The SEC issued the release (the “Release”) regarding the adoption of new Rule 151A under the Securities Act of 1933, as amended (the “Securities Act”), which will require registration under the Securities Act of certain indexed annuities. The SEC also adopted new Rule 12h‑7 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which provides an exemption from the Exchange Act’s periodic reporting requirements for insurance companies issuing indexed annuities and certain other insurance contracts.
Rule 151A Requirements
Rule 151A under the Securities Act provides that an annuity issued by an insurance company is not an “annuity contract” or an “optional annuity contract” excluded from the Securities Act’s registration requirements under Section 3(a)(8) of the Securities Act if the annuity has both of the following two characteristics:
the contract specifies that amounts payable by the issuer under the contract are calculated at or after the end of one or more specified crediting periods, in whole or in part, by reference to the performance during the crediting period or periods of the security, including a group or index of securities; and
amounts payable by the issuer under the contract are more likely than not to exceed the amounts guaranteed under the contract.
The first provision is intended to describe indexed annuities, the target of the rule. The SEC modified the wording of this provision to address concerns of commenters that the provision, as proposed, would have covered annuities other than indexed annuities, such as traditional fixed annuities (where amounts payable under the contract accumulate at a fixed interest rate) or discretionary excess interest contracts (where the amounts payable under the contract may include a discretionary excess interest component over and above the guaranteed minimum interest rate offered by the contract). The Release notes that while an insurance company, for example, may look to the performance of securities in its general account in establishing the rate to be provided under a traditional fixed annuity, such a contract does not obligate the insurer to do so and thus is not covered by Rule 151A. The Release also notes that annuity contracts covered by the Rule 151 safe harbor, such as certain discretionary excess interest contracts, are not required to be registered by Rule 151A.
The second provision – the “more likely than not” standard – implements the SEC’s determination that allocation of risk should be used to draw the line, on a prospective basis, between contracts that should be subject to registration under the Securities Act and those that should be entitled to exclusion under Section 3(a)(8). The SEC determined that, when the amounts payable by an insurer under an indexed annuity are more likely than not to exceed the amounts guaranteed under that annuity, the majority of the investment risk for the fluctuating, securities-linked portion of the return is born by the individual purchaser, not the insurer, and thus the purchaser is entitled to the protections provided by registration.
Rule 151A requires that the “more likely than not” determination must be made by the insurer at or prior to the issuance of the contract, provided that the following three requirements are met: (1) both the methodology and the economic, actuarial, and other assumptions used in the determination are reasonable; (2) the computations made by the issuer in support of the determination are materially accurate; and (3) the determination is made not more than six months prior to the date on which the form of contract is first offered. The SEC did not adopt the proposed requirement that the insurer make a determination every three years.
The Release assumes that most, if not all, current indexed annuities would be required to be registered under Rule 151A. The Release cites industry data that there were 322 indexed annuities offered in 2007 by 58 different insurance companies.
Indexed Life Insurance Policies
The Release provides the following statement on indexed life insurance policies:
“The rule will not apply to contracts that are regulated under state insurance law as life insurance, health insurance, or any form of insurance other than an annuity, and it does not apply to any contract issued by an insurance company if the contract itself is not subject to regulation under state insurance law. Thus, rule 151A itself will not apply to indexed life insurance policies, in which the cash value of the policy is credited with a guaranteed minimum return and a securities-linked return. The status of an indexed life insurance policy under the federal securities laws will continue to be a facts and circumstances determination, undertaken by reference to the factors and analysis that have been articulated by the Supreme Court and the Commission. We note, however, that the considerations that form the basis for rule 151A are also relevant in analyzing indexed life insurance because indexed life insurance and indexed annuities share certain features (e.g., securities-linked returns).”
Rule 151A Effective Date
The effective date of Rule 151A is January 12, 2011. The two-year delay is designed to provide sufficient time for insurers to make the determinations required by the rule and prepare registration statements for indexed annuities that are required to be registered. The delay is also designed to provide sufficient time for insurers and distributors to establish the required infrastructure for distribution of registered indexed annuities. The SEC also noted that it intends: (1) to consider how to tailor disclosure requirements for indexed annuities; and (2) to consider any requests for additional guidance that it receives regarding determinations required under Rule 151A. The Release states: “We encourage indexed annuity issuers to work with the Commission during that period to address their concerns.”
The SEC emphasized that the Rule 151A is prospective only. The Commission does not believe that issuers and sellers of indexed annuities should be subject to any additional legal risks relating to their past offers and sales of indexed annuity contracts as a result of the proposal and adoption of Rule 151A. Under the SEC’s adopted approach, the application of Rule 151A will be based on the date of the sale of a particular contract, not the date a particular form was approved by state regulators or introduced to the market. The Release provides the following clarifications:
If an indexed annuity is issued to a particular individual purchaser on or after January 12, 2011, that specific contract is subject to Rule 151A, even if the same form of indexed annuity was offered and sold prior to January 12, 2011, and even if the individual contract issued on or after January 12, 2011, is issued under a group contract that was in place prior to January 12, 2011.
An issuer that determines to register an annuity that is currently not registered may continue to make unregistered offers and sales of that same annuity until the earlier of (a) the effective date of the registration statement or (b) the effective date of the rule, without such offers and sales being unlawful under Section 5 of the Securities Act as a result of the pending effectiveness of Rule 151A.
Rule 12h-7 Requirements
Rule 12h-7 under the Exchange Act provides an insurance company with an exemption from Exchange Act reporting with respect to indexed annuities and certain other registered securities that are regulated as insurance under state law (including market value adjustment contracts and so-called “synthetic annuities”). The SEC concluded that it is consistent with the federal system of regulation, which has allocated the responsibility for oversight of insurers’ solvency to state insurance regulators, to exempt insurers from Exchange Act reporting with respect to state regulated insurance contracts.
In particular, Rule 12h-7 provides that an issuer is exempt from Exchange Act reporting with respect to securities registered under the Securities Act provided that each of the following six requirements is met:
- The issuer is a corporation subject to the supervision of the insurance commissioner, bank commissioner, or any agency or officer performing like functions, of any State;
The securities do not constitute an equity interest in the issuer and are either subject to regulation under the insurance laws of the domiciliary State of the issuer or are guarantees of securities that are subject to regulation under the insurance laws of that jurisdiction;
The issuer files an annual statement of its financial condition with, and is supervised and its financial condition examined periodically by, the insurance commissioner, bank commissioner, or any agency or officer performing like functions, of the issuer’s domiciliary State;
The securities are not listed, traded, or quoted on an exchange, alternative trading system, inter-dealer quotation systems, electronic communications network, or any other similar system, network, or publication for trading or quoting;
The issuer takes steps reasonably designed to ensure that a trading market for the securities does not develop, including, except to the extent prohibited by the law of any State or by action of the insurance commissioner, bank commissioner, or any agency or officer performing like functions of any State, requiring written notice to, and acceptance by, the issuer prior to any assignment or other transfer of the securities and reserving the right to refuse assignments or other transfers at any time on a non-discriminatory basis; and
The prospectus for the securities contains a statement indicating that the issuer is relying on the exemption provided by this rule.
The SEC made two changes in response to comments. First, in requirement (5) above, the SEC added the provision clarifying that an insurer need not take steps designed to ensure that a trading market does not develop if those steps would be prohibited by state law. Second, the SEC added requirement (6) above to clarify that reliance on Rule 12h‑7 is optional.
Rule 12h-7 Effective Date
The effective date of Rule 12h-7 is May 1, 2009.
Commissioner Troy A. Paredes voted against the adoption of Rule 151A and provided a dissenting statement. He stated:
“I am not persuaded that Rule 151A represents merely an attempt to provide clarification to the scope of exempted securities falling within Section 3(a)(8). Instead, by defining indexed annuities in the manner done in Rule 151A, I believe the SEC will be entering into a realm that Congress prohibited us from entering. Therefore, I cannot vote in favor of the rule and respectfully dissent.”
Commissioner Paredes also outlined the reasons why he believes that Rule 151A conflicts with the two U.S. Supreme Court cases construing the scope of Section 3(a)(8). He questioned the “more likely than not” test, which in his view would result in the registration of all indexed annuities.