Friday, December 19, 2008


New SEC Rule Would Regulate Most Indexed Annuities

The SEC adopted a new rule, despite substantial opposition from the insurance industry and over a dissent from Commissioner Troy Paredes, that defines the terms "annuity contract" and "optional annuity contract" under the Securities Act. New Rule 151A is intended to clarify the federal securities law status of indexed annuities, under which payments to the purchaser are dependent on the performance of a securities index. Under the rule, certain indexed annuities would be defined as not being "annuity contracts" or "optional annuity contracts" if the amounts payable by the insurer under the contract are more likely than not to exceed the amounts guaranteed under the contract. Under this definition, these securities would not fall within the statutory insurance exemption set forth in Section 3(a)(8) of the Securities Act.

According to the SEC, these instruments are not the kind of investment vehicles that Congress intended to be regulated exclusively by state insurance commissioners. Purchasers of these instruments, noted the SEC, assume the risk of an uncertain and fluctuating financial instrument, in exchange for exposure to future, securities-linked returns. The SEC determined that this assumption of risk merited the application of the registration and provisions of the federal securities laws to these contracts.

The Commission proposed the rule in June 2008 to curb abusive sales practices of equity-indexed annuities that have particularly harmed senior investors. Chairman Christopher Cox said that one reason the abusive sales practices have gone unchecked is that the question of whether the annuity contracts are securities has been left unanswered.

In remarks made at the open meeting, Commissioner Paredes explained why he voted against the adoption of the rule. He stated that the Commission's action was based on good intentions and founded on a desire to protect investors from unscrupulous practices. Despite these laudable objectives, however, the commissioner stated that the rulemaking exceeded the SEC's authority. According to Commissioner Paredes, "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."

The rule, in Mr. Paredes' opinion, could result in blanket SEC regulation of the indexed annuity market. He also criticized the majority for not exploring less burdensome alternatives. Compliance would be costly, he asserted, and could force smaller issuers out of the market, according to the commissioner. Finally, he expressed disappointment that the Commission apparently dismissed as inadequate the oversight of these instruments by state regulators.

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