[Federal Register Volume 62, Number 166 (Wednesday, August 27, 1997)]
[Proposed Rules]
[Pages 45359-45363]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-22597]


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 Proposed Rules
                                                 Federal Register
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 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.
 
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  Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / 
Proposed Rules  

[[Page 45359]]


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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.

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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: [email protected]. 
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
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    \1\ See, e.g., Bill Harris, ``Tips For Selling Indexed 
Annuities,'' National Underwriter, Aug. 5, 1996, at 12.
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    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
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    \2\ See, e.g., Linda Koco, ``3 More Equity Index Annuities Make 
Mkt. Debuts,'' National Underwriter, Dec. 23, 1996, at 11.
    \3\ See, 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''].
    \4\ See, e.g., Bank Investment Product News, supra note 3.
    \5\ See, 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.
    \6\ See, e.g., Linda Koco, ``Some Index Annuity Products Are 
Going Optional,'' National Underwriter, Oct. 21, 1996, at 21 
[hereinafter ``Going Optional''].
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    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

[[Page 45360]]

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
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    \7\ See, 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., Pre-Effective 
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).
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    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 time-consuming 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
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    \8\ The 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.
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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
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    \9\ See, e.g., Survey, supra note 3.
    \10\ See, e.g., Going Optional, supra note 6.
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    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
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    \11\ See, e.g., Michelle Clayton, ``How Product Marketers 
Stylize Equity Indexed Annuities,'' Bank Mutual Fund Report, Mar. 
10, 1997, at 1.
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    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
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    \12\ See, 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: Equity-Indexed Annuities,'' Washington Post, Oct. 20, 1996, at 
H1.
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     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

[[Page 45361]]

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
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    \13\ See, 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).
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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
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    \14\ See, 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.
    \15\ See, e.g., ``Transamerica Occidental,'' supra note 14.
    \16\ See, e.g., Linda Koco, ``Equity Index Market Shows Signs of 
Fierce Competition,'' National Underwriter, Jan. 27, 1997, at 9.
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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
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    \17\ The 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''].
    \18\ SEC v. Variable Annuity Life Ins. Co., 359 U.S. 65 (1959); 
SEC v. United Benefit Life Ins. Co., 387 U.S. 202 (1967).
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    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.
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    \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.
    \20\ Adopting Release, supra note 19, 51 FR at 20255 n.4, 20261.
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    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.
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    \21\ 17 CFR 230.151(a)(1). This requirement is parallel to the 
language of Section 3(a)(8).
    \22\ Adopting Release, supra note 19, 51 FR at 20255.
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    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

[[Page 45362]]

and other equities and the value of the contract owner's benefit 
payments varied directly with the success of the underlying 
investments.
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    \23\ 359 U.S. 65, 71 (1959).
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    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
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    \24\ 387 U.S. 202, 205 (1962).
    \25\ Id. at 211.
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    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.
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    \26\ 17 CFR 230.151(a)(2).
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    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.
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    \27\ 17 CFR 230.151(b)(1).
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    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 index-based 
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.
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    \28\ 17 CFR 230.151(b)(2)(i).
    \29\ See 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).
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    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?
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    \30\ 17 CFR 230.151(b)(2)(ii) and (c).
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    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.
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    \31\ 17 CFR 230.151(b)(3).
    \32\ Proposing Release, supra note 17, 49 FR at 46753 n.19.
    \33\ Adopting Release, supra note 19, 51 FR at 20260.
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    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

[[Page 45363]]

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.
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    \34\ United 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).
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    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
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    \37\ Adopting 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'').
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    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