January 5, 1998

Mr. Jonathan Katz, Secretary

Securities and Exchange Commission

450 Fifth Street, N.W.

Washington, D.C. 20549-6009

Re: File No. S7-22-97

Comments on Equity Index Insurance Products

Dear Mr. Katz:

This letter represents the response of Southland Life Insurance Company (the "Company") to the Securities and Exchange Commission’s (the "Commission") request for comments on the structure of equity index insurance products ("EIPs"), 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. 1

The Company is a life insurance company domiciled in the state of Texas with its primary operations headquartered in Atlanta, Georgia. It is a member of the ING Group of Companies and is licenced to conduct its business in 48 states.

Currently, the Company issues an equity index universal life insurance contract, specifically, the Legacy Index Universal Life Policy (the "Contract" or "Legacy Index"). A copy of the Contract and accompanying promotional materials are submitted under separate cover of even date herewith. As one of the first carriers to issue an equity index life product, the Company is extremely interested in the Commission’s examination of equity index life and annuity products. The Company believes that equity index products are representative of the current innovation of products being provided by the financial services industry. In the case of equity index universal life insurance, the Company believes that its design is simply an enhancement of general account universal life.

It is the Company’s view that EIPs are innovative insurance products that, when structured and marketed properly, clearly fall within the exemption provided by Section 3(a)(8) of the Securities Act of 1933. We have used, where applicable or helpful, features of our Contract to illustrate our views of the status of EIPs and the Section 3(a)(8) exemption.

I. Product Description

In general, today’s EIPs are life insurance policies or annuity contracts that credit interest in excess of a floor guarantee on product cash values based upon the performance of a specific equity index. Among the approximately forty companies presently issuing EIPs, there is a variety of different product chassis including single premium deferred annuities, flexible premium deferred annuities, immediate annuities and life insurance policies. To date, most of the EIPs available in today’s financial product marketplace are underwritten through the general account of the issuing insurer. 2 Thus, from an insurance accounting standpoint, they are generally treated like any other traditional annuity or life insurance contract. EIPs have guaranteed values under the terms of the contract. As a general rule, the guaranteed amount is composed of purchase payments or premiums paid, less contract charges, plus interest at a minimally guaranteed level. These guarantees are typically in effect for the life of the contract. Interest credited to account or accumulation values in excess of the above-described guarantees are based upon the contract’s "linkage" to the index specified in the contract. The movement in the index, as determined by a formula contained in the contract, provides the amount of excess interest to be credited from the insurer’s general account to the contract or policy. Unlike variable life and annuity products, where the contract owner "owns" subaccount units whereby financial experience is "passed through" to the owner, an EIP simply uses its applicable index to "measure" the excess interest to be credited. While most of today’s EIPs are linked to the Standard & Poor’s ("S & P") 500 Index, other indices (e.g., S & P Midcap 400, NASDAQ 100, Dow Jones Industrials) are also beginning to appear in products. There is a great variety in the ways in which particular EIPs credit excess interest and in general, different formulas provide different results based on the same index.

In the Company’s case, like its other universal life products (which provide discretionary interest), its equity index universal life contract provides an identical (to certain other of its UL products) platform of death benefits, principal and interest guarantees and anticipates (but does not contractually guarantee) the crediting of excess interest. Unlike its other universal life products which credit interest at a rate determined in advance by the Company, the Legacy Index product credits interest by reference to a formula specified in the contract in advance at a rate determined retrospectively. This formula is described in detail in the contract in terms that the consumer should clearly understand. It is significant to note that with regard to the Company’s other universal life products, the Company has the discretion to reduce or eliminate the crediting of excess interest, however, the Company must credit interest in accordance with the formula contained in the Legacy Index contract, thus increasing the Company’s investment risk.

II. Applicability of the Federal Securities Laws to Equity Index Insurance Products

A. Judicial Interpretations

Pursuant to Section 3(a)(8) of the Securities Act of 1933 (the "Act"), any insurance, endowment or annuity contract issued by an insurance company subject to the supervision of a state insurance commissioner (or similar entity or official) is exempt from registration under the Act. In determining whether an equity index insurance product is exempt under Section 3(a)(8), the Commission and the courts have focused on three key factors: (1) the assumption of a significant investment risk by the insurer (and, conversely, a shifting of sufficient investment risk from the insured to the insurance company); (2) the product’s marketing, i.e., whether the product is being promoted primarily as insurance or as an investment; and (3) whether the insurer assumes a meaningful mortality risk.

In S.E.C. v. Variable Annuity Life Ins. Co. of America ("VALIC"), 3 the Supreme Court held that the annuity contract at issue, a variable annuity, was not an "annuity" within the meaning of Section 3(a)(8) because the entire investment risk was borne by the annuitant, not the insurance company. Premiums collected under the VALIC contract were invested in common stocks and other equities, while benefits payable under the VALIC contract varied with the success of the investment portfolio in equities--an interest which the Court characterized as having "a ceiling but no floor." 4 The Court noted that "insurance" typically involves the company’s guarantee that at least some fraction of the benefits will be payable in fixed amounts. Thus, absent some guarantee of fixed income, an annuity places all investment risks on the annuitant, not the insurance company, thus failing the test of "insurance." 5 By contrast, nonregistered EIPs generally provide an assumption of investment risk by the insurance carrier.

In S.E.C. v. United Benefit Life Ins. Co. ("United Benefit"), 6 United Benefit’s contract, marketed as the "Flexible Fund Annuity," was a deferred or optional annuity plan, with a "pay-in" period during which the annuitant’s net premiums were placed in a separate account, composed primarily of common stocks. The value of the net premiums varied according to the investment experience of the separate account. At maturity, the purchaser could convert the value of his or her interest to a fixed annuity or elect to receive the greater of (a) his or her interest in the separate account or (b) aggregate net premiums. Upon review, the Court concluded that the variable "pay-in" phase did not qualify for the Section 3(a)(8) exemption. The Court reasoned that during the "pay-in" period, "instead of promising to the contractholder an accumulation of savings at interest, the insurer promise(d) to serve as an investment agency and allow the contractholder to share in its investment experience." 7 United Benefit merely promised to return, at a minimum, net premiums paid, an "amount (that) is substantially less than that guaranteed by the same premiums in a conventional deferred annuity contract." 8 The Court found that while this guarantee "reduce(d) substantially the (contractholder’s) investment risk, the assumption of an investment risk cannot by itself create an insurance provision." 9 Moreover, the Court noted that the annuity’s appeal to purchasers was its prospect of "growth" through sound investment management rather than the "usual insurance basis of stability and security." 10

In addition to the Supreme Court, various circuit and district courts have examined annuities and life insurance contracts in the context of securities fraud claims brought by purchasers of such contracts. In Olpin v. Ideal National Ins. Co. ("Olpin"), 11 the Tenth Circuit considered whether certain endorsements to life insurance policies were securities because the endorsements provided for a payment on death or after a specified period from a "bonus fund." The insurer allocated a specified amount to the "bonus fund" (at least $1.00 but not more than $2.00, as determined by Ideal’s Board of Directors, for each $1,000 in life insurance in force under certain policies), and credited a set interest rate to such amounts. The court concluded that the endorsements were not securities because the insurer was obligated to pay an amount that could be mathematically calculated (a share of the allocated amounts plus 2-1/2% annual interest), regardless of the investment performance of amounts the insurer set aside to fund its obligation, and that therefore the insurer bore the entire investment risk. Moreover, the court noted that the contractholders "had no interest in and in nowise were affected by investment gains or investment losses by Ideal or its predecessors, except losses so great that they would threaten the solvency of Ideal or its predecessors." 12

In Peoria Union Stock Yards Co. v. Penn Mutual Life Ins. Co. ("Peoria Union"), 13 the Seventh Circuit considered an appeal from the dismissal of a complaint alleging that a "group deposit administration contract" used as the funding vehicle for a pension plan was a security. The contract provided for plan contributions to be deposited in a deposit account and guaranteed a minimum fixed interest rate only on deposits made during the first three years of the contract (declining from 7-1/2% to 3-1/2% over the period these contributions were on deposit), with no interest guarantees on deposits made after the first three years. Comparing the Penn Mutual contract to United Benefit’s annuity, the court found that the Penn Mutual contract--like the United Benefit annuity--guaranteed a minimum value at maturity, but a low minimum, and that the Penn Mutual contract’s guarantees were non-existent after the third contract year. Thus, the court concluded that the Penn Mutual contract was an "investment contract" subject to the federal securities laws.

In Otto v. Variable Annuity Life Ins. Co. ("Otto"), 14 the Seventh Circuit examined a fixed annuity’s guaranteed minimum rate of return of 3-1/2% and 4%, wherein the insurance company retained complete discretion to alter at any time the rate of excess interest paid on past contributions under the contract. The court noted that the ability of the insurer to eliminate excess interest payments entirely at any time tended to shift the investment risk from the insurer to the participant. Therefore, the court found that the fixed annuity plan was a security because it provided no one-year guarantee of excess interest.

In Associates in Adolescent Psychiatry v. Home Life Ins. Co. ("Home Life"), 15 the Seventh Circuit affirmed the district court’s holding that the insurer’s fixed annuity contract was not a security. Home Life’s annuity guaranteed a return of 7% during the first year, declining to 4% in the contract’s sixth year and thereafter. A variable excess interest rate (referred to in the contract as an "annual dividend"), applicable prospectively to all value held under the contract, was declared annually by Home Life’s Board of Directors. One contractual feature that led the court to conclude that the Home Life contract looked more like a fixed annuity than the contracts in question in Peoria Union and Otto was that the excess interest rate, which was derived from the rate of return Home Life earned on its general investment portfolio, was declared in advance. In dicta, the court distinguished Peoria Union, Otto, VALIC and United Benefit on the grounds that in those cases, the rate of interest to be credited under the contracts was declared retroactively, noting that "(t)he ex ante uncertainty about (the rate of excess interest to be credited) made the ‘annuity’ look like a mutual fund, with the seller supplying only investment advice." 16 By declaring the annual excess interest rate for the coming year in advance, the insurer in Home Life reduced the purchaser’s investment risk, giving the purchaser certainty as to the rate of excess interest to be credited on the accumulated value in the coming year.

In Berent v. Kemper Corp. ("Kemper"), 17 the U.S. District Court for the Eastern District of Michigan examined the sale of single premium life insurance policies. The court evaluated the investment risk assumed by the insurer relying heavily on Rule 151 (discussed below) and found that the policies were not securities under Section 3(a)(8). The court held that the policies met all of the conditions of Rule 151: (1) the net premiums under the policies were invested in Kemper’s general account, not in a separate account; (2) principal and interest were guaranteed under the policies; (3) the relevant guaranteed minimum interest rates exceeded the 3% minimum of the Michigan and NAIC nonforfeiture laws for annuities; and (4) excess interest rates under the policies were guaranteed for a full contract year.

Finally, in Dryden v. Sun Life Assurance Co. of Canada ("Dryden"), 18 the U.S. District Court for the Southern District of Indiana examined participating whole life insurance policies issued by a mutual insurance company. The insurer periodically paid dividends to contractholders. The dividends varied based on whether the contractholders had taken out contract loans. In determining whether the policies were securities, the court utilized the two-pronged test set forth in VALIC and S.E.C. v. Howey, 19 : (1) whether the policies in question would cause a contract owner to bear the investment risk of premiums paid; and (2) whether a contract owner would reasonably expect to share in the profit generated by the investment of his or her premiums. The court found the response to both questions to be negative, noting that the insurer was obligated to pay a fixed sum at death and that the insurer bore the risk of poor investment performance. Moreover, the court found that the "dividends" issued by the insurer represented refunds of excess premiums (in effect, a retroactive reduction in premium rates), rather than a distribution of profits. Accordingly, the court held that the policies in question were not securities.

B. Commission Interpretations

Rule 151 provides a safe harbor for annuity contracts. By its terms, it does not provide a safe harbor for life insurance contracts. However, the Commission noted, in Release 6645 that "(t)he securities law status of a life insurance contract may be analyzed by reference to the principles discussed in Rule 151 and accompanying releases and by reference to relevant judicial interpretation of Section 3(a)(8). 20 Thus, to the extent a life insurance contract can meet the standards set by Rule 151, insofar as such standards can be meaningfully applied to life insurance, the life insurance contract should fall within the scope of Section 3(a)(8). In any event, such analysis is relevant to any federal securities law analysis of EIPs.

Prior to the Commission’s adoption of Rule 151, a "Statement of Policy" represented the Commission’s views on the status of certain "fixed" annuity contracts. 21 Release 6051 explained that in order for a contract to fall within the Section 3(a)(8) exemption, an insurance company must assume: (1) a meaningful mortality risk; and (2) a significant investment risk (with a corresponding absence of significant investment risk assumed by the purchaser). The Commission further noted that to assess the significance of the risk assumption, all facts and circumstances must be considered, i.e., not only the terms of the contract, but also sales literature, oral and written representations made by authorized salespersons, and other promotional efforts should be scrutinized. 22 Although Release 6051 was withdrawn by the Commission with the adoption of Rule 151, it provides insight in interpreting Section 3(a)(8) and Rule 151 in situations not specifically addressed by the Rule.

In 1986, the Commission adopted Rule 151, which establishes a "safe harbor" for an "annuity contract or optional annuity contract" that meets each of the Rule’s three elements. Under Rule 151, an annuity contract will be deemed to be within the exemptive provisions of Section 3(a)(8), and thus excluded from the Act, 23 if: (1) it is issued by a corporation subject to the supervision of a state insurance commissioner; (2) the insurer assumes the investment risk under the contract; and (3) the contract is not marketed primarily as an investment.

With respect to the second element, the assumption of risk, Rule 151 lists four conditions, all of which must be satisfied: (1) the value of the contract must not vary according to the investment experience of a separate account; (2) the insurer must for the life of the contract guarantee the principal amount of premiums and interest credited thereto (less deductions, without regard to timing, for sales, administrative or other expenses or charges); (3) the insurer for the life of the contract must credit net premiums and interest credited thereto with a specified rate of interest at least equal to the minimum rate required to be credited by the relevant nonforfeiture law in the jurisdiction in which the contract is issued (or if no such law is applicable, the rate required for individual annuity contracts by the NAIC Standard Nonforfeiture Law); and (4) the insurer must guarantee that the rate of any discretionary excess interest to be credited will not be modified more frequently than once per year.

Under the principles of Rule 151, the insurer must minimize the shifting of investment risk to the purchaser so that the investment risk the insurer does assume is sufficient to qualify the contract for the Section 3(a)(8) exemption. The Commission noted in Release 6645, relying on VALIC, "absent some element of a fixed return, an annuity contract is outside the scope of Section 3(a)(8)." 24 The Commission has also stated that the length of time between interest rate modifications is one legitimate measure of the degree of investment risk assumed by the insurer, 25 and that "the longer the period for which such interest is guaranteed, the greater the degree of investment risk assumed by the insurer." 26 In adopting the one-year requirement for excess interest under the Rule 151 safe harbor, the Commission indicated that this requirement was "on balance, a reasonable condition, complementing the other two components of the rule’s investment risk test." 27

The Company bears significant investment risk under the Contract. As is the case with a traditional universal life insurance policy, the Contract provides that the benefits it guarantees will be paid out upon death or surrender, regardless of the investment experience of the Company’s general account assets. Moreover, those guaranteed benefits are significant, given the amount and long-term nature of the guarantees.

As the Commission has recognized in Rule 151, by guaranteeing a minimum interest rate, the Company assumes the risk that it will not earn a sufficient amount to pay the rate guaranteed for that period. Because index-based Bonuses, determined in accordance with a formula guaranteed in advance, must be applied to determine certain Contract values, the Company does not have discretion to declare the rate of excess interest in the manner found insufficient by the Seventh Circuit in Otto. Unlike the annuities in Otto, the Contract provides a guarantee of the crediting of an index-based Bonus at the end of a one-year period that the Company cannot eliminate, nor can the Company "adjust" the rate--it is only calculated once for an Index Period applicable to an Index Segment on an indexed basis. Furthermore, the use of an external index in accordance with a predetermined fixed formula contradicts the notion that the Company is serving as an investment agency or supplying investment advice, and the six-month averaging or "smoothing" feature of the Contract’s indexing formula further distinguishes the Contract from an "investment" in the index. Thus, the Company not only assumes investment risk with respect to the permanent guaranteed rate, but also relative to the excess interest rates that may be credited under the Contract.

The primary mortality risk under the Contract assumed by the Company is the possibility that insureds named under the Contracts will produce mortality experience worse than that assumed in the rate structure in determining the death benefits under the Contracts. Like other conventional life insurance policies, the Contract is designed so that the death benefit is always greater than the Accumulation Value. Therefore, so long as the Contract is in effect, the Company is at risk for the difference (the net amount at risk) between the death benefit and the Accumulation Value. This net amount at risk represents the pure mortality risk included in the death benefit payable at any given time.

In addition to the assumption of mortality risk associated with the payment of the death benefit under the Contract, the Company also assumes mortality risk in connection with the income payment option provided under the Contract. The owner has the right to select at any time during the life of the Contract an income payment (settlement) option pursuant to which the proceeds of the Contract will be paid out by the Company upon death or surrender. By providing a guaranteed annuity settlement option under the Contract that can be selected at some distant future time, the Company assumes a meaningful mortality risk.

III. Rule 151: Contract Value Not Tied to a Separate Account

Rule 151 provides that one of the conditions that must be met for the insurer to be deemed to have assumed the investment risk under the contract is that the value of the contract not vary according to the investment experience of a separate account and that all of the assets in the insurer’s general account remain available to meet the guarantees provided under the contract. 28 With respect to the Company’s Contract, the assets supporting it are held as part of the general account assets of the Company and do not support the Contract to any greater or lesser extent than they support any other general account liability of the Company. Moreover, the general account assets of the Company are subject to all of the various quantitative and qualitative restrictions on insurance company general account investments under state insurance law. Because the general assets of the Company support the Company’s guarantees under the Contract and because the Contract’s Accumulation Value will not vary with the investment experience of a separate account, the Contract complies with the first investment risk condition under Rule 151. 29

IV. Rule 151: Guarantee of Purchase Payments and Credited Interest

The second condition of Rule 151 requires the insurer to guarantee the principal amount of the premium and interest credited thereto, net of deductions for sales, administrative charges and other expenses. In Release 6558, the Commission explained the mechanics of this provision: "If in year one interest is credited under the contract at a rate of 10%, the rule requires the insurer to guarantee, for the remaining life of the contract, the principal amount of the dollar equivalent of the 10% interest actually credited in that year." 30

Under the Company’s Contract, Cash Value (Accumulation Value minus Surrender Charges, if any) will reflect deductions from premiums for the Premium Expense Charge (2% of each premium); deductions from Accumulation Value of Monthly Deductions (cost of insurance charges, the monthly administrative charges, extra premium, and rider costs); reductions for withdrawals, including the $25 withdrawal fee; and Surrender Charges. Debt includes any outstanding policy loans and unpaid loan interest.

The Premium Expense Charge, Monthly Deductions, withdrawal fee and loan interest charges are not based on and do not reflect, directly or indirectly, market or other rates (or changes therein), and thus do not shift investment risk to the purchaser. In addition, the Contract’s Surrender Charge is either based on a fixed percentage of a planned periodic premium established at the time a Contract is issued (full surrender), or a fixed dollar amount per $1000 (Face Amount decrease). Because the Surrender Charge is unrelated to the Company’s investment experience and does not reflect movements in the index, interest rates or market rates at the time of surrender or Face Amount reduction, and is a fixed percentage or fixed per $1000 amount, it does not shift additional investment risk to the owner. Because this kind of charge discourages the purchase of contracts as short-term investment vehicles, it traditionally has been analyzed as evidence of insurance, rather than as an element of an investment contract. Moreover, the Surrender Charge represents a method by which the Company can expect to recover its expenses. As a result, this charge does not shift additional investment risk to the Contract owner. 31 In effect, the Contract’s expense charges represent charges typically imposed under traditional fixed (general account) universal life insurance policies, and therefore, comport with Rule 151's investment risk standard.

V. Specified Rate of Interest

Rule 151 requires that an annuity contract credit at least the minimum specified interest rate required by the relevant nonforfeiture law to net purchase payments and interest credited thereto. The Company guarantees that interest on Accumulation Value will be credited daily at an annual rate at least equal to 3%. (The Accumulation Value is reduced by withdrawals accumulated with interest at 3% per year, and the policy charges described above.) All amounts of net premium remaining in the Contract will be credited with daily interest at an annual rate of 3% until such date as the amount is withdrawn (for withdrawals or policy charges), or paid as a benefit. The minimum interest rate is consistent with rates permitted under applicable nonforfeiture laws for individual life insurance policies in the states where the Contract is sold.

The 3% interest is credited on a compounded basis, and therefore, the Contract provides for guaranteed interest at 3% to be credited to principal (net premiums) and to interest credited thereto, less deductions for policy charges. The Contract also provides for the payment of current interest to each net premium received, from the date of receipt to the start of the Index Period applicable to the Bonus Segment to which such net premium is applied. Current interest is credited to net premiums at an effective annual rate, declared in advance, of at least 3%. The current interest is credited on a compounded basis, and therefore, the Contract provides for guaranteed interest at a rate at least equal to 3% to be credited to net "principal" and to interest credited thereto, less deductions for policy expenses, for the life of the Contract.

The Contract contrasts with those issued by Penn Mutual and evaluated in Peoria Union. In that case, the court determined that the insurer did not assume sufficient investment risk to be entitled to rely on the Section 3(a)(8) exclusion when the Penn Mutual product failed to provide any guarantee of interest after the third year of the product’s life, and did not provide the significant interest rate guarantees provided by the Contract. 32 The Company’s permanent guaranteed minimum interest rate and guaranteed rolling "step up" of Accumulation Value (to reflect current interest credited prior to the commencement of each Index Period, and to reflect the Standard & Poor’s ("S&P") Index Bonuses, if any, credited at the end of each Index Period) do not shift the investment risk to Contract owners. This distinguishes the Contract from the Penn Mutual product, which shifted such investment risk to pension plan participants after the third year of the plan.

In Olpin, the Tenth Circuit found that the insurer’s guarantee of a 2.5% interest rate on amounts allocated to a "bonus fund" under a life insurance contract constituted an assumption of significant investment risk by the insurer. Similarly, the Contract provides a guaranteed Cash Value for the life of the Contract. Thus, much like the risk assumed by the insurer in Olpin, the Contract’s minimum interest guarantee is a risk that only the Company bears, and no part of that risk is borne by the owner. 33 By guaranteeing a minimum interest rate, the Company assumes the risk that it will not earn a sufficient amount to pay the rate guaranteed for that period.

VI. Marketing

The Supreme Court has set forth a marketing test to determine whether an insurance product is a security within the meaning of Section 3(a)(8): "The test is what character the instrument is given in commerce by the terms of the offer, the plan of distribution and the economic inducements held out to the prospect." 34 In United Benefit, the Court noted that the Flexible Fund Annuity in question, and contracts like it, are not promoted "on the usual insurance basis of stability and security, but on the prospect of ‘growth’ through sound investment management." 35 Such contracts are marketed to compete with mutual funds and are pitched to the same consumer interest in growth through professionally managed investment.

In Home Life, the court found that the annuity contract was not marketed primarily as an investment just because isolated statements in the company’s sales literature referred to the investment aspects of the annuity contract. The court acknowledged that certain statements in the marketing materials mentioned the desirability of excess interest as a way of taking advantage of fluctuating interest rates and that the "sales pitch" for the contract emphasized the insurer’s abilities in the management and investment of money. However, the court concluded that the sales literature "does not, when read as a whole, promote the (annuity) primarily as an investment. The document repeatedly stresses that the (annuity) is a method of saving for retirement, with guaranteed principal, guaranteed interest and a guaranteed life income (through purchase of an annuity with the accumulated funds)." 36

In Release 6558, the Commission also set forth a marketing test as the third element of the proposed Rule 151 safe harbor: the contract "is not marketed primarily as an investment." 37 Citing the Supreme Court’s decision in United Benefit, the Commission stated that insurers marketing a contract "with primary emphasis on discretionary excess interest and other investment-oriented features, while relegating mention of the traditional retirement planning features of an annuity contract to the ‘fine print,’ must be viewed as offering a security, and not insurance." 38 The Commission also quoted United Benefit language to the effect that exempt insurance and annuity policies appeal "on the usual insurance basis of stability and security," and that offerings should be judged as being what they are represented to be. 39

In determining whether a contract is being marketed primarily as an investment, the Commission further noted that among the factors to be considered are whether the contract is promoted: (1) with substantial emphasis on current discretionary excess interest or other investment-oriented features of the contract; and (2) as one type of tax-sheltered investment that is interchangeable with other such investments. 40

Release 6558 further states that an insurer relying upon Rule 151 has the responsibility to "take reasonable steps" to ensure that the marketing of its products is not inconsistent with the marketing test of Rule 151, even if the insurer does not directly control the distribution of its products. 41 Rule 151 permits a contract to qualify for the rule’s safe harbor only if the contract "is not marketed primarily as an investment." 42 The Commission explains that the standard adopted by the rule follows the Court’s language in United Benefit and means simply that "the thrust of the insurer’s total marketing plan for the product must be targeted to appeal to purchasers ‘on the usual insurance basis of stability and security.’ For example, a marketing approach that fairly and accurately describes both the insurance and investment features of a particular contract, and that emphasizes the product’s usefulness as a long-term insurance device for retirement or income security purposes, would undoubtedly ‘pass’ the rule’s marketing test." 43

The Consumer Brochure of the Contract is consistent with the principles of Rule 151 because the Contract is not marketed primarily as an investment. The first "fold out" page of the Brochure clearly states that the Contract provides life insurance benefits, and the opposite page again prominently identifies the Contract as life insurance ("that gives you safety ... plus") and indicates in the text that the Contract "provides a death benefit, of course" and "combines the safety of minimum guaranteed values with the potential for additional interest linked to the S&P 500 Composite Stock Price Index." In addition, while page 2 of the Brochure describes the benefits of the Contract’s indexing feature ("What if you could receive additional interest on your life insurance policy based upon a percentage of gains in the S&P 500?") and indicates that the S&P 500 has historically outpaced the rate of inflation, the text does not overemphasize the relationship of the index to the Contract or Contract values. Throughout the piece, the equity indexed aspect of the Contract is described as an interest crediting method, and not as a means of achieving the gains of the S&P 500. While the benefits of equity indexing are described, the Brochure places equal emphasis on the guarantees provided. Traditional life insurance features, such as the death benefit, safety of principal, long-term planning and reduced volatility are highlighted. Although the Brochure highlights tax-deferred growth and access to assets with tax advantages, these features are described in tandem with information about death benefits, protection of principal and the 3% guaranteed interest rate. Moreover, the Brochure cautions Contract owners to consult with tax advisors and mentions the adverse tax (and other) consequences that may be associated with "MEC" status. Overall, the Brochure appeals to prospects on the basis of stability and security, and it accurately describes the Contract’s indexed interest--which is consistent with the Contract’s status as insurance.

The Company’s Producer Guide repeatedly identifies the Contract as a life insurance policy and highlights the death benefit and guarantees provided by the Contract. The Contract is distinguished from a variable life insurance policy, and downside protection (as well as "upside" limitations) are accurately described. Moreover, the questions and answers include an accurate and detailed description of the indexing feature that does not "tie" indexing to equity markets or individual stocks. Of further note, when the Company’s product was introduced to the field force, it was done through a series of producer training seminars which included a detailed review of the product features, a primer on how to properly market the product and a Slide Presentation providing "up front" focus on the Company and its financial strength, and distinguishing indexing from "direct participation" in "market performance." In addition, the slides did not promote the Contract "as an investment."

Nevertheless, the Company urges the Commission to consider providing objective guidance to insurers marketing EIPs. The Commission may wish to consider rules similar to those currently in development by the American Academy of Actuaries ("AAA") and the various states. The Company would like to see the goal of such an effort to assist insurers (and subsequently consumers) in developing accurate, balanced and fair presentations of both the insurance and "investment" features of an EIP.

VII. Mortality Risk

Under both judicial and Commission interpretations, mortality risk is a factor under a Section 3(a)(8) analysis outside the scope of the Rule 151 safe harbor. In VALIC, the Supreme Court stated that the insurer’s assumption of mortality risk under an annuity contract "gives (the annuity) an aspect of insurance." 44 However, the Court determined that assumption of mortality risk by the insurer is insufficient, by itself, to bring an annuity contract within Section 3(a)(8). 45

In Dryden, the district court examined life insurance policies that guaranteed a fixed payment at the owner’s death to a designated beneficiary. 46 Without performing a full analysis under Section 3(a)(8) or Rule 151, the court concluded that the insurer’s obligation to pay the fixed sum caused it to bear the risk of poor performance of its investments. Consequently, the court found that there was a true underwriting of risks by the insurer.

Similarly, the Commission has noted that mortality risk is an appropriate factor to consider in determining the availability of an exemption from Section 3(a)(8) beyond the scope of Rule 151, and in interpreting Rule 151 in situations not specifically addressed by the Rule. 47 The United States’ amicus curiae brief in Otto stated the Commission’s view that "if (an insurance company’s) marketing tactics place the status of its fixed-annuity contract in doubt, (the company’s) assumption of a meaningful mortality risk might nonetheless tip the balance in favor of a conclusion that the contract is an ‘annuity contract’ under Section 3(a)(8)." 48

VIII. State Regulation of Equity Index Products

State insurance departments have, as their primary duty, the protection of its citizens who purchase insurance products. Commensurate with this duty, state insurance departments must ensure that insurance companies have sufficient assets to meet their obligations under their outstanding contracts.

The insurance industry is highly regulated at the state level. In addition to regulating and approving policy forms, virtually all states regulate the type and amount of investments that may be undertaken by insurance companies. Furthermore, most states have established detailed reserving and risk-based capital requirements for different types of insurance products. State regulators periodically conduct examinations to scrutinize an insurer’s investments, test the adequacy of reserves and risk-based capital and otherwise oversee an insurer’s operations.

State insurance regulators are addressing these issues in a comprehensive way in the context of EIPs. The Life and Health Actuarial Task Force of the National Association of Insurance Commissioners ("NAIC") has asked the AAA to develop recommendations governing all actuarial aspects of EIPs. The AAA in turn has formed a Task Force (the "AAA Task Force") to comply with this request. The areas in which the AAA Task Force is preparing recommendations include reserving issues, valuation actuary issues, risk-based capital issues, investment issues, and marketing and disclosure issues. As of November 1997, the AAA Task Force had issued three Interim Reports. The report of the AAA Task Force, when completed, will be used by the NAIC in formulating new model regulations and changes to existing regulations applicable to EIPs.

IX. Investments Supporting EIPs

The Commission requests comment on the investments used by an insurer to support obligations under EIPs and asks whether the nature of the investments made in the insurer’s general account affects the federal securities law analysis of EIPs. The Concept Release specifically questions whether an insurer’s "hedging" of its general account obligations under such products effectively results in a "pass-through" of investment performance from insurer to contract owner. 49 It would appear that the Concept Release suggests that the allocation of investment risk is only one factor in a federal securities law analysis and that perhaps consideration should also be given to "how" an insurer manages its investment risk.

As stated above in section VIII, the general account investments of insurance companies is one of the primary areas of state regulation. State law and business economics require that insurance companies carefully manage their general account assets in order to achieve maximum rates of return while assuring adequate profitability and solvency. While the Company utilizes both reinsurance and hedging strategies to back its obligations under the Contracts, these investment techniques are also utilized (to differing degrees, depending on the product) in other general account products.

Such strategies are utilized to assist in the management of investment risk, not its elimination. There are always default risks in reinsurance and hedging transactions as well as risks of being over-hedged or over-reinsured (with resulting disintermediation exposure) or asset/liability mismatching. Regardless of an insurer’s prowess (or lack thereof) in managing such general account assets, the insurer remains contractually obligated to pay contract benefits and credit formula driven excess interest.

The Company believes that "how" an insurance company manages its investment risk is beyond the scope of a federal securities law analysis of a general account product, and moreover, such management of assets has been and is the purview of state insurance regulatory authorities.

X. General Questions

EIPs can be distinguished from variable annuity or variable life insurance products. EIPs generally provide an account or cash value credited with earnings that are linked to some degree to the movement of a specified index. An EIP "controls" a contract owner’s equity index linkage by providing a platform of contractual guarantees and by applying an indexing formula that does not provide a "pass through" of index "performance." The use of an external index in accordance with a predetermined fixed formula contradicts the notion that an insurance company is serving as an investment agency or supplying investment advice. Moreover, the index to be used, the formula for crediting indexed interest, and the dates on which indexed interest is calculated and credited, are established in the contract and guaranteed for the life of the contract. From a marketing standpoint, EIPs are attractive to insurers’ traditional target market of conservative savers. 50

Furthermore, unlike variable and market-value adjusted ("MVA") products, all unregistered EIPs have guaranteed minimum nonforfeiture values. State nonforfeiture laws for individual fixed annuities require that single premium equity index annuities guarantee the return of an amount at least equal to 90% of premium, accumulated at an annual rate of at least 3%. For flexible premium individual deferred annuities, state nonforfeiture laws require a guaranteed return of an amount equal to 65% of the net consideration for the first contract year and 87.5% of the net considerations for the second and later contract years, all accumulated at an annual interest rate of at least 3%.

XI. Conclusion

The Company believes that EIPs, when structured and marketed properly, clearly fall within the exemption provided by Section 3(a)(8) of the Securities Act of 1933. The Company urges the Commission to find that EIPs that provide a substantial platform of principal and interest guarantees as well as long-term benefit guarantees (e.g., in accordance with applicable nonforfeiture law) involve sufficient risk assumption by the insurance company. With respect to the so-called

"marketing test," the Company urges the Commission to consider the adoption of the same "objective" set of standards or other guidance.

Very truly yours,

B. Scott Burton

Vice President & General Counsel


-[1]- Equity Index Insurance Products, Securities Act Release No. 7438, 62 Fed. Reg. 45,359 (Aug. 27, 1997) (the "Concept Release").

-[2]- However, Valley Forge Life Insurance Company recently registered, on Form S-1, an annuity contract which has both market value adjustment and equity indexed features through a separate account (File No. 333-02093).

-[3]- 359 U.S. 65 (1959).

-[4]- Id. at 74.

-[5]- Id. at 71.

-[6]- 387 U.S. 202 (1967).

-[7]- Id. at 208.

-[8]- Id.

-[9]- Id. at 211.

-[10]- Id.

-[11]- 419 F.2d 1250 (10th Cir. 1969).

-[12]- Id. at 1262.

-[13]- 698 F.2d 320 (7th Cir. 1983).

-[14]- 814 F.2d 1127 (7th Cir. 1986), rev’d on rehearing , 814 F.2d 1140 (1987), modified , (1987), cert. denied , 486 U.S. 1026 (1988).

-[15]- 941 F.2d 561 (7th Cir. 1991), cert. denied , 502 U.S. 1099 (1992).

-[16]- Id. at 567.

-[17]- 780 F. Supp. 431 (E.D. Mich. 1991), aff’d , 973 F.2d 1291 (6th Cir. 1992).

-[18]- 737 F. Supp. 1058 (S.D. Ind. 1989), aff’d without opinion , 909 F.2d 1486 (7th Cir. 1990).

-[19]- 328 U.S. 293 (1946). The Dryden Court did not perform an analysis under Section 3(a)(8) or Rule 151, but noted that insurance policies are exempt from regulation as securities pursuant to Section 3(a)(8).

-[20]- Release 6645 at 88,129 n.4.

-[21]- Statement of Policy Regarding the Determination of the Status Under the Federal Securities Laws of Certain Contracts Issued by Insurance Companies, Securities Act Release No. 6051, 1 Fed. Sec. L. Rep. (CCH) ¶ 2111 (Apr. 5, 1979) ("Release 6051"). Release 6051 was withdrawn in Release 6645, which adopted Rule 151.

-[22]- Id.

-[23]- H.R. Rep. No. 85, 73d Cong., 1st Sess. 15 (1933). In proposing Rule 151 under the Act, the Commission set forth its view that any contract falling within the provisions of Section 3(a)(8) is not merely exempt from registration but also is excluded from all provisions of the Act. Securities Act Release No. 6558, (1984-85 Transfer Binder) Fed. Sec. L. Rep. (CCH) ¶ 83,710 at 87,160 (November 21, 1984) ("Release 6558"). This view was not altered when the Commission adopted Rule 151. The Supreme Court and commentators also view Section 3(a)(8) as an exclusion from all of the provisions of the Act. Tcherepnin v. Knight , 389 U.S. 332, 342-43 n.30 (1967) (dictum) ("the exemption from registration for insurance policies was clearly supererogation"); See also L. Loss, Fundamentals of Securities Regulation 204 (1988).

-[24]- Release 6645 at 88,133.

-[25]- Release 6558 at 88,134.

-[26]- Release 6645 at 87,161.

-[27]- Release 6645 at 88,134. The Commission recognized that selection of any period was necessarily somewhat arbitrary, but considered a one-year period a reasonable way of defining the scope of a safe harbor rule. Release 6558 at 87,161-62. The Commission further noted that the meaning of "one year" is to be interpreted with a "rule of reason" approach. Release 6645 at 88,134-35.

-[28]- See Release 6645 at 88,130-31.

-[29]- The general account requirement does not preclude the Company from "earmarking" certain assets, or using assets in a designated portion of its general account to make investments designed to match its assets with its liabilities under the Contracts. In adopting Rule 151, the Commission recognized that insurers may use "nonunitized" separate accounts to facilitate the matching of maturities of investments to contractual liabilities and as a mechanism for complying with state law reserve requirements or statutory accounting standards. In this regard, the adopting release states that a contract that "provides for the allocation of net contributions to a separate account but does not provide for contract values that vary with the investment performance of the separate account would satisfy" this requirement of Rule 151. Release 6645 at 88,130-31.

-[30]- Release 6558 at 87,161 n.15.

-[31]- See Release 6645 at 88, 132 n.20.

-[32]- Peoria Union , 698 F.2d at 320.

-[33]- See Olpin , 419 F.2d at 1261.

-[34]- United Benefit , 387 U.S. at 211 (quoting S.E.C. v. Joiner Leasing Corp. , 320 U.S. 344, 352-53 (1943)).

-[35]- Id.

-[36]- Home Life , 729 F. Supp. at 1174.

-[37]- Release 6558 at 87,160.

-[38]- Id. at 87, 162.

-[39]- Id.

-[40]- Id.

-[41]- Id.

-[42]- Release 6645 at 88, 129.

-[43]- Id. at 88,137. The Release stated that it would be "counterproductive" to provide a "mechanical checklist of acceptable and unacceptable marketing techniques," and therefore, the Commission decided not to publish specific guidelines. Id.

-[44]- VALIC , 359 U.S. at 71. See also 359 U.S. at 81 n.19 (Brennan, J., concurring) (an annuity contract that lacked any "mortality" factor would appear to be wholly without an insurance element.)

-[45]- Id. at 71.

-[46]- Dryden , 737 F. Supp. at 1058.

-[47]- Release 6645 at 88, 130.

-[48]- Brief at 9-10.

-[49]- Concept Release at 15.

-[50]- The Commission noted the appeal of equity index products to consumers of traditional insurance products: "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." Equity Index Insurance Products, Securities Act Release No. 7438, 62 Fed. Reg. 45,359 (Aug. 27, 1997) (the "Concept Release").