This section of the FEDERAL REGISTER

contains notices to the public of the proposed

issuance of rules and regulations. The

purpose of these notices is to give interested

persons an opportunity to participate in the

rule making prior to the adoption of the final

rules.

Proposed Rules Federal Register

45359

Vol. 62, No. 166

Wednesday, August 27, 1997

1See, e.g., Bill Harris, ‘‘Tips For Selling Indexed

Annuities,’’ National Underwriter, Aug. 5, 1996, at

12.

2See, e.g., Linda Koco, ‘‘3 More Equity Index

Annuities Make Mkt. Debuts,’’ National

Underwriter, Dec. 23, 1996, at 11.

3See, e.g., ‘‘More Insurers Expected To Jump On

Indexed Bandwagon,’’ Bank Investment Product

News, Feb. 3, 1997, at 11 [hereinafter ‘‘Bank

Investment Product News’’]; James B. Smith, Jr.,

‘‘Survey Shows Strong Interest in Offering EIAs,’’

National Underwriter, Jan. 20, 1997, at 14

[hereinafter ‘‘Survey’’].

4See, e.g., Bank Investment Product News, supra

note 3.

5See, e.g., Bridget O’Brian and Leslie Scism,

‘‘Equity-Indexed Annuities Score Big Hit, But They

Put a High Price on Protection,’’ Wall Street Journal,

May 30, 1997, at C1.

6See, e.g., Linda Koco, ‘‘Some Index Annuity

Products Are Going Optional,’’ National

Underwriter, Oct. 21, 1996, at 21 [hereinafter

‘‘Going Optional’’].

SECURITIES AND EXCHANGE

COMMISSION

17 CFR Part 230

[Release No. 33–7438; File No. S7–22–97]

RIN 3235–AH23

Equity Index Insurance Products

AGENCY: Securities and Exchange

Commission.

ACTION: Concept release; request for

comments.

SUMMARY: The Securities and Exchange

Commission is requesting comments on

the structure of equity index insurance

products, the manner in which they are

marketed, and any other matters the

Commission should consider in

addressing federal securities law issues

raised by equity index insurance

products.

DATES: Comments must be received on

or before November 20, 1997.

ADDRESSES: Comments should be

submitted in triplicate to Jonathan G.

Katz, Secretary, Securities and Exchange

Commission, 450 Fifth Street, N.W.,

Washington, D.C. 20549–6009.

Comments also may be submitted

electronically at the following E-mail

address: rule-comments@sec.gov. All

comment letters should refer to File No.

S7–22–97; this file number should be

included on the subject line if E-mail is

used. All comments received will be

available for public inspection and

copying in the Commission’s Public

Reference Room, 450 Fifth Street, N.W.,

Washington, D.C. 20549–6009.

Electronically submitted comments will

also be posted on the Commission’s

Internet site (http://www.sec.gov).

FOR FURTHER INFORMATION CONTACT:

Megan L. Dunphy, Attorney, Mark C.

Amorosi, Branch Chief, or Susan Nash,

Assistant Director, (202) 942–0670,

Office of Insurance Products, Division of

Investment Management, Securities and

Exchange Commission, 450 Fifth Street,

N.W., Mail Stop 10–6, Washington, D.C.

20549–6009.

SUPPLEMENTARY INFORMATION: The

Securities Act of 1933 (the ‘‘Securities

Act’’) includes an ‘‘insurance

exemption’’ that exempts ‘‘insurance

policies’’ and ‘‘annuity contracts’’ from

the Act’s registration requirements.

Equity index insurance products,

recently introduced by the insurance

industry, combine features of traditional

insurance products and traditional

securities. The Commission requests

information about the structure of

equity index insurance products and the

manner in which they are marketed.

The Commission also requests comment

on any other matters the Commission

should consider in addressing federal

securities law issues raised by equity

index insurance products.

Table of Contents

I. Background

II. Description of Equity Index Insurance

Products

A. Equity Index Annuities

1. Product Features

2. Funding of Insurer’s Obligation

3. Distribution Channels

B. Equity Index Life Insurance

III. Applicability of the Federal Securities

Laws to Equity Index Insurance Products

A. Applicability of State Insurance

Regulation

B. Investment Risk

1. Case Law

2. Rule 151

a. Contract Value not Tied to Separate

Account

b. Guarantee of Purchase Payments and

Credited Interest

c. Specified Rate of Interest

d. Excess Interest

C. Marketing

D. Mortality Risk

IV. Request for Comments

V. Conclusion

I. Background

The Commission is considering the

status of equity index annuities and

other equity index insurance products

under the federal securities laws. Today

the Commission is requesting public

comment regarding these products.

An equity index annuity is a contract

issued by a life insurance company that

generally provides for accumulation of

the contract owner’s payments, followed

by payment of the accumulated value to

the contract owner in a lump sum or

series of payments. During the

accumulation period, the insurer credits

the contract owner with a return that is

based on changes in an equity index,

such as the Standard & Poor’s

Composite Index of 500 Stocks (‘‘S&P

500 Index’’). The insurer also guarantees

a minimum return to the contract owner

if the contract is held to maturity.

Equity index annuities are designed to

appeal to risk averse consumers who

desire to participate in market increases,

without sacrificing the guarantees of

principal and minimum return offered

in traditional fixed annuities. Other

consumers may be seeking to lock in

prior gains from stock market

investments while retaining some

exposure to the market.1

The first equity index annuities were

introduced in 1995.2 By the end of 1995,

there were four insurers marketing

equity index annuities; and, by the end

of 1996, over 30 equity index annuities

were available.3 In 1997, this expansion

is expected to continue with as many as

40 insurers issuing an estimated 50

equity index annuity contracts.4 Equity

index annuity sales reached $2 billion

in 1996, with 1997 sales projected to be

as much as $10 billion.5 Recently, the

types of equity index insurance

products have proliferated, with single

premium deferred annuities joined by

flexible premium deferred annuities,

immediate annuities, and life insurance

policies.6

Equity index insurance products

combine features of traditional

insurance products (guaranteed

minimum return) and traditional

securities (return linked to equity

markets). Depending upon the mix of

features in any insurance product,

including an equity index insurance

product, the product may or may not be

entitled to exemption from registration
45360 Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Proposed Rules

7See, e.g., Jeffrey S. Puretz and Christopher M.

Gregory, ‘‘Should Equity Index Annuities Be

Registered?,’’ National Underwriter, Jan. 20, 1997,

at 22; Stephen E. Roth and Kimberly J. Smith,

‘‘Emerging Developments Relating to Fixed

Insurance Products Under the Federal Securities

Laws,’’ ALI–ABA Conference on Life Insurance

Company Products 45, 65–95 (1996). The equity

index annuities that have been registered contain

features that could reduce amounts received by

contract owners below the floor typically

guaranteed by equity index annuities. See, e.g., PreEffective Amendment No. 1 to Registration

Statement on Form S–1 of Keyport Life Insurance

Company (File No. 333–13609) (filed Feb. 7, 1997);

Pre-Effective Amendment No. 1 to Registration

Statement of Valley Forge Life Insurance Company

(File No. 333–02093) (filed Oct. 17, 1996).

8The Commission’s consideration of whether

equity index insurance products are exempt from

registration as ‘‘insurance products’’ or ‘‘annuity

contracts’’ does not relate to the status under the

federal securities laws of index products issued by

non-insurers to which the insurance exemption is

inapplicable.

9See, e.g., Survey, supra note 3.

10See, e.g., Going Optional, supra note 6.

11See, e.g., Michelle Clayton, ‘‘How Product

Marketers Stylize Equity Indexed Annuities,’’ Bank

Mutual Fund Report, Mar. 10, 1997, at 1.

12See, e.g., Thomas F. Streiff, ‘‘Three Basic Ways

of Achieving Equity Indexing,’’ National

Underwriter, Nov. 4, 1996, at 18; William Harris,

‘‘A Selling Perspective on Equity Indexed

Annuities,’’ National Underwriter, Nov. 4, 1996, at

16; Going Optional, supra note 6; Albert B.

Crenshaw, ‘‘A Rising Investment Star: EquityIndexed Annuities,’’ Washington Post, Oct. 20,

1996, at H1.

under the Securities Act as an

‘‘insurance policy’’ or ‘‘annuity

contract.’’ To date, most equity index

annuities have not been registered

under the Securities Act, although

commentators have acknowledged that

substantial uncertainty exists whether

all of these products are entitled to

exemption from registration.7

The Commission believes that both

purchasers and insurers may benefit

from greater clarity in this area. With

respect to products that are not covered

by the insurance exemption, investors

are entitled to the protections afforded

by the federal securities laws—full

disclosure concerning the issuer and the

product and marketing through

registered broker-dealers that are subject

to the Commission’s oversight. With

respect to products that are covered by

the insurance exemption, greater

certainty would reduce the risk to all

parties of expensive and timeconsuming litigation.

The Commission is considering the

issues raised by equity index insurance

products. As part of its consideration,

the Commission today seeks public

comment on the structure of these

products, the manner in which they are

marketed, and any other matters the

Commission should consider in

addressing federal securities law issues

raised by equity index insurance

products.8

II. Description of Equity Index

Insurance Products

A. Equity Index Annuities

1. Product Features

Equity index annuity contracts

generally share two characteristics: (i) A

return based on changes in an equity

index, and (ii) a guaranteed minimum

return if the contract is held to maturity.

Other features of equity index annuity

contracts vary from product to product.

Premium Payments. To date, the

majority of products on the market are

single premium deferred annuities, with

the purchaser making one premium

payment that is accumulated for some

period prior to pay-out. 9 Some insurers

offer flexible premium deferred

annuities, permitting multiple premium

payments in amounts determined by the

purchaser, and immediate annuities,

providing for immediate

commencement of the pay-out period. 10

Floor Guarantee. The guaranteed

minimum return for a single premium

product typically is 90% of premium

accumulated at a 3% annual rate of

interest, an amount that is generally

required by applicable state insurance

laws. 11

Computation of Index-Based Return.

The index-based return depends on the

particular combination of indexing

features specified in the contract. The

most common indexing features are

described below. 12

• Index. The return of equity index

annuities is typically based on the S&P

500 Index, but other domestic and

international indices are also used.

Some products permit the contract

owner to select one or more indices

from a specified group of indices.

• Determining Change in Index. Index

growth generally is computed without

regard to dividends. There are several

methods for determining the change in

the relevant index over the period of the

contract. The ‘‘point-to-point’’ method

compares the level of the index at two

discrete points in time, such as the

beginning and ending dates of the

contract term. The ‘‘high water mark’’ or

‘‘look-back’’ method compares the

highest index level reached on specified

dates throughout the term of the

contract (e.g., contract anniversaries) to

the index level at the beginning of the

contract term. The ‘‘annual reset,’’

‘‘cliquet,’’ or ‘‘lock-in’’ method

compares the index level at the end of

each contract year to the index level at

the beginning of that year, with the gain

for each year ‘‘locked in’’ even if the

index declines in the following year.

Averaging techniques may be used with

these formulas to dampen the volatility

of index changes. For example, in the

point-to-point method, the ending index

value could be computed by averaging

index values on each of the final 90

days of the contract term.

• Participation Rate or Spread. Two

methods typically are used to compute

the extent to which a contract owner is

credited with index growth. In some

contracts, the participation rate,

frequently between 75% and 90%, is

multiplied by index growth to

determine the applicable share of index

appreciation to be credited. The

participation rate is typically set at the

time the annuity is purchased and may

be reset either annually or at the start of

the next contract term. Other contracts

specify a percentage, called the

‘‘margin’’ or ‘‘spread,’’ that is subtracted

from index growth to determine the

applicable share of index appreciation

to be credited.

• Caps and Floors. Some contracts

limit the maximum (‘‘cap’’) and

minimum (‘‘floor’’) index-based returns

that may be credited to a contract. Caps

and floors are generally guaranteed for

the entire contract term, although a few

equity index annuities provide for

annual reset of the cap and floor.

Computation of Contractual Benefits.

Equity index annuities provide a variety

of benefits, including surrender values,

annuitization benefits, and death

benefits, each of which may be

computed in a different manner.

Term of Product. Equity index

annuities are issued for varying terms,

including terms of three, five, seven, or

nine years.

Surrender Charges. Surrender charges

are commonly deducted from

withdrawals, but these charges often are

eliminated for a 30 to 45 day window

at the end of each index term. There

may also be a limited free withdrawal

privilege.

Vesting. Vesting schedules are often

implemented to deter early surrenders

of contracts that credit the index-based

return periodically throughout the term

of the contract. Typically, a small

percentage of the index-based return is

available for withdrawal in the first

year, with the percentage increasing

over time until the entire return is

available at the end of the term.

2. Funding of Insurer’s Obligation

Equity index annuities typically are

backed by assets held in the insurance

company’s general account. A portion of

the general account assets is invested in

fixed income instruments to support the

minimum return guarantee. Insurance

companies typically purchase
Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Proposed Rules 45361

13See, e.g., Survey, supra note 3; Cerulli

Associates, Inc. and Lipper Analytical Services,

Inc., The Cerulli-Lipper Analytical Report: The

State of the Variable Annuity and Variable

Insurance Markets 37–40 (1996).

14See, e.g., Linda Koco, ‘‘Transamerica

Occidental Unveils Equity-Indexed UL,’’ National

Underwriter, Jan. 6, 1997, at 25 [hereinafter

‘‘Transamerica Occidental’’]; Linda Koco, ‘‘Two

More Index UL Policies Make Their Debuts,’’

National Underwriter, Mar. 10, 1997, at 9.

15See, e.g., ‘‘Transamerica Occidental,’’ supra

note 14.

16See, e.g., Linda Koco, ‘‘Equity Index Market

Shows Signs of Fierce Competition,’’ National

Underwriter, Jan. 27, 1997, at 9.

17The Commission has previously stated its view

that Congress intended any insurance contract

falling within Section 3(a)(8) to be excluded from

all provisions of the Securities Act notwithstanding

the language of the Act indicating that Section

3(a)(8) is an exemption from the registration but not

the antifraud provisions. Definition of ‘‘Annuity

Contract or Optional Annuity Contract,’’ Securities

Act Rel. No. 6558 (Nov. 21, 1984) [49 FR 46750,

46753 (Nov. 28, 1984)] [hereinafter ‘‘Proposing

Release’’].

18SEC v. Variable Annuity Life Ins. Co., 359 U.S.

65 (1959); SEC v. United Benefit Life Ins. Co., 387

U.S. 202 (1967).

19 17 CFR 230.151; Definition of Annuity Contract

or Optional Annuity Contract, Securities Act Rel.

No. 6645 (May 29, 1986) [51 FR 20254 (June 4,

1986)] [hereinafter ‘‘Adopting Release’’]. A

guaranteed investment contract is a deferred

annuity contract under which the insurer pays

interest on the purchaser’s payments at a

guaranteed rate for the term of the contract. In some

cases, the insurer also pays discretionary interest in

excess of the guaranteed rate.

20Adopting Release, supra note 19, 51 FR at

20255 n.4, 20261.

21 17 CFR 230.151(a)(1). This requirement is

parallel to the language of Section 3(a)(8).

22Adopting Release, supra note 19, 51 FR at

20255.

23 359 U.S. 65, 71 (1959).

derivatives to hedge their indexed-based

return obligations, although insurers

vary in the degree to which they hedge

these obligations.

3. Distribution Channels

The most frequently used channels of

distribution for equity index annuities

have been banks and insurance agents

who are not licensed as registered

representatives of a broker-dealer. To

date, broker-dealers have played a less

significant role.13

B. Equity Index Life Insurance

Equity index life insurance policies

have been introduced recently.14 The

available policies are universal life

insurance policies that permit the

holder to vary the amount and timing of

premium payments and change the

death benefit. The cash value of an

equity index life insurance policy is

credited with a return that is based on

changes in an equity index. As with

equity index annuities, the insurer also

guarantees a minimum return on the

policy’s cash value. Equity index life

insurance policies typically offer annual

crediting of index-based interest and

index participation rates that are reset

annually and are generally lower than

those for equity index annuities.15 At

least two companies currently offer

equity index life insurance policies, and

it is estimated that as many as 25

companies are developing these

products.16

III. Applicability of the Federal

Securities Laws to Equity Index

Insurance Products

Section 3(a)(8) of the Securities Act

exempts from the registration

requirements of the Act any ‘‘insurance

policy’’ or ‘‘annuity contract’’ issued by

a corporation subject to the supervision

of the insurance commissioner, bank

commissioner, or similar state

regulatory authority.17 The exemption,

however, is not available to all products

labelled ‘‘insurance policies’’ or

‘‘annuity contracts.’’ For example,

‘‘variable annuities,’’ which pass

through to the contract owner the

investment performance of a pool of

assets, are securities rather than exempt

annuity contracts.18

The Commission and the courts have

addressed the insurance exemption on a

number of occasions. Under existing

case law, factors that are important to a

determination of a contract’s status

under Section 3(a)(8) include (1) the

allocation of investment risk between

insurer and contract owner and (2) the

manner in which the contract is

marketed.

In 1986, faced with the proliferation

of annuity contracts commonly known

as ‘‘guaranteed investment contracts,’’

the Commission adopted Rule 151

under the Securities Act to establish a

safe harbor for certain annuity contracts

that will not be deemed subject to the

federal securities laws.19 The factors

that determine an annuity contract’s

eligibility for the safe harbor include the

applicability of state insurance

regulation, the assumption of

investment risk by the insurer, and the

manner of marketing the contract. In

situations when the Rule 151 safe

harbor is not applicable, the status of a

contract may be analyzed by reference

to the principles discussed in Rule 151

and the accompanying releases and to

judicial precedents construing Section

3(a)(8).20 This would include, for

example, an annuity that does not fall

within the safe harbor or a life insurance

policy.

This section discusses the factors that

have been used by the Commission and

courts to determine whether a product

is entitled to the insurance exemption,

and the manner in which those factors

may apply to equity index insurance

products. Commenters are asked to

provide detailed information on the

structure, operation, and marketing of

equity index insurance products.

Commenters should specifically discuss

the application to equity index

insurance products of the factors that

have been used by the Commission and

the courts to determine whether a

product is entitled to the insurance

exemption.

A. Applicability of State Insurance

Regulation

To gain the benefit of the Rule 151

safe harbor, an annuity contract is

required to be issued by a corporation

subject to the supervision of a state

insurance commissioner, bank

commissioner, or similar state

regulator.21 In addition, the contract

itself is required to be subject to state

regulation as an annuity or insurance.22

Equity index insurance products on the

market today generally are issued by

companies subject to state insurance

regulation, thereby appearing to meet

this threshold requirement for insurance

status.

Commenters are requested to address

the status under state law of equity

index insurance products. Are all of

these contracts regulated as annuities or

insurance? For contracts that are

regulated as annuities or insurance,

commenters are asked to describe the

provisions of state law that apply, e.g.,

regulation of reserves, investment

restrictions, approval of contract forms,

illustration requirements, market

conduct standards, applicability of state

insurance guaranty laws. How does the

applicability of state insurance

regulation to equity index insurance

products affect the need for federal

securities regulation of these products?

B. Investment Risk

1. Case Law

Under existing case law, the

allocation of investment risk between

insurer and contract owner is significant

in determining whether a particular

contract is insurance for purposes of the

federal securities laws. In SEC v.

Variable Annuity Life Insurance Co.

(hereinafter ‘‘VALIC’’), the Supreme

Court determined that absent some

element of fixed return, i.e.,’’some

investment risk-taking on the part of the

company,’’ an annuity contract is

outside the scope of Section 3(a)(8).23

The VALIC court found a variable

annuity contract to be a security, not

insurance, when the insurer invested

premiums in a pool of common stocks
45362 Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Proposed Rules

24 387 U.S. 202, 205 (1962).

25 Id. at 211.

26 17 CFR 230.151(a)(2).

27 17 CFR 230.151(b)(1).

28 17 CFR 230.151(b)(2)(i).

29See Registration Statement of Valley Forge Life

Insurance Company (File No. 333–02093) (filed

Mar. 29, 1996) (minimum guaranteed value of

registered equity index annuity reduced by rider

charge for equity index feature).

30 17 CFR 230.151(b)(2)(ii) and (c).

31 17 CFR 230.151(b)(3).

32Proposing Release, supra note 17, 49 FR at

46753 n.19.

33Adopting Release, supra note 19, 51 FR at

20260.

and other equities and the value of the

contract owner’s benefit payments

varied directly with the success of the

underlying investments.

The Supreme Court subsequently

clarified that a contract could provide

for some assumption of investment risk

by the insurer, but nonetheless be a

security. In SEC v. United Benefit Life

Ins. Co. (hereinafter ‘‘United Benefit’’),

the insurer guaranteed that the cash

value of its variable annuity contract

would never be less than 50% of

purchase payments made and that, after

ten years, the value would be no less

than 100% of payments.24 The Court

determined that this contract, under

which the insurer did assume some

investment risk through minimum

guarantees, was a security. In making

this determination, the Court

distinguished a contract ‘‘which to some

degree is insured’’ from a contract of

‘‘insurance.’’ 25

Commenters are requested to discuss

generally how investment risk is

allocated between insurer and contract

owner in equity index insurance

products. Commenters should also

compare this allocation of risk to other

insurance products and discuss how

this allocation of investment risk affects

the application of the federal securities

laws to equity index insurance

products.

2. Rule 151

To gain the benefit of the Rule 151

safe harbor, an insurer is required to

assume the investment risk under the

contract.26 For purposes of the safe

harbor, an insurer is deemed to assume

the investment risk if the following

conditions are satisfied.

a. Contract Value not Tied to Separate

Account. The safe harbor requires that

the value of the contract not vary

according to the investment experience

of a separate account, a separately

managed pool of assets operating

independently of the investment

experience of the insurer’s general

account.27 Equity index annuities

typically are general account products,

whose value does not vary according to

the investment experience of a separate

account. These products therefore

appear to satisfy the first condition of

the Rule 151 investment risk test.

Commenters are requested to describe

the investments used by an insurer to

support its obligations under an equity

index insurance product. Commenters

should also address how the nature of

these investments affects the analysis of

equity index insurance products under

the federal securities laws. For example,

should the relative levels of a contract

owner’s purchase payment allocated to

the floor guarantee and the index-based

benefit affect the status of a contract as

insurance under the federal securities

laws? Is the status of an equity index

insurance product affected by whether,

or the degree to which, an insurer

hedges its obligations to pay the indexbased benefit? To the extent an insurer’s

obligations are hedged, does it bear

investment risk with respect to those

obligations? In the alternative, is there,

in essence, a pass-through of

performance from insurer to contract

owner, with the contract owner

experiencing the performance of the

hedging instruments that the insurer

purchased to hedge the contract?

b. Guarantee of Purchase Payments

and Credited Interest. The safe harbor

requires that the insurer, for the life of

the contract, guarantee the principal

amount of purchase payments and

credited interest, less any deduction for

sales, administrative, or other expenses

or charges.28 For equity index annuities,

insurers generally guarantee 90% of

purchase payments and annual interest

of 3%. Commenters should address

whether the typical floor guarantee for

equity index annuities, by itself,

satisfies the investment risk

requirement, or whether there must be

some additional guarantee. Commenters

are requested to address whether, and

under what circumstances, the typical

10% deduction from purchase payments

is attributable to sales, administrative,

or other expenses or charges and

therefore falls within the rule’s

parameters. Commenters should also

address whether there are equity index

annuities that reduce the floor guarantee

by charges of any type, and how any

such charges affect the investment risk

analysis.29 Commenters should also

discuss any floor guarantees in equity

index annuities that are different from

90% of purchase payments with annual

interest of 3%. Commenters should

address how the different floor

guarantees affect the investment risk

analysis.

Commenters should describe any

floor guarantees provided by equity

index life insurance products and how

the guarantees affect their status under

the federal securities laws. Commenters

should address whether an equity index

life insurance policyholder is dependent

on cash value growth in excess of

guaranteed minimums to gain the

anticipated benefits under the policy.

c. Specified Rate of Interest. The safe

harbor requires that the insurer credit a

specified rate of interest, in an amount

at least equal to the minimum rate

required by applicable state law.30

Equity index annuities typically appear

to satisfy this condition by guaranteeing

a minimum interest rate of 3%, which

is generally equal to the minimum rate

required by state law. Commenters

should describe the minimum

guaranteed rate on various equity index

insurance products. Do the guaranteed

rates satisfy this condition of the safe

harbor?

d. Excess Interest. The safe harbor

requires that the insurer guarantee that

the rate of any interest to be credited in

excess of the guaranteed minimum rate

not be modified more frequently than

once per year.31 Rule 151, as originally

proposed, would have excluded from

the safe harbor any annuity that linked

excess interest to an index. The

Commission reasoned that an insurer

that uses an index feature externalizes

its discretionary excess interest rate,

shifting to the contract owner all of the

investment risk regarding fluctuations

in that rate.32 In adopting Rule 151, the

Commission extended the rule’s

coverage to permit insurers to make

limited use of index features in

determining the excess interest rate, so

long as the excess rate is not modified

more frequently than annually.33

Specifically, the insurer could specify

an index to which it would refer, no

more often than annually, to determine

the excess rate that it would guarantee

under the contract for the next 12-

month or longer period. In addition, an

insurer could not change the terms of

the index feature used for calculating

the excess rate more frequently than

once per year.

Commenters are requested to discuss

how the use of an index-based formula

for calculating contract values under

equity index annuities affects the

allocation of investment risk between

insurer and contract owner. How does

the use of an indexed-based return

determined retrospectively by reference

to a formula that is established

prospectively affect the status of these

contracts as securities or insurance?

Commenters are specifically requested
Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Proposed Rules 45363

34United Benefit, 387 U.S. 202, 211 (1962).

35 Id. For other cases applying a marketing test,

see Berent v. Kemper Corp., 780 F.Supp. 431 (E.D.

Mich. 1991), aff’d, 973 F.2d 1291 (6th Cir. 1992);

Associates in Adolescent Psychiatry v. Home Life

Ins. Co., 729 F.Supp. 1162 (N.D. Ill. 1989), aff’d, 941

F.2d 561 (7th Cir. 1991); Grainger v. State Security

Life Ins. Co., 547 F.2d 303 (5th Cir. 1977).

36 17 CFR 230.151(a)(3).

37Adopting Release, supra note 19, at 20255–56.

See also Proposing Release, supra note 17, at 46752

(requesting comment on whether mortality risk

assumption should be a required element of the

Rule 151 safe harbor); General Statement of Policy

Regarding Exemptive Provisions Relating to

Annuity and Insurance Contracts, Securities Act.

Rel. No. 6051 (Apr. 5, 1979) [44 FR 21626, 21627–

28 (Apr. 11, 1979)] (predecessor interpretive release

to Rule 151 stating that meaningful mortality risk

by insurer was prerequisite to determination that

contract was ‘‘insurance,’’ not ‘‘security’’).

to address the Commission’s expressed

concern with shifting the risk of

fluctuations in an index rate to a

contract owner and the Commission’s

decision to limit the benefit of Rule 151

to situations where an index is used to

fix a specific excess interest rate in

advance. Additionally, comment is

requested on how the nature of

particular indexing formulas and the

duration of any guarantees of caps,

floors, participation rates, margins, or

other terms affect the allocation of

investment risk between the contract

owner and the insurer.

C. Marketing

Marketing is another significant factor

in distinguishing insurance from a

security. In United Benefit, the Supreme

Court, in holding an annuity contract to

be outside the scope of Section 3(a)(8),

found significant the fact that the

contract was ‘‘considered to appeal to

the purchaser not on the usual

insurance basis of stability and security

but on the prospect of ‘growth’ through

sound investment management.’’ 34

Under these circumstances, the Court

concluded ‘‘it is not inappropriate that

promoters’ offerings be judged as being

what they were represented to be.’’ 35

Rule 151 incorporates a ‘‘marketing’’

test.36 As a condition to the safe harbor,

the contract must not be ‘‘marketed

primarily as an investment.’’ The

Commission is concerned that the

nature of equity index insurance

products may make it particularly

difficult to market these products

without primary emphasis on their

investment aspects.

Commenters should describe how

equity index insurance products are

marketed and how the marketing factor

applies to equity index insurance

products. Given the structure and

purposes of equity index insurance

products, can they be marketed without

focusing primarily on their investment

aspects? Comments should address both

written sales materials and oral sales

presentations, including the ability of an

insurer to train and monitor its sales

force to ensure that equity index

insurance products are not marketed

with primary focus on their investment

aspects. Commenters are requested to

identify the distribution channels that

are used in marketing equity index

insurance products and discuss whether

the use of particular distribution

channels affects an insurer’s ability to

market these products without focusing

primarily on their investment aspects.

Commenters are also asked to identify

the products that are viewed as

competitive alternatives to equity index

annuities and address how the nature of

these other products (e.g., whether

securities or insurance) affects the

manner in which equity index

insurance products are marketed.

D. Mortality Risk

When the Commission adopted the

Rule 151 safe harbor, it determined not

to include a requirement that the insurer

assume some mortality risk through, for

example, guaranteeing annuity purchase

rates for the life of the contract. The

Commission noted, however, that in a

Section 3(a)(8) facts and circumstances

analysis of contracts outside the Rule

151 safe harbor, the presence or absence

of mortality risk may be an appropriate

factor to consider.37

Commenters are requested to describe

with specificity the nature of the

mortality risks assumed by insurers in

connection with equity index insurance

products. For equity index annuities,

commenters should describe the terms

of any guaranteed annuity purchase

rates, whether those rates are

comparable to rates available in more

traditional annuity contracts, and the

likelihood that contract owners will

annuitize. Comment is also requested on

the significance of mortality risk in

determining whether an equity index

insurance product is exempted by

Section 3(a)(8). Is mortality risk a

relevant factor and, if so, what weight

should it be given?

IV. Request for Comments

All interested persons are invited to

submit written comments on equity

index insurance products. Whenever

possible, submissions should describe

particular equity index insurance

products with specificity and include

sample sales literature and contracts.

Commenters should address the ways in

which equity index insurance products

are similar to or different from

traditional fixed annuities and life

insurance, on the one hand, and

variable annuities and variable life

insurance, on the other. Particular

emphasis should be placed on the

factors described above, including state

insurance law, investment risk,

marketing, and mortality risk.

The Commission also requests that

commenters address the following:

• Are there features that all equity

index insurance products share that

result in all of them being covered by

the insurance exemption or, in the

alternative, not covered by the

insurance exemption? If so, commenters

should identify the features that cause

all equity index insurance products to

be classified together. If not,

commenters should identify the features

that distinguish equity index insurance

products that are covered by the

insurance exemption from those that are

not.

• Are there differences between broad

types of equity index insurance

products that are relevant to the analysis

of their status under the federal

securities laws? If so, commenters

should separately address different

types of products, e.g., single premium

products versus flexible premium

products or annuities versus life

insurance. For example, commenters

should address any differences in

mortality risk between equity index

annuities and life insurance.

The Commission also requests

comment on the implications for small

business of federal securities law issues

raised by equity index insurance

products.

V. Conclusion

The Commission is requesting

comments on a number of specific

issues raised by equity index insurance

products. In addition, commenters are

encouraged to address any other matters

that they believe merit examination.

Dated: August 20, 1997.

By the Commission.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97–22597 Filed 8–26–97; 8:45 am]

BILLING CODE 8010–01–P