Wednesday, July 06, 2016

Fixed indexed annuities are not securities under the Illinois Securities Law

By R. Jason Howard, J.D.

An Illinois appellate court has affirmed the judgments of the lower court, determining that fixed indexed annuities (FIAs) are insurance products and not securities under the Illinois Securities Law of 1953 (Babiarz v. Stearns, June 30, 2016, Cobbs, C.).

The plaintiff purchased three annuities but was dissatisfied with the annuities as an investment vehicle and instead filed a complaint in the circuit court of Cook County alleging breach of fiduciary duty, negligent misrepresentation, violation of the Consumer Fraud and Deceptive Business Practices Act, violation of the Illinois Securities Law, common-law fraud, breach of contract to confirm annuities were suitable, breach of contract to investigate plaintiff’s complaints, and negligent suitability review.

The consumer fraud claim proceeded to a bench trial at which the court granted a directed verdict in defendants’ favor. The remaining claim for breach of contract to confirm the annuities were suitable was disposed of at a jury trial, at which the jury found in defendants’ favor. This appeal followed.

Appeal. On appeal, it was the plaintiff’s contention that the trial court erred in granting summary judgment on her breach of fiduciary duty, Illinois Securities Law, negligent misrepresentation, and common law fraud claims because the annuities at issue in this case were securities, not insurance products.

Fixed index annuities. Focusing on the primary issue, the court addressed whether an annuity is an insurance product or a security. The court explained that in analyzing what constitutes a security, federal courts have explained that the definition is broad and includes virtually any product sold as an investment. But federal courts have observed that FIAs, such as the annuities at issue in this case, share characteristics of both investments and insurance products.

The court noted that FIAs were first offered in the 1990s by insurance companies and, by default, have been regulated by state insurance codes and, like traditional fixed annuities, FIAs must provide the base-line protections to consumers that those codes require. Unlike traditional fixed annuities, however, FIAs base their interest rates on a financial market index and, consequently, similar to a security, if the financial market does well, an FIA could have increasingly higher interest rates resulting in a greater account balance. Unlike most securities, however, FIAs have guaranteed minimum interest rates. Thus, no possibility of loss from the unpredictability of the financial market exists. Nevertheless, the court explained that FIAs subject purchasers to more risk than traditional annuities because their interest rates will always be uncertain and purchasers can lose principal if they withdraw their money prior to a specified date and incur surrender charges.

The court continued, saying that despite the fact that FIAs have been regulated by state insurance codes, their hybrid nature has led to confusion regarding whether they would be more appropriately regulated under securities laws.

On the question of whether FIAs are exempt from the Illinois Securities Law, the court turned to the Illinois Insurance code which classifies “annuity contracts” as insurance products and regulates annuities as insurance products in various provisions throughout the Insurance Code, although the code does not refer specifically to FIAs. The Illinois Department of Insurance issued a bulletin declaring that it governs FIAs and advises on its website that “[w]hen you buy an equity-indexed annuity you own an insurance contract. You are not buying shares of any stock or index.” Additionally, FIAs are registered as insurance products with the Illinois Department of Insurance. They are not registered with the Illinois Secretary of State under the Illinois Securities Law.

Moreover, “Illinois case law suggests that FIAs are insurance products. Although this court has not ruled on whether FIAs are insurance products, we have previously held that an ‘annuity’ is an insurance product,” said the court. Additionally, although the Illinois Securities Law does not contain the term “fixed indexed annuity,” the law further supports the conclusion that FIAs are insurance products.

The court, taking all the evidence into account, said that in sum, although the Illinois Securities Law and the Insurance Code did not specifically mention FIAs, they generally refer to annuities as insurance products and, accordingly, held that FIAs are insurance products exempt from the Illinois Securities Law.

The court then addressed several other arguments briefly and determined that the lower court did not err in granting summary judgment on plaintiff’s claims.

The case is No. 1-15-0988.

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