[Federal Register Volume 62, Number 166 (Wednesday, August 27, 1997)]
[Proposed Rules]
[Pages 45359-45363]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-22597]
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Proposed Rules
Federal Register
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This section of the FEDERAL REGISTER contains notices to the public of
the proposed issuance of rules and regulations. The purpose of these
notices is to give interested persons an opportunity to participate in
the rule making prior to the adoption of the final rules.
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Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 /
Proposed Rules
[[Page 45359]]
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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.
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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
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
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
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\1\ See, e.g., Bill Harris, ``Tips For Selling Indexed
Annuities,'' National Underwriter, Aug. 5, 1996, at 12.
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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 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
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\2\ See, e.g., Linda Koco, ``3 More Equity Index Annuities Make
Mkt. Debuts,'' National Underwriter, Dec. 23, 1996, at 11.
\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''].
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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
[[Page 45360]]
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 registration.7
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\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).
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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 insurance products.8
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\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.
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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
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\9\ See, e.g., Survey, supra note 3.
\10\ See, e.g., Going Optional, supra note 6.
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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
insurance laws. 11
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\11\ See, e.g., Michelle Clayton, ``How Product Marketers
Stylize Equity Indexed Annuities,'' Bank Mutual Fund Report, Mar.
10, 1997, at 1.
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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
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\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.
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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 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.
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
[[Page 45361]]
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
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\13\ See, e.g., Survey, supra note 3; Cerulli Associates, Inc.
and Lipper Analytical Services, Inc., The Cerulli-Lipper Analytical
Report: The State of the Variable Annuity and Variable Insurance
Markets 37-40 (1996).
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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
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\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.
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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 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
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\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).
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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 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.
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\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)] [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.
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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 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.
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\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.
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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 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
[[Page 45362]]
and other equities and the value of the contract owner's benefit
payments varied directly with the success of the underlying
investments.
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\23\ 359 U.S. 65, 71 (1959).
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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
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\24\ 387 U.S. 202, 205 (1962).
\25\ Id. at 211.
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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
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.
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\26\ 17 CFR 230.151(a)(2).
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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.
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\27\ 17 CFR 230.151(b)(1).
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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 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 investment risk
analysis.
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\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).
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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?
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\30\ 17 CFR 230.151(b)(2)(ii) and (c).
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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 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.
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\31\ 17 CFR 230.151(b)(3).
\32\ Proposing Release, supra note 17, 49 FR at 46753 n.19.
\33\ Adopting Release, supra note 19, 51 FR at 20260.
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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
[[Page 45363]]
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
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.
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\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).
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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 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
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\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'').
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Commenters are requested to describe with specificity the nature of
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
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.
Dated: August 20, 1997.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-22597 Filed 8-26-97; 8:45 am]
BILLING CODE 8010-01-P
