Thoughts on Rule 151A

August, 2009

Dear Friends and Clients,

As many of you know, the U.S. Court of Appeals recently delivered its decision on the SEC’s actions late last year in adopting Rule 151A.  This rule attempts to define most indexed annuities as securities, thus falling under the SEC’s purview.  The ruling is a mixed bag for the industry, and needless to say, this issue is far from closed.  I am happy to talk with you more about the details of the ruling, if you like.

The main topic here, though, is the interesting direction which the SEC’s arguments have taken in justifying treatment of indexed annuities as securities.  The SEC is placing great emphasis on the fact that because a policyholder does not know precisely what their annuity’s total credited yield will be at the beginning of the crediting period, then the annuity should be treated as a security, even though their minimum return is known in advance.

One is struck by why this element has become the apparent linchpin of the SEC’s stance versus other criteria.  One is also struck by the apparent inconsistency of this treatment relative to other product types.  Should an interest-indexed annuity be deemed a security?  (No one seems to be suggesting that.)  A dividend-paying annuity or life insurance contract – isn’t that essentially the same concept – the complete return is not known until year-end?  How about indexed universal life? – same crediting methods, but appropriately not in the SEC Rule 151A crosshairs.  If a standard declared rate fixed annuity or UL contract only guarantees a credited rate for a month at a time, is that too short of a time?  Should those be treated as securities since the full-year return is not known in advance?  That seems far-fetched.

Some have suggested that indexed annuities could be designed whereby the return for this policy year is declared at the beginning of the year, but is based upon an index’s return from the prior year.  This apparently would pass the SEC’s “pre-ordain” test and the contract would not be deemed a security, despite the fact that an equity index is still at the heart of the crediting method.  Yes, these designs could be developed, quite easily in fact.  But they are persistency nightmares for insurers – what policyholder wants to keep a contract heading into a year in which they know their returns are only the minimums, while the actual index may be skyrocketing?  It is difficult to disengage a return from the index it is meant to follow, even if it only lags for a twelve-month period.  

This story has many more chapters to follow.

Tim Pfeifer
President