DC Circuit Sends SEC Back to the Drawing Board on Fixed Indexed Annuities

By Rodney Tonkovic, Wolters Kluwer Associate Writer-Analyst, and N. Peter Rasmussen

A D.C. Circuit appellate panel remanded the SEC's fixed index annuity rule, Securities Act Rule 151A, to the Commission for reconsideration. While the court found that the SEC’s interpretation of the term "annuity contract" in its rulemaking was reasonable, it concluded that the agency failed to properly consider the effect of the rule upon efficiency, competition, and capital formation. American Equity Investment Life Insurance Co. v. SEC.

A fixed index annuity (FIA) is a hybrid financial product. Unlike traditional fixed annuities, the purchaser’s rate of return is not based upon a guaranteed interest rate. In FIAs the insurance company credits the purchaser with a return that is based on the performance of a securities index, such as the Dow Jones Industrial Average, Nasdaq 100 Index, or Standard & Poor’s 500 Index. Depending on the performance of the securities index to which a particular FIA is tied, the return on an FIA might be much higher or lower than the guaranteed rate of return offered by a traditional fixed annuity.

In early 2009, the SEC adopted Rule 151A, which defined the terms "annuity contract "and "optional annuity contract" under the Securities Act. Under the rule, certain indexed annuities would be defined as not being "annuity contracts" or "optional annuity contracts" for purposes of the Section 3(a)(8) exemption if the amounts payable by the insurer under the contract were more likely than not to exceed the amounts guaranteed under the contract.

Initially, the appellate panel disagreed with the annuity issuer's argument that the SEC erred in excluding fixed indexed annuities from the definition of annuity contract. The court found that the SEC's interpretation of "annuity contract" was reasonable under the Chevron analysis because Section 3(a)(8) is ambiguous as to what forms of contracts it encompasses. Further, the SEC's interpretation of the statute was reasonable because the fixed indexed annuities' variability in potential return results in a risk to the investor. Finally, the SEC's decision to not include an analysis of how the annuities are marketed in the rule was not unreasonable because the SEC reasoned that the securities-like structure of fixed indexed annuities "is itself an implicit marketing tool aimed at consumers who wish to participate to some extent in the securities market."

The panel then held that the SEC's analysis of the efficiency, competition, and capital formation effects of Rule 151A as required under Securities Act Section 2(b) was flawed. The Commission argued that it was not required to undertake such an analysis, even though it did in fact do so. The panel found that the Commission's analysis was arbitrary and capricious because it had made no findings on the existing level of competition and efficiency under the existing state law regime. Because it was based on the flawed efficiency analysis, the court found that the SEC's capital formation analysis was similarly arbitrary and capricious. The panel then remanded the matter to the SEC to address the deficiencies of its Section 2(b) analysis.

.