine the excess rate that it would
guarantee under the contract for the next 12-month or longer period. In
addition, an insurer could not change the terms of the index feature used
for calculating the excess rate more frequently than once per year.
Commenters are requested to discuss how the use of an index-based
formula for calculating contract values under equity index annuities
affects the allocation of investment risk between insurer and contract
owner. How does the use of an indexed-based return determined
retrospectively by reference to a formula that is established prospectively
affect the status of these contracts as securities or insurance?
Commenters are specifically requested to address the Commission's expressed
concern with shifting the risk of fluctuations in an index rate to a
contract owner and the Commission's decision to limit the benefit of Rule
151 to situations where an index is used to fix a specific excess interest
rate in advance. Additionally, comment is requested on how the nature of
particular indexing formulas and the duration of any guarantees of caps,
floors, participation rates, margins, or other terms affect the allocation
of investment risk between the contract owner and the insurer.
C. Marketing
<(32)> Proposing Release, supra note 17, 49 FR at 46753 n.19.
<(33)> Adopting Release, supra note 19, 51 FR at 20260.
======END OF PAGE 18======
Marketing is another significant factor in distinguishing insurance
from a security. In United Benefit, the Supreme Court, in holding an
annuity contract to be outside the scope of Section 3(a)(8), found
significant the fact that the contract was "considered to appeal to the
purchaser not on the usual insurance basis of stability and security but on
the prospect of growth' through sound investment management."<(34)>
Under these circumstances, the Court concluded "it is not inappropriate
that promoters' offerings be judged as being what they were represented to
be."<(35)> Rule 151 incorporates a "marketing" test.<(36)> As
a condition to the safe harbor, the contract must not be "marketed
primarily as an investment." The Commission is concerned that the nature
of equity index insurance products may make it particularly difficult to
market these products without primary emphasis on their investment aspects.
Commenters should describe how equity index insurance products are
marketed and how the marketing factor applies to equity index insurance
products. Given the structure and purposes of equity index insurance
products, can they be marketed without focusing primarily on their
investment aspects? Comments should address both written sales materials
and oral sales presentations, including the ability of an insurer to train
and monitor its sales force to ensure that equity index insurance products
<(34)> United Benefit, 387 U.S. 202, 211 (1962).
<(35)> Id. For other cases applying a marketing test, see
Berent v. Kemper Corp., 780 F.Supp. 431 (E.D. Mich.
1991), aff'd, 973 F.2d 1291 (6th Cir. 1992); Associates
in Adolescent Psychiatry v. Home Life Ins. Co., 729
F.Supp. 1162 (N.D. Ill. 1989), aff'd, 941 F.2d 561 (7th
Cir. 1991); Grainger v. State Security Life Ins. Co.,
547 F.2d 303 (5th Cir. 1977).
<(36)> 17 CFR 230.151(a)(3).
======END OF PAGE 19======
are not marketed with primary focus on their investment aspects.
Commenters are requested to identify the distribution channels that are
used in marketing equity index insurance products and discuss whether the
use of particular distribution channels affects an insurer's ability to
market these products without focusing primarily on their investment
aspects. Commenters are also asked to identify the products that are
viewed as competitive alternatives to equity index annuities and address
how the nature of these other products (e.g., whether securities or
insurance) affects the manner in which equity index insurance products are
marketed.
D. Mortality Risk
When the Commission adopted the Rule 151 safe harbor, it determined
not to include a requirement that the insurer assume some mortality risk
through, for example, guaranteeing annuity purchase rates for the life of
the contract. The Commission noted, however, that in a Section 3(a)(8)
facts and circumstances analysis of contracts outside the Rule 151 safe
harbor, the presence or absence of mortality risk may be an appropriate
factor to consider.<(37)>
Commenters are requested to describe with specificity the nature of
<(37)> Adopting Release, supra note 19, at 20255-56. See also
Proposing Release, supra note 17, at 46752 (requesting
comment on whether mortality risk assumption should be
a required element of the Rule 151 safe harbor);
General Statement of Policy Regarding Exemptive
Provisions Relating to Annuity and Insurance Contracts,
Securities Act. Rel. No. 6051 (Apr. 5, 1979) [44 FR
21626, 21627-28 (Apr. 11, 1979)] (predecessor
interpretive release to Rule 151 stating that
meaningful mortality risk by insurer was prerequisite
to determination that contract was "insurance," not
"security").
======END OF PAGE 20======
the mortality risks assumed by insurers in connection with equity index
insurance products. For equity index annuities, commenters should describe
the terms of any guaranteed annuity purchase rates, whether those rates are
comparable to rates available in more traditional annuity contracts, and
the likelihood that contract owners will annuitize. Comment is also
requested on the significance of mortality risk in determining whether an
equity index insurance product is exempted by Section 3(a)(8). Is
mortality risk a relevant factor and, if so, what weight should it be
given?
IV. REQUEST FOR COMMENTS
All interested persons are invited to submit written comments on
equity index insurance products. Whenever possible, submissions should
describe particular equity index insurance products with specificity and
include sample sales literature and contracts. Commenters should address
the ways in which equity index insurance products are similar to or
different from traditional fixed annuities and life insurance, on the one
hand, and variable annuities and variable life insurance, on the other.
Particular emphasis should be placed on the factors described above,
including state insurance law, investment risk, marketing, and mortality
risk.
The Commission also requests that commenters address the following:
* Are there features that all equity index insurance products share
that result in all of them being covered by the insurance
exemption or, in the alternative, not covered by the insurance
exemption? If so, commenters should identify the features that
cause all equity index insurance products to be classified
======END OF PAGE 21======
together. If not, commenters should identify the features that
distinguish equity index insurance products that are covered by
the insurance exemption from those that are not.
* Are there differences between broad types of equity index
insurance products that are relevant to the analysis of their
status under the federal securities laws? If so, commenters
should separately address different types of products, e.g.,
single premium products versus flexible premium products or
annuities versus life insurance. For example, commenters should
address any differences in mortality risk between equity index
annuities and life insurance.
The Commission also requests comment on the implications for small business
of federal securities law issues raised by equity index insurance products.
V. CONCLUSION
The Commission is requesting comments on a number of specific issues
raised by equity index insurance products. In addition, commenters are
encouraged to address any other matters that they believe merit
examination.
By the Commission.
Jonathan G. Katz
Secretary
Dated: August 20, 1997
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