DATE:DECEMBER 17, 2008

TO:NCOIL LEGISLATORS

FROM:JORDAN ESTEY

NCOIL DIRECTOR OF LEGISLATIVE AFFAIRS & EDUCATION

RE:SEC APPROVES CONTROVERSIAL INDEXED ANNUITYRULEDESPITESTATE AND FEDERAL OFFICIAL PROTESTS

The United States Securities and Exchange Commission (SEC) today approved controversial proposed rule 151A—which will shift regulatory authority over the marketing and sale of indexed annuity products from state insurance regulators to federal securities regulators. The five-member Commission voted 4 to 1 to approve the rule despite calls from NCOIL, the NAIC and other state officials, as well as several members of Congress to withdraw, or at least delay, consideration of the rule.

BACKGROUND

The rule—which was released for comment in June 2008—is justified by the SEC as its solution to what it views as growing concerns of fraud and abuse in the sale of indexed annuities to consumers. A September 10 comment deadline was extended in October after the SEC received thousands of initial comments that overwhelmingly opposed the draft rule. NCOIL, the NAIC, the NCSL, and the NGA, among others, wrote to the SEC to request an extension of the comment period.

NCOIL POSITION

The NCOIL Executive Committee formerly opposed the rule on November 23, 2008, when it unanimously adopted a Resolution in Support of State Insurance Commissioner Authority Over Fixed Indexed Annuity Products. The resolution(attached) reaffirms NCOIL support for existing insurance commissioner authority over fixed indexed annuities. It also encourages increased communication between state insurance regulators and both state and federal securities regulators in order to identify areas of mutual concern and to explore potential opportunities to leverage regulatory resources. NCOIL delivered both a letter reiterating NCOIL’s position (attached) and the resolution to Commissioners yesterday, December 16.

RULE 151A

The rule amends the Security Act of 1933 to clarify an indexed annuity as a security, rather than an insurance contract. Under the new rule, anyone selling indexed annuities will be subject to federal securities regulation, including:

  • mandatory disclosure of all material terms, fees, and risks
  • mandatory securities licensure through the Financial Industry Regulatory Authority (FINRA)
  • “enhanced” anti-fraud and suitability standards delivered at the point of sale
  • uniform sanctions and criminal penalties

SEC Commissioners today approved amendments to the proposal that would:

  • narrow the rule’s scope from broad language to specify its application only to fixed-indexed products
  • delete a provision requiring the status of a product be determined every three (3) years

SEC MEETING

SEC Chairman Commissioner Christopher Cox provided a brief history of the fixed-indexed annuity industry and said its products were both simple and complicated. He said they were simple because an investment could grow based on a securities index, but complicated because they contained a variety of fees and charges that could lower returns to below guaranteed minimum value. He said consumers have a difficult time comparing the products and understanding the details of indexed annuities. He said the products were often marketed to consumers lacking the ability to scrutinize their features.

Three (3) other Commissioners (Kathleen Casey, Elisse Walter, and Luis Aguilar) joined the Chairman in supporting the proposed rule, also arguing that the rule was needed because regulatory uncertainty has resulted in insufficient consumer protections. Commissioners argued, among other things, that the rule would:

  • close the regulatory gap for fixed-indexed annuity products
  • provide regulatory uniformity that did not exist at the state level
  • increase consumer protections while providing greater certainty to annuity issuers
  • properly regulate fixed-indexed products as securities

Commissioner Troy Paredes opposed the proposed rule, saying that while the rule was well-intentioned, the SEC’s jurisdiction over annuities was limited. He said that by approving the proposal, the SEC would “enter a realm that Congress prohibited them from” when it created the SEC. He said he believed the rule conflicted with two (2) previous Supreme Court cases and that it “misconceptualized” the investment risk of the products. He noted that the rule departed from previous SEC positions and amicus briefs that kept annuity products outside the scope of federal securities regulators. He further commented that the rule:

  • makes the judgment that state insurance regulators are inadequate
  • could force insurance companies to bear more costs
  • could lead to less competition in the annuity industry
  • could result in other annuity products being inappropriately rendered as securities
  • should be delayed to further consider the 4,800 comments that were received and any possible alternatives

OUTLOOK

Several organizations and companies have publicly questioned the legality of the proposed rule, which will likely lead to litigation. The rule has a two-year grace period before it takes effect, and will be enforced on a prospective basis.

During this morning’s meeting, SEC staff said that the transitional period would be used to tailor disclosure forms for fixed-indexed products, and to address other issues—including accounting rules and filing fees. SEC staff said that the organization handled similar concerns with variable products in the past and that any issues would be adequately addressed.