[Federal Register Volume 74, Number 11 (Friday, January 16, 2009)]
[Rules and Regulations]
[Pages 3138-3176]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-597]



[[Page 3137]]

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Part II





Securities and Exchange Commission





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17 CFR Parts 230 and 240



Indexed Annuities and Certain Other Insurance Contracts; Final Rule

  Federal Register / Vol. 74, No. 11 / Friday, January 16, 2009 / Rules 
and Regulations  

[[Page 3138]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 230 and 240

[Release Nos. 33-8996, 34-59221; File No. S7-14-08]
RIN 3235-AK16


Indexed Annuities And Certain Other Insurance Contracts

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: We are adopting a new rule that defines the terms ``annuity 
contract'' and ``optional annuity contract'' under the Securities Act 
of 1933. The rule is intended to clarify the status under the federal 
securities laws of indexed annuities, under which payments to the 
purchaser are dependent on the performance of a securities index. The 
rule applies on a prospective basis to contracts issued on or after the 
effective date of the rule. We are also adopting a new rule that 
exempts insurance companies from filing reports under the Securities 
Exchange Act of 1934 with respect to indexed annuities and other 
securities that are registered under the Securities Act, provided that 
certain conditions are satisfied, including that the securities are 
regulated under state insurance law, the issuing insurance company and 
its financial condition are subject to supervision and examination by a 
state insurance regulator, and the securities are not publicly traded.

DATES: Effective Date: The effective date of Sec.  230.151A is January 
12, 2011. The effective date of Sec.  240.12h-7 is May 1, 2009. 
Sections III.A.3. and III.B.3. of this release discuss the effective 
dates applicable to rule 151A and rule 12h-7, respectively.

FOR FURTHER INFORMATION CONTACT: Michael L. Kosoff, Attorney, or Keith 
E. Carpenter, Senior Special Counsel, Office of Disclosure and 
Insurance Product Regulation, Division of Investment Management, at 
(202) 551-6795, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-5720.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'') is adding rule 151A under the Securities Act of 1933 
(``Securities Act'') \1\ and rule 12h-7 under the Securities Exchange 
Act of 1934 (``Exchange Act'').\2\
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    \1\ 15 U.S.C. 77a et seq.
    \2\ 15 U.S.C. 78a et seq.
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Table of Contents

I. Executive Summary
II. Background
    A. Description of Indexed Annuities
    B. Section 3(a)(8) Exemption
III. Discussion of the Amendments
    A. Definition of Annuity Contract
    1. Analysis
    2. Commenters' Concerns Regarding Commission's Analysis
    3. Definition
    B. Exchange Act Exemption for Securities that are Regulated as 
Insurance
    1. The Exemption
    2. Conditions to Exemption
    3. Effective Date
IV. Paperwork Reduction Act
V. Cost-Benefit Analysis
VI. Consideration of Promotion of Efficiency, Competition, and 
Capital Formation; Consideration of Burden on Competition
VII. Final Regulatory Flexibility Analysis
VIII. Statutory Authority
Text of Rules

I. Executive Summary

    We are adopting new rule 151A under the Securities Act of 1933 in 
order to clarify the status under the federal securities laws of 
indexed annuities, under which payments to the purchaser are dependent 
on the performance of a securities index.\3\ Section 3(a)(8) of the 
Securities Act provides an exemption under the Securities Act for 
certain ``annuity contracts,'' ``optional annuity contracts,'' and 
other insurance contracts. The new rule prospectively defines certain 
indexed annuities as not being ``annuity contracts'' or ``optional 
annuity contracts'' under this exemption if the amounts payable by the 
insurer under the contract are more likely than not to exceed the 
amounts guaranteed under the contract.
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    \3\ 17 CFR 230.151A. Rule 151A was proposed by the Commission in 
June 2008. See Securities Act Release No. 8933 (June 25, 2008) [73 
FR 37752 (July 1, 2008)] (``Proposing Release'').
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    The definition hinges upon a familiar concept: the allocation of 
risk. Insurance provides protection against risk, and the courts have 
held that the allocation of investment risk is a significant factor in 
distinguishing a security from a contract of insurance. The Commission 
has also recognized that the allocation of investment risk is 
significant in determining whether a particular contract that is 
regulated as insurance under state law is insurance for purposes of the 
federal securities laws.
    Individuals who purchase indexed annuities are exposed to a 
significant investment risk--i.e., the volatility of the underlying 
securities index. Insurance companies have successfully utilized this 
investment feature, which appeals to purchasers not on the usual 
insurance basis of stability and security, but on the prospect of 
investment growth. Indexed annuities are attractive to purchasers 
because they offer the promise of market-related gains. Thus, 
purchasers obtain indexed annuity contracts for many of the same 
reasons that individuals purchase mutual funds and variable annuities, 
and open brokerage accounts.
    When the amounts payable by an insurer under an indexed annuity are 
more likely than not to exceed the amounts guaranteed under the 
contract, this indicates that the majority of the investment risk for 
the fluctuating, securities-linked portion of the return is borne by 
the individual purchaser, not the insurer. The individual underwrites 
the effect of the underlying index's performance on his or her contract 
investment and assumes the majority of the investment risk for the 
securities-linked returns under the contract.
    The federal interest in providing investors with disclosure, 
antifraud, and sales practice protections arises when individuals are 
offered indexed annuities that expose them to investment risk. 
Individuals who purchase such indexed annuities assume many of the same 
risks and rewards that investors assume when investing their money in 
mutual funds, variable annuities, and other securities. However, a 
fundamental difference between these securities and indexed annuities 
is that--with few exceptions--indexed annuities historically have not 
been registered as securities. As a result, most purchasers of indexed 
annuities have not received the benefits of federally mandated 
disclosure, antifraud, and sales practice protections.
    In a traditional fixed annuity, the insurer bears the investment 
risk under the contract. As a result, such instruments have 
consistently been treated as insurance contracts under the federal 
securities laws. At the opposite end of the spectrum, the purchaser 
bears the investment risk for a traditional variable annuity that 
passes through to the purchaser the performance of underlying 
securities, and we have determined and the courts have held that 
variable annuities are securities under the federal securities laws. 
Indexed annuities, on the other hand, fall somewhere in between--they 
possess both securities and insurance features. Therefore, we have 
determined that providing greater clarity with regard to the status of 
indexed annuities under the federal securities laws will enhance 
investor protection, as well as provide greater certainty to the 
issuers and sellers of these products with respect to their obligations 
under the federal securities laws. Accordingly, we

[[Page 3139]]

are adopting a new definition of ``annuity contract'' that, on a 
prospective basis, will define a class of indexed annuities that are 
outside the scope of Section 3(a)(8). We carefully considered where to 
draw the line, and we believe that the line that we have drawn, which 
will be applied on a prospective basis only, is rational and reasonably 
related to fundamental concepts of risk and insurance. That is, if more 
often than not the purchaser of an indexed annuity will receive a 
guaranteed return like that of a traditional fixed annuity, then the 
instrument will be treated as insurance; on the other hand, if more 
often than not the purchaser will receive a return based on the value 
of a security, then the instrument will be treated as a security. With 
respect to the latter group of indexed annuities, investors will be 
entitled to all the protections of the federal securities laws, 
including full and fair disclosure and antifraud and sales practice 
protections.
    We are aware that many insurance companies and sellers of indexed 
annuities, in the absence of definitive interpretation or definition by 
the Commission, have of necessity acted in reliance on their own 
analysis of the legal status of indexed annuities based on the state of 
the law prior to the proposal and adoption of rule 151A. Under these 
circumstances, we do not believe that insurance companies and sellers 
of indexed annuities should be subject to any additional legal risk 
relating to their past offers and sales of indexed annuities as a 
result of the proposal and adoption of rule 151A. Therefore, the new 
definition will apply prospectively only--that is, only to indexed 
annuities that are issued on or after the effective date of our final 
rule.
    Finally, we are adopting rule 12h-7 under the Exchange Act, a new 
exemption from Exchange Act reporting that will apply to insurance 
companies with respect to indexed annuities and certain other 
securities that are registered under the Securities Act and regulated 
as insurance under state law. We believe that this exemption is 
necessary or appropriate in the public interest and consistent with the 
protection of investors. Where an insurer's financial condition and 
ability to meet its contractual obligations are subject to oversight 
under state law, and where there is no trading interest in an insurance 
contract, the concerns that periodic and current financial disclosures 
are intended to address are generally not implicated.
    The Commission received approximately 4,800 comments on the 
proposed rules. The commenters were divided with respect to proposed 
rule 151A. Many issuers and sellers of indexed annuities opposed the 
proposed rule. However, other commenters supported the proposed rule, 
including the North American Securities Administrators Association, 
Inc. (``NASAA''),\4\ the Financial Industry Regulatory Authority, Inc. 
(``FINRA''),\5\ several insurance companies, and the Investment Company 
Institute (``ICI'').\6\ A number of commenters, both those who 
supported and those who opposed rule 151A, suggested modifications to 
the proposed rule. Sixteen commenters addressed proposed rule 12h-7, 
and all of these commenters supported the proposal, with some 
suggesting modifications. We are adopting proposed rules 151A and 12h-
7, with significant modifications to address the concerns of 
commenters.
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    \4\ NASAA is the association of all state, provincial, and 
territorial securities regulators in North America.
    \5\ FINRA is the largest non-governmental regulator for 
registered broker-dealer firms doing business in the United States. 
FINRA was created in July 2007 through the consolidation of NASD and 
the member regulation, enforcement, and arbitration functions of the 
New York Stock Exchange.
    \6\ ICI is a national association of investment companies, 
including mutual funds, closed-end funds, exchange-traded funds, and 
unit investment trusts.
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II. Background

    Beginning in the mid-1990s, the life insurance industry introduced 
a new type of annuity, referred to as an ``equity-indexed annuity,'' 
or, more recently, ``fixed indexed annuity'' (herein ``indexed 
annuity''). Amounts paid by the insurer to the purchaser of an indexed 
annuity are based, in part, on the performance of an equity index or 
another securities index, such as a bond index.
    The status of indexed annuities under the federal securities laws 
has been uncertain since their introduction in the mid-1990s.\7\ Under 
existing precedents, the status of each indexed annuity is determined 
based on a facts and circumstances analysis of factors that have been 
articulated by the U.S. Supreme Court.\8\ Insurers have typically 
marketed and sold indexed annuities without registering the contracts 
under the federal securities laws.
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    \7\ See Securities Act Release No. 7438 (Aug. 20, 1997) [62 FR 
45359, 45360 (Aug. 27, 1997)] (``1997 Concept Release''); NASD, 
Equity-Indexed Annuities, Notice to Members 05-50 (Aug. 2005), 
available at: http://www.finra.org/web/groups/rules_regs/documents/notice_to_members/p014821.pdf (``NTM 05-50''); Letter of William 
A. Jacobson, Esq., Associate Clinical Professor, Director, 
Securities Law Clinic, and Matthew M. Sweeney, Cornell Law School 
'10, Cornell University Law School (Sept. 10, 2008) (``Cornell 
Letter''); Letter of FINRA (Aug. 11, 2008) (``FINRA Letter''); 
Letter of Investment Company Institute (Sept. 10, 2008) (``ICI 
Letter'').
    \8\ SEC v. Variable Annuity Life Ins. Co., 359 U.S. 65 (1959) 
(``VALIC ''); SEC v. United Benefit Life Ins. Co., 387 U.S. 202 
(1967) (``United Benefit'').
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    In the years after indexed annuities were first introduced, sales 
volumes and the number of purchasers were relatively small. Sales of 
indexed annuities for 1998 totaled $4 billion and grew each year 
through 2005, when sales totaled $27.2 billion.\9\ Indexed annuity 
sales for 2006 totaled $25.4 billion and $24.8 billion in 2007.\10\ In 
2007, indexed annuity assets totaled $123 billion, 58 companies were 
issuing indexed annuities, and there were a total of 322 indexed 
annuity contracts offered.\11\ As sales have grown in more recent 
years, these products have affected larger and larger numbers of 
purchasers. They have also become an increasingly important business 
line for some insurers.\12\
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    \9\ NAVA, 2008 Annuity Fact Book, at 57 (2008).
    \10\ Id.
    \11\ Id.
    \12\ See, e.g., Allianz Life Insurance Company of North America 
(Best's Company Reports, Allianz Life Ins. Co. of N. Am., Dec. 3, 
2007) (Indexed annuities represent approximately two-thirds of gross 
premiums written.); American Equity Investment Life Holding Company 
(Annual Report on Form 10-K, at F-16 (Mar. 14, 2008)) (Indexed 
annuities accounted for approximately 97% of total purchase payments 
in 2007.); Americo Financial Life and Annuity Insurance Company 
(Best's Company Reports, Americo Fin. Life and Annuity Ins. Co., 
Sept. 5, 2008) (Indexed annuities represent over 90% of annuity 
premiums and almost 60% of annuity reserves.); Aviva USA Group 
(Best's Company Reports, Aviva Life Insurance Company, July 14, 
2008) (Indexed annuity sales represent more than 85% of total 
annuity production.); Investors Insurance Corporation (IIC) (Best's 
Company Reports, Investors Ins. Corp., July 10, 2008) (IIC's primary 
product has been indexed annuities.); Life Insurance Company of the 
Southwest (``LSW'') (Best's Company Reports, Life Ins. Co. of the 
Southwest, June 28, 2007) (LSW specializes in the sale of annuities, 
primarily indexed annuities.); Midland National Life Insurance 
Company (Best's Company Reports, Midland Nat'l Life Ins. Co., Jan. 
24, 2008) (Sales of indexed annuities in recent years have been the 
principal driver of growth in annuity deposits.).
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    The growth in sales of indexed annuities has, unfortunately, been 
accompanied by complaints of abusive sales practices. These include 
claims that the often-complex features of these annuities have not been 
adequately disclosed to purchasers, as well as claims that rapid sales 
growth has been fueled by the payment of outsize commissions that are 
funded by high surrender charges imposed over long periods, which can 
make these annuities unsuitable for seniors and others who may need 
ready access to their assets.\13\
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    \13\ See Letter of Susan E. Voss, Commissioner, Iowa Insurance 
Division (Nov. 18, 2008) (``Voss Letter'') (acknowledging sales 
practice issues and ``great deal'' of concern about suitability and 
disclosures in indexed annuity market). See also FINRA, Equity 
Indexed Annuities--A Complex Choice (updated Apr. 22, 2008), 
available at: http://www.finra.org/InvestorInformation/InvestorAlerts/AnnuitiesandInsurance/Equity-IndexedAnnuities-AComplexChoice/P010614 (``FINRA Investor Alert'') (investor alert on 
indexed annuities); Office of Compliance Inspections and 
Examinations, Securities and Exchange Commission, et al., Protecting 
Senior Investors: Report of Examinations of Securities Firms 
Providing `Free Lunch' Sales Seminars, at 4 (Sept. 2007), available 
at: http://www.sec.gov/spotlight/seniors/freelunchreport.pdf (joint 
examination conducted by Commission, North American Securities 
Administrators Association (``NASAA''), and FINRA identified 
potentially misleading sales materials and potential suitability 
issues relating to products discussed at sales seminars, which 
commonly included indexed annuities); Statement of Patricia Struck, 
President, NASAA, at the Senior Summit of the United States 
Securities and Exchange Commission, July 17, 2006, available at: 
http://www.nasaa.org/IssuesAnswers/Legislative_Activity/Testimony/4999.cfm (identifying indexed annuities as among the most pervasive 
products involved in senior investment fraud); NTM 05-50, supra note 
7 (citing concerns about marketing of indexed annuities and the 
absence of adequate supervision of sales practices).

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    We have observed the development of indexed annuities for some time 
and have become persuaded that guidance is needed with respect to their 
status under the federal securities laws. Given the current size of the 
market for indexed annuities, we believe that it is important for all 
parties, including issuers, sellers, and purchasers, to understand, in 
advance, the legal status of these products and the rules and 
protections that apply. Today, we are adopting rules that will provide 
greater clarity regarding the scope of the exemption provided by 
Section 3(a)(8). We believe our action is consistent with Congressional 
intent in that the definition will afford the disclosure, antifraud, 
and sales practice protections of the federal securities laws to 
purchasers of indexed annuities who are more likely than not to receive 
payments that vary in accordance with the performance of a security. In 
addition, the rules will provide relief from Exchange Act reporting 
obligations to the insurers that issue these indexed annuities and 
certain other securities that are regulated as insurance under state 
law. We base the Exchange Act exemption on two factors: First, the 
nature and extent of the activities of insurance company issuers, and 
their income and assets, and, in particular, the regulation of these 
activities and assets under state insurance law; and, second, the 
absence of trading interest in the securities.

A. Description of Indexed Annuities

    An indexed annuity is a contract issued by a life insurance company 
that generally provides for accumulation of the purchaser's payments, 
followed by payment of the accumulated value to the purchaser either as 
a lump sum, upon death or withdrawal, or as a series of payments (an 
``annuity''). During the accumulation period, the insurer credits the 
purchaser with a return that is based on changes in a securities index, 
such as the Dow Jones Industrial Average, Lehman Brothers Aggregate 
U.S. Index, Nasdaq 100 Index, or Standard & Poor's 500 Composite Stock 
Price Index. The insurer also guarantees a minimum value to the 
purchaser.\14\ The specific features of indexed annuities vary from 
product to product. Some key features, found in many indexed annuities, 
are as follows.
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    \14\ FINRA Investor Alert, supra note 13; National Association 
of Insurance Commissioners, Buyer's Guide to Fixed Deferred 
Annuities with Appendix for Equity-Indexed Annuities, at 9 (2007) 
(``NAIC Guide''); National Association for Fixed Annuities, White 
Paper on Fixed Indexed Insurance Products Including 'Fixed Indexed 
Annuities' and Other Fixed Indexed Insurance Products, at 1 (2006), 
available at: http://www.nafa.us/index.php?act=attach&type=post&id=68 (``NAFA Whitepaper''); Jack 
Marrion, Index Annuities: Power and Protection, at 13 (2004) 
(``Marrion'').
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Computation of Index-Based Return
    The purchaser's index-based return under an indexed annuity depends 
on the particular combination of features specified in the contract. 
Typically, an indexed annuity specifies all aspects of the formula for 
computing return in advance of the period for which return is to be 
credited, and the crediting period is generally at least one year 
long.\15\ The rate of the index-based return is computed at the end of 
the crediting period, based on the actual performance of a specified 
securities index during that period, but the computation is performed 
pursuant to a mathematical formula that is guaranteed in advance of the 
crediting period. Common indexing features are described below.
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    \15\ NAFA Whitepaper, supra note 14, at 13.
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     Index. Indexed annuities credit return based on the 
performance of a securities index, such as the Dow Jones Industrial 
Average, Lehman Brothers Aggregate U.S. Index, Nasdaq 100 Index, or 
Standard & Poor's 500 Composite Stock Price Index. Some annuities 
permit the purchaser to select one or more indices from a specified 
group of indices.
     Determining Change in Index. There are several methods for 
determining the change in the relevant index over the crediting 
period.\16\ For example, the ``point-to-point'' method compares the 
index level at two discrete points in time, such as the beginning and 
ending dates of the crediting period. Typically, in determining the 
amount of index change, dividends paid on securities underlying the 
index are not included. Indexed annuities typically do not apply 
negative changes in an index to contract value. Thus, if the change in 
index value is negative over the course of a crediting period, no 
deduction is taken from contract value nor is any index-based return 
credited.\17\
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    \16\ See FINRA Investor Alert, supra note 13; NAIC Guide, supra 
note 14, at 12-14; NAFA Whitepaper, supra note 14, at 9-10; Marrion, 
supra note 14, at 38-59.
    \17\ NAIC Guide, supra note 14, at 11; NAFA Whitepaper, supra 
note 14, at 5 and 9; Marrion, supra note 14, at 2.
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     Portion of Index Change to be Credited. The portion of the 
index change to be credited under an indexed annuity is typically 
determined through the application of caps, participation rates, spread 
deductions, or a combination of these features.\18\ Some contracts 
``cap'' the index-based returns that may be credited. For example, if 
the change in the index is 6%, and the contract has a 5% cap, 5% would 
be credited. A contract may establish a ``participation rate,'' which 
is multiplied by index growth to determine the rate to be credited. If 
the change in the index is 6%, and a contract's participation rate is 
75%, the rate credited would be 4.5% (75% of 6%). In addition, some 
indexed annuities may deduct a percentage, or spread, from the amount 
of gain in the index in determining return. If the change in the index 
is 6%, and a contract has a spread of 1%, the rate credited would be 5% 
(6% minus 1%).
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    \18\ See FINRA Investor Alert, supra note 13; NAIC Guide, supra 
note 14, at 10-11; NAFA Whitepaper, supra note 14, at 10; Marrion, 
supra note 14, at 38-59.
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Surrender Charges
    Surrender charges are commonly deducted from withdrawals taken by a 
purchaser.\19\ The maximum surrender charges, which may be as high as 
15-20%,\20\ are imposed on surrenders made during the early years of 
the contract and decline gradually to 0% at the end of a specified 
surrender charge period, which may be in excess of 15 years.\21\

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Imposition of a surrender charge may have the effect of reducing or 
eliminating any index-based return credited to the purchaser up to the 
time of a withdrawal. In addition, a surrender charge may result in a 
loss of principal, so that a purchaser who surrenders prior to the end 
of the surrender charge period may receive less than the original 
purchase payments.\22\ Many indexed annuities permit purchasers to 
withdraw a portion of contract value each year, typically 10%, without 
payment of surrender charges.
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    \19\ See FINRA Investor Alert, supra note 13; NAIC Guide, supra 
note 14, at 3-4 and 11; NAFA Whitepaper, supra note 14, at 7; 
Marrion, supra note 14, at 31.
    \20\ The highest surrender charges are often associated with 
annuities in which the insurer credits a ``bonus'' equal to a 
percentage of purchase payments to the purchaser at the time of 
purchase. The surrender charge may serve, in part, to recapture the 
bonus.
    \21\ See A Producer's Guide to Indexed Annuities 2007, LIFE 
INSURANCE SELLING (June 2007), available at: http://www.lifeinsuranceselling.com/Media/MediaManager/0607_IASurvey_1.pdf; Equity Indexed Annuities, ANNUITYADVANTAGE, available at: 
http://datafeeds.annuityratewatch.com/annuityadvantage/fixed-indexed-accounts.htm.
    \22\ FINRA Investor Alert, supra note 13; Marrion, supra note 
14, at 31.
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Guaranteed Minimum Value
    Indexed annuities generally provide a guaranteed minimum value, 
which serves as a floor on the amount paid upon withdrawal, as a death 
benefit, or in determining the amount of annuity payments. The 
guaranteed minimum value is typically a percentage of purchase 
payments, accumulated at a specified interest rate, and may not be 
lower than a floor established by applicable state insurance law. In 
the years immediately following their introduction, indexed annuities 
typically guaranteed 90% of purchase payments accumulated at 3% annual 
interest.\23\ More recently, however, following changes in state 
insurance laws,\24\ indexed annuities typically provide that the 
guaranteed minimum value is equal to at least 87.5% of purchase 
payments, accumulated at annual interest rate of between 1% and 3%.\25\ 
Assuming a guarantee of 87.5% of purchase payments, accumulated at 1% 
interest compounded annually, it would take approximately 13 years for 
a purchaser's guaranteed minimum value to be 100% of purchase payments.
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    \23\ 1997 Concept Release, supra note 7 (concept release 
requesting comments on structure of equity indexed insurance 
products, the manner in which they are marketed, and other matters 
the Commission should consider in addressing federal securities law 
issues raised by these products). See also Letter from American 
Academy of Actuaries (Jan. 5, 1998); Letter from Aid Association for 
Lutherans (Nov. 19, 1997) (comment letters in response to 1997 
Concept Release). The comment letters on the 1997 Concept Release 
are available for public inspection and copying in the Commission's 
Public Reference Room, 100 F Street, NE., Washington, DC (File No. 
S7-22-97). Those comment letters that were transmitted 
electronically to the Commission are also available on the 
Commission's Web site at http://www.sec.gov/rules/concept/s72297.shtml.
    \24\ See, e.g., CAL. INS. CODE Sec.  10168.25 (West 2007) & IOWA 
CODE Sec.  508.38 (2008) (current requirements, providing for 
guarantee based on 87.5% of purchase payments accumulated at minimum 
of 1% annual interest); CAL. INS. CODE Sec.  10168.2 (West 2003) & 
IOWA CODE Sec.  508.38 (2002) (former requirements, providing for 
guarantee for single premium annuities based on 90% of premium 
accumulated at minimum of 3% annual interest).
    \25\ NAFA Whitepaper, supra note 14, at 6.
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Registration
    Insurers typically have concluded that the indexed annuities they 
issue are not securities. As a result, virtually all indexed annuities 
have been issued without registration under the Securities Act.\26\
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    \26\ In a few instances, insurers have registered indexed 
annuities as securities as a result of particular features, such as 
the absence of any guaranteed interest rate or the absence of a 
guaranteed minimum value. See, e.g., Pre-Effective Amendment No. 4 
to Registration Statement on Form S-1 of PHL Variable Insurance 
Company (File No. 333-132399) (filed Feb. 7, 2007); Pre-Effective 
Amendment No. 1 to Registration Statement on Form S-3 of Allstate 
Life Insurance Company (File No. 333-105331) (filed May 16, 2003); 
Initial Registration Statement on Form S-2 of Golden American Life 
Insurance Company (File No. 333-104547) (filed Apr. 15, 2003).
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 B. Section 3(a)(8) Exemption

    Section 3(a)(8) of the Securities Act provides an exemption for any 
``annuity contract'' or ``optional annuity contract'' issued by a 
corporation that is subject to the supervision of the insurance 
commissioner, bank commissioner, or similar state regulatory 
authority.\27\ The exemption, however, is not available to all 
contracts that are considered annuities under state insurance law. For 
example, variable annuities, which pass through to the purchaser the 
investment performance of a pool of assets, are not exempt annuity 
contracts.
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    \27\ 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. 
Securities Act Release No. 6558 (Nov. 21, 1984) [49 FR 46750, 46753 
(Nov. 28, 1984)]. See also Tcherepnin v. Knight, 389 U.S. 332, 342 
n.30 (1967) (Congress specifically stated that ``insurance policies 
are not to be regarded as securities subject to the provisions of 
the [Securities] act,'' (quoting H.R. Rep. 85, 73d Cong., 1st Sess. 
15 (1933)).
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    The U.S. Supreme Court has addressed the insurance exemption on two 
occasions.\28\ Under these cases, factors that are important to a 
determination of an annuity's status under Section 3(a)(8) include (1) 
the allocation of investment risk between insurer and purchaser, and 
(2) the manner in which the annuity is marketed.
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    \28\ VALIC, supra note 8, 359 U.S. 65; United Benefit, supra 
note 8, 387 U.S. 202.
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    With regard to investment risk, beginning with SEC v. Variable 
Annuity Life Ins. Co. (``VALIC''),\29\ the Court has considered whether 
the risk is borne by the purchaser (tending to indicate that the 
product is not an exempt ``annuity contract'') or by the insurer 
(tending to indicate that the product falls within the Section 3(a)(8) 
exemption). In VALIC, the Court determined that variable annuities, 
under which payments varied with the performance of particular 
investments and which provided no guarantee of fixed income, were not 
entitled to the Section 3(a)(8) exemption. In SEC v. United Benefit 
Life Ins. Co. (``United Benefit''),\30\ the Court extended the VALIC 
reasoning, finding that a contract that provides for some assumption of 
investment risk by the insurer may nonetheless not be entitled to the 
Section 3(a)(8) exemption. The United Benefit 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. The Court determined that this 
contract, under which the insurer did assume some investment risk 
through minimum guarantees, was not an ``annuity contract'' under the 
federal securities laws. In making this determination, the Court 
concluded that ``the assumption of an investment risk cannot by itself 
create an insurance provision under the federal definition'' and 
distinguished a ``contract which to some degree is insured'' from a 
``contract of insurance.'' \31\
---------------------------------------------------------------------------

    \29\ VALIC, supra note 8, 359 U.S. at 71-73.
    \30\ United Benefit, supra note 8, 387 U.S. at 211.
    \31\ Id. at 211.
---------------------------------------------------------------------------

    In analyzing investment risk, Justice Brennan's concurring opinion 
in VALIC applied a functional analysis to determine whether a new form 
of investment arrangement that emerges and is labeled ``annuity'' by 
its promoters is the sort of arrangement that Congress was willing to 
leave exclusively to the state insurance commissioners. In that 
inquiry, the purposes of the federal securities laws and state 
insurance laws are important. Justice Brennan noted, in particular, 
that the emphasis in the Securities Act is on disclosure and that the 
philosophy of the Act is that ``full disclosure of the details of the 
enterprise in which the investor is to put his money should be made so 
that he can intelligently appraise the risks involved.'' \32\ We agree 
with the concurring opinion's analysis. Where an investor's investment 
in an annuity is sufficiently protected by the insurer, state insurance 
law regulation of insurer solvency and the adequacy of reserves are 
relevant. Where the investor's investment is not sufficiently 
protected, the disclosure

[[Page 3142]]

protections of the Securities Act assume importance.
---------------------------------------------------------------------------

    \32\ VALIC, supra note 8, 359 U.S. at 77.
---------------------------------------------------------------------------

    Marketing is another significant factor in determining whether a 
state-regulated insurance contract is entitled to the Securities Act 
``annuity contract'' exemption. In United Benefit, the U.S. Supreme 
Court, in holding an annuity 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.'' \33\ Under these circumstances, the Court 
concluded ``it is not inappropriate that promoters' offerings be judged 
as being what they were represented to be.'' \34\
---------------------------------------------------------------------------

    \33\ United Benefit, supra note 8, 387 U.S. at 211.
    \34\ Id. at 211 (quoting SEC v. Joiner Leasing Corp., 320 U.S. 
344, 352-53 (1943)). 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); and Grainger v. State Security Life Ins. 
Co., 547 F.2d 303 (5th Cir. 1977).
---------------------------------------------------------------------------

    In 1986, given 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 are not deemed subject to the federal 
securities laws and are entitled to rely on Section 3(a)(8) of the 
Securities Act.\35\ Under rule 151, an annuity contract issued by a 
state-regulated insurance company is deemed to be within Section 
3(a)(8) of the Securities Act if (1) the insurer assumes the investment 
risk under the contract in the manner prescribed in the rule; and (2) 
the contract is not marketed primarily as an investment.\36\ Rule 151 
essentially codifies the tests the courts have used to determine 
whether an annuity contract is entitled to the Section 3(a)(8) 
exemption, but adds greater specificity with respect to the investment 
risk test. Under rule 151, an insurer is deemed to assume the 
investment risk under an annuity contract if, among other things,
---------------------------------------------------------------------------

    \35\ 17 CFR 230.151; Securities Act Release No. 6645 (May 29, 
1986) [51 FR 20254 (June 4, 1986)]. 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.
    \36\ 17 CFR 230.151(a).
---------------------------------------------------------------------------

    (1) The insurer, for the life of the contract,
    (a) Guarantees the principal amount of purchase payments and 
credited interest, less any deduction for sales, administrative, or 
other expenses or charges; and
    (b) Credits a specified interest rate that is at least equal to the 
minimum rate required by applicable state law; and
    (2) The insurer guarantees that the rate of any interest to be 
credited in excess of the guaranteed minimum rate described in 
paragraph 1(b) will not be modified more frequently than once per 
year.\37\
---------------------------------------------------------------------------

    \37\ 17 CFR 230.151(b) and (c). In addition, the value of the 
contract may not vary according to the investment experience of a 
separate account.
---------------------------------------------------------------------------

    Indexed annuities are not entitled to rely on the safe harbor of 
rule 151 because they fail to satisfy the requirement that the insurer 
guarantee that the rate of any interest to be credited in excess of the 
guaranteed minimum rate will not be modified more frequently than once 
per year.\38\
---------------------------------------------------------------------------

    \38\ Some indexed annuities also may fail other aspects of the 
safe harbor test.
    In adopting rule 151, the Commission declined to extend the safe 
harbor to excess interest rates that are computed pursuant to an 
indexing formula that is guaranteed for one year. Rather, the 
Commission determined that it would be appropriate to permit 
insurers to make limited use of index features, provided that the 
insurer specifies an index to which it would refer, no more often 
than annually, to determine the excess interest rate that it would 
guarantee for the next 12-month or longer period. For example, an 
insurer would meet this test if it established an ``excess'' 
interest rate of 5% by reference to the past performance of an 
external index and then guaranteed to pay 5% interest for the coming 
year. Securities Act Release No. 6645, supra note 35, 51 FR at 
20260. The Commission specifically expressed concern that index 
feature contracts that adjust the rate of return actually credited 
on a more frequent basis operate less like a traditional annuity and 
more like a security and that they shift to the purchaser all of the 
investment risk regarding fluctuations in that rate. See infra note 
71 and accompanying text.
---------------------------------------------------------------------------

III. Discussion of the Amendments

    The Commission has determined that providing greater clarity with 
regard to the status of indexed annuities under the federal securities 
laws will enhance investor protection, as well as provide greater 
certainty to the issuers and sellers of these products with respect to 
their obligations under the federal securities laws. We are adopting a 
new definition of ``annuity contract'' that, on a prospective basis, 
defines a class of indexed annuities that are outside the scope of 
Section 3(a)(8). With respect to these annuities, investors will be 
entitled to all the protections of the federal securities laws, 
including full and fair disclosure and antifraud and sales practice 
protections. We are also adopting a new exemption under the Exchange 
Act that applies to insurance companies that issue indexed annuities 
and certain other securities that are registered under the Securities 
Act and regulated as insurance under state law. We believe that this 
exemption is necessary or appropriate in the public interest and 
consistent with the protection of investors because of the presence of 
state oversight of insurance company financial condition and the 
absence of trading interest in these securities.

A. Definition of Annuity Contract

    The Commission is adopting new rule 151A, which defines a class of 
indexed annuities that are not ``annuity contracts'' or ``optional 
annuity contracts'' \39\ for purposes of Section 3(a)(8) of the 
Securities Act. Although we recognize that these instruments are issued 
by insurance companies and are treated as annuities under state law, 
these facts are not conclusive for purposes of the analysis under the 
federal securities laws.
---------------------------------------------------------------------------

    \39\ An ``optional annuity contract'' is a deferred annuity. See 
United Benefit, supra note 8, 387 U.S. at 204. In a deferred 
annuity, annuitization begins at a date in the future, after assets 
in the contract have accumulated over a period of time (normally 
many years). In contrast, in an immediate annuity, the insurer 
begins making annuity payments shortly after the purchase payment is 
made, i.e., within one year. See Kenneth Black, Jr., and Harold D. 
Skipper, Jr., Life and Health Insurance, at 164 (2000).
---------------------------------------------------------------------------

1. Analysis
``Insurance'' and ``Annuity'': Federal Terms Under the Federal 
Securities Laws
    Our analysis begins with the well-settled conclusion that the terms 
``insurance'' and ``annuity contract'' as used in the Securities Act 
are ``federal terms,'' the meanings of which are a ``federal question'' 
under the federal securities laws.\40\ The Securities Act does not 
provide a definition of either term, and we have not previously 
provided a definition that applies to indexed annuities.\41\ Moreover, 
indexed

[[Page 3143]]

annuities did not exist and were not contemplated by Congress when it 
enacted the insurance exemption.
---------------------------------------------------------------------------

    \40\ See VALIC, supra note 8, 359 U.S. at 69. Although the 
McCarran-Ferguson Act, 15 U.S.C. 1012(b), provides that ``No Act of 
Congress shall be construed to invalidate, impair or supersede any 
law enacted by any State for the purpose of regulating the business 
of insurance,'' the United States Supreme Court has stated that the 
question common to both the federal securities laws and the 
McCarran-Ferguson Act is whether the instruments are contracts of 
insurance. See VALIC, supra note 8. Thus, where a contract is not an 
``annuity contract'' or ``optional annuity contract,'' which we have 
concluded is the case with respect to certain indexed annuities, we 
do not believe that such contract is ``insurance'' for purposes of 
the McCarran-Ferguson Act.
    \41\ The last time the Commission formally addressed indexed 
annuities was in 1997. At that time, the Commission issued a concept 
release requesting public comment regarding indexed insurance 
contracts. The concept release stated that ``depending on the mix of 
features * * * [an indexed insurance contract] may or may not be 
entitled to exemption from registration under the Securities Act'' 
and that the Commission was ``considering the status of [indexed 
annuities and other indexed insurance contracts] under the federal 
securities laws.'' See 1997 Concept Release, supra note 7, at 4-5.
    The Commission has previously adopted a safe harbor for certain 
annuity contracts that are entitled to rely on Section 3(a)(8) of 
the Securities Act. However, as discussed in Part II.B., indexed 
annuities are not entitled to rely on the safe harbor.
---------------------------------------------------------------------------

    We therefore analyze indexed annuities under the facts and 
circumstances factors articulated by the U.S. Supreme Court in VALIC 
and United Benefit. In particular, we focus on whether these 
instruments are ``the sort of investment form that Congress was * * * 
willing to leave exclusively to the State Insurance Commissioners'' and 
whether they necessitate the ``regulatory and protective purposes'' of 
the Securities Act.\42\
---------------------------------------------------------------------------

    \42\ See VALIC, supra note 8, 359 U.S. at 75 (Brennan, J., 
concurring) (``* * * if a brand-new form of investment arrangement 
emerges which is labeled `insurance' or `annuity' by its promoters, 
the functional distinction that Congress set up in 1933 and 1940 
must be examined to test whether the contract falls within the sort 
of investment form that Congress was then willing to leave 
exclusively to the State Insurance Commissioners. In that inquiry, 
an analysis of the regulatory and protective purposes of the Federal 
Acts and of state insurance regulation as it then existed becomes 
relevant.'').
---------------------------------------------------------------------------

Type of Investment
    We believe that the indexed annuities that will be included in our 
definition are not the sort of investment that Congress contemplated 
leaving exclusively to state insurance regulation. According to the 
U.S. Supreme Court, Congress intended to include in the insurance 
exemption only those policies and contracts that include a ``true 
underwriting of risks'' and ``investment risk-taking'' by the 
insurer.\43\ Moreover, the level of risk assumption necessary for a 
contract to be ``insurance'' under the Securities Act must be 
meaningful--the assumption of an investment risk does not ``by itself 
create an insurance provision under the federal definition.'' \44\
---------------------------------------------------------------------------

    \43\ Id. at 71-73.
    \44\ See United Benefit, supra note 8, 387 U.S. at 211 (``[T]he 
assumption of investment risk cannot by itself create an insurance 
provision. * * * The basic difference between a contract which to 
some degree is insured and a contract of insurance must be 
recognized.'').
---------------------------------------------------------------------------

    The annuities that ``traditionally and customarily'' were offered 
at the time Congress enacted the insurance exemption were fixed 
annuities that typically involved no investment risk to the 
purchaser.\45\ These contracts offered the purchaser ``specified and 
definite amounts beginning with a certain year of his or her life,'' 
and the ``standards for investments of funds'' by the insurer under 
these contracts were ``conservative.'' \46\ Moreover, these types of 
annuity contracts were part of a ``concept which had taken on its 
coloration and meaning largely from state law, from state practice, 
from state usage.'' \47\ Thus, Congress exempted these instruments from 
the requirements of the federal securities laws because they were a 
``form of `investment' * * * which did not present very squarely the 
problems that [the federal securities laws] were devised to deal 
with,'' and were ``subject to a form of state regulation of a sort 
which made the federal regulation even less relevant.'' \48\
---------------------------------------------------------------------------

    \45\ See VALIC, supra note 8, 359 U.S. at 69.
    \46\ Id. (``While all the States regulate `annuities' under 
their `insurance' laws, traditionally and customarily they have been 
fixed annuities, offering the annuitant specified and definite 
amounts beginning with a certain year of his or her life. The 
standards for investment of funds underlying these annuities have 
been conservative.'').
    \47\ Id. (``Congress was legislating concerning a concept which 
had taken on its coloration and meaning largely from state law, from 
state practice, from state usage.'').
    \48\ Id. at 75 (Brennan, J., concurring).
---------------------------------------------------------------------------

    In contrast, when the amounts payable by an insurer under an 
indexed annuity contract are more likely than not to exceed the amounts 
guaranteed under the contract, the purchaser assumes substantially 
different risks and benefits. Notably, at the time that such a contract 
is purchased, the risk for the unknown, unspecified, and fluctuating 
securities-linked portion of the return is primarily assumed by the 
purchaser.
    By purchasing this type of indexed annuity, the purchaser assumes 
the risk of an uncertain and fluctuating financial instrument, in 
exchange for participation in future securities-linked returns. The 
value of such an indexed annuity reflects the benefits and risks 
inherent in the securities market, and the contract's value depends 
upon the trajectory of that same market. Thus, the purchaser obtains an 
instrument that, by its very terms, depends on market volatility and 
risk.
    Such indexed annuity contracts provide some protection against the 
risk of loss, but these provisions do not, ``by [themselves,] create an 
insurance provision under the federal definition.'' \49\ Rather, these 
provisions reduce--but do not eliminate--a purchaser's exposure to 
investment risk under the contract. These contracts may to some degree 
be insured, but that degree may be too small to make the indexed 
annuity a contract of insurance.\50\
---------------------------------------------------------------------------

    \49\ See United Benefit, supra note 8, 387 U.S. at 211 (finding 
that while a ``guarantee of cash value'' provided by an insurer to 
purchasers of a deferred annuity plan reduced ``substantially the 
investment risk of the contract holder, the assumption of investment 
risk cannot by itself create an insurance provision under the 
federal definition.'').
    \50\ Id. at 211 (``The basic difference between a contract which 
to some degree is insured and a contract of insurance must be 
recognized.'').
---------------------------------------------------------------------------

    Thus, the protections provided by indexed annuities may not 
adequately transfer investment risk from the purchaser to the insurer 
when amounts payable by an insurer under the contract are more likely 
than not to exceed the amounts guaranteed under the contract. 
Purchasers of these annuities assume the investment risk for 
investments that are more likely than not to fluctuate and move with 
the securities markets. The value of the purchaser's investment is more 
likely than not to depend on movements in the underlying securities 
index. The protections offered in these indexed annuities may give the 
instruments an aspect of insurance, but we do not believe that these 
protections are substantial enough.\51\
---------------------------------------------------------------------------

    \51\ See VALIC, supra note 8, 359 U.S. at 71 (finding that 
although the insurer's assumption of a traditional insurance risk 
gives variable annuities an ``aspect of insurance,'' this is 
``apparent, not real; superficial, not substantial.'').
---------------------------------------------------------------------------

Need for the Regulatory Protections of the Federal Securities Acts
    We also analyze indexed annuities to determine whether they 
implicate the regulatory and protective purposes of the federal 
securities laws. Based on that analysis, we believe that the indexed 
annuities that are included in the definition that we are adopting 
present many of the concerns that Congress intended the federal 
securities laws to address.
    Indexed annuities are similar in many ways to mutual funds, 
variable annuities, and other securities. Although these contracts 
contain certain features that are typical of insurance contracts, \52\ 
they also may contain ``to a very substantial degree elements of 
investment contracts.'' \53\ Indexed annuities are attractive to 
purchasers precisely because they offer participation in the securities 
markets. However, indexed annuities historically have not been 
registered with us as securities. Insurers have treated these

[[Page 3144]]

annuities as subject only to state insurance laws.
---------------------------------------------------------------------------

    \52\ The presence of protection against loss does not, in 
itself, transform a security into an insurance or annuity contract. 
Like indexed annuities, variable annuities typically provide some 
protection against the risk of loss, but are registered as 
securities. Historically, variable annuity contracts have typically 
provided a minimum death benefit at least equal to the greater of 
contract value or purchase payments less any withdrawals. More 
recently, many contracts have offered benefits that protect against 
downside market risk during the purchaser's lifetime.
    \53\ VALIC, supra note 8, 359 U.S. at 91 (Brennan, J., 
concurring).
---------------------------------------------------------------------------

    There is a strong federal interest in providing investors with 
disclosure, antifraud, and sales practice protections when they are 
purchasing annuities that are likely to expose them to market 
volatility and risk. We believe that individuals who purchase indexed 
annuities that are more likely than not to provide payments that vary 
with the performance of securities are exposed to significant 
investment risks. They are confronted with many of the same risks and 
benefits that other securities investors are confronted with when 
making investment decisions. Moreover, they are more likely than not to 
experience market volatility because they are more likely than not to 
receive payments that vary with the performance of securities.
    We believe that the regulatory objectives that Congress was 
attempting to achieve when it enacted the Securities Act are present 
when the amounts payable by an insurer under an indexed annuity 
contract are more likely than not to exceed the guaranteed amounts. 
Therefore, we are adopting a rule that will define such contracts as 
falling outside the insurance exemption.
2. Commenters' Concerns Regarding Commission's Analysis
    Many commenters raised significant concerns regarding the 
Commission's analysis of indexed annuities under Section 3(a)(8). 
Commenters argued that the Commission's analysis is inconsistent with 
applicable legal precedent, particularly the VALIC and United Benefit 
cases. Specifically, the commenters argued that the purchaser of an 
indexed annuity does not assume investment risk in the sense 
contemplated by applicable precedent, that the Commission failed to 
take into account the investment risk assumed by the insurer, and that 
the Commission's analysis ignored the factors of marketing and 
mortality risk which have been articulated in applicable precedents. In 
addition, commenters questioned the need for federal securities 
regulation of indexed annuities, arguing that there is no evidence of 
widespread sales practice abuse in the indexed annuity marketplace, 
that state insurance regulators are effective in protecting purchasers 
of indexed annuities, and that the Commission's disclosure requirements 
would not result in enhanced information flow to purchasers of indexed 
annuities. We disagree with each of these assertions for the reasons 
outlined below.
Commission's Analysis is Consistent With Applicable Precedents
    We disagree with commenters who argued that the Commission's 
analysis is inconsistent with applicable legal precedents, particularly 
the VALIC and United Benefit cases.\54\ These commenters asserted, 
first, that because of guarantees of principal and minimum interest, 
the purchaser of an indexed annuity does not assume investment risk in 
the sense contemplated by applicable precedent which, in their view, is 
the risk of loss of principal. Second, the commenters argued that the 
Commission's analysis failed to take into account the investment risk 
assumed by the insurer, including the risk associated with guaranteeing 
principal and a minimum interest rate and with guaranteeing in advance 
the formula for determining index-linked return. Third, commenters 
argued that the Commission's analysis is inconsistent with precedent 
because it does not take into account the manner in which indexed 
annuities are marketed.\55\ Fourth, commenters faulted the Commission's 
analysis for ignoring mortality risk.\56\
---------------------------------------------------------------------------

    \54\ See, e.g., Letter of Advantage Group Associates, Inc. (Nov. 
16, 2008) (``Advantage Group Letter''); Letter of Allianz Life 
Insurance Company of North America (Sept. 10, 2008) (``Allianz 
Letter''); Letter of American Academy of Actuaries (Sept. 10, 2008) 
(``Academy Letter''); Letter of American Academy of Actuaries (Nov. 
17, 2008) (``Second Academy Letter''); Letter of American Equity 
Investment Life Holding Company (Sept. 10, 2008) (``American Equity 
Letter''); Letter of American National Insurance Company (Sept. 10. 
2008) (``American National Letter''); Letter of Aviva USA 
Corporation (Sept. 10, 2008) (``Aviva Letter''); Letter of Aviva USA 
Corporation (Nov. 17, 2008) (``Second Aviva Letter''); Letter of 
Coalition for Indexed Products (Sept. 10, 2008) (``Coalition 
Letter''); Letter of Committee of Annuity Insurers regarding 
proposed rule 151A (Sept. 10, 2008) (``CAI 151A Letter''); Letter of 
Lafayette Life Insurance Company (Sept. 10, 2008) (``Lafayette 
Letter''); Letter of Maryland Insurance Administration (Sept. 9, 
2008) (``Maryland Letter''); Letter of the Officers of the National 
Association of Insurance Commissioners (Sept. 10, 2008) (``NAIC 
Officer Letter''); Letter of National Association for Fixed 
Annuities (Sept. 10, 2008) (``NAFA Letter''); Letter of National 
Association of Insurance and Financial Advisers (Sept. 10, 2008) 
(``NAIFA Letter''); Letter of National Conference of Insurance 
Legislators (Nov. 25, 2008) (``NCOIL Letter''); Letter of National 
Western Life Insurance Company (Sept. 10, 2008) (``National Western 
Letter''); Letter of Old Mutual Financial Network (Sept. 10, 2008) 
(``Old Mutual Letter''); Letter of Sammons Annuity Group (Sept. 10, 
2008) (``Sammons Letter''); Letter of Transamerica Life Insurance 
Company (Sept. 10, 2008) (``Transamerica Letter''); Letter of 
Transamerica Life Insurance Company (Nov. 17, 2008) (``Second 
Transamerica Letter'').
    Other commenters, however, supported the Commission's 
interpretation of Section 3(a)(8) and applicable legal precedents. 
See, e.g., ICI Letter, supra note 7; Letter of K&L Gates on behalf 
of AXA Equitable Life Insurance Company, Hartford Financial Services 
Group, Inc., Massachusetts Mutual Life Insurance Company, MetLife, 
Inc., and New York Life Insurance Company (Oct. 7, 2008) (``K&L 
Gates Letter'').
    \55\ See, e.g., Coalition Letter, supra note 54; Letter of The 
Hartford Financial Services Group, Inc. (Sept. 10, 2008) (``Hartford 
Letter''); NAFA Letter, supra note 54.
    \56\ See, e.g., CAI 151A Letter, supra note 54; Old Mutual 
Letter, supra note 54; Sammons Letter, supra note 54.
---------------------------------------------------------------------------

    Our investment risk analysis is an application of the Court's 
reasoning in the VALIC and United Benefit cases, and rule 151A applies 
that analysis with a specific test to determine the status under the 
federal securities laws of indexed annuities. Indexed annuities are a 
relatively new product and are different from the securities considered 
in those cases. These very differences have resulted in the uncertain 
legal status of indexed annuities from their introduction in the mid-
1990s. Like the contract at issue in United Benefit, indexed annuities 
present a new case that requires us to determine whether ``a contract 
which to some degree is insured'' constitutes a ``contract of 
insurance'' for purposes of the federal securities laws.\57\ Indexed 
annuities offer to purchasers a financial instrument with uncertain and 
fluctuating returns that are, in part, securities-linked. We believe 
that whether such an instrument is a security hinges on the likelihood 
that the purchaser's return will, in fact, be based on the returns of a 
securities index. In cases where the amounts payable by an insurer 
under an indexed annuity contract are more likely than not to exceed 
the amounts guaranteed under the contract, the amount the purchaser 
receives will be dependent on market returns and will vary because of 
investment risk. In such a case, we have concluded that, on a 
prospective basis, the indexed annuity is not entitled to rely on the 
Section 3(a)(8) exemption. Though the contract may to some degree be 
insured, it is not a contract of insurance because of the substantial 
investment risk assumed by the purchaser.
---------------------------------------------------------------------------

    \57\ See United Benefit, supra note 8, 387 U.S. at 211 (``The 
basic difference between a contract which to some degree is insured 
and a contract of insurance must be recognized.'').
---------------------------------------------------------------------------

    A number of commenters equated investment risk with the risk of 
loss of principal for purposes of analysis under Section 3(a)(8) and 
argued that, because of guarantees of principal and minimum interest, 
the purchaser of an indexed annuity does not assume investment risk. We 
disagree. While the potential for loss of principal was important in 
the VALIC and United Benefit cases and helpful in analyzing the 
particular products at issue in those cases, it is by

[[Page 3145]]

no means the only type of investment risk. Defining risk only as the 
possibility of principal loss or an approximate equivalent, as 
suggested by commenters, fails to account for important forms of risk 
and leads to conclusions inconsistent with the contemporary 
understanding of investment risk. Such a limited definition of risk 
would thus be incomplete.
    One widely accepted definition of ``risk'' in financial instruments 
is the degree to which returns deviate from their statistical 
expectation.\58\ Accordingly, even investments guaranteeing a positive 
minimum return over long investment horizons, such as indexed 
annuities, may have returns that meaningfully and unpredictably deviate 
from the expected return and therefore have investment risk under this 
definition.
---------------------------------------------------------------------------

    \58\ Zvi Bodie, Alex Kane and Alan J. Marcus, Investments, at 
143 (2005) (``The standard deviation of the rate of return is a 
measure of risk.'').
---------------------------------------------------------------------------

    For example, accepting the definition of risk suggested by 
commenters as a complete characterization of risk would lead to the 
conclusion that any two assets that both guarantee return of principal 
equally have no risk. However, we believe that the market would 
generally view an asset where the future payoff of the amount over the 
guaranteed principal return is uncertain to be more risky than a zero-
coupon U.S. government bond maturing at the same date, which also 
guarantees principal return but has a nearly certain future payoff. 
Defining risk as the potential for loss of principal, or principal plus 
some minimal amount, misses important aspects of risk as commonly 
understood. While U.S. government bonds are commonly accepted as the 
standard benchmark of a nominally risk-free rate of return because 
their returns are considered to be nearly certain at specific horizons, 
the definition suggested by commenters fails to distinguish between 
these risk-free assets and assets that are protected against principal 
loss but that have uncertain payoffs above the guaranteed principal 
return.\59\
---------------------------------------------------------------------------

    \59\ Zvi Bodie, Alex Kane and Alan J. Marcus, Investments, at 
144 (2005).
---------------------------------------------------------------------------

    Additionally, under the definition of risk suggested by the 
commenters, most assets with positive expected returns would appear to 
have little to no risk over long horizons. As an example, using 
reasonable assumptions it can be estimated that a value-weighted 
portfolio of New York Stock Exchange (``NYSE'') stocks has 
approximately a 6% chance of returning less than principal in 10 years, 
and approximately a 1% chance of returning less than principal in 20 
years.\60\ Despite these relatively low probabilities of losing 
principal over long periods of time, we believe that it is generally 
understood that market participants, even those with long investment 
horizons, bear meaningful investment risk when investing in such a 
diversified portfolio of stocks. Indeed, investors generally consider 
modest long-term returns, even if greater than 0% or some minimal rate, 
to be undesirable outcomes when the expected return was substantially 
greater. We therefore believe that the commenters' suggestion that such 
a portfolio is without risk is at odds both with the commonly accepted 
meaning of the term as well as with the definition of risk generally 
accepted by financial economists.
---------------------------------------------------------------------------

    \60\ Our Office of Economic Analysis conducted a simulation, in 
which annual returns from the Center for Research in Security Prices 
(``CRSP'') capitalization-weighted NYSE index, annually rebalanced, 
from 1926 through 2007, are drawn randomly and aggregated (a 
bootstrap procedure). This procedure replicates the observed mean, 
standard deviation, skewness, kurtosis, and other observed moments 
of returns, but assumes that returns are intertemporally 
independent. Realized 10-year returns in this period are negative 4% 
of the time, and there have been no 20-year negative returns.
---------------------------------------------------------------------------

    The purchaser of an indexed annuity assumes investment risk because 
his or her return is not known in advance and therefore varies from its 
expected value. When the amounts payable to the purchaser are more 
likely than not to exceed the guaranteed amounts, the investment risk 
assumed by the purchaser of an indexed annuity is substantial, and we 
believe that the contract should not be treated as an ``annuity 
contract'' for purposes of the federal securities laws. We also note 
that indexed annuities are not, in fact, without the risk of principal 
loss. An indexed annuity purchaser who surrenders the contract during 
the surrender charge period, which for some indexed annuities may be in 
excess of 15 years, may receive less than his or her original 
principal. Unlike a purchaser of a fixed annuity, a purchaser of an 
indexed annuity is dependent on favorable securities market returns to 
overcome the impact of the surrender charge and create a positive 
return rather than a loss.
    We also disagree with commenters who argued that the Commission's 
analysis failed to take into account the investment risk assumed by the 
insurer, including the risk associated with guaranteeing principal and 
a minimum interest rate and with guaranteeing in advance the formula 
for determining securities-linked return. We agree with commenters 
that, in analyzing the status of indexed annuities under the federal 
securities laws, it is important to take into account the relative 
significance of the risks assumed by the insurer and the purchaser. In 
our analysis, the Commission does not ignore the risk assumed by the 
insurer as the commenters suggest. In fact, the rule, as proposed and 
adopted, specifically contemplates different outcomes based on the 
relative risks assumed by the insurer and purchaser. When the amounts 
payable by the insurer under the contract are more likely than not to 
exceed the amounts guaranteed, the contract loses the insurance 
exemption under rule 151A.
    Unlike a traditional fixed annuity where the investment risk for 
the contract is assumed by the insurer, or a traditional variable 
annuity where the investment risk for the contract is assumed by the 
purchaser, the very mixed nature of indexed annuities led the 
Commission to carefully consider the relative risks assumed by both 
parties to the contract. The fact that the rule does not define all 
indexed annuities as outside Section 3(a)(8), but rather sets forth a 
test for analyzing these contracts, reflects the Commission's 
understanding that the status of these contracts under the federal 
securities laws hinges on the allocation of risk between both the 
insurer and the purchaser. Specifically, the rule recognizes that where 
the insurer is more likely than not to pay an amount that is fixed and 
guaranteed by the insurer, significant investment risks are assumed by 
the insurer and such a contract may therefore be entitled to the 
Section 3(a)(8) exemption. Conversely, where the purchaser is more 
likely than not to receive an amount that is variable and dependent on 
fluctuations and movements in the securities markets, rule 151A 
recognizes the significant investment risks assumed by the purchaser 
and specifies that such a contract would not be considered to fall 
within Section 3(a)(8). Moreover, both the guaranteed interest rate 
within an indexed annuity and the formula for crediting interest are 
typically reset on an annual basis. This provides insurers with a 
number of ways to reduce or eliminate their investment risks, including 
hedging market risk through the purchase of options or other 
derivatives and adjusting guarantees downwards in subsequent years to 
offset losses in earlier years of a contract. For purposes of analysis 
under Section 3(a)(8), we do not consider these investment risks to be 
comparable to

[[Page 3146]]

those of the indexed annuity purchaser, who bears the risk of a 
fluctuating and uncertain return based on the performance of a 
securities index.
    Some commenters argued that the Commission's investment risk 
analysis is inconsistent with its own position in the Brief for the 
United States as Amicus Curiae in Variable Annuity Life Insurance 
Company, et al. v. Otto (``VALIC v. Otto'').\61\ That matter involved 
an annuity in which the insurer guaranteed principal and a minimum rate 
of interest and also could, in its discretion, credit excess interest 
above the guaranteed rate. The Commission argued that by guaranteeing 
principal and an adequate fixed rate of interest, and guaranteeing 
payment of all discretionary excess interest declared under the 
contract, the insurer assumed sufficient investment risk under the 
contract for it to fall within Section 3(a)(8), notwithstanding the 
assumption of the risk by the contract owner that the excess interest 
rate could be reduced or eliminated at the insurer's discretion.
---------------------------------------------------------------------------

    \61\ Brief for the United States as Amicus Curiae on Petition 
for a Writ of Certiorari to the United States Court of Appeals for 
the Seventh Circuit, VALIC v. Otto, No. 87-600, October Term, 1987. 
See, e.g., Aviva Letter, supra note 54; CAI 151A Letter, supra note 
54; Coalition Letter, supra note 54; NAFA Letter, supra note 54.
---------------------------------------------------------------------------

    We agree with commenters that our analysis is different from the 
position taken by the Commission in the VALIC v. Otto brief. However, 
this results from the fact that indexed annuity contracts are different 
from the contracts considered in VALIC v. Otto. Unlike the contracts in 
that case, which were annuity contracts that provided for wholly 
discretionary payment of excess interest, indexed annuities 
contractually specify that excess interest will be calculated by 
reference to a securities index. As a result, the purchaser of an 
indexed annuity is contractually bound to assume the investment risk 
for the fluctuations and movements in the underlying securities index. 
The contract in VALIC v. Otto did not impose this securities-linked 
investment risk on the purchaser. Moreover, we note that the Supreme 
Court did not grant certiorari in VALIC v. Otto. The final opinion in 
the case was rendered by the Seventh Circuit and was to the effect 
that, as a result of the insurer's discretion to declare excess 
interest under the contract, the insurer's guarantees were not 
sufficient to exempt the contract from the federal securities laws. 
Thus, the Commission's position in the case was not adopted by either 
the Seventh Circuit or the Supreme Court. We believe that the position 
articulated in the VALIC v. Otto brief is not relevant in the context 
of indexed annuities and, to the extent that the brief may imply 
otherwise, the position taken in the brief does not reflect the 
Commission's current position. Where the contractual return paid by an 
insurer under an annuity contract is retroactively determined based, in 
whole or in part, on the returns of a security in a prior period, we do 
not believe that fact--and the investment risk that it entails--can be 
ignored in determining whether the contract is an ``annuity contract'' 
that is entitled to the Section 3(a)(8) exemption.
    Though rule 151A does not explicitly incorporate a marketing 
factor, we disagree with commenters who argued that the Commission's 
analysis is inconsistent with precedent, because it does not take into 
account the manner in which indexed annuities are marketed.\62\ The 
very nature of an indexed annuity, where return is contractually linked 
to the return on a securities index, is, to a very substantial extent, 
designed to appeal to purchasers on the prospect of investment 
growth.\63\ This is particularly true in the case of indexed annuities 
that rule 151A defines as not ``annuity contracts''--i.e., indexed 
annuities where the purchaser is more likely than not to receive 
securities-linked returns. It would be inconsistent with the character 
of such an indexed annuity, and potentially misleading, to market the 
annuity without placing significant emphasis on the securities-linked 
return and the related risks. We disagree with commenters who argued 
that purchasers do not buy indexed annuities on the basis of the 
prospect for investment growth, but rather on the basis of guarantees 
and stability of principal.\64\ We agree with commenters that 
purchasers of indexed annuities, just like purchasers of variable 
annuities, have a blend of reasons for their purchase, including 
product guarantees and tax deferral.\65\ However, we also believe that 
purchasers who are uninterested in the growth offered by securities-
linked returns would opt for higher fixed returns in lieu of the lower 
fixed returns, coupled with the prospect of securities-linked growth, 
offered by indexed annuities. Indeed, data submitted by one indexed 
annuity issuer confirm that almost half (46.60%) of its 2008 indexed 
annuity purchasers identify the prospect for growth as a reason for 
their purchase.\66\ Just as with variable annuities, the fact that 
indexed annuities appeal to purchasers for a variety of reasons does 
not detract from the significant appeal of securities-linked growth. 
Accordingly, we have concluded that, in light of the nature of indexed 
annuities, it is unnecessary to include a separate marketing factor 
within rule 151A. The Supreme Court did not address marketing in VALIC. 
Similarly, we have concluded that a separate marketing analysis is 
unnecessary in the case of indexed annuities that are addressed by rule 
151A.
---------------------------------------------------------------------------

    \62\ See, e.g., Coalition Letter, supra note 54; NAFA Letter, 
supra note 54; Old Mutual Letter, supra note 54; Sammons Letter, 
supra note 54.
    \63\ See, e.g., K&L Gates Letter, supra note 54. But see Letter 
of National Western Life Insurance Company (Nov. 17, 2008) (``Second 
National Western Letter'') (criticizing the K&L Gates position).
    \64\ See, e.g., Allianz Letter, supra note 54; American Equity 
Letter, supra note 54; Coalition Letter, supra note 54.
    \65\ See, e.g., Allianz Letter, supra note 54 (55.45% purchased 
indexed annuities because of guarantees and 54.88% because of tax 
deferral).
    \66\ See Allianz Letter, supra note 54. But see Coalition 
Letter, supra note 54 (sampling by some indexed annuity issuers 
reveals that a large majority of purchasers acquire fixed annuities 
for stability of premiums). We are not able to ascertain from the 
statement in the Coalition Letter the degree to which purchasers 
identified growth as a goal as the letter addressed only stability 
of premiums.
---------------------------------------------------------------------------

    Nor do we agree with commenters who argued that the Commission's 
analysis departs from precedent in that it does not take into account 
mortality risk.\67\ In both VALIC and United Benefit, the Supreme Court 
found the investment risk test to be determinative (together with the 
marketing test in the case of United Benefit) that an insurance 
contract was not entitled to the Section 3(a)(8) exemption. While the 
Commission has stated, and we continue to believe, that the presence or 
absence of assumption of mortality risk may be an appropriate factor to 
consider in a Section 3(a)(8) analysis,\68\ we do not believe that it 
should be given undue weight in determining the status of a contract 
under the federal securities laws, where it is clear from the nature of 
the investment risk that the contract is not an ``annuity contract'' 
for securities law purposes. We have concluded that this is the case 
for an indexed annuity where the amounts payable by the insurance 
company under the contract are more likely than not to exceed the 
amounts guaranteed under the contract.
---------------------------------------------------------------------------

    \67\ See, e.g., CAI 151A Letter, supra note 54; Old Mutual 
Letter, supra note 54; Sammons Letter, supra note 54.
    \68\ Securities Act Release No. 6645, supra note 35.
---------------------------------------------------------------------------

    Some commenters criticized the Commission for failing to adequately 
address a federal district court decision, Malone v. Addison Ins. 
Marketing, Inc. (``Malone''),\69\ where the court

[[Page 3147]]

determined that a particular indexed annuity was entitled to rely on 
Section 3(a)(8).\70\ We disagree with the Malone court's analysis of 
investment risk, which, we believe, understated the investment risk to 
the purchaser of an indexed annuity from the fluctuating and uncertain 
securities-linked return and therefore is inconsistent with applicable 
legal precedent. We also disagree with the court's interpretation of 
the Commission's rule 151 safe harbor, which does not apply to indexed 
annuities. As we discussed in the proposing release, in that case, the 
district court concluded that the contracts at issue fell within the 
Commission's rule 151 safe harbor notwithstanding the fact that they 
apparently did not meet the test articulated by the Commission in 
adopting rule 151, i.e., specifying an index that would be used to 
determine a rate that would remain in effect for at least one year.\71\ 
Instead, the contracts appear to have guaranteed the index-based 
formula, but not, as required by rule 151, the actual rate of interest.
---------------------------------------------------------------------------

    \69\ 225 F.Supp. 2d 743 (W.D. Ky. 2002).
    \70\ See, e.g., Coalition Letter, supra note 54; NAFA Letter, 
supra note 54; Sammons Letter, supra note 54.
    \71\ See supra note 38.
---------------------------------------------------------------------------

Need for Federal Securities Regulation
    Some commenters agreed that federal securities regulation is needed 
with respect to indexed annuities.\72\ Other commenters questioned the 
need for federal securities regulation of indexed annuities, and we 
disagree with those commenters. These commenters argued, first, that 
there is no evidence of widespread sales practice abuse in the indexed 
annuity marketplace, which would suggest a need for federal securities 
regulation.\73\ Second, commenters argued that state insurance 
regulators are effective in protecting purchasers of indexed 
annuities.\74\ Third, commenters argued that the Commission's 
disclosure requirements would not result in enhanced information flow 
to purchasers of indexed annuities.\75\
---------------------------------------------------------------------------

    \72\ See, e.g., Letter of Joseph P. Borg, Director, Alabama 
Securities Commission (Aug. 5, 2008) (``Alabama Letter''); Cornell 
Letter, supra note 7; Letter of Financial Planning Association 
(Sept. 10, 2008) (``FPA Letter''); FINRA Letter, supra note 7; 
Hartford Letter, supra note 55; ICI Letter, supra note 7; Letter of 
Max Maxfield, Secretary of State, State of Wyoming (Sept. 9, 2008) 
(``Wyoming Letter'').
    \73\ See, e.g., American Equity Letter, supra note 54; Coalition 
Letter, supra note 54; Letter of FBL Financial Group (Sept. 8, 2008) 
(``FBL Letter''); Lafayette Letter, supra note 54; Maryland Letter, 
supra note 54; NAIFA Letter, supra note 54; Sammons Letter, supra 
note 54.
    \74\ See, e.g., Allianz Letter, supra note 54; Academy Letter, 
supra note 54; Letter of American Bankers Insurance Association 
(Sept. 10, 2008) (``American Bankers Letter''); American Equity 
Letter, supra note 54; American National Letter, supra note 54; 
Aviva Letter, supra note 54; Coalition Letter, supra note 54; Letter 
of Connecticut Insurance Commissioner (Aug. 25, 2008) (``Connecticut 
Letter''); Letter of Iowa Insurance Commissioner (Sept. 10, 2008) 
(``Iowa Letter''); Maryland Letter, supra note 54; NAFA Letter, 
supra note 54; NAIC Officer Letter, supra note 54; NAIFA Letter, 
supra note 54; National Western Letter, supra note 54; Old Mutual 
Letter, supra note 54; Sammons Letter, supra note 54; Transamerica 
Letter, supra note 54.
    \75\ See, e.g., Allianz Letter, supra note 54; Aviva Letter, 
supra note 54.
---------------------------------------------------------------------------

    We believe that the commenters who argued that regulation of 
indexed annuities under the federal securities laws is unnecessary 
because there is no evidence of widespread sales abuse misunderstand 
the exemption under Section 3(a)(8) of the Securities Act as well as 
our purpose in proposing, and now adopting, rule 151A. Some of these 
commenters cited data that they argued demonstrated that the incidence 
of abuse in the indexed annuity marketplace is low.\76\ Some of these 
commenters argued that the proposing release failed to present 
persuasive evidence of sales practice abuse.\77\
---------------------------------------------------------------------------

    \76\ See, e.g., Advantage Group Letter, supra note 54; American 
Equity Letter, supra note 54; Maryland Letter, supra note 54; NAIFA 
Letter, supra note 54; Letter of Old Mutual Financial Network (Nov. 
12, 2008) (``Second Old Mutual Letter''); Letter Type A (``Letter 
A''); Letter Type E (``Letter E''). ``Letter Type'' refers to a form 
letter submitted by multiple commenters, which is listed on the 
Commission's Web site (http://www.sec.gov/comments/s7-14-08/s71408.shtml) as a single comment, with a notation of the number of 
letters received by the Commission matching that form type.
    \77\ See, e.g., American Equity Letter, supra note 54; FBL 
Letter supra note 73; Maryland Letter, supra note 54; NAIFA Letter, 
supra note 54; Old Mutual Letter, supra note 54; Sammons Letter, 
supra note 54; Second National Western Letter, supra note 63.
---------------------------------------------------------------------------

    A vital aspect of the Commission's mission is investor protection. 
As a result, reports of sales practice abuses surrounding a product, 
indexed annuities, whose status has long been unresolved under the 
federal securities laws, are a matter of grave concern to us. However, 
the presence or absence of sales practice abuses is irrelevant in 
determining whether an annuity contract is entitled to the exemption 
from federal securities regulation under Section 3(a)(8) of the 
Securities Act. Where an annuity contract is entitled to the Section 
3(a)(8) exemption, the federal securities laws do not apply, and 
purchasers are not entitled to their protections, regardless of whether 
sales practice abuses may be pervasive. Where, however, an annuity 
contract is not entitled to the Section 3(a)(8) exemption, which we 
have concluded is the case with respect to certain indexed annuities, 
Congress intended that the federal securities laws apply, and 
purchasers are entitled to the disclosure and suitability protections 
under those laws without regard to whether there is a single documented 
incident of abuse.
    This view is consistent with applicable precedent which makes clear 
that the necessity for federal regulation arises from the 
characteristics of the financial instrument itself. This has been the 
approach of the United States Supreme Court in the two leading 
precedents. In those cases, the Court made a realistic judgment about 
the point at which a contract between a purchaser and an insurance 
company tips from being the sole concern of state regulators of 
insurance to also become the concern of the federal securities laws.
    The United Benefit Court observed that the products at issue in 
that case were ``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.'' \78\ They were 
``pitched to the same consumer interest in growth through 
professionally managed investment,'' and, as a result, the Court 
concluded that it seemed ``eminently fair that a purchaser of such a 
plan be afforded the same advantages of disclosure which inure to a 
mutual fund purchaser under Section 5 of the Securities Act.'' \79\
---------------------------------------------------------------------------

    \78\ United Benefit, supra note 8, 387 U.S. at 211.
    \79\ Id.
---------------------------------------------------------------------------

    The United Benefit decision picked up and extended a theme 
previously discussed in Justice Brennan's concurring opinion in VALIC. 
Justice Brennan examined the differing nature of state regulation of 
insurance and federal regulation of the securities markets. He looked 
at the nature of the obligation the insurer assumed and its connection 
to the regulation of investment policy. He concluded that there came a 
point when the ``contract between the investor and the organization no 
longer squares with the sort of contract in regard to which Congress in 
1933 thought its `disclosure' statute was unnecessary.'' \80\
---------------------------------------------------------------------------

    \80\ VALIC, supra note 8, 359 U.S. at 72.
---------------------------------------------------------------------------

    It is precisely this realistic judgment about identifying the 
appropriate circumstances in which to apply the disclosure and other 
regulatory protections of the federal securities laws that rule 151A 
makes. That is why the rule adopts the principle that an indexed 
annuity providing for a combination of minimum guaranteed payments plus 
a potentially higher payment dependent on the performance of a 
securities index does not qualify for the insurance exclusion in 
Section

[[Page 3148]]

3(a)(8) when the amounts payable by the insurer under the contact are 
more likely than not to exceed the amounts guaranteed under the 
contract.
    Our intent in adopting rule 151A is to clarify the status of 
indexed annuities under the federal securities laws, so that purchasers 
of these products receive the protections to which they are entitled by 
federal law and so that issuers and sellers of these products are not 
subject to uncertainty and litigation risk with respect to the laws 
that are applicable. We expect that clarity will enhance investor 
protection in the future, and indeed will help prevent future sales 
practice abuses, but rule 151A is not based on the perception that 
there are widespread sales abuses in the indexed annuity marketplace. 
Rather, the rule is intended to address an uncertain area of the law, 
which, because of the growth of the indexed annuity market and 
allegations of sales practice abuses, has become of pressing 
importance.
    A number of commenters cited efforts by state insurance regulators 
to address disclosure and sales practice concerns with respect to 
indexed annuities as evidence that federal securities regulation is 
unnecessary and could result in duplicative or overlapping 
regulation.\81\ Commenters argued that state regulation extends beyond 
overseeing solvency and adequacy of the insurers' reserves, and that it 
is also addressed to investor protection issues such as suitability and 
disclosure.\82\ Commenters cited, in particular, the NAIC Suitability 
in Annuity Transactions Model Regulation,\83\ which has been adopted in 
35 states,\84\ and its adoption by the majority of states as evidence 
that states are addressing suitability concerns in connection with 
indexed annuity sales.\85\ Commenters also noted that a number of 
states have adopted the NAIC Annuity Disclosure Model Regulation,\86\ 
which has been adopted in 22 states and which requires delivery of 
certain disclosure documents regarding indexed annuity contracts.\87\ 
Commenters also cited the existence of state market conduct 
examinations, the use of state enforcement and investigative authority, 
and licensing and education requirements applicable to insurance agents 
who sell indexed annuities.\88\
---------------------------------------------------------------------------

    \81\ See, e.g., Allianz Letter, supra note 54; American Bankers 
Letter, supra note 74; American Equity Letter, supra note 54; FBL 
Letter supra note 73; Maryland Letter, supra note 54; NAFA Letter, 
supra note 54; Letter of National Association of Health Underwriters 
(Sept. 10, 2008) (``Health Underwriters Letter''); National Western 
Letter, supra note 54; Letter of Vermont Department of Banking, 
Insurance, Securities and Health Care Administration (Nov. 17, 
2008).
    \82\ See, e.g., Allianz Letter, supra note 54; American Equity 
Letter, supra note 54; Aviva Letter, supra note 54; Coalition 
Letter, supra note 54; Maryland Letter, supra note 54; NAFA Letter, 
supra note 54; NAIFA Letter, supra note 54; National Western Letter, 
supra note 54; Old Mutual Letter, supra note 54; Sammons Letter, 
supra note 54.
    \83\ NAIC Suitability in Annuity Transactions Model Regulation 
(Model 275-1) (2003).
    \84\ National Association of Insurance Commissioners, Draft 
Model Summaries, available at: http://www.naic.org/committees_models.htm.
    \85\ See, e.g., Letter A, supra note 76; American Bankers 
Letter, supra note 74; CAI 151A Letter, supra note 54; NAFA Letter, 
supra note 54; NAIC Officer Letter, supra note 54; NAIFA Letter, 
supra note 54.
    \86\ NAIC Annuity Disclorues Model Regulation (Model 245-1) 
(1998).
    \87\ See, e.g., Aviva Letter, supra note 54; CAI 151A Letter, 
supra note 54; NAFA Letter, supra note 54; NAIC Officer Letter, 
supra note 54; NAIFA Letter, supra note 54.
    \88\ See, e.g., American Equity Letter, supra note 54; Aviva 
Letter, supra note 54; Coalition Letter, supra note 54; Maryland 
Letter, supra note 54; NAIC Officer Letter, supra note 54; NAFA 
Letter, supra note 54.
---------------------------------------------------------------------------

    Commenters described a number of recent and ongoing efforts by 
state insurance regulators. Some commenters cited efforts being 
undertaken by individual states. For example, commenters cited an Iowa 
regulation which recently became effective requiring that agents 
receive indexed product training approved by the Iowa Insurance 
Division before they can sell indexed annuity products.\89\ In 
addition, commenters stated that Iowa has partnered with the American 
Council of Life Insurers (``ACLI'') to operate a one-year pilot project 
with some ACLI members using templates developed for disclosure 
regarding indexed annuities, with the goal of assuring uniformity among 
insurers in the preparation of disclosure documents.\90\ Commenters 
also noted recent efforts by state regulators addressed to annuities 
generally, such as the creation of NAIC working groups to review and 
consider possible improvements to the NAIC Suitability in Annuity 
Transactions Model Regulation and the NAIC Annuity Disclosure Model 
Regulation.\91\
---------------------------------------------------------------------------

    \89\ See, e.g., Aviva Letter, supra note 54; Iowa Letter, supra 
note 74; NAIC Officer Letter, supra note 54.
    \90\ See, e.g., Iowa Letter, supra note 74; NAIC Officer Letter, 
supra note 54.
    \91\ See, e.g., NAIC Officer Letter, supra note 54.
---------------------------------------------------------------------------

    We applaud the efforts in recent years of state insurance 
regulators to address sales practice complaints that have arisen with 
respect to indexed annuities, and it is not our intention to question 
the effectiveness of state regulation. Nonetheless, we do not believe 
that the states' regulatory efforts, no matter how strong, can 
substitute for our responsibility to identify securities covered by the 
federal securities laws and the protections Congress intended to apply. 
State insurance laws, enforced by multiple regulators whose primary 
charge is the solvency of the issuing insurance company, cannot serve 
as an adequate substitute for uniform, enforceable investor protections 
provided by the federal securities laws. Indeed, at least one state 
insurance regulator acknowledged the developmental nature of state 
efforts and the lack of uniformity in those efforts.\92\ Where the 
purchaser of an indexed annuity assumes the investment risk of an 
instrument that fluctuates with the securities markets, and the 
contract therefore does not fall within the Section 3(a)(8) exemption, 
the application of state insurance regulation, no matter how effective, 
is not determinative as to whether the contract is subject to the 
federal securities laws.
---------------------------------------------------------------------------

    \92\ See Voss Letter, supra note 13 (proposing to accelerate 
NAIC efforts to strengthen the NAIC model laws affecting indexed 
annuity products and urge adoption by more of the member states).
---------------------------------------------------------------------------

    Some commenters also cited voluntary measures taken by insurance 
companies, such as suitability reviews and the provision of plain 
English disclosures, as a reason why federal securities regulation of 
indexed annuities is unnecessary.\93\ While these voluntary measures 
are commendable, they are not a substitute for the provisions of the 
federal securities laws that Congress mandated.
---------------------------------------------------------------------------

    \93\ See, e.g., Allianz Letter, supra note 54; American Equity 
Letter, supra note 54; Letter of R. Preston Pitts (Sept. 10, 2008) 
(``Pitts Letter''); Sammons Letter, supra note 54; Karlan Tucker, 
Tucker Advisory Group, Inc. (Sept. 10, 2008) (``Tucker Letter'').
---------------------------------------------------------------------------

    Finally, we note that some commenters argued that regulation of 
indexed annuities by the Commission would not enhance investor 
protection, in particular because the Commission's disclosure scheme is 
not tailored to these contracts.\94\ Commenters cited a number of 
factors, including the lack of a registration form that is well-suited 
to indexed annuities, questions about the appropriate method of 
accounting to be used by insurance companies that issue indexed 
annuities, questions about advertising restrictions that may apply 
under the federal securities laws, and concerns about parity of the 
registration process vis-[agrave]-vis mutual funds. We acknowledge 
that, as a result of indexed annuity issuers having historically 
offered and sold their contracts without

[[Page 3149]]

complying with the federal securities laws, the Commission has not 
created specific disclosure requirements tailored to these products. 
This fact, though, is not relevant in determining whether indexed 
annuities are subject to the federal securities laws. The Commission 
has a long history of creating appropriate disclosure requirements for 
different types of securities, including securities issued by insurance 
companies, such as variable annuities and variable life insurance.\95\ 
We note that we are providing a two-year transition period for rule 
151A, and, during this period, we intend to consider how to tailor 
disclosure requirements for indexed annuities. We encourage indexed 
annuity issuers to work with the Commission during that period to 
address their concerns.
---------------------------------------------------------------------------

    \94\ See, e.g., Letter of American Council of Life Insurers 
(Sep. 19, 2008) (``ACLI Letter''); Allianz Letter, supra note 54; 
Aviva Letter, supra note 54; CAI 151A Letter, supra note 54; 
National Western Letter, supra note 54; Sammons Letter, supra note 
54; Transamerica Letter, supra note 54.
    \95\ See Form N-4 [17 CFR 239.17b and 274.11c] (registration 
form for variable annuities); Form N-6 [17 CFR 239.17c and 274.11d] 
(registration form for variable life insurance).
---------------------------------------------------------------------------

3. Definition
Scope of the Definition
    Rule 151A will apply, as proposed, to a contract that is issued by 
a corporation subject to the supervision of the insurance commissioner, 
bank commissioner, or any agency or officer performing like functions, 
of any State or Territory of the United States or the District of 
Columbia.\96\ This language is the same language used in Section 
3(a)(8) of the Securities Act. Thus, the insurance companies covered by 
the rule are the same as those covered by Section 3(a)(8).
---------------------------------------------------------------------------

    \96\ Rule 151A(a).
---------------------------------------------------------------------------

    In addition, in order to be covered by the rule, a contract must be 
subject to regulation as an annuity under state insurance law.\97\ The 
rule will not apply to contracts that are regulated under state 
insurance law as life insurance, health insurance, or any form of 
insurance other than an annuity, and it does not apply to any contract 
issued by an insurance company if the contract itself is not subject to 
regulation under state insurance law.\98\ Thus, rule 151A itself will 
not apply to indexed life insurance policies,\99\ in which the cash 
value of the policy is credited with a guaranteed minimum return and a 
securities-linked return. The status of an indexed life insurance 
policy under the federal securities laws will continue to be a facts 
and circumstances determination, undertaken by reference to the factors 
and analysis that have been articulated by the Supreme Court and the 
Commission. We note, however, that the considerations that form the 
basis for rule 151A are also relevant in analyzing indexed life 
insurance because indexed life insurance and indexed annuities share 
certain features (e.g., securities-linked returns).
---------------------------------------------------------------------------

    \97\ Id. We note that the majority of states include in their 
insurance laws provisions that define annuities. See, e.g., ALA. 
CODE Sec.  27-5-3 (2008); CAL. INS. CODE Sec.  1003 (West 2007); 
N.J. ADMIN. CODE tit. 11, Sec.  4-2.2 (2008); N.Y. INS. LAW Sec.  
1113 (McKinney 2008). Those states that do not expressly define 
annuities typically have regulations in place that address 
annuities. See, e.g., Iowa Admin. Code Sec.  191-15.70 (5078) 
(2008); Kan. Admin. Regs. Sec.  40-2-12 (2008); Minn. Stat. Sec.  
61B.20 (2007); Miss. Code Ann. Sec.  83-1-151 (2008).
    \98\ One commenter was concerned that rule 151A might apply to a 
certain type of health insurance contract, where some portion of any 
favorable financial experience of the insurer is refunded to the 
insured.'' Letter of America's Health Insurance Plans (Sep. 10, 
2008) (``AHIP Letter''). Rule 151A will not apply to contracts that 
are regulated under state insurance law as health insurance.
    \99\ See, e.g., Aviva Letter, supra note 54; Sammons Letter, 
supra note 54 (requesting clarification that rule 151A does not 
apply to indexed life insurance policies).
---------------------------------------------------------------------------

    The adopted rule, like the proposed rule, expressly states that it 
does not apply to any contract whose value varies according to the 
investment experience of a separate account.\100\ The effect of this 
provision is to eliminate variable annuities from the scope of the 
rule.\101\ It has long been established that variable annuities are not 
entitled to the exemption under Section 3(a)(8) of the Securities Act, 
and, accordingly, the new definition does not cover them or affect 
their regulation in any way.\102\
---------------------------------------------------------------------------

    \100\ Rule 151A(d).
    \101\ The assets of a variable annuity are held in a separate 
account of the insurance company that is insulated for the benefit 
of the variable annuity owners from the liabilities of the insurance 
company, and amounts paid to the owner under a variable annuity vary 
according to the investment experience of the separate account. See 
Black and Skipper, supra note 39, at 174-77 (2000).
    \102\ See, e.g., VALIC, supra note 8, 359 U.S. 65; United 
Benefit, supra note 8, 387 U.S. 202. In addition, an insurance 
company separate account issuing variable annuities is an investment 
company under the Investment Company Act of 1940. See Prudential 
Ins. Co. of Am. v. SEC, 326 F.2d 383 (3d Cir. 1964).
---------------------------------------------------------------------------

Definition of ``Annuity Contract'' and ``Optional Annuity Contract''
    We are adopting, with modifications to address commenters' 
concerns, the proposal that an annuity issued by an insurance company 
would not be an ``annuity contract'' or an ``optional annuity 
contract'' under Section 3(a)(8) of the Securities Act if the annuity 
has two characteristics. As adopted, those characteristics are as 
follows. First, the contract specifies that amounts payable by the 
insurance company under the contract are calculated at or after the end 
of one or more specified crediting periods, in whole or in part, by 
reference to the performance during the crediting period or periods of 
a security, including a group or index of securities.\103\ Second, 
amounts payable by the insurance company under the contract are more 
likely than not to exceed the amounts guaranteed under the 
contract.\104\
---------------------------------------------------------------------------

    \103\ Rule 151A(a)(1).
    \104\ Rule 151A(a)(2).
---------------------------------------------------------------------------

Annuities Subject to Rule 151A
    The first characteristic, as proposed and as adopted, is intended 
to describe indexed annuities, which are the subject of the rule. As 
proposed, this characteristic would simply have required that amounts 
payable by the insurance company under the contract are calculated, in 
whole or in part, by reference to the performance of a security, 
including a group or index of securities.\105\ We have modified this 
characteristic to address the concern expressed by many commenters 
that, as proposed, the first characteristic was overly broad and would 
reach annuities that were not indexed annuities.\106\ Commenters were 
concerned that the rule could, for example, be interpreted as extending 
to traditional fixed annuities, where amounts payable under the 
contract accumulate at a fixed interest rate, or to discretionary 
excess interest contracts, where amounts payable under the contract may 
include a discretionary excess interest component over and above the 
guaranteed minimum interest rate offered under the contract.\107\ With 
both traditional fixed annuities and discretionary excess interest 
contracts, the interest rates are often based, at least in part, on the 
performance of the securities held by the insurer's general account.
---------------------------------------------------------------------------

    \105\ Proposed rule 151A(a)(1).
    \106\ See, e.g., ACLI Letter, supra note 94; Allianz Letter, 
supra note 54; Aviva Letter, supra note 54; Letter of AXA Equitable 
Life Insurance Company (Sept. 10, 2008) (``AXA Equitable Letter''); 
Letter of Financial Services Institute (Sept. 10, 2008) (``FSI 
Letter''); CAI 151A Letter, supra note 54; Hartford Letter, supra 
note 55; NAFA Letter, supra note 54; NAIFA Letter, supra note 54; 
Letter of NAVA (Sept. 10, 2008) (``NAVA Letter''); Old Mutual 
Letter, supra note 54; Sammons Letter, supra note 54; Second Academy 
Letter, supra note 54; Transamerica Letter, supra note 54.
    \107\ See, e.g., Letter of Association for Advanced Life 
Underwriting (Oct. 31, 2008); AXA Equitable Letter, supra note 106.
---------------------------------------------------------------------------

    The modified language of the first characteristic addresses 
commenters' concerns in three ways. First, the language requires that 
the contract itself specify that amounts payable by the insurance 
company are calculated by reference to the performance of a security. 
Thus, a contract will not be covered by the proposed rule unless the 
insurance company is contractually bound to pay amounts that are

[[Page 3150]]

dependent upon the performance of a security. While an insurance 
company may, in fact, look to the performance of the securities in its 
general account in, for example, establishing the rate to be paid under 
a traditional fixed annuity, such a contract does not itself obligate 
the insurer to do so or undertake in any way that the purchaser will 
receive payments that are linked to the performance of any security. 
Second, the language requires that the amounts payable by the insurance 
company be calculated at or after the end of one or more specified 
crediting periods by reference to the performance during the crediting 
period of a security. That is, in order to be covered by the rule, an 
annuity contract must provide that the amount to be paid with respect 
to a crediting period is determined retrospectively, by reference to 
the performance during the period of a security. This retrospective 
determination of amounts to be paid is characteristic of indexed 
annuities and eliminates from the scope of the rule discretionary 
excess interest contracts, pursuant to which a specified interest rate 
may be established by reference to the past performance of a security 
or securities and applied on a prospective basis with respect to a 
future crediting period. Third, limiting the rule to contracts where 
the amount payable is determined retrospectively addresses the concerns 
of the commenters that the rule, as proposed, could reach annuity 
contracts covered by the rule 151 safe harbor.\108\ As explained above, 
contracts where the amount payable is determined retrospectively do not 
fall within rule 151.\109\
---------------------------------------------------------------------------

    \108\ AXA Equitable Letter, supra note 106; Hartford Letter, 
supra note 55; ICI Letter, supra note 7; K&L Gates Letter, supra 
note 54.
    \109\ See supra note 38 and accompanying text.
---------------------------------------------------------------------------

    Rule 151A, like the proposed rule, will apply whenever any amounts 
payable under the contract under any circumstances, including full or 
partial surrender, annuitization, or death, satisfy the first 
characteristic of the rule. If, for example, a contract specifies that 
the amount payable under a contract upon a full surrender is not 
calculated at or after the end of one or more specified crediting 
periods by reference to the performance during the period or periods of 
a security, but the amount payable upon annuitization is so calculated, 
then the contract would need to be analyzed under the rule. As another 
example, if a contract specifies that amounts payable under the 
contract are partly fixed in amount and partly dependent on the 
performance of a security in the manner specified by the rule, the 
contract would need to be analyzed under the rule.
    We note that, like the proposal, rule 151A applies to contracts 
under which amounts payable are calculated by reference to the 
performance of a security, including a group or index of securities. 
Thus, the rule, by its terms, applies to indexed annuities but also to 
other similar annuities where the contract specifies that amounts 
payable are retrospectively calculated by reference to a single 
security or any group of securities.\110\ The federal securities laws, 
and investors' interests in full and fair disclosure and sales practice 
protections, are equally implicated, whether amounts payable under an 
annuity are retrospectively calculated by reference to a securities 
index, another group of securities, or a single security.
---------------------------------------------------------------------------

    \110\ A commenter inquired whether an annuity product whose 
returns were indexed to the consumer price index, a real estate 
index, or a commodities index would be considered a security. Letter 
of Meaghan L. McFadden (Aug. 13, 2008). Rule 151A, by its terms, 
does not apply to such an annuity.
---------------------------------------------------------------------------

    The term ``security'' in rule 151A has the same broad meaning as in 
Section 2(a)(1) of the Securities Act. Rule 151A does not define the 
term ``security,'' and our existing rules provide that, unless 
otherwise specifically provided, the terms used in the rules and 
regulations under the Securities Act have the same meanings defined in 
the Act.\111\
---------------------------------------------------------------------------

    \111\ 17 CFR 230.100(b).
---------------------------------------------------------------------------

``More Likely Than Not'' Test
    The second characteristic sets forth the test that would define a 
class of indexed annuity contracts that are not ``annuity contracts'' 
or ``optional annuity contracts'' under the Securities Act and that, 
therefore, are not entitled to the Section 3(a)(8) exemption. As 
adopted, the second characteristic defines that class to include those 
contracts where the amounts payable by the insurance company under the 
contract are more likely than not to exceed the amounts guaranteed 
under the contract.
    We are adopting the second characteristic as proposed. As explained 
above, by purchasing such an indexed annuity, the purchaser assumes the 
risk of an uncertain and fluctuating financial instrument, in exchange 
for exposure to future, securities-linked returns. As a result, the 
purchaser assumes many of the same risks that investors assume when 
investing in mutual funds, variable annuities, and other securities. 
The rule that we are adopting will provide the purchaser of such an 
annuity with the same protections that are provided under the federal 
securities laws to other investors who participate in the securities 
markets, including full and fair disclosure regarding the terms of the 
investment and the significant risks that he or she is assuming, as 
well as protections from abusive sales practices and the recommendation 
of unsuitable transactions. Some commenters raised concerns about the 
proposed rule's treatment of de minimis amounts of securities-linked 
returns.\112\ These commenters suggested that the smaller the amount of 
securities-linked return, the less investment risk is assumed by the 
purchaser, and the more is assumed by the insurer. In particular, 
commenters suggested that where the securities-linked return is de 
minimis the purchaser does not assume the primary investment risk under 
the contract.\113\ However, based on our current understanding, we 
believe that almost all current indexed annuity contracts provide for 
securities-linked returns that are more likely than not to exceed a de 
minimis amount in excess of the guaranteed return. Nevertheless, in the 
case of an indexed annuity contract that is more likely than not to 
provide only a de minimis securities-linked return in excess of the 
guaranteed return, the Commission and the staff would be prepared to 
consider a request for relief, if appropriate.
---------------------------------------------------------------------------

    \112\ See, e.g., CAI 151A Letter, supra note 54; National 
Western Letter, supra note 54; Sammons, supra note 54.
    \113\ See, e.g., CAI 151A Letter, supra note 54; National 
Western Letter, supra note 54; Sammons, supra note 54.
---------------------------------------------------------------------------

    Under rule 151A, amounts payable by the insurance company under a 
contract will be more likely than not to exceed the amounts guaranteed 
under the contract if this is the expected outcome more than half the 
time. In order to determine whether this is the case, it will be 
necessary to analyze expected outcomes under various scenarios 
involving different facts and circumstances. In performing this 
analysis, the amounts payable by the insurance company under any 
particular set of facts and circumstances will be the amounts that the 
purchaser \114\ would be entitled to receive from the insurer under 
those facts and circumstances. The facts and circumstances include, 
among other things, the particular features of the annuity contract 
(e.g., the relevant index, participation rate, and other features), the 
particular options selected

[[Page 3151]]

by the purchaser (e.g., surrender or annuitization), and the 
performance of the relevant securities benchmark (e.g., in the case of 
an indexed annuity, the performance of the relevant index, such as the 
Dow Jones Industrial Average, Lehman Brothers Aggregate U.S. Index, 
Nasdaq 100 Index, or Standard & Poor's 500 Composite Stock Price 
Index). The amounts guaranteed under a contract under any particular 
set of facts and circumstances will be the minimum amount that the 
insurer would be obligated to pay the purchaser under those facts and 
circumstances without reference to the performance of the security that 
is used in calculating amounts payable under the contract. Thus, if an 
indexed annuity, in all circumstances, guarantees that, on surrender, a 
purchaser will receive 87.5% of an initial purchase payment, plus 1% 
interest compounded annually, and that any additional payout will be 
based exclusively on the performance of a securities index, the amount 
guaranteed after 3 years will be 90.15% of the purchase payment (87.5% 
x 1.01 x 1.01 x 1.01).
---------------------------------------------------------------------------

    \114\ For simplicity, we are referring to payments to the 
purchaser. The rule, however, references payments by the insurer 
without reference to a specified payee. In performing the analysis, 
payments to any payee, including the purchaser, annuitant, and 
beneficiaries, must be included.
---------------------------------------------------------------------------

Determining Whether an Annuity Is Not an ``Annuity Contract'' or 
``Optional Annuity Contract'' Under Rule 151A
    We are adopting, with modifications to address commenters' 
concerns, the provisions of proposed rule 151A that address the manner 
in which a determination will be made regarding whether amounts payable 
by the insurance company under a contract are more likely than not to 
exceed the amounts guaranteed under the contract. Rule 151A is 
principles-based, providing that a determination made by the insurer at 
or prior to issuance of a contract will be conclusive, provided that: 
(i) Both the insurer's methodology and the insurer's economic, 
actuarial, and other assumptions are reasonable; (ii) the insurer's 
computations are materially accurate; and (iii) the determination is 
made not earlier than six months prior to the date on which the form of 
contract is first offered.\115\ We have eliminated the proposed 
requirement that the insurer's determination be made not more than 
three years prior to the date on which a particular contract is issued. 
The rule specifies the treatment of charges that are imposed at the 
time of payments under the contract by the insurer, and we have 
modified the proposal in order to provide for consistent treatment of 
these charges in computing both amounts payable by the insurance 
company and amounts guaranteed under the contract.\116\
---------------------------------------------------------------------------

    \115\ Rule 151A(b)(2).
    \116\ Rule 151A(b)(1).
---------------------------------------------------------------------------

    We are adopting this principles-based approach because we believe 
that an insurance company should be able to evaluate anticipated 
outcomes under an annuity that it issues. We believe that many insurers 
routinely undertake similar analyses for purposes of pricing and 
valuing their contracts.\117\ In addition, we believe that it is 
important to provide reasonable certainty to insurers with respect to 
the application of the rule and to preclude an insurer's determination 
from being second guessed, in litigation or otherwise, in light of 
actual events that may differ from assumptions that were reasonable 
when made.
---------------------------------------------------------------------------

    \117\ See generally Black and Skipper, supra note 39, at 26-47, 
890-99. Several commenters who issue indexed annuities disputed that 
insurers undertake these analyses. See, e.g., American Equity 
Letter, supra note 54; National Western Letter, supra note 54; 
Sammons Letter, supra note 54. Other commenters, however, confirmed 
that these analytical methods exist and are used by insurers for 
internal purposes. See, e.g., Aviva Letter, supra note 54; Academy 
Letter, supra note 54. We give substantial weight to the views of 
the American Academy of Actuaries (``Academy'') on this point, given 
their expertise in this type of analysis, and are not persuaded that 
the contrary comments of several issuers are representative of 
industry practice. See Black's Law Dictionary 39 (8th ed. 2004) (An 
actuary is a statistician who determines the present effects of 
future contingent events and who calculates insurance and pension 
rates on the basis of empirically based tables.); American Academy 
of Actuaries, Mission, available at: http://www.actuary.org/mission.asp (The mission of the Academy is to, among other things, 
provide independent and objective actuarial information, analysis, 
and education for the formation of sound public policy.).
---------------------------------------------------------------------------

    As with all exemptions from the registration and prospectus 
delivery requirements of the Securities Act, the party claiming the 
benefit of the exemption--in this case, the insurer--bears the burden 
of proving that the exemption applies.\118\ Thus, an insurer that 
believes an indexed annuity is entitled to the exemption under Section 
3(a)(8) based, in part, on a determination made under the rule will--if 
challenged in litigation--be required to prove that its methodology and 
its economic, actuarial, and other assumptions were reasonable, and 
that the computations were materially accurate.
---------------------------------------------------------------------------

    \118\ See, e.g., SEC v. Ralston Purina, 346 U.S. 119, 126 (1953) 
(an issuer claiming an exemption under Section 4 of the Securities 
Act carries the burden of showing that the exemption applies).
---------------------------------------------------------------------------

    The rule provides that an insurer's determination under the rule 
will be conclusive only if it is made at or prior to issuance of the 
contract. Rule 151A is intended to provide certainty to both insurers 
and investors, and we believe that this certainty will be undermined 
unless insurance companies undertake the analysis required by the rule 
no later than the time that an annuity is issued. The rule also 
provides that, for an insurer's determination to be conclusive, the 
computations made by the insurance company in support of the 
determination must be materially accurate. An insurer should not be 
permitted to rely on a determination of an annuity's status under the 
rule that is based on computations that are materially inaccurate. For 
this purpose, we intend that computations will be considered to be 
materially accurate if any computational errors do not affect the 
outcome of the insurer's determination as to whether amounts payable by 
the insurer under the contract are more likely than not to exceed the 
amounts guaranteed under the contract.
    In order for an insurer's determination to be conclusive, both the 
methodology and the economic, actuarial, and other assumptions used 
must be reasonable. We recognize that a range of methodologies and 
assumptions may be reasonable and that a reasonable methodology or 
assumption utilized by one insurer may differ from a reasonable 
assumption or methodology selected by another insurer. In determining 
whether an insurer's methodology is reasonable, it is appropriate to 
look to methods commonly used for pricing, valuing, and hedging similar 
products in insurance and derivatives markets.
    An insurer will need to make assumptions in several areas, 
including assumptions about (i) insurer behavior, (ii) purchaser 
behavior, and (iii) market behavior, and will need to assign 
probabilities to various potential behaviors. With regard to insurer 
behavior, the insurer will need to make assumptions about discretionary 
actions that it may take under the terms of an annuity. In the case of 
an indexed annuity, for example, an insurer often has discretion to 
modify various features, such as guaranteed interest rates, caps, 
participation rates, and spreads. Similarly, the insurer will need to 
make assumptions concerning purchaser behavior, including matters such 
as how long purchasers will hold a contract, how they will allocate 
contract value among different investment options available under the 
contract, and the form in which they will take payments under the 
contract. Assumptions about market behavior will include assumptions 
about expected return, market volatility, and interest rates. In 
general, insurers will need to make assumptions about any feature of 
insurer, purchaser, or market behavior, or any other factor, that is

[[Page 3152]]

material in determining the likelihood that amounts payable under the 
contract exceed the amounts guaranteed.
    In determining whether assumptions are reasonable, insurers should 
generally be guided by both history and their own expectations about 
the future. An insurer may look to its own, and to industry, experience 
with similar or otherwise comparable contracts in constructing 
assumptions about both insurer behavior and investor behavior. In 
making assumptions about future market behavior, an insurer may be 
guided, for example, by historical market characteristics, such as 
historical returns and volatility, provided that the insurer bases its 
assumptions on an appropriate period of time and does not have reason 
to believe that the time period chosen is likely to be 
unrepresentative. As a general matter, assumptions about insurer, 
investor, or market behavior that are not consistent with historical 
experience would not be reasonable unless an insurer has a reasonable 
basis for any differences between historical experience and the 
assumptions used.
    In addition, an insurer may look to its own expectations about the 
future in constructing reasonable assumptions. As noted above, insurers 
routinely analyze anticipated outcomes for purposes of pricing and 
valuing their contracts. We expect that, in making a determination 
under rule 151A, an insurer will use assumptions that are consistent 
with the assumptions that it uses for other purposes, such as pricing 
and valuation. In addition, an insurer generally should use assumptions 
that are consistent with its marketing materials. In general, 
assumptions that are inconsistent with the assumptions that an insurer 
uses for other purposes will not be reasonable under rule 151A.
    As noted above, we are adopting a principles-based approach because 
we believe that it will provide reasonable certainty to insurers with 
respect to the application of the rule. We recognize, however, that a 
number of commenters expressed concern that the principles-based 
approach provides insufficient guidance regarding implementation and 
the methodologies and assumptions that are appropriate and could result 
in inconsistent determinations by different insurance companies and 
present enforcement and litigation risk.\119\ Some commenters suggested 
that the Commission address these concerns by providing guidance as to 
how to make the determination under the rule, which, they asserted, 
could result in greater uniformity and consistency in the application 
of the rule.\120\ While we believe that further guidance may, indeed, 
be helpful in response to specific questions of affected insurance 
companies, we note that commenters generally did not articulate with 
specificity the areas where they believe that further guidance is 
required. As a result, in order to provide guidance in the manner that 
would be most helpful, we encourage insurance companies, sellers of 
indexed annuities, and other affected parties to submit specific 
requests for guidance, which we will consider during the two-year 
period between adoption of rule 151A and its effectiveness.\121\
---------------------------------------------------------------------------

    \119\ See, e.g., Academy Letter, supra note 54; ACLI Letter, 
supra note 94; Aviva Letter, supra note 54; AXA Equitable Letter, 
supra note 106; CAI 151A Letter, supra note 54; FINRA Letter, supra 
note 7; Letter of Genesis Financial Products, Inc. (Aug. 29, 2008) 
(``Genesis Letter''); Letter of Janice Hart (Aug. 15, 2008) (``Hart 
Letter''); ICI Letter, supra note 7; National Western Letter, supra 
note 54; Sammons Letter, supra note 54.
    \120\ See, e.g., FINRA Letter, supra note 7; Hart Letter, supra 
note 119; ICI Letter, supra note 7; NAIC Officer Letter, supra note 
54.
    \121\ See infra text accompanying notes 129 and 130.
---------------------------------------------------------------------------

    Like the proposal, rule 151A requires that, in order for an 
insurer's determination to be conclusive, the determination must be 
made not more than six months prior to the date on which the form of 
contract is first offered.\122\ For example, if a form of contract were 
first offered on January 1, 2012, the insurer would be required to make 
the determination not earlier than July 1, 2011. We are not adopting 
the proposed requirement that the insurer's determination be made not 
more than three years prior to the date on which the particular 
contract is issued.\123\ We were persuaded by the commenters that if 
the status of a form of contract under the federal securities laws were 
to change, over time, from exempt to non-exempt and vice versa, this 
would present practical difficulties resulting from the possibility 
that an annuity could be exempted from registration at one time but be 
required to be registered subsequently and vice versa, as well as 
heightened litigation and enforcement risk.\124\ We believe that the 
substantial uncertainties and resulting potential costs introduced by 
the proposed requirement that a contract's status be redetermined every 
three years would be inconsistent with the intent of rule 151A, which 
is to clarify the status of indexed annuities.
---------------------------------------------------------------------------

    \122\ Rule 151A(b)(2)(iii).
    \123\ Proposed rule 151A(b)(2)(C).
    \124\ See, e.g., Aviva Letter, supra note 54; Sammons Letter, 
supra note 54. See also ICI Letter, supra note 7 (possibility that 
indexed annuity's status under the federal securities laws could 
change is not consistent with the purposes of the federal securities 
laws).
---------------------------------------------------------------------------

    Rule 151A, as adopted, requires that, in determining whether 
amounts payable by the insurance company are more likely than not to 
exceed the amounts guaranteed, both amounts payable and amounts 
guaranteed are to be determined by taking into account all charges 
under the contract, including, without limitation, charges that are 
imposed at the time that payments are made by the insurance 
company.\125\ For example, surrender charges would be deducted from 
both amounts payable and amounts guaranteed under the contract. This is 
a change from the proposal, which would have required that, in 
determining whether amounts payable by the insurance company under a 
contract are more likely than not to exceed the amounts guaranteed 
under the contract, amounts payable be determined without reference to 
any charges that are imposed at the time of payment, such as surrender 
charges, while those charges would be reflected in computing the 
amounts guaranteed under the contract.\126\
---------------------------------------------------------------------------

    \125\ Rule 151A(b)(1). In many cases, amounts guaranteed under 
annuities are not affected by charges imposed at the time payments 
are made by the insurer under the contract. This is a result of the 
fact that guaranteed minimum value, as commonly defined in indexed 
annuity contracts, equals a percentage of purchase payments, 
accumulated at a specified interest rate, as explained above, and 
this amount is not subject to surrender charges. However, under some 
indexed annuity contracts, the amounts guaranteed are affected by 
charges imposed at the time payments are made. For example, a 
purchaser buys a contract for $100,000. The contract defines 
surrender value as the greater of (i) purchase payments plus index-
linked interest minus surrender charges or (ii) the guaranteed 
minimum value. The maximum surrender charge is equal to 10%. The 
guaranteed minimum value is defined in the contract as 87.5% of 
premium accumulated at 1% annual interest. If the purchaser 
surrenders within the first year of purchase, and there is no index-
linked interest credited, the surrender value would equal $90,000 
(determined under clause (i) as $100,000 purchase payment minus 10% 
surrender charge), and this amount would be the guaranteed amount 
under the contract, not the lower amount defined in the contract as 
guaranteed minimum value ($87,500).
    \126\ Proposed rule 151A(b)(1).
---------------------------------------------------------------------------

    We are making the foregoing change because we are persuaded by 
commenters who argued that the proposed provision could result in 
contracts being determined not to be entitled to the Section 3(a)(8) 
exemption irrespective of the likelihood of securities-linked return 
being included in the amount payable.\127\ Specifically, commenters 
argued that as long as the surrender charge is in effect, the amount 
payable would always exceed the amount guaranteed if the surrender

[[Page 3153]]

charge were subtracted from the latter but not the former. The 
commenters further argued that bona fide surrender charges should not 
result in a contract being deemed a security, since a surrender charge 
is an expense and does not represent a transfer of risk from insurer to 
contract purchaser. Because the rule, as adopted, requires surrender 
charges to be subtracted from both amounts payable and amounts 
guaranteed, the surrender charges will not affect the determination of 
whether a contract is a security (i.e., the determination of whether 
amounts payable are more likely than not to exceed the amounts 
guaranteed).
---------------------------------------------------------------------------

    \127\ See, e.g., Aviva Letter, supra note 54; CAI 151A Letter, 
supra note 54; Coalition Letter, supra note 54.
---------------------------------------------------------------------------

Effective Date
    The effective date of rule 151A is January 12, 2011. We originally 
proposed that rule 151A, if adopted, would be effective 12 months after 
publication in the Federal Register. We are persuaded by commenters, 
however, that additional time is required for, among other things, 
making the determinations required by the rule, preparing registration 
statements for indexed annuities that are required to be registered, 
and establishing the needed infrastructure for distributing registered 
indexed annuities.\128\ Based on the comments, we believe that a 
January 12, 2011 effective date will provide the time needed to 
accomplish these tasks.\129\ We note that, during this period, the 
Commission intends to consider how to tailor disclosure requirements 
for indexed annuities and will also consider any requests for 
additional guidance that we receive concerning the determinations 
required under rule 151A.\130\
---------------------------------------------------------------------------

    \128\ Letter of American International Group (Sept. 10, 2008) 
(``AIG Letter''); Aviva Letter, supra note 54; CAI 151A Letter, 
supra note 54; NAVA Letter, supra note 106; Letter of New York Life 
Insurance Company (Sept. 18, 2008) (``NY Life Letter''); Sammons 
Letter, supra note 54.
    \129\ AIG Letter, supra note 128 (recommending transition period 
of 2 years); Aviva Letter, supra note 54 (at least 24 months); CAI 
151A Letter, supra note 54 (24 months); Letter of NAVA (Nov. 17, 
2008) (``Second NAVA Letter'') (at least 24 months); NY Life Letter, 
supra note 128 (at least 24 months).
    \130\ See supra text accompanying notes 95 and 121.
---------------------------------------------------------------------------

    The new definition in rule 151A will apply prospectively as we 
proposed--that is, only to indexed annuities issued on or after January 
12, 2011. We are using our definitional rulemaking authority under 
Section 19(a) of the Securities Act, and the explicitly prospective 
nature of our rule is consistent with similar prospective rulemaking 
that we have undertaken in the past when doing so was appropriate and 
fair under the circumstances.\131\
---------------------------------------------------------------------------

    \131\ See, e.g., Securities Act Release No. 4896 (Feb. 1, 1968) 
[33 FR 3142, 3143 (Feb. 17, 1968)] (``The Commission is aware that 
for many years issuers of the securities identified in this rule 
have not considered their obligations to be separate securities and 
that they have acted in reliance on the view, which they believed to 
be the view of the Commission, that registration under the 
Securities Act was not required. Under the circumstances, the 
Commission does not believe that such issuers are subject to any 
penalty or other damages resulting from entering into such 
arrangements in the past. Paragraph (b) provides that the rule shall 
apply to transactions of the character described in paragraph (a) 
only with respect to bonds or other evidence of indebtedness issued 
after adoption of the rule.''). See also Securities Act Release No. 
5316 (Oct. 6, 1972) [37 FR 23631, 23632 (Nov. 7, 1972)] (``The 
Commission recognizes that the `no-sale' concept has been in 
existence in one form or another for a long period of time. * * * 
The Commission believes, after a thorough reexamination of the 
studies and proposals cited above, that the interpretation embodied 
in Rule 133 is no longer consistent with the statutory objectives of 
the [Securities] Act. * * * Rule 133 is rescinded prospectively on 
and after January 1, 1973. * * *'').
---------------------------------------------------------------------------

    We are aware that many insurance companies and sellers of indexed 
annuities, such as insurance agents, broker-dealers, and registered 
representatives of broker-dealers, in the absence of definitive 
interpretation or definition by the Commission, have of necessity acted 
in reliance on their own analysis of the legal status of indexed 
annuities based on the state of the law prior to this rulemaking. Under 
these circumstances, we do not believe that issuers and sellers of 
indexed annuities should be subject to any additional legal risk 
relating to their past offers and sales of indexed annuity contracts as 
a result of the proposal and adoption of rule 151A.\132\
---------------------------------------------------------------------------

    \132\ See FSI Letter, supra note 106 (asking for clarification 
that, like insurance company issuers, independent broker-dealers and 
their affiliated financial advisers are not subject to any 
additional legal risk relating to past offers and sales of indexed 
annuities as a result of rule 151A).
---------------------------------------------------------------------------

    Several commenters requested clarification of the statement that 
rule 151A will apply prospectively to indexed annuities issued on or 
after the rule's effective date (i.e., January 12, 2011).\133\ As a 
result, we are clarifying that if an indexed annuity has been issued to 
a particular individual purchaser prior to January 12, 2011, then that 
specific contract between that individual and the insurance company 
(including any additional purchase payments made under the contract on 
or after January 12, 2011) is not subject to rule 151A, and its status 
under the federal securities laws is to be determined under the law as 
it existed without reference to rule 151A. By contrast, if an indexed 
annuity is issued to a particular individual purchaser on or after 
January 12, 2011, then that specific contract between that individual 
and the insurance company is subject to rule 151A, even if the same 
form of indexed annuity was offered and sold prior to January 12, 2011, 
and even if the individual contract issued on or after January 12, 
2011, is issued under a group contract that was in place prior to 
January 12, 2011.
---------------------------------------------------------------------------

    \133\ See, e.g., AIG Letter, supra note 128; Hartford Letter, 
supra note 55; Letter of North American Securities Administrators 
Association (Sept. 10, 2008) (``NASAA Letter'').
---------------------------------------------------------------------------

    The Commission believes that permitting new sales of an existing 
form of contract (as opposed to additional purchase payments made under 
a specific existing contract between an individual and an insurance 
company) after the rule's effective date without reference to the rule 
is contrary to the purpose of the rule. If the rule were not applicable 
to all contracts issued on or after the effective date without regard 
to when the forms of the contracts were originally sold, then two 
substantially similar contracts could be sold after the effective date, 
one not subject to the rule and one subject to the rule, even though 
they present the same level of risk to the purchaser and present the 
same need for investor protection. The fact that one was designed and 
released into the marketplace prior to January 12, 2011, and the other 
was designed and released into the marketplace after that date should 
not be a determining factor as to the availability of the protections 
of the federal securities laws. We note that, because we have extended 
the effective date to January 12, 2011, insurers should have adequate 
time to prepare for compliance with rule 151A.
    Some commenters raised concerns that the registration of an indexed 
annuity as required by rule 151A could cause offers and sales of the 
same annuity that occurred on an unregistered basis after adoption but 
prior to the effective date of the rule, January 12, 2011, to be 
unlawful under Section 5 of the Securities Act.\134\
---------------------------------------------------------------------------

    \134\ See, e.g., Aviva Letter, supra note 54; CAI 151A Letter, 
supra note 54; Sammons Letter, supra note 54.
---------------------------------------------------------------------------

    We reiterate that nothing in this adopting release is intended to 
affect the current analysis of the legal status of indexed annuities 
until the effective date of rule 151A. Therefore, after the adoption of 
rule 151A but prior to the effective date of the rule:
     An indexed annuity issuer making unregistered offers and 
sales of a contract that will not be an ``annuity contract'' or 
``optional annuity contract'' under rule 151A may continue to do so 
until the effective date of rule 151A without such offers and sales 
being

[[Page 3154]]

unlawful under Section 5 of the Securities Act as a result of the 
pending effectiveness of rule 151A; and
     An indexed annuity issuer that wishes to register a 
contract that will not be an ``annuity contract'' or ``optional annuity 
contract'' under rule 151A may continue to make unregistered offers and 
sales of the same annuity until the earlier of the effective date of 
the registration statement or the effective date of the rule without 
such offers and sales being unlawful under Section 5 of the Securities 
Act as a result of the pending effectiveness of rule 151A.
Annuities Not Covered by the Definition
    Rule 151A applies to annuities where the contract specifies that 
amounts payable by the insurance company under the contract are 
calculated at or after the end of one or more specified crediting 
periods, in whole or in part, by reference to the performance during 
the crediting period or periods of a security, including a group or 
index of securities. The rule defines certain of those annuities 
(annuities under which amounts payable by the issuer are more likely 
than not to exceed the amounts guaranteed under the contract) as not 
``annuity contracts'' or ``optional annuity contracts'' under Section 
3(a)(8) of the Securities Act. The rule, however, does not provide a 
safe harbor under Section 3(a)(8) for any other annuities, including 
any other indexed annuities. The status under the Securities Act of any 
annuity, other than an annuity that is determined under rule 151A to be 
not an ``annuity contract'' or ``optional annuity contract,'' continues 
to be determined by reference to the investment risk and marketing 
tests articulated in existing case law under Section 3(a)(8) and, to 
the extent applicable, the Commission's safe harbor rule 151.\135\
---------------------------------------------------------------------------

    \135\ As noted in Part II.B., above, indexed annuities are not 
entitled to rely on the rule 151 safe harbor.
---------------------------------------------------------------------------

    Some commenters suggested that the Commission, instead of adopting 
a rule that defines certain indexed annuities as not being ``annuity 
contracts'' under Section 3(a)(8), should instead define a safe harbor 
that would provide that indexed annuities that meet certain conditions 
are entitled to the Section 3(a)(8) exemption.\136\ We are not adopting 
this approach for two reasons. First, such a rule would not address in 
any way the federal interest in providing investors with disclosure, 
antifraud, and sales practice protections that arise when individuals 
are offered indexed annuities that expose them to investment risk. A 
safe harbor would address circumstances where purchasers of indexed 
annuities are not entitled to the protections of the federal securities 
laws; one of our primary goals is to address circumstances where 
purchasers of indexed annuities are entitled to the protections of the 
federal securities laws. We are concerned that many purchasers of 
indexed annuities today should be receiving the protections of the 
federal securities laws, but are not. Rule 151A addresses this problem; 
a safe harbor rule would not. Second, we believe that, under many of 
the indexed annuities that are sold today, the purchaser bears 
significant investment risk and is more likely than not to receive a 
fluctuating, securities-linked return. In light of that fact, we 
believe that is far more important to address this class of contracts 
with our definitional rule than to address the remaining contracts, or 
some subset of those contracts, with a safe harbor rule.
---------------------------------------------------------------------------

    \136\ See, e.g., Academy Letter, supra note 54; AIG Letter, 
supra note 128; Aviva Letter, supra note 54; Second Academy Letter, 
supra note 54; Second Aviva Letter, supra note 54; Second 
Transamerica Letter, supra note 54; Letter of Life Insurance Company 
of the Southwest (Sept. 10, 2008) (``Southwest Letter''); Voss 
Letter, supra note 13.
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B. Exchange Act Exemption for Securities That Are Regulated as 
Insurance

    The Commission is also adopting new rule 12h-7 under the Exchange 
Act, which provides an insurance company with an exemption from 
Exchange Act reporting with respect to indexed annuities and certain 
other securities issued by the company that are registered under the 
Securities Act and regulated as insurance under state law.\137\ Sixteen 
commenters supported the exemption.\138\ No commenters opposed the 
exemption. We are adopting this exemption, with changes to the proposal 
that address commenters' concerns, because we believe that the 
exemption is necessary or appropriate in the public interest and 
consistent with the protection of investors. We base that view on two 
factors: first, the nature and extent of the activities of insurance 
company issuers, and their income and assets, and, in particular, the 
regulation of those activities and assets under state insurance law; 
and, second, the absence of trading interest in the securities.\139\ 
The new rule imposes conditions to the exemption that relate to these 
factors and that we believe are necessary or appropriate in the public 
interest and consistent with the protection of investors.
---------------------------------------------------------------------------

    \137\ The Commission received a petition requesting that we 
propose a rule that would exempt issuers of certain types of 
insurance contracts from Exchange Act reporting requirements. Letter 
from Stephen E. Roth, Sutherland Asbill & Brennan LLP, on behalf of 
Jackson National Life Insurance Co., to Nancy M. Morris, Secretary, 
U.S. Securities and Exchange Commission (Dec. 19, 2007) (File No. 4-
553) available at: http://www.sec.gov/rules/petitions/2007/petn4-553.pdf.
    \138\ See, e.g., ACLI Letter, supra note 94; Allianz Letter, 
supra note 54; AXA Equitable Letter, supra note 106; Letter of 
Committee of Annuity Insurers regarding proposed rule 12h-7 (Sept. 
10, 2008) (``CAI 12h-7 Letter''); FSI Letter, supra note 106; Letter 
of Great-West Life & Annuity Insurance Company (Sept. 10, 2008) 
(``Great-West Letter''); ICI Letter, supra note 7; Letter of 
MetLife, Inc. (Sept. 11, 2008) (``MetLife Letter''); NAVA Letter, 
supra note 106; Sammons Letter, supra note 54.
    \139\ See Section 12(h) of the Exchange Act [15 U.S.C. 78l(h)] 
(Commission may, by rules, exempt any class of issuers from the 
reporting provisions of the Exchange Act ``if the Commission finds, 
by reason of the number of public investors, amount of trading 
interest in the securities, the nature and extent of the activities 
of the issuer, income or assets of the issuer, or otherwise, that 
such action is not inconsistent with the public interest or the 
protection of investors.'') (emphasis added).
---------------------------------------------------------------------------

    State insurance regulation is focused on insurance company solvency 
and the adequacy of insurers' reserves, with the ultimate purpose of 
ensuring that insurance companies are financially secure enough to meet 
their contractual obligations.\140\ State insurance regulators require 
insurance companies to maintain certain levels of capital, surplus, and 
risk-based capital; restrict the investments in insurers' general 
accounts; limit the amount of risk that may be assumed by insurers; and 
impose requirements with regard to valuation of insurers' 
investments.\141\ Insurance companies are required to file annual 
reports on their financial condition with state insurance regulators. 
In addition, insurance companies are subject to periodic examination of 
their financial condition by state insurance regulators. State 
insurance regulators also preside over the conservation or liquidation 
of companies with inadequate solvency.\142\
---------------------------------------------------------------------------

    \140\ Black and Skipper, supra note 39, at 949.
    \141\ Id. at 949 and 956-59.
    \142\ Id. at 949.
---------------------------------------------------------------------------

    State insurance regulation, like Exchange Act reporting, relates to 
an entity's financial condition. We are of the view that, in 
appropriate circumstances, it may be unnecessary for both to apply in 
the same situation, which may result in duplicative regulation that is 
burdensome. Through Exchange Act reporting, issuers periodically 
disclose their financial condition, which enables investors and the 
markets to independently evaluate an issuer's income, assets, and 
balance sheet. State insurance regulation takes a different approach to 
the issue of financial condition, instead relying on

[[Page 3155]]

state insurance regulators to supervise insurers' financial condition, 
with the goal that insurance companies be financially able to meet 
their contractual obligations. We believe that it is consistent with 
our federal system of regulation, which has allocated the 
responsibility for oversight of insurers' solvency to state insurance 
regulators, to exempt insurers from Exchange Act reporting with respect 
to state-regulated insurance contracts. Commenters asserted that, in 
light of the protections available under state insurance regulation, 
periodic reporting under the Exchange Act by state-regulated insurers 
does not enhance investor protection with respect to the securities 
covered under the rule.\143\
---------------------------------------------------------------------------

    \143\ CAI 12h-7 Letter, supra note 138; ICI Letter, supra note 
7; MetLife Letter, supra note 138.
---------------------------------------------------------------------------

    Our conclusion is strengthened by the general absence of trading 
interest in insurance contracts. Insurance is typically purchased 
directly from an insurance company. While insurance contracts may be 
assigned in some circumstances, they typically are not listed or traded 
on securities exchanges or in other markets. As a result, outside the 
context of publicly owned insurance companies, there is little, if any, 
market interest in the information that is required to be disclosed in 
Exchange Act reports.
1. The Exemption
    Rule 12h-7 provides an insurance company that is covered by the 
rule with an exemption from the duty under Section 15(d) of the 
Exchange Act to file reports required by Section 13(a) of the Exchange 
Act with respect to certain securities registered under the Securities 
Act.\144\
---------------------------------------------------------------------------

    \144\ Introductory paragraph to rule 12h-7. Cf. Rule 12h-3(a) 
under the Exchange Act [17 CFR 240.12h-3(a)] (suspension of duty 
under Section 15(d) of the Exchange Act to file reports with respect 
to classes of securities held by 500 persons or less where total 
assets of the issuer have not exceeded $10,000,000); Rule 12h-4 
under the Exchange Act [17 CFR 240.12h-4] (exemption from duty under 
Section 15(d) of the Exchange Act to file reports with respect to 
securities registered on specified Securities Act forms relating to 
certain Canadian issuers).
    Section 15(d) of the Exchange Act requires each issuer that has 
filed a registration statement that has become effective under the 
Securities Act to file reports and other information and documents 
required under Section 13 of the Exchange Act [15 U.S.C. 78m] with 
respect to issuers registered under Section 12 of the Exchange Act 
[15 U.S.C. 78l]. Section 13(a) of the Exchange Act [15 U.S.C. 
78m(a)] requires issuers of securities registered under Section 12 
of the Act to file annual reports and other documents and 
information required by Commission rule.
---------------------------------------------------------------------------

Covered Insurance Companies
    The Exchange Act exemption applies to an issuer that is a 
corporation subject to the supervision of the insurance commissioner, 
bank commissioner, or any agency or officer performing like functions, 
of any state, including the District of Columbia, Puerto Rico, the 
Virgin Islands, and any other possession of the United States.\145\ In 
the case of a variable annuity contract or variable life insurance 
policy, the exemption applies to the insurance company that issues the 
contract or policy. However, the exemption does not apply to the 
insurance company separate account in which the purchaser's payments 
are invested and which is separately registered as an investment 
company under the Investment Company Act of 1940 and is not regulated 
as an insurance company under state law.\146\
---------------------------------------------------------------------------

    \145\ Rule 12h-7(a). The Exchange Act defines ``State'' as any 
state of the United States, the District of Columbia, Puerto Rico, 
the Virgin Islands, or any other possession of the United States. 
Section 3(a)(16) of the Exchange Act [15 U.S.C. 78c(a)(16)]. The 
term ``State'' in rule 12h-7 has the same meaning as in the Exchange 
Act. Rule 12h-7 does not define the term ``State,'' and our existing 
rules provide that, unless otherwise specifically provided, the 
terms used in the rules and regulations under the Exchange Act have 
the same meanings defined in the Exchange Act. See rule 240.0-1(b) 
[17 CFR 240.0-1(b)].
    \146\ The separate account's Exchange Act reporting requirements 
are deemed to be satisfied by filing annual reports on Form N-SAR. 
17 CFR 274.101. See Section 30(d) of the Investment Company Act [15 
U.S.C. 80a-30(d)] and rule 30a-1 under the Investment Company Act 
[17 CFR 270.30a-1].
---------------------------------------------------------------------------

Covered Securities
    The exemption applies with respect to securities that do not 
constitute an equity interest in the insurance company issuer and that 
are either subject to regulation under the insurance laws of the 
domiciliary state of the insurance company or are guarantees of 
securities that are subject to regulation under the insurance laws of 
that jurisdiction.\147\ The exemption does not apply with respect to 
any other securities issued by an insurance company. As a result, if an 
insurance company issues securities with respect to which the exemption 
applies, and other securities that do not entitle the insurer to the 
exemption, the insurer will remain subject to Exchange Act reporting 
obligations. For example, if an insurer that is a publicly held stock 
company \148\ also issues insurance contracts that are registered 
securities under the Securities Act, the insurer generally would be 
required to file Exchange Act reports as a result of being a publicly 
held stock company. Similarly, if an insurer raises capital through a 
debt offering, the exemption does not apply with respect to the debt 
securities.
---------------------------------------------------------------------------

    \147\ Rule 12h-7(a)(2).
    \148\ A stock life insurance company is a corporation authorized 
to sell life insurance, which is owned by stockholders and is formed 
for the purpose of earning a profit for its stockholders. This is in 
contrast to another prevailing insurance company structure, the 
mutual life insurance company. In this structure, the corporation 
authorized to sell life insurance is owned by and operated for the 
benefit of its policy owners. Black and Skipper, supra note 39, at 
577-78.
---------------------------------------------------------------------------

    The exemption is available with respect to securities that are 
either subject to regulation under the insurance laws of the 
domiciliary state of the insurance company or are guarantees of 
securities that are subject to regulation under the insurance laws of 
that jurisdiction.\149\ Rule 12h-7 is a broad exemption that applies to 
any contract that is regulated under the insurance laws of the 
insurer's home state because we intend that the exemption apply to all 
contracts, and only those contracts, where state insurance law, and the 
associated regulation of insurer financial condition, applies. A key 
basis for the exemption is that investors are already entitled to the 
financial condition protections of state law and that, under our 
federal system of regulation, Exchange Act reporting may be 
unnecessary. Therefore, we believe it is important that the reach of 
the exemption and the reach of state insurance law be the same. A 
single commenter addressed the scope of securities with respect to 
which the proposed exemption would apply, supporting the Commission's 
approach and noting that limiting the exemption to enumerated types of 
securities would require the Commission to revisit the rule every few 
years, or would provide a significant barrier to the introduction of 
new investment products.\150\
---------------------------------------------------------------------------

    \149\ A domiciliary state is the jurisdiction in which an 
insurer is incorporated or organized. See National Association of 
Insurance Commissioners Model Laws, Regulations and Guidelines 555-
1, Sec.  104 (2007).
    \150\ Great-West Letter, supra note 138.
---------------------------------------------------------------------------

    The Exchange Act exemption applies both to certain existing types 
of insurance contracts and to types of contracts that are developed in 
the future and that are registered as securities under the Securities 
Act. The exemption applies to indexed annuities that are registered 
under the Securities Act. However, the Exchange Act exemption is 
independent of rule 151A and applies to types of contracts in addition 
to those that are covered by rule 151A. There are at least two types of 
existing insurance contracts with respect to which the Exchange Act 
exemption applies, contracts with so-called ``market value adjustment'' 
(``MVA'') features and insurance contracts that provide certain

[[Page 3156]]

guaranteed benefits in connection with assets held in an investor's 
account, such as a mutual fund, brokerage, or investment advisory 
account.
    Contracts including MVA features have, for some time, been 
registered under the Securities Act.\151\ Insurance companies issuing 
contracts with these features have also complied with Exchange Act 
reporting requirements.\152\ MVA features have historically been 
associated with annuity and life insurance contracts that guarantee a 
specified rate of return to purchasers.\153\ In order to protect the 
insurer against the risk that a purchaser may make withdrawals from the 
contract at a time when the market value of the insurer's assets that 
support the contract has declined due to rising interest rates, 
insurers sometimes impose an MVA upon surrender. Under an MVA feature, 
the insurer adjusts the proceeds a purchaser receives upon surrender 
prior to the end of the guarantee period to reflect changes in the 
market value of its portfolio securities supporting the contract.\154\
---------------------------------------------------------------------------

    \151\ Securities Act Release No. 6645, supra note 35, 51 FR at 
20256-58.
    \152\ See, e.g., ING Life Insurance and Annuity Company (Annual 
Report on Form 10-K (Mar. 31, 2008)); Protective Life Insurance 
Company (Annual Report on Form 10-K (Mar. 31, 2008)); Union Security 
Insurance Company (Annual Report on Form 10-K (Mar. 3, 2008)).
    \153\ Some indexed annuities also include MVA features. See, 
e.g., Pre-Effective Amendment No. 4 to Registration Statement on 
Form S-1 of PHL Variable Insurance Company (File No. 333-132399) 
(filed Feb. 7, 2007); Initial Registration Statement on Form S-1 of 
ING USA Annuity and Life Insurance Company (File No. 333-133153) 
(filed Apr. 7, 2006); Pre-Effective Amendment No. 2 to Registration 
Statement on Form S-3 of Allstate Life Insurance Company (File No. 
333-117685) (filed Dec. 20, 2004).
    \154\ See Proposing Release, supra note 3, 73 FR at 37764 
(describing MVA features).
---------------------------------------------------------------------------

    More recently, some insurance companies have registered under the 
Securities Act insurance contracts that provide certain guarantees in 
connection with assets held in an investor's account, such as a mutual 
fund, brokerage, or investment advisory account.\155\ As a result, the 
insurers become subject to Exchange Act reporting requirements if they 
are not already subject to those requirements. These contracts, often 
called ``guaranteed living benefits,'' are intended to provide 
insurance to the purchaser against the risk of outliving the assets 
held in the mutual fund, brokerage, or investment advisory 
account.\156\
---------------------------------------------------------------------------

    \155\ See, e.g., PHL Variable Life Insurance Company, File No. 
333-137802 (Form S-1 filed Feb. 25, 2008); Genworth Life and Annuity 
Insurance Company, File No. 333-143494 (Form S-1 filed Apr. 4, 
2008).
    \156\ See Proposing Release, supra note 3, 73 FR at 37764 
(describing guaranteed living benefits).
---------------------------------------------------------------------------

    As noted above, the Exchange Act exemption also applies with 
respect to a guarantee of a security if the guaranteed security is 
subject to regulation under state insurance law.\157\ We are adopting 
this provision because we believe that it is appropriate to exempt from 
Exchange Act reporting an insurer that provides a guarantee of an 
insurance contract (that is also a security) when the insurer would not 
be subject to Exchange Act reporting if it had issued the guaranteed 
contract. This situation may arise, for example, when an insurance 
company issues a contract that is a security and its affiliate, also an 
insurance company, provides a guarantee of benefits provided under the 
first company's contract.\158\
---------------------------------------------------------------------------

    \157\ The Securities Act defines ``security'' in Section 2(a)(1) 
of the Act [15 U.S.C. 77b(a)(1)]. That definition provides that a 
guarantee of any of the instruments included in the definition is 
also a security.
    \158\ For example, an insurance company may offer a registered 
variable annuity, and a parent or other affiliate of the issuing 
insurance company may act as guarantor for the issuing company's 
insurance obligations under the contract.
---------------------------------------------------------------------------

    Finally, the exemption is not available with respect to any 
security that constitutes an equity interest in the issuing insurance 
company. As a general matter, an equity interest in an insurer is not 
covered by the exemption because it is not subject to regulation under 
state insurance law and often is publicly traded. Nonetheless, we 
believe that the rule should expressly preclude any security that 
constitutes an equity interest in the issuing insurance company from 
being covered by the exemption. Where investors own an equity interest 
in an issuing insurance company, and are therefore dependent on the 
financial condition of the issuer for the value of that interest, we 
believe that they have a significant interest in directly evaluating 
the issuers' financial condition for themselves on an ongoing basis and 
that Exchange Act reporting is appropriate.
2. Conditions to Exemption
    As described above, we believe that the exemption is necessary or 
appropriate in the public interest and consistent with the protection 
of investors because of the existence of state regulation of insurers' 
financial condition and because of the general absence of trading 
interest in insurance contracts. The Exchange Act exemption that we are 
adopting, like the proposal, is subject to conditions that are designed 
to ensure that both of these factors are, in fact, present in cases 
where an insurance company is permitted to rely on the exemption. We 
have modified the conditions related to trading interest in one respect 
to address the concerns of commenters. We have also added a condition 
to the proposed rule in order to address a commenter's concern.

Regulation of Insurer's Financial Condition

    In order to rely on the exemption, an insurer must file an annual 
statement of its financial condition with, and the insurer must be 
supervised and its financial condition examined periodically by, the 
insurance commissioner, bank commissioner, or any agency or any officer 
performing like functions, of the insurer's domiciliary state.\159\ 
Commenters did not address this condition, and we are adopting this 
condition as proposed. This condition is intended to ensure that an 
insurer claiming the exemption is, in fact, subject to state insurance 
regulation of its financial condition. Absent satisfaction of this 
condition, Exchange Act reporting would not be duplicative of state 
insurance regulation, and the exemption would not be available.
---------------------------------------------------------------------------

    \159\ Rule 12h-7(c). Cf. Section 26(f)(2)(B)(ii) and (iii) of 
the Investment Company Act [15 U.S.C. 80a-26(f)(2)(B)(ii) and (iii)] 
(using similar language in requirements that apply to insurance 
companies that sell variable insurance products).
---------------------------------------------------------------------------

Absence of Trading Interest

    The Exchange Act exemption is subject to two conditions intended to 
insure that there is no trading interest in securities with respect to 
which the exemption applies, and we are modifying the proposed 
conditions in one respect to address the concerns of commenters. First, 
the securities may not be listed, traded, or quoted on an exchange, 
alternative trading system,\160\ inter-dealer quotation system,\161\ 
electronic communications network, or any other similar system, 
network, or publication for trading or quoting.\162\ This condition is 
designed to ensure that there is no established trading market for the 
securities. Second, the issuing insurance company must take steps 
reasonably designed to ensure that a trading market for the securities 
does

[[Page 3157]]

not develop.\163\ This includes, except to the extent prohibited by the 
law of any state, including the District of Columbia, Puerto Rico, the 
Virgin Islands, and any other possession of the United States,\164\ or 
by action of the insurance commissioner, bank commissioner, or any 
agency or officer performing like functions of any state, requiring 
written notice to, and acceptance by, the issuer prior to any 
assignment or other transfer of the securities and reserving the right 
to refuse assignments or other transfers at any time on a non-
discriminatory basis. This condition is designed to ensure that the 
insurer takes reasonable steps to ensure the absence of trading 
interest in the securities.
---------------------------------------------------------------------------

    \160\ For this purpose, ``alternative trading system'' would 
have the same meaning as in Regulation ATS. See 17 CFR 242.300(a) 
(definition of ``alternative trading system'').
    \161\ For this purpose, ``inter-dealer quotation system'' would 
have the same meaning as in Exchange Act rule 15c2-11. See 17 CFR 
240.15c2-11(e)(2) (definition of ``inter-dealer quotation system'').
    \162\ Rule 12h-7(d).
    \163\ Rule 12h-7(e).
    \164\ See supra note 145 for a discussion of the term ``State'' 
as used in rule 12h-7.
---------------------------------------------------------------------------

    We are adopting the first condition, relating to the absence of 
listing, trading, and quoting on any exchange or similar system, 
network, or publication for trading or quoting, as proposed. We are not 
adopting the suggestion of a commenter that the Commission limit this 
condition to exchanges and other similar systems, networks, and 
publications for trading or quoting that are registered with, or 
regulated by, the Commission or a self-regulatory organization.\165\ 
The commenter argued that, absent this limitation, insurance companies 
would be placed in the position of enforcing the Commission's 
requirements by identifying any exchanges and other similar systems, 
networks, and publications for trading or quoting that may arise from 
time to time and operate in violation of the Commission's rules and 
regulations. We disagree that this limitation is appropriate. We have 
determined that the exemption provided by rule 12h-7 is necessary or 
appropriate in the public interest and consistent with the protection 
of investors, in part, because of the absence of trading interest in 
the insurance contracts covered by the exemption. We do not believe 
that there would be an absence of trading interest where an insurance 
contract trades on an exchange or similar system, network, or 
publication for trading or quoting, whether regulated by the Commission 
or not.
---------------------------------------------------------------------------

    \165\ CAI 12h-7 Letter, supra note 138.
---------------------------------------------------------------------------

    We are modifying the second condition, which requires the issuing 
insurance company to take steps reasonably designed to ensure that a 
trading market for the securities does not develop. As the condition 
was proposed, this would have included requiring written notice to, and 
acceptance by, the insurance company prior to any assignment or 
transfer of the securities and reserving the right to refuse 
assignments or other transfers of the securities at any time on a non-
discriminatory basis.\166\ Under the adopted rule, these particular 
steps will continue to be required, except to the extent that they are 
prohibited by the law of any state or by action of the insurance 
commissioner, bank commissioner, or any agency or officer performing 
like functions of any state.
---------------------------------------------------------------------------

    \166\ Proposed rule 12h-7(e).
---------------------------------------------------------------------------

    This modification addresses the concern expressed by several 
commenters that the proposed condition could, in some circumstances, be 
inconsistent with applicable state law.\167\ The commenters stated that 
some states may not permit restrictions on transfers or assignments 
and, indeed, that some states specifically grant contract owners the 
right to transfer or assign their contracts. In proposing the condition 
relating to restrictions on assignment, it was not our intent to 
require restrictions that are inconsistent with applicable state law. 
Our modification to rule 12h-7 clarifies this and, accordingly, 
addresses the commenters' concern.
---------------------------------------------------------------------------

    \167\ Allianz Letter, supra note 54; CAI 12h-7 Letter, supra 
note 138; ICI Letter, supra note 7; NAVA, supra note 106; Sammons 
Letter, supra note 54.
---------------------------------------------------------------------------

    Three commenters requested that the second condition be removed in 
its entirety.\168\ These commenters stated that the second condition is 
unnecessary, because the first should give sufficient comfort that a 
trading market will not arise. The commenters also stated that this 
condition would be difficult to apply. One of the commenters stated 
that the condition is ambiguous, and that there is no clear definition 
of ``trading market'' in the federal securities laws.\169\ We continue 
to believe that the second condition is important because it will 
ensure that the issuer takes steps reasonably designed to preclude the 
development of a trading market. We do not believe that, as modified to 
address concerns about inconsistency with state law, the second 
condition will be unduly difficult to apply.
---------------------------------------------------------------------------

    \168\ CAI 12h-7 Letter, supra note 138; Sammons Letter, supra 
note 54; Transamerica Letter, supra note 54; Second Transamerica 
Letter, supra note 54.
    \169\ CAI 12h-7 Letter, supra note 138.
---------------------------------------------------------------------------

    Two commenters requested that rule 12h-7 include a transition 
period for filing required reports under the Exchange Act for any 
insurance company previously relying on the rule that no longer meets 
its conditions.\170\ We do not believe that it would be appropriate to 
include such a transition period because, if an insurer no longer meets 
the conditions, this generally would mean that either the securities 
are not regulated as insurance under state law or the securities are 
traded or may become traded. In such a case, the very basis on which we 
are granting the exemption would no longer exist. Therefore, we have 
determined not to include such a transition period in rule 12h-7. If an 
issuer no longer meets the conditions of the rule, it will immediately 
become subject to the filing requirements of the Exchange Act. We 
would, in any event, expect situations where an insurance company 
ceases to meet the conditions of rule 12h-7 to be extremely rare. In 
such a case, at an insurer's request, we would consider, based on the 
particular facts and circumstances, whether individual exemptive relief 
to provide for a transition period would be appropriate.
---------------------------------------------------------------------------

    \170\ Letter of Committee of Annuity Insurers regarding proposed 
rule 12h-7 (Nov. 17, 2008) (``Second CAI 12h-7 Letter''); Second 
Transamerica Letter, supra note 54.
---------------------------------------------------------------------------

Prospectus Disclosure
    We are adding a condition to proposed rule 12h-7 to require that, 
in order for an insurer to be entitled to the Exchange Act exemption 
provided by the rule with respect to securities, the prospectus for the 
securities must contain a statement indicating that the issuer is 
relying on the exemption provided by the rule.\171\ This addresses a 
commenter's request that the Commission clarify that reliance on the 
exemption is optional because some insurers may conclude that the 
benefits that flow from the ability to incorporate by reference 
Exchange Act reports may outweigh any costs associated with filing 
those reports.\172\ The new condition will permit an insurance company 
that desires to remain subject to Exchange Act reporting requirements 
to do so by omitting the required statement from its prospectus. The 
new provision also has the advantage of providing notice to investors 
of an insurer's reliance on the exemption. An insurer who does not 
include this statement will be subject to mandatory Exchange Act 
reporting.\173\
---------------------------------------------------------------------------

    \171\ Rule 12h-7(f).
    \172\ CAI 12h-7 Letter, supra note 138. See Form S-1, General 
Instruction VII.A. (incorporation by reference permitted only if, 
among other things, registrant subject to Exchange Act reporting 
requirements); Form S-3, General Instruction I.A.2. (Form S-3, which 
permits incorporation by reference, available to registrant that, 
among other things, is required to file Exchange Act reports).
    \173\ As described above, the exemption applies to an insurance 
company that issues a variable annuity contract or variable life 
insurance policy, but not to the associated separate account. See 
supra note 146 and accompanying text. On or after the effective date 
of rule 12h-7, the prospectus for a variable insurance contract with 
respect to which the insurer does not file Exchange Act reports (and 
therefore is relying on rule 12h-7) will be required to include the 
statement that the insurer is relying on rule 12h-7.

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[[Page 3158]]

3. Effective Date
    The effective date of rule 12h-7 is May 1, 2009.

IV. Paperwork Reduction Act

A. Background

    Rule 151A contains no new ``collection of information'' 
requirements within the meaning of the Paperwork Reduction Act of 1995 
(``PRA'').\174\ However, we believe that rule 151A will result in an 
increase in the disclosure burden associated with existing Form S-1 as 
a result of additional filings that will be made on Form S-1.\175\ Form 
S-1 contains ``collection of information'' requirements within the 
meaning of the PRA. Although we are not amending Form S-1, we have 
submitted the Form S-1 ``collection of information'' (``Form S-1 
Registration Statement'' (OMB Control No. 3235-0065)), which we 
estimate will increase as a result of rule 151A, to the Office of 
Management and Budget (``OMB'') for review and approval in accordance 
with the PRA.\176\ We published notice soliciting comment on the 
increase in the collection of information requirements in the release 
proposing rule 151A and submitted the proposed collection of 
information to OMB for review and approval in accordance with 44 U.S.C. 
3507(d) and 5 CFR 1320.11.
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    \174\ 44 U.S.C. 3501 et seq.
    \175\ 17 CFR 239.11.
    \176\ 44 U.S.C. 3507(d); 5 CFR 1320.11.
---------------------------------------------------------------------------

    We adopted Form S-1 pursuant to the Securities Act. This form sets 
forth the disclosure requirements for registration statements that are 
prepared by eligible issuers to provide investors with the information 
they need to make informed investment decisions in registered 
offerings. We anticipate that, absent amendments to our disclosure 
requirements to specifically address indexed annuities, indexed 
annuities that register under the Securities Act would generally 
register on Form S-1.\177\ As a result, we have assumed, for purposes 
of our PRA analysis, that this would be the case. We note, however, 
that we are providing a two-year transition period for rule 151A and, 
during this period, we intend to consider how to tailor disclosure 
requirements for indexed annuities.\178\
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    \177\ Some Securities Act offerings are registered on Form S-3 
[17 CFR 239.13]. We do not believe that rule 151A will have any 
significant impact on the disclosure burden associated with Form S-3 
because we believe that very few, if any, insurance companies that 
issue indexed annuities will be eligible to register those contracts 
on Form S-3. In order to be eligible to file on Form S-3, an issuer 
must, among other things, have filed Exchange Act reports for a 
period of at least 12 calendar months. General Instruction I.A.3. of 
Form S-3. Very few insurance companies that issue indexed annuities 
are currently eligible to file Form S-3. Further, any insurance 
companies that issue indexed annuities and rely on the Exchange Act 
reporting exemption that we are adopting will not meet the 
eligibility requirements for Form S-3. We believe that very few, if 
any, issuers of indexed annuities will choose to be subject to the 
reporting requirements of the Exchange Act because of the costs that 
this would impose. In any event, the number of indexed annuity 
issuers that choose to be subject to the reporting requirements of 
the Exchange Act would be insignificant compared to the total number 
of Exchange Act reporting companies, which is approximately 12,100. 
The number of indexed annuity issuers in 2007 was 58. NAVA, supra 
note 9, at 57.
    We also do not believe that the rules will have any significant 
impact on the disclosure burden associated with reporting under the 
Exchange Act on Forms 10 K, 10 Q, and 8 K. As a result of rule 12h-
7, insurance companies will not be required to file Exchange Act 
reports on these forms in connection with indexed annuities that are 
registered under the Securities Act, and, as noted in the prior 
paragraph, we believe that very few, if any, issuers of indexed 
annuities will choose to be subject to the reporting requirements of 
the Exchange Act because of the costs that this would impose. While 
rule 12h 7 will permit some insurance companies that are currently 
required to file Exchange Act reports as a result of issuing 
insurance contracts that are registered under the Securities Act, to 
cease filing those reports, the number of such companies is 
insignificant compared to the total number of Exchange Act reporting 
companies. Likewise, we do not believe that the prospectus statement 
required under rule 12h-7 for insurers relying on that rule will 
have any significant impact on the disclosure burden associated with 
registration statements for insurance contracts that are securities 
(Forms S-1, S-3, N-3, N-4, and N-6). We do not believe that the 
currently approved collections of information for these forms will 
change based on the rule 12h-7 prospectus statement.
    \178\ As noted above, some commenters expressed concern about 
what they believed to be a lack of a registration form that is well-
suited to indexed annuities. See supra text accompanying notes 94 
and 95.
---------------------------------------------------------------------------

    The hours and costs associated with preparing disclosure, filing 
forms, and retaining records constitute reporting and cost burdens 
imposed by the collection of information. An agency may not conduct or 
sponsor, and a person is not required to respond to, a collection of 
information unless it displays a currently valid OMB control number.
    The information collection requirements related to registration 
statements on Form S-1 are mandatory. There is no mandatory retention 
period for the information disclosed, and the information disclosed 
will be made publicly available on the EDGAR filing system.

B. Summary of Information Collection

    Because rule 151A will affect the number of filings on Form S-1 but 
not the disclosure required by this form, we do not believe that the 
rules will impose any new recordkeeping or information collection 
requirements. However, we expect that some insurance companies will 
register indexed annuities in the future that they would not previously 
have registered. We believe this will result in an increase in the 
number of annual responses expected with respect to Form S-1 and in the 
disclosure burden associated with Form S-1. At the same time, we expect 
that, on a per response basis, rule 151A will decrease the existing 
disclosure burden for Form S-1. This is because the disclosure burden 
for each indexed annuity on Form S-1 is likely to be lower than the 
existing burden per respondent on Form S-1. The decreased burden per 
response on Form S-1 will partially offset the increased burden 
resulting from the increase in the annual number of responses on Form 
S-1. We believe that, in the aggregate, the disclosure burden for Form 
S-1 will increase as a result of the adoption of rule 151A.

C. Paperwork Reduction Act Burden Estimates

    For purposes of the PRA, we estimate that the rule will result in 
an annual increase in the paperwork burden for companies to comply with 
the Form S-1 collection of information requirements of approximately 
60,000 hours of in-house company personnel time and approximately 
$72,000,000 for the services of outside professionals. These estimates 
represent the combined effect of an expected increase in the number of 
annual responses on Form S-1 and a decrease in the expected burden per 
response. These estimates include the time and the cost of preparing 
and reviewing disclosure, filing documents, and retaining records. Our 
methodologies for deriving the above estimates are discussed below.
    We are adopting a new definition of ``annuity contract'' that, on a 
prospective basis, defines a class of indexed annuities that are not 
``annuity contracts'' or ``optional annuity contracts'' for purposes of 
Section 3(a)(8) of the Securities Act, which provides an exemption 
under the Securities Act for certain insurance contracts. These indexed 
annuities will, on a prospective basis, be required to register under 
the Securities Act on Form S-1.\179\
---------------------------------------------------------------------------

    \179\ Some Securities Act offerings are registered on Form S-3, 
but we believe that very few, if any, insurance companies that issue 
indexed annuities will be eligible to register those contracts on 
Form S-3. See supra note 177.

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[[Page 3159]]

    We received numerous comment letters on the proposal, and we have 
revised proposed rule 151A in response to the comments. However, we do 
not believe that any of the modifications affect the estimated 
reporting and cost burdens discussed in this PRA analysis. These 
modifications include:
    [cir] Revising the proposed definition so that the rule will apply 
to a contract that specifies that amounts payable by the issuer under 
the contract are calculated at or after the end of one or more 
specified crediting periods, in whole or in part, by reference to the 
performance during the crediting period or periods of a security, 
including a group or index of securities; \180\
---------------------------------------------------------------------------

    \180\ Rule 151A(a)(1).
---------------------------------------------------------------------------

    [cir] Eliminating the provision in proposed rule 151A that the 
issuer's determination as to whether amounts payable under the contract 
are more likely than not to exceed the amounts guaranteed under the 
contract be made not more than three years prior to the date on which 
the particular contract is issued; \181\ and
---------------------------------------------------------------------------

    \181\ Proposed Rule 151A(b)(2)(iii).
---------------------------------------------------------------------------

    [cir] Adopting a requirement that amounts payable by the issuer and 
amounts guaranteed are to be determined by taking into account all 
charges under the contract, including, without limitation, charges that 
are imposed at the time that payments are made by the issuer.\182\
---------------------------------------------------------------------------

    \182\ Rule 151A(b)(1).
---------------------------------------------------------------------------

    We do not believe that any of these changes will affect the annual 
increase in the number of responses on Form S-1 or the hours per 
response required. As we state below, we assume that all indexed 
annuities that are offered on or after January 12, 2011, will be 
registered, and that each of the 400 registered indexed annuities will 
be the subject of one response per year on Form S-1. We do not expect 
the changes in the rule, as adopted, to affect our estimates of the 
increase in the number of annual responses required on Form S-1. The 
first change, revising the scope of the rule, addresses commenters' 
concerns that the rule was overly broad and would reach annuities that 
were not indexed annuities, such as traditional fixed annuities and 
discretionary excess interest contracts. While the revision clarifies 
the intended scope of the rule to address these concerns, our PRA 
estimates with respect to the proposed rule were based on the intended 
scope of the proposed rule, which did not extend to these other types 
of annuities. As a result, this change has no effect on our estimates 
of the number of responses required on Form S-1. Our PRA estimates 
assume that all indexed annuities that are offered will be registered, 
and we do not believe that this assumption is affected by the 
elimination of the requirement that an insurer's determination under 
rule 151A be made not more than three years prior to the date on which 
a particular contract is issued or the change to the manner of taking 
charges into account under the rule. In addition, the changes in the 
rule will not affect the information required to be disclosed by Form 
S-1, or the time required to prepare and file the form.
Increase in Number of Annual Responses
    For purposes of the PRA, we estimate that there will be an annual 
increase of 400 responses on Form S-1 as a result of the rule. In 2007, 
there were 322 indexed annuity contracts offered.\183\ For purposes of 
the PRA analysis, we assume that 400 indexed annuities will be offered 
each year. This allows for some escalation in the number of contracts 
offered in the future over the number offered in 2007. Our Office of 
Economic Analysis has considered the effect of the rule on indexed 
annuity contracts with typical terms and has determined that these 
contracts would not meet the definition of ``annuity contract'' or 
``optional annuity contract'' if they were to be issued after the 
effective date of the rule. Therefore, we assume that all indexed 
annuities that are offered will be registered, and that each of the 400 
registered indexed annuities will be the subject of one response per 
year on Form S-1,\184\ resulting in the estimated annual increase of 
400 responses on Form S-1.
---------------------------------------------------------------------------

    \183\ See NAVA, supra note 9, at 57.
    \184\ Annuity contracts are typically offered to purchasers on a 
continuous basis, and as a result, an insurer offering an annuity 
contract that is registered under the Securities Act generally will 
be required to update the registration statement once a year. See 
Section 10(a)(3) of the Securities Act [15 U.S.C. 77j(a)(3)] (when 
prospectus used more than 9 months after effective date of 
registration statement, information therein generally required to be 
not more than 16 months old).
---------------------------------------------------------------------------

Decrease in Expected Hours per Response
    For purposes of the PRA, we estimate that there will be a decrease 
of 120 hours per response on Form S-1 as a result of the rule. Current 
OMB approved estimates and recent Commission rulemaking estimate the 
hours per response on Form S-1 as 950.\185\ The current hour estimate 
represents the burden for all issuers, both large and small. We believe 
that registration statements on Form S-1 for indexed annuities will 
result in a significantly lower number of hours per response, which, 
based on our experience with other similar contracts, we estimate as 
600 hours per indexed annuity response on Form S-1. We attribute this 
lower estimate to two factors. First, the estimated 400 indexed annuity 
registration statements will likely be filed by far fewer than 400 
different insurance companies,\186\ and a significant part of the 
information in each of the multiple registration statements filed by a 
single insurance company will be the same, resulting in economies of 
scale with respect to the multiple filings. Second, many of the 400 
responses on Form S-1 each year will be annual updates to registration 
statements for existing contracts, rather than new registration 
statements, resulting in a significantly lower hour burden than a new 
registration statement.\187\ Combining our estimate of 600 hours per 
indexed annuity response on Form S-1 (for an estimated 400 responses) 
with the existing estimate of 950 hours per response on Form S-1 (for 
an estimated 768 responses),\188\ our new estimate is 830 hours per 
response (((400 x 600) + (768 x 950))/1168).
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    \185\ These estimates have been revised by other rules that the 
Commission has adopted, and OMB approval is pending. See Supporting 
Statement to the Office of Management and Budget under the PRA for 
Securities Act Release No. 8876, available at: http://www.reginfo.gov/public/do/DownloadDocument?documentID=90204&version=0 (``33-8876 Supporting 
Statement'').
    \186\ The 322 indexed annuities offered in 2007 were issued by 
58 insurance companies. See NAVA, supra note 9, at 57.
    \187\ See supra note 184.
    \188\ See 33-8876 Supporting Statement, supra note 185.
---------------------------------------------------------------------------

Net Increase in Burden
    To calculate the total effect of the rules on the overall 
compliance burden for all issuers, large and small, we added the burden 
associated with the 400 additional Forms S-1 that we estimate will be 
filed annually in the future and subtracted the burden associated with 
our reduced estimate of 830 hours for each of the current estimated 768 
responses. We used current OMB approved estimates in our calculation of 
the hours and cost burden associated with preparing, reviewing, and 
filing Form S-1.
    Consistent with current OMB approved estimates and recent 
Commission rulemaking,\189\ we estimate that 25% of the burden of 
preparation of Form S-1 is carried by the company

[[Page 3160]]

internally and that 75% of the burden is carried by outside 
professionals retained by the issuer at an average cost of $400 per 
hour.\190\ The portion of the burden carried by outside professionals 
is reflected as a cost, while the burden carried by the company 
internally is reflected in hours.
---------------------------------------------------------------------------

    \189\ See Securities Act Release No. 8878 (Dec. 19, 2007) [72 FR 
73534, 73547 (Dec. 27, 2007)].
    \190\ Id. at note 110 and accompanying text.
---------------------------------------------------------------------------

    The tables below illustrate our estimates concerning the 
incremental annual compliance burden in the collection of information 
in hours and cost for Form S-1.

             Incremental PRA Burden Due to Increased Filings
------------------------------------------------------------------------
 Estimated increase in                              Incremental burden
    annual responses         Hours/ response              (hours)
------------------------------------------------------------------------
              400                      830                 332,000
------------------------------------------------------------------------


Incremental Decrease in PRA Burden Due to Decrease in Hours Per Response
------------------------------------------------------------------------
                            Current estimated
 Estimated decrease in       number of annual      Incremental decrease
     hours/response              filings             in burden (hours)
------------------------------------------------------------------------
            (120)                      768                (92,200)
------------------------------------------------------------------------


                               Summary of Change in Incremental Compliance Burden
----------------------------------------------------------------------------------------------------------------
                                                                           75% Professional        $400/hr.
             Incremental burden (hours)               25% Issuer (hours)        (hours)        professional cost
----------------------------------------------------------------------------------------------------------------
240,000.............................................             60,000             180,000         $72,000,000
----------------------------------------------------------------------------------------------------------------

D. Response to Comments on Commission's Paperwork Reduction Act 
Analysis

    A few commenters commented on the Commission's Paperwork Reduction 
Act analysis in the Proposing Release.\191\ One commenter stated that 
external costs of registering indexed annuities on Form S-1 will vary 
considerably depending on whether the insurer has previously prepared a 
Form S-1.\192\ The commenter stated that, for insurers that have not 
previously prepared a Form S-1 registration statement, external legal 
costs could be as high as $250,000-$500,000 for each registration 
statement. The same commenter estimated external legal costs for an 
issuer that has previously filed a Form S-1 at $50,000-$100,000. 
Another commenter estimated external legal costs for preparation and 
filing of a Form S-1 registration statement with the SEC at $350,000 
for the first few years, which, the commenter stated, would decrease 
over time as the insurer gained more expertise.\193\ However, these 
commenters did not specify the sources of these cost estimates or how 
they were made.
---------------------------------------------------------------------------

    \191\ See, e.g., Allianz Letter, supra note 54; Second Aviva 
Letter, supra note 54; Letter of National Association for Fixed 
Annuities (Nov. 17, 2008) (``Second NAFA Letter''); Transamerica 
Letter, supra note 54.
    \192\ Allianz Letter, supra note 54.
    \193\ Second Aviva Letter, supra note 54.
---------------------------------------------------------------------------

    As stated above, we estimate the average burden per indexed annuity 
response on Form S-1 to be 600 hours. We further estimate that 75% of 
that burden will be carried by outside professionals retained by the 
issuer at an average cost of $400 per hour. Accordingly, we estimate 
the cost for outside professionals for each indexed annuity 
registration statement on Form S-1 to be on average $180,000 ((600 x 
.75) x $400). We do not believe that it is necessary to change our 
estimate of outside professional costs based on the commenters' 
estimated costs. The $250,000-$500,000 range cited by the commenters is 
for an issuer that has not previously filed a Form S-1, with commenters 
acknowledging that the costs to an experienced filer would be lower (as 
low as $50,000-$100,000). Our $180,000 estimate reflects outside 
professional costs incurred not only by first-time Form S-1 filers, but 
also the costs of preparing Form S-1 for contracts offered by 
experienced Form S-1 filers, as well as annual updates to existing Form 
S-1 registration statements, which we expect to be significantly lower 
than costs incurred by first-time filers.
    One commenter cites a cost of $255,000 for the insurer to prepare a 
registration statement.\194\ It is not clear whether this cost 
represents only external costs or total costs. The commenter also 
estimates the cost of preparing a registration statement for certain 
types of carriers at $62,500 \195\ and further indicates that there are 
27 such carriers issuing indexed annuities, which is approximately half 
the number of insurers currently issuing indexed annuities.\196\ 
Because the commenter does not provide information as to the basis for 
the $255,000 figure, and because the $62,500 figure is substantially 
below the Commission's estimate of $180,000, we are not revising our 
estimate of the burden of registering an indexed annuity on Form S-1 to 
reflect these estimates.
---------------------------------------------------------------------------

    \194\ Second NAFA Letter, supra note 191.
    \195\ This estimate is for carriers ``without variable 
authority.'' The commenter does not explain the meaning of the 
phrase ``without variable authority.''
    \196\ NAVA, supra note 9, at 57 (58 companies issued indexed 
anuities in 2007).
---------------------------------------------------------------------------

    Another commenter stated that the Commission's estimate of outside 
professional costs of $400 per hour does not reflect market rates for 
securities counsel.\197\ However, the commenter did not cite a 
different rate and did not explain the basis for its disagreement with 
the $400 per hour rate cited by the Commission. Our estimate of $400 
per hour for outside professionals retained by the issuer is consistent 
with recent rulemakings and is based on discussions between our staff 
and several law firms.\198\ Accordingly, we are not changing our 
estimate of the cost per hour of outside professional costs. The 
commenter further stated that the estimates of time involved are low 
for persons unfamiliar with the process of registration of securities 
under the federal securities laws and the anticipated need for 
interaction with Commission staff. However, as discussed, our estimate 
of time required to prepare a registration statement reflects time 
needed not only by first-time Form S-1 filers, but also the time 
involved in preparing Form S-1 for contracts offered by experienced 
Form S-1 filers, as well as annual updates to the existing Form S-1 
registration statement, which we expect to be significantly less than 
time needed by first-time filers. We are not revising our estimate of 
time involved in preparing registration statements on Form S-1.
---------------------------------------------------------------------------

    \197\ Transamerica Letter, supra note 54.
    \198\ See, e.g., Securities Act Release No. 8909 (Apr. 10, 2008) 
[73 FR 20512, 20515 (Apr. 15, 2008)] (``Revisions to Form S-11 
Release'').
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V. Cost-Benefit Analysis

    The Commission is sensitive to the costs and benefits imposed by 
its rules. Rule 151A is intended to clarify the status under the 
federal securities laws

[[Page 3161]]

of indexed annuities, under which payments to the purchaser are 
dependent on the performance of a securities index. Section 3(a)(8) of 
the Securities Act provides an exemption for certain insurance 
contracts. The rule prospectively defines certain indexed annuities as 
not being ``annuity contracts'' or ``optional annuity contracts'' under 
this insurance exemption if the amounts payable by the insurer under 
the contract are more likely than not to exceed the amounts guaranteed 
under the contract. With respect to these annuities, investors are 
entitled to all the protections of the federal securities laws, 
including full and fair disclosure and sales practice protections. We 
are also adopting new rule 12h-7 under the Exchange Act, which exempts 
certain insurance companies from Exchange Act reporting with respect to 
indexed annuities and certain other securities that are registered 
under the Securities Act and regulated as insurance under state law.
    In the Proposing Release, we identified certain costs and benefits 
and requested comment on our cost-benefit analysis, including 
identification of any costs and benefits not discussed. We also 
requested that commenters provide empirical data and factual support 
for their views.
    Discussed below is our analysis of the costs and benefits of rules 
151A and 12h-7, as well as the issues raised by commenters. As noted 
above, we are sensitive to the costs imposed by our rules and we have 
estimated the costs associated with adoption of rule 151A. We 
emphasize, however, that the burdens of complying with the federal 
securities laws apply to all market participants who issue or sell 
securities under the federal securities laws. Rule 151A, by defining 
those indexed annuities that are not entitled to the Section 3(a)(8) 
exemption, does not impose any greater or different burdens than those 
imposed on other similarly situated market participants. Rather, the 
effect of rule 151A is that issuers and sellers of indexed annuities 
that are not entitled to the Section 3(a)(8) exemption are treated in 
the same manner under the federal securities laws as issuers and 
sellers of other registered securities, and that investors purchasing 
these instruments receive the same disclosure, antifraud, and sales 
practice protections that apply when they are offered and sold other 
securities that pose similar investment risks.

A. Benefits

    We anticipate that the rules will benefit investors and covered 
institutions by: (i) Creating greater regulatory certainty with regard 
to the status of indexed annuities under the federal securities laws; 
(ii) enhancing disclosure of information needed to make informed 
investment decisions about indexed annuities; (iii) applying sales 
practice protections to those indexed annuities that are outside the 
insurance exemption; (iv) enhancing competition; and (v) relieving from 
Exchange Act reporting obligations insurers that issue certain 
securities that are regulated as insurance under state law.
Regulatory Certainty
    Rule 151A will provide the benefit of increased regulatory 
certainty to insurance companies that issue indexed annuities and the 
distributors who sell them, as well as to purchasers of indexed 
annuities. The status of indexed annuities under the federal securities 
laws has been uncertain since their introduction in the mid-1990s. 
Under existing precedents, the status of each indexed annuity is 
determined based on a facts and circumstances analysis of factors that 
have been articulated by the U.S. Supreme Court. Rule 151A will bring 
greater certainty into this area by defining a class of indexed 
annuities that are outside the scope of the insurance exemption and by 
providing that an insurer's determination, in accordance with the rule, 
will be conclusive.
    Indexed annuities possess both insurance and securities features, 
and fall somewhere between traditional fixed annuities, which are 
clearly insurance falling within Section 3(a)(8), and variable 
annuities, which are clearly securities. We have carefully considered 
where to draw the line, and we believe that the line that we have drawn 
is rational and reasonably related to fundamental concepts of risk and 
insurance.
    Some commenters agreed that the proposal would provide greater 
regulatory certainty.\199\ One commenter stated that current 
uncertainty regarding the status of indexed annuities has impeded the 
ability of regulators to protect indexed annuity consumers,\200\ and 
another stated that it is apparent that clarification is needed and 
will set a clear national standard of regulatory oversight for indexed 
annuities.\201\ Some commenters, however, expressed concern that the 
principles-based approach provides insufficient guidance regarding 
implementation and the methodologies and assumptions that are 
appropriate and could result in inconsistent determinations by 
different insurance companies and present enforcement and litigation 
risk.\202\ While we believe that further guidance may be helpful in 
response to specific questions from affected insurance companies, 
commenters generally did not articulate with specificity the areas 
where they believe that further guidance is required. As a result, in 
order to provide guidance in the manner that would be most helpful, we 
encourage insurance companies, sellers of indexed annuities, and other 
affected parties to submit specific requests for guidance, which we 
will consider during the two-year period between adoption of rule 151A 
and its effectiveness.
---------------------------------------------------------------------------

    \199\ See, e.g., Advantage Group Letter, supra note 54; Cornell 
Letter, supra note 7; FINRA Letter, supra note 7; ICI Letter, supra 
note 7; Letter of State of Washington Department of Financial 
Institutions Securities division (Nov. 17, 2008) (``Washington State 
Letter'').
    \200\ FINRA Letter, supra note 7.
    \201\ Washington State Letter, supra note 199.
    \202\ See supra note 119.
---------------------------------------------------------------------------

Disclosure
    Rule 151A extends the benefits of full and fair disclosure under 
the federal securities laws to investors in indexed annuities that, 
under the rule, fall outside the insurance exemption. Without such 
disclosure, investors face significant obstacles in making informed 
investment decisions with regard to purchasing indexed annuities that 
expose them to investment risk. Indexed annuities are similar in many 
ways to mutual funds, variable annuities, and other securities. 
Investors in indexed annuities are confronted with many of the same 
risks and benefits that other securities investors are confronted with 
when making investment decisions. Extending the federal securities 
disclosure regime to indexed annuities under which amounts payable by 
the insurer are more likely than not to exceed the amounts guaranteed 
should help to provide investors with the information they need.
    Disclosures required for registered indexed annuities include 
information about costs (such as surrender charges); the method of 
computing indexed return (e.g., applicable index, method for 
determining change in index, caps, participation rates, spreads); 
minimum guarantees, as well as guarantees, or lack thereof, with 
respect to the method for computing indexed return; and benefits (lump 
sum, as well as annuity and death benefits). We think there are 
significant benefits to the disclosures provided under the federal 
securities laws. This information will be public and accessible to all 
investors, intermediaries, third party information providers, and 
others through the

[[Page 3162]]

Commission's Electronic Data Gathering, Analysis and Retrieval 
(``EDGAR'') system. Public availability of this information will be 
helpful to investors in making informed decisions about purchasing 
indexed annuities. The information will enhance investors' ability to 
compare various indexed annuities and also to compare indexed annuities 
with mutual funds, variable annuities, and other securities and 
financial products. The potential liability for materially false and 
misleading statements and omissions under the federal securities laws 
will provide additional encouragement for accurate and complete 
disclosures by insurers that issue indexed annuities and by the broker-
dealers who sell them.\203\
---------------------------------------------------------------------------

    \203\ See, e.g., Section 12(a)(2) of the Securities Act [15 
U.S.C. 77l(a)(2)] (imposing liability for materially false or 
misleading statements in a prospectus or oral communication, subject 
to a reasonable care defense). See also Section 10(b) of the 
Exchange Act [15 U.S.C. 78j(b)]; rule 10-5 under the Exchange Act 
[17 CFR 240.10b-;5]; Section 17 of the Securities Act [15 U.S.C. 
77q] (general antifraud provisions).
---------------------------------------------------------------------------

    In addition, we believe that potential purchasers of indexed 
annuities that an insurer determines do not fall outside the insurance 
exemption under the rule may benefit from enhanced information that 
will help a purchaser to evaluate the value of the contract and, 
specifically, the index-based return. Specifically, an indexed annuity 
that is not registered under the Securities Act after the effective 
date of rule 151A would reflect the insurer's determination that 
investors in the annuity will not receive more than the amounts 
guaranteed under the contract at least half the time.
    A number of commenters acknowledged the need for improved 
disclosures and agreed that indexed annuity purchasers will benefit 
from disclosures required under the federal securities laws.\204\ These 
commenters noted that indexed annuities are complicated products that 
can confuse experienced investment professionals and consumers, and 
strongly supported rule 151A as improving critical disclosures about 
these products. One commenter expressed strong support for enhanced 
disclosures regarding critical costs of indexed annuities, such as 
surrender charges, and the method of computing indexed returns, as well 
as guaranteed interest rates.\205\ Another commenter noted that the 
Commission could greatly improve consumer protection by subjecting 
indexed annuities that are not ``annuity contracts'' under rule 151A to 
the ``thorough, standardized, accessible, and transparent disclosure 
requirements and antifraud rules of the federal securities laws.'' 
\206\
---------------------------------------------------------------------------

    \204\ See, e.g., Alabama Letter, supra note 72; Cornell Letter, 
supra note 7; FPA Letter, supra note 72; Hartford Letter, supra note 
55.
    \205\ FPA Letter, supra note 72.
    \206\ Hartford Letter, supra note 55.
---------------------------------------------------------------------------

    However, some commenters argued that the proposed rule would not 
result in enhanced disclosure, in particular because the Commission's 
disclosure scheme is not tailored to indexed annuities and Form S-1 is 
not well-suited to indexed annuities.\207\ We acknowledge that, as a 
result of indexed annuity issuers having historically offered and sold 
their contracts without complying with the federal securities laws, the 
Commission has not created specific disclosure requirements tailored to 
these products. This fact, though, is not relevant in determining 
whether indexed annuities are subject to the federal securities laws. 
The Commission has a long history of creating appropriate disclosure 
requirements for different types of securities, including securities 
issued by insurance companies, such as variable annuities and variable 
life insurance.\208\ We note that we are providing a two-year 
transition period for rule 151A, and, during this period, we intend to 
consider how to tailor disclosure requirements for indexed annuities. 
We encourage indexed annuity issuers to work with the Commission during 
that period to address their concerns.
---------------------------------------------------------------------------

    \207\ See supra note 94 and accompanying text.
    \208\ See Form N-4 [17 CFR 239.17b and 274.11c] (registration 
form for variable annuities); Form N-6 [17 CFR 239.17c and 274.11d] 
(registration form for variable life insurance).
---------------------------------------------------------------------------

    Some commenters also cited recent efforts by state insurance 
regulators to address disclosure concerns with respect to indexed 
annuities as evidence that federal securities regulation is 
unnecessary.\209\ However, as we state above, we disagree. We do not 
believe that the states' regulatory efforts, no matter how strong, can 
substitute for our obligation to identify securities covered by the 
federal securities laws and the protections Congress intended to apply. 
State insurance laws, enforced by multiple regulators whose primary 
charge is the solvency of the issuing insurance company, cannot serve 
as an adequate substitute for uniform, enforceable investor protections 
provided by the federal securities laws.
---------------------------------------------------------------------------

    \209\ See supra note 81 and accompanying text.
---------------------------------------------------------------------------

    We have carefully considered the concerns raised by commenters, and 
we continue to believe that rule 151A will greatly enhance disclosures 
regarding indexed annuities. In addition to the specific benefits 
described above, we anticipate that these enhanced disclosures will 
also benefit the overall financial markets and their participants.
    We anticipate that the disclosure of terms of indexed annuities 
will be broadly beneficial to investors, enhancing the efficiency of 
the market for indexed annuities through increased competition. 
Disclosure will make information on indexed annuity contracts, 
including terms, publicly available. Public availability of terms will 
better enable investors to compare indexed annuities and may focus 
attention on the price competitiveness of these products. It will also 
improve the ability of third parties to price contracts, giving 
purchasers a better understanding of the fees implicit in the products. 
We anticipate that third-party information providers may provide 
services to price or compare terms of different indexed annuities. 
Analogously, we note that public disclosure of mutual fund information 
has enabled third-party information aggregators to facilitate 
comparison of fees.\210\ We believe that increasing the level of price 
transparency and the resulting competition through enhanced disclosure 
regarding indexed annuities would be beneficial to investors. It could 
also expand the size of the market, as investors may have increased 
confidence that indexed annuities are competitively priced.
---------------------------------------------------------------------------

    \210\ See, e.g., FINRA, Fund Analyzer, available at: http://www.finra.org/fundanalyzer (``FINRA Fund Analyzer'').
---------------------------------------------------------------------------

Sales Practice Protections
    Investors will also benefit because, under the federal securities 
laws, persons effecting transactions in indexed annuities that fall 
outside the insurance exemption under rule 151A will be required to be 
registered broker-dealers or become associated persons of a broker-
dealer through a networking arrangement. Thus, the broker-dealer sales 
practice protections will apply to transactions in registered indexed 
annuities. As a result, investors who purchase these indexed annuities 
after the effective date of rule 151A will receive the benefits 
associated with a registered representative's obligation to make only 
recommendations that are suitable. The registered representatives who 
sell registered indexed annuities will be subject to supervision by the 
broker-dealer with which they are associated. Both the selling broker-
dealer and its registered representatives will be subject to the 
oversight of FINRA.\211\ The registered broker-dealers

[[Page 3163]]

will also be required to comply with specific books and records, 
supervisory, and other compliance requirements under the federal 
securities laws, as well as be subject to the Commission's general 
inspections and, where warranted, enforcement powers.
---------------------------------------------------------------------------

    \211\ Cf. NASD Rule 2821 (rule designed to enhance broker-
dealers' compliance and supervisory systems and provide more 
comprehensive and targeted protection to investors regarding 
deferred variable annuities). See Order Approving FINRA's NASD Rule 
2821 Regarding Members' Responsibilities for Deferred Variable 
Annuities (Approval Order), Securities Exchange Act Release No. 
56375 (Sept. 7, 2007), 72 FR 52403 (Sept. 13, 2007) (SR-NASD-2004-
183); Corrective Order, Securities Exchange Act Release No. 56375A 
(Sept. 14, 2007), 72 FR 53612 (September 19, 2007) (SR-NASD-2004-
183) (correcting the rule's effective date).
---------------------------------------------------------------------------

    A number of commenters agreed that indexed annuity purchasers will 
benefit from the sales practice protections accorded by the federal 
securities laws.\212\ These commenters indicated that sales practice 
protections accorded by the federal securities laws are the most 
effective means of preventing abusive sales practices. Some commenters 
specifically stated that the protections of the federal securities laws 
are needed for the protection of seniors in the indexed annuity 
marketplace.\213\
---------------------------------------------------------------------------

    \212\ See, e.g., Alabama Letter, supra note 72; Cornell Letter, 
supra note 7; FPA Letter, supra note 72; FINRA Letter, supra note 7; 
Hartford Letter, supra note 55; Wyoming Letter, supra note 72.
    \213\ Alabama Letter, supra note 72; Wyoming Letter, supra note 
72.
---------------------------------------------------------------------------

    As stated above, however, a number of commenters argued that, 
because of efforts by state insurance regulators to address sales 
practice concerns with respect to indexed annuities, federal securities 
regulation is unnecessary and could result in duplicative or 
overlapping regulation.\214\ Commenters cited, in particular, the 
adoption by the majority of states of the NAIC Suitability in Annuity 
Transactions Model Regulation.\215\ Commenters also cited the existence 
of state market conduct examinations, the use of state enforcement and 
investigative authority, licensing and education requirements 
applicable to insurance agents who sell indexed annuities, and a number 
of recent and ongoing efforts by state insurance regulators.\216\ 
Commenters also noted recent efforts by state regulators addressed to 
annuities generally, such as the creation of NAIC working groups to 
review and consider possible improvements to the NAIC Suitability in 
Annuity Transactions Model Regulation.\217\
---------------------------------------------------------------------------

    \214\ See supra note 81 and accompanying text.
    \215\ NAIC Suitability in Annuity Transactions Model Regulation 
(Model 275-1) (2003). National Association of Insurance 
Commissioners, Draft Model Summaries, available at: http://www.naic.org/committees_models.htm. See, e.g., Letter A, supra note 
76; American Bankers Letter, supra note 74; CAI 151A Letter, supra 
note 54; NAFA Letter, supra note 54; NAIC Officer Letter, supra note 
54; NAIFA Letter, supra note 54.
    \216\ See, e.g., American Equity Letter, supra note 54; Aviva 
Letter, supra note 54; Coalition Letter, supra note 54; Iowa Letter, 
supra note 74; Maryland Letter, supra note 54; NAIC Officer Letter, 
supra note 54; NAFA Letter, supra note 54.
    \217\ See, e.g., NAIC Officer Letter, supra note 54.
---------------------------------------------------------------------------

    However, for the same reasons that we do not believe recent state 
disclosure efforts can substitute for federally required disclosures, 
we do not believe that the state's efforts to address sales practice 
concerns, no matter how strong, can substitute for our responsibility 
to identify securities covered by the statutes and the protections 
Congress intended to apply. State insurance laws, enforced by multiple 
regulators whose primary charge is the solvency of the issuing 
insurance company, cannot serve as an adequate substitute for uniform, 
enforceable investor protections provided by the federal securities 
laws.\218\ Where the purchaser of an indexed annuity assumes the 
investment risk of an instrument that fluctuates with the securities 
markets, and the contract therefore does not fall within the Section 
3(a)(8) exemption, the application of state insurance regulation, no 
matter how effective, is not determinative as to whether the contract 
is subject to the federal securities laws.
---------------------------------------------------------------------------

    \218\ Indeed, at least one state regulator acknowledged the 
developmental nature of state efforts and the lack of uniformity in 
those efforts. See Voss Letter, supra note 13.
---------------------------------------------------------------------------

Enhanced Competition
    Rule 151A may result in enhanced competition among indexed 
annuities, as well as between indexed annuities and other competing 
financial products, such as mutual funds and variable annuities. Rule 
151A will result in enhanced disclosure, and, as a result, more 
informed investment decisions by potential investors, which may enhance 
competition among indexed annuities and competing products. The greater 
clarity that results from rule 151A may enhance competition as well 
because insurers who may have been reluctant to issue indexed annuities 
while their status was uncertain may now decide to enter the market. 
Similarly, registered broker-dealers who currently may be unwilling to 
sell unregistered indexed annuities because of their uncertain 
regulatory status may become willing to sell indexed annuities that are 
registered, thereby increasing competition among distributors of 
indexed annuities. Further, we believe that the Exchange Act exemption 
may enhance competition among insurance products and between insurance 
products and other financial products because the exemption may 
encourage insurers to innovate and introduce a range of new insurance 
contracts that are securities, since the exemption will reduce the 
regulatory costs associated with doing so. Increased competition may 
benefit investors through improvements in the terms of insurance 
products and other financial products, such as reductions of direct or 
indirect fees.
    We anticipate that the disclosure of terms of indexed annuities 
will be broadly beneficial to investors, enhancing the efficiency of 
the market for indexed annuities through increased competition. 
Disclosure will make information on indexed annuity contracts, 
including terms, publicly available. Public availability of terms will 
better enable investors to compare indexed annuities and may focus 
attention on the price competitiveness of these products. It will also 
improve the ability of third parties to price contracts, giving 
purchasers a better understanding of the fees implicit in the products. 
We anticipate that third-party information providers may provide 
services to price or compare terms of different indexed annuities. 
Analogously, we note that public disclosure of mutual fund information 
has enabled third-party information aggregators to facilitate 
comparison of fees.\219\ We believe that increasing the level of price 
transparency and the resulting competition through enhanced disclosure 
regarding indexed annuities would be beneficial to investors. It could 
also expand the size of the market, as investors may have increased 
confidence that indexed annuities are competitively priced.
---------------------------------------------------------------------------

    \219\ See, e.g., FINRA Fund Analyzer, supra note 210.
---------------------------------------------------------------------------

    A number of commenters argued that proposed rule 151A would hinder 
competition, citing a number of factors that they argued would result 
in indexed annuities becoming less available.\220\ Commenters indicated 
that they did not believe that broker-dealers would become more willing 
to sell indexed annuities.\221\ They stated that

[[Page 3164]]

broker-dealers have limited ``shelf space'' for new products.\222\ One 
commenter stated that a broker-dealer would incur start-up costs in 
selling indexed annuities, such as becoming familiar with the products, 
performing due diligence, setting up supervisory systems, introducing 
appropriate technology, and becoming licensed to sell insurance, and 
these costs would deter a broker-dealer from selling indexed 
annuities.\223\ A number of commenters stated that many agents 
currently selling indexed annuities would stop selling them, rather 
than incur the costs of becoming licensed to sell securities and 
becoming associated with a broker-dealer.\224\ Two commenters stated 
that some agents would not be able to associate with a broker-dealer 
due to remote locations of the agents, so that rural areas would be 
underserved.\225\ Commenters further pointed to obstacles to 
distributors networking with registered broker-dealers.\226\ Commenters 
also stated that some insurance companies may stop issuing indexed 
annuities, because of the rule's adverse impact on distribution and 
because of the costs that the rule would impose on insurers, such as 
the cost of registering indexed annuities.\227\
---------------------------------------------------------------------------

    \220\ See, e.g., Advantage Group Letter, supra note 54; Allianz 
Letter, supra note 54; American Equity Letter, supra note 54; 
American National Letter, supra note 54; Aviva Letter, supra note 
54; Coalition Letter, supra note 54; FBL Letter, supra note 73; 
National Western Letter, supra note 54; Old Mutual Letter, supra 
note 54; Southwest Letter, supra note 136.
    We note that a number of commenters supporting the proposal are 
industry participants, such as insurers, see, e.g., Hartford letter, 
supra note 55, and industry groups, see, e.g., ICI letter, supra 
note 7.
    \221\ See, e.g., Allianz Letter, supra note 54; Aviva Letter, 
supra note 54; Coalition Letter, supra note 54.
    \222\ See, e.g., Allianz Letter, supra note 54; Aviva Letter, 
supra note 54.
    \223\ Allianz Letter, supra note 54.
    \224\ See, e.g., Allianz Letter, supra note 54; American Equity 
Letter, supra note 54; Aviva Letter, supra note 54; Coalition 
Letter, supra note 54.
    \225\ Second Old Mutual Letter, supra note 76; Southwest Letter, 
supra note 136.
    \226\ See, e.g., American Equity Letter, supra note 54; 
Coalition Letter, supra note 54; Old Mutual Letter, supra note 54.
    \227\ See, e.g., Aviva Letter, supra note 54; National Western 
Letter, supra note 54; Old Mutual Letter, supra note 54.
---------------------------------------------------------------------------

    The Commission believes that there could be costs associated with 
diminished competition as a result of rule 151A. As the commenters 
note, some insurance companies may stop issuing indexed annuities, and 
some broker-dealers and agents may determine not to sell indexed 
annuities. We recognize that the impact of rule 151A on competition may 
be mixed, but, on balance, we continue to believe that rule 151A will 
provide the benefits described above and has the potential to increase 
competition. In this regard, the demand for financial products is 
relatively fixed, in the aggregate. Any potential reduction in indexed 
annuities sold under the rule would likely correspond with an increase 
in the sale of other financial products, such as mutual funds or 
variable annuities. Thus, total reductions in competition may not be 
significant, when effects on the financial industry as a whole, 
including insurance companies together with other providers of 
financial instruments, are considered. Within the insurance industry, 
if some insurers cease selling indexed annuities, it is also likely 
that these insurers will sell other products through the same 
distribution channels, such as annuities with fixed interest rates.
Relief From Reporting Obligations
    The exemption from Exchange Act reporting requirements with respect 
to certain securities that are regulated as insurance under state law 
will provide a cost savings to insurers. We have identified 
approximately 24 insurance companies that currently are subject to 
Exchange Act reporting obligations solely as a result of issuing 
insurance contracts that are securities and that we believe will be 
entitled to an exemption from Exchange Act reporting obligations under 
rule 12h-7.\228\ We estimate that, each year, these insurers file an 
estimated 24 annual reports on Form 10-K, 72 quarterly reports on Form 
10-Q, and 26 reports on Form 8-K.\229\ Based on current cost estimates, 
we believe that the total estimated annual cost savings to these 
companies will be approximately $15,414,600.\230\
---------------------------------------------------------------------------

    \228\ In addition, because we are adopting both rules 151A and 
12h-7, insurers that currently are not Exchange Act reporting 
companies and that will be required to register indexed annuities 
under the Securities Act will be entitled to rely on the Exchange 
Act exemption and obtain the benefits of the exemption. We have not 
included potential cost savings to these companies in our 
computation because they are not currently Exchange Act reporting 
companies.
    \229\ These estimates are based on the requirement to file one 
Form 10-K each year and three Forms 10-Q each year, and on our 
review of the actual number of Form 8-K filings by these insurers in 
calendar year 2007.
    \230\ This consists of $8,748,950 attributable to internal 
personnel costs, representing 49,994 burden hours at $175 per hour, 
and $6,665,600 attributable to the costs of outside professionals, 
representing 16,664 burden hours at $400 per hour. Our estimates of 
$175 per hour for internal time and $400 per hour for outside 
professionals are consistent with the estimates that we have used in 
recent rulemaking releases.
    Our total burden hour estimate for Forms 10-K, 10-Q, and 8-K is 
66,658 hours, which, consistent with current OMB estimates and 
recent Commission rulemaking, we have allocated 75% (49,994 hours) 
to the insurers internally and 25% (16,664 hours) to outside 
professional time. See Supporting Statement to the Office of 
Management and Budget under the PRA for Securities Act Release No. 
8819, available at: http://www.reginfo.gov/public/do/DownloadDocument?documentID=42924&version=1. The total burden hour 
estimate was derived as follows. The burden attributable to Form 10-
K is 52,704 hours, representing 24 Forms 10-K at 2,196 hours per 
Form 10-K. The burden attributable to Form 10-Q is 13,824 hours, 
representing 72 Forms 10-Q at 192 hours per Form 10-Q. The burden 
attributable to Form 8-K is 130 hours, representing 26 Forms 8-K at 
5 hours per Form 8-K. The burden hours per response for Form 10-K 
(2,196 hours), Form 10-Q (192 hours), and Form 8-K (5 hours) are 
consistent with current OMB estimates.
---------------------------------------------------------------------------

    One commenter estimated a higher cost savings.\231\ The commenter 
estimated costs of $1.5-$2 million annually for an issuer to comply 
with Exchange Act reporting obligations. Under our current cost 
estimates, we estimate that it costs $642,275 per issuer \232\ to 
comply with these obligations. We are not revising our estimate, 
however, because the commenter did not explain how it arrived at its 
estimate and we have no basis for determining whether or not it is 
accurate.
---------------------------------------------------------------------------

    \231\ Great-West Letter, supra note 138.
    \232\ The $642,275 cost was derived by dividing the total annual 
cost savings for all insurance companies that we believe will be 
entitled to the rule 12h-7 exemption ($15,414,600) by the number of 
such companies (24). See supra text accompanying notes 228 and 230.
---------------------------------------------------------------------------

B. Costs

    While the rules we are adopting will result in significant cost 
savings for insurers as a result of the exemption from Exchange Act 
reporting requirements, we believe that there will be costs associated 
with the rules. These include costs associated with: (i) Determining 
under rule 151A whether amounts payable by the insurer under an indexed 
annuity are more likely than not to exceed the amounts guaranteed under 
the contract; (ii) preparing and filing required Securities Act 
registration statements with the Commission; (iii) printing 
prospectuses and providing them to investors; (iv) entering into a 
networking arrangement with a registered broker-dealer for those 
entities that are not currently parties to a networking arrangement or 
registered as broker-dealers and that intend to distribute indexed 
annuities that are registered as securities; \233\ (v) loss of revenue 
to insurance companies that determine to cease issuing indexed 
annuities; and (vi) diminished competition that may result.
---------------------------------------------------------------------------

    \233\ While some distributors may register as broker-dealers or 
cease distributing indexed annuities that will be required to be 
registered as a result of rule 151A, based on our experience with 
insurance companies that issue insurance products that are also 
securities, we believe that the vast majority will continue to 
distribute those indexed annuities via networking arrangements with 
registered broker-dealers, as discussed below.
---------------------------------------------------------------------------

    Some commenters opined that the benefits of the proposal to indexed 
annuity purchasers would outweigh any costs to the indexed annuity 
industry.\234\ One commenter, for example, recognized that the proposal 
would impose some compliance costs

[[Page 3165]]

on the indexed annuity industry, but stated that these costs are 
minimal relative to the gains to investors in regulatory 
oversight.\235\ The commenter stated that the rule would bring clarity 
regarding the status of indexed annuities under the federal securities 
laws and would subject indexed annuity sales to the application of 
suitability and antifraud protections under the federal securities 
laws.
---------------------------------------------------------------------------

    \234\ See, e.g., Cornell Letter, supra note 7; NASAA Letter, 
supra note 133.
    \235\ Cornell Letter, supra note 7.
---------------------------------------------------------------------------

    A number of other commenters, however, stated that the Commission 
significantly underestimated the costs of the proposal.\236\ As 
discussed below, these commenters stated that the proposal would impose 
substantial costs throughout the industry, affecting insurers, agents, 
marketing organizations. Commenters also stated that consumers would 
face additional costs as a result of the proposal, as the costs of 
product development and offering and selling registered securities are 
passed on to consumers.\237\ We also received a number of comments 
specifically stating that the proposal would have an adverse impact on 
small entities, such as small insurance distributors.\238\
---------------------------------------------------------------------------

    \236\ See, e.g., Allianz Letter, supra note 54; ACLI Letter, 
supra note 94; American Equity Letter, supra note 54; Coalition 
Letter, supra note 54; Old Mutual Letter, supra note 54; Second 
Aviva Letter, supra note 54. Southwest Letter, supra note 136; 
Transamerica Letter, supra note 54.
    \237\ See, e.g., American National Letter, supra note 54; 
National Western Letter, supra note 54; Old Mutual Letter, supra 
note 54; Southwest Letter, supra note 136.
    \238\ See infra Section VII.
---------------------------------------------------------------------------

    The following is a more detailed discussion of specific costs that 
we believe will be associated with the rule. We specifically identified 
and discussed each of these costs in the Proposing Release. We received 
comments on each identified cost.
Determination Under Rule 151A
    Insurers may incur costs in performing the analysis necessary to 
determine whether amounts payable under an indexed annuity would be 
more likely than not to exceed the amounts guaranteed under the 
contract. This analysis calls for the insurer to analyze expected 
outcomes under various scenarios involving different facts and 
circumstances. Insurers routinely undertake such analyses for purposes 
of pricing and valuing their contracts.\239\ As a result, we believe 
that the costs of undertaking the analysis for purposes of the rule may 
not be significant. However, the determinations necessary under the 
rule may result in some additional costs for insurers that issue 
indexed annuities, either because the timing of the determination does 
not coincide with other similar analyses undertaken by the insurer or 
because the level or type of actuarial and legal analysis that the 
insurer determines is appropriate under the rule is different or 
greater than that undertaken for other purposes, or for other reasons. 
These costs, if any, could include the costs of software, as well as 
the costs of internal personnel and external consultants (e.g., 
actuarial, accounting, legal).
---------------------------------------------------------------------------

    \239\ See generally Black and Skipper, supra note 39, at 26-47, 
890-99.
---------------------------------------------------------------------------

    Several commenters who issue indexed annuities disputed that 
insurers undertake these analyses.\240\ Other commenters, however, 
confirmed that these analytical methods exist and are used by insurers 
for internal purposes.\241\ We continue to believe that because 
insurers routinely undertake these types of analyses, the costs of 
doing so for purposes of the rule may not be significant.
---------------------------------------------------------------------------

    \240\ See, e.g., American Equity Letter, supra note 54; National 
Western Letter, supra note 54; Sammons Letter, supra note 54. The 
commenters did not provide cost estimates for performing the 
analysis necessary under the rule.
    \241\ See, e.g., Aviva Letter, supra note 54; Academy Letter, 
supra note 54. We give substantial weight to the views of the 
Academy on this point, given their expertise in this type of 
analysis, and are not persuaded that the contrary comments of 
several issuers are representative of industry practice. See BLACK'S 
LAW DICTIONARY 39 (8th ed. 2004) (An actuary is a statistician who 
determines the present effects of future contingent events and who 
calculates insurance and pension rates on the basis of empirically 
based tables.); American Academy of Actuaries, Mission, available 
at: http://www.actuary.org/mission.asp (The mission of the Academy 
is to, among other things, provide independent and objective 
actuarial information, analysis, and education for the formation of 
sound public policy.).
---------------------------------------------------------------------------

Securities Act Registration Statements
    As noted above, we believe that significant benefits arise from the 
registration of indexed annuities, including enhanced disclosures of 
critical information regarding these products. Without such disclosure, 
investors face significant obstacles in making informed investment 
decisions with regard to purchasing indexed annuities that expose 
investors to securities investment risk. Investors in indexed annuities 
are confronted with many of the same risks and benefits that other 
securities investors are confronted with when making investment 
decisions. Extending the federal securities disclosure regime to 
indexed annuities that impose investment risk should help to provide 
investors with the information they need. The costs of preparing and 
filing registration statements are not unique to indexed annuities that 
are outside the scope of the Section 3(a)(8) exemption for annuities as 
a result of rule 151A, but apply to all issuers of registered 
securities. However, we are sensitive to these costs and discuss them 
below, along with comments that we received on this analysis.
    Insurers will incur costs associated with preparing and filing 
registration statements for indexed annuities that are outside the 
insurance exemption as a result of rule 151A. These include the costs 
of preparing and reviewing disclosure, filing documents, and retaining 
records. Our Office of Economic Analysis has considered the effect of 
the rule on indexed annuity contracts with typical terms and has 
determined that, more likely than not, these contracts would not meet 
the definition of ``annuity contract'' or ``optional annuity contract'' 
if they were issued after the effective date of the rule. For purposes 
of the PRA, we have estimated an annual increase in the paperwork 
burden for companies to comply with the rules to be 60,000 hours of in-
house company personnel time and $72,000,000 for services of outside 
professionals.\242\ We estimate that the additional burden hours of in-
house company personnel time will equal total internal costs of 
$10,500,000 \243\ annually, resulting in aggregate annual costs of 
$82,500,000 \244\ for in-house personnel and outside professionals. 
These costs reflect the assumption that filings will be made on Form S-
1 for 400 contracts each year, which we made for purposes of the PRA.
---------------------------------------------------------------------------

    \242\ See supra Part IV.C.
    \243\ This cost increase is estimated by multiplying the total 
annual hour burden (60,000 hours) by the estimated hourly wage rate 
of $175 per hour. Consistent with recent rulemaking releases, we 
estimate the value of work performed by the company internally at a 
cost of $175 per hour.
    \244\ $10,500,000 (in-house personnel) + $72,000,000 (outside 
professionals).
---------------------------------------------------------------------------

    As indicated in our analysis for purposes of the PRA, we received 
several comments questioning our estimate of the costs of registering 
an indexed annuity on Form S-1.\245\ One commenter stated that, for 
insurers that have not previously prepared a Form S-1 registration 
statement, external legal costs could be as high as $250,000-$500,000 
for each registration statement.\246\ However, the commenter did not 
specify the source of this range of cost estimates or how it was made. 
The $250,000-$500,000 range cited by the commenter is for an

[[Page 3166]]

issuer that has not previously filed a Form S-1, with the commenter 
acknowledging that the costs to an experienced filer would be lower (as 
low as $50,000 to $100,000).\247\ Another commenter estimated external 
legal costs for preparation and filing of a Form S-1 registration 
statement with the SEC at $350,000 for the first few years, which, the 
commenter stated, would decrease over time as the insurer gained more 
expertise.\248\ Our average $180,000 estimate reflects outside 
professional costs incurred not only by first-time Form S-1 filers, but 
also the costs of preparing Form S-1 for contracts offered by 
experienced Form S-1 filers, as well as annual updates to existing Form 
S-1 registration statements, which we expect to be significantly lower 
than costs incurred by first-time filers. Therefore, we do not believe 
that it is necessary to change our estimate of outside professional 
costs based on the commenters' estimated costs.
---------------------------------------------------------------------------

    \245\ See, e.g., Allianz Letter, supra note 54; Second Aviva 
Letter, supra note 54; Second NAFA Letter, supra note 191.
    \246\ Allianz Letter, supra note 54.
    \247\ Id.
    \248\ Second Aviva Letter, supra note 54.
---------------------------------------------------------------------------

    One commenter cites a cost of $62,500 per insurance company for 
``Registration Statement Preparation'' but also appears to assume a 
cost of $255,000 per contract for registration statement 
preparation.\249\ It is unclear how these estimates should be 
reconciled, and we are not revising our estimate of the burden of 
preparation of registration statement on the basis of the commenter's 
estimates.
---------------------------------------------------------------------------

    \249\ Second NAFA Letter, supra note 191.
---------------------------------------------------------------------------

    Another commenter stated that the Commission's estimate of outside 
professional costs of $400 per hour does not reflect market rates for 
securities counsel.\250\ However, the commenter did not cite a 
different rate and did not explain the basis for its disagreement with 
the $400 per hour rate cited by the Commission. Our estimate of $400 
per hour for outside professionals retained by the issuer is consistent 
with recent rulemakings and is based on discussions between our staff 
and several law firms.\251\ Accordingly, we are not changing our 
estimate of the cost per hour of outside professional costs.
---------------------------------------------------------------------------

    \250\ Transamerica Letter, supra note 54.
    \251\ See, e.g., Securities Act Release No. 8909 (Apr. 10, 2008) 
[73 FR 20512, 20515 (Apr. 15, 2008)] (``Revisions to Form S-11 
Release'').
---------------------------------------------------------------------------

    The commenter further stated that the estimates of time involved 
are low for persons unfamiliar with the process of registration of 
securities under the federal securities laws and the anticipated need 
for interaction with Commission staff. However, our estimate of time 
required to prepare a registration statement reflects time needed not 
only by first-time Form S-1 filers, but also the time involved in 
preparing Form S-1 for contracts offered by experienced S-1 filers, as 
well as annual updates to the existing Form S-1 registration statement, 
which we expect to be significantly less than time needed by first-time 
filers. Therefore, we are not revising our estimate of time involved in 
preparing registration statements on Form S-1.
    Commenters stated that insurers will be subject to significant 
additional costs as a result of having to register on Form S-1.\252\ 
These include required registration fees for securities sold. One 
commenter estimated Commission registration fees, assuming sales of $5 
billion annually, as $196,500.\253\ Commenters also stated that the due 
diligence necessary to verify disclosures in the registration statement 
will require significant resources.\254\ We acknowledge that these are 
additional costs associated with registration. However, these costs are 
not unique to indexed annuities, but are incurred by all issuers of 
registered securities.
---------------------------------------------------------------------------

    \252\ See, e.g., Allianz Letter, supra note 54; American Equity 
Letter, supra note 54; Old Mutual Letter, supra note 54; 
Transamerica Letter, supra note 54.
    \253\ Allianz Letter, supra note 54.
    \254\ National Western Letter, supra note 54; Old Mutual Letter, 
supra note 54.
---------------------------------------------------------------------------

    Commenters also cited other costs of registration on Form S-1, such 
as preparation of financial statements in accordance with generally 
accepted accounting principles (``GAAP''), which, according to the 
commenters, many insurers currently do not do.\255\ One commenter 
estimated a cost of at least several million dollars for an insurer to 
develop GAAP financial statements.\256\ We acknowledge that if an 
indexed annuity issuer that did not currently prepare GAAP financial 
statements were required to do so in order to register its indexed 
annuities, the one-time start-up costs could be significant. We note 
that, during the two-year transition period for rule 151A, the 
Commission intends to consider how to tailor accounting requirements 
for indexed annuities.\257\
---------------------------------------------------------------------------

    \255\ See, e.g., Allianz Letter, supra note 54. See Second Aviva 
Letter, supra note 54.
    \256\ Second Aviva Letter, supra note 54.
    \257\ See supra note 95 and accompanying text.
---------------------------------------------------------------------------

    Based on the foregoing analysis, our estimates of the costs of 
registration for indexed annuities include the costs of preparing Form 
S-1 registration statements, totaling $82,500,000 annually, or $206,250 
per contract, and, based on a commenter's estimate, registration fees 
of $196,000 assuming sales by an insurer of $5 billion annually. If the 
insurer does not already prepare financial statements in accordance 
with GAAP, the insurer will also incur costs of developing GAAP 
financials, which one commenter estimated to involve one-time start-up 
costs of at least several million dollars per insurer. Commenters also 
mentioned due diligence as a cost of registration, but did not 
separately break out its cost.
Costs of Printing Prospectuses and Providing Them to Investors
    Insurers will incur costs to print and provide prospectuses to 
investors for indexed annuities that are outside the insurance 
exemption as a result of rule 151A. For purposes of the PRA, we have 
estimated that registration statements will be filed for 400 indexed 
annuities per year. In the Proposing Release, we estimated that it 
would cost $0.35 to print each prospectus and $1.21 to mail each 
prospectus,\258\ for a total of $1.56 per prospectus. These estimates 
would be reduced to the extent that prospectuses are delivered in 
person or electronically, or to the extent that Securities Act 
prospectuses are substituted for written materials used today, rather 
than being delivered in addition to those materials.
---------------------------------------------------------------------------

    \258\ These estimates reflect estimates provided to us by 
Broadridge Financial Solutions, Inc. (``Broadridge''), in connection 
with our recent proposal to create a summary prospectus for mutual 
funds. The estimates depend on factors such as page length and 
number of copies printed and not on the content of the disclosures. 
Because we believe that these factors may be reasonably comparable 
for indexed annuity and mutual fund prospectuses, we believe that it 
is reasonable to use these estimates in the context of indexed 
annuities. See Memorandum to File number S7-28-07 regarding October 
27, 2007 meeting between Commission staff members and 
representatives of Broadridge Financial Solutions, Inc. (Nov. 28, 
2007) (``Broadridge Memo''). The memorandum is available for 
inspection and copying in File No. S7-28-07 in the Commission's 
Public Reference Room and on the Commission's Web site at http://www.sec.gov/comments/s7-28-07/s72807-5.pdf.
---------------------------------------------------------------------------

    One commenter questioned whether the cost of printing an indexed 
annuity prospectus on Form S-1 would be roughly equivalent to that of 
printing a mutual fund prospectus on Form N-1A, as we were assuming for 
purposes of our estimate in the proposing release.\259\ The commenter, 
based on its internal projections of prospectus printing and mailing 
costs, stated that the indexed annuity prospectus would cost twice as 
much as the mutual fund prospectus. The commenter estimated printing 
costs for an indexed annuity prospectus on Form S-1 as $1.50 and the 
cost of mailing as $1.38 for a total cost of $2.88. In making its cost 
projections, the commenter assumed that the mutual fund prospectus 
would be 25 pages

[[Page 3167]]

long, while the indexed annuity prospectus (including financial 
statements) would be 100 pages long. Our estimate of the cost of 
printing and mailing a mutual fund prospectus was based on an assumed 
page length of 45 pages.\260\ We believe that the commenter's estimate 
of page length may be more realistic for a prospectus prepared on Form 
S-1.\261\ Accordingly, we are revising our estimate of the costs of 
printing and mailing the prospectus to the costs cited by the 
commenter; i.e., $1.50 for printing the prospectus and $1.38 for 
mailing for a total cost of $2.88.\262\ Though we have revised our 
estimate as described above, we believe that the revised estimate is 
conservative because some indexed annuity issuers who file Exchange Act 
reports and incorporate their financial statements from their Exchange 
Act reports by reference may have significantly shorter prospectuses as 
a result.\263\
---------------------------------------------------------------------------

    \259\ Allianz Letter, note 54.
    \260\ Broadridge Memo, supra note 258.
    \261\ See Pre-effective Amendment No. 4 to Registration 
Statement on Form S-1 of PHL Variable Insurance Company (File No. 
333-132399) (filed Feb. 7, 2007) (67-page prospectus); 257 Pre-
effective Amendment No. 1 to Registration Statement on Form S-1 of 
Golden America Life Insurance Company (File No. 333-67660) (filed 
Feb. 8, 2002) (170-page prospectus).
    \262\ Allianz Letter, supra note 54. This revision does not 
affect our estimate of the cost burden for Form S-1 under the 
Paperwork Reduction Act. Printing and mailing costs are not 
``collections of information'' for purposes of the Paperwork 
Reduction Act.
    \263\ See Pre-effective Amendment No. 4 to Registration 
Statement on Form S-1 of PHL Variable Insurance Company (File No. 
333-132399) (filed Feb. 7, 2007) (20 pages of the prospectus are 
attributable to financial statements); Pre-effective Amendment No. 1 
to Registration Statement on Form S-1 of Golden America Life 
Insurance Company (File No. 333-67660) (filed Feb. 8, 2002) (63 
pages of the prospectus are attributable to financial statements).
---------------------------------------------------------------------------

    Another commenter estimated the cost per insurance company of 
``printing prospectuses/supply chain'' \264\ at $20,000 per insurance 
company for a combined total of $880,000. The commenter does not 
explain how it arrived at this estimate. Moreover, because the 
commenter's estimate is for total cost per insurance company and does 
not specify the number of prospectuses printed by each insurance 
company, and our estimate is a per prospectus cost, we are not able to 
compare the two estimates. Thus, we are not revising our estimate of 
the cost of printing prospectuses and providing them to investors.
---------------------------------------------------------------------------

    \264\ Second NAFA Letter, supra note 191. It is not fully clear 
what the commenter intends by ``supply chain,'' but we are citing 
the estimate, because it references printing of prospectuses.
---------------------------------------------------------------------------

Networking Arrangements With Registered Broker-Dealers and Other 
Related Costs
    Rule 151A may impose costs on indexed annuity distributors that are 
not currently parties to a networking arrangement or registered as 
broker-dealers. These costs are not unique to indexed annuity 
distributors but apply to all distributors of federally registered 
securities that are not registered broker-dealers. While these entities 
may choose to register as broker-dealers, in order to continue to 
distribute indexed annuities that are registered as securities, these 
distributors will likely enter into a networking arrangement with a 
registered broker-dealer. Under these arrangements, an affiliated or 
third-party broker-dealer provides brokerage services for an insurance 
agency's customers, in connection with transactions in insurance 
products that are also securities. Entering into a networking 
arrangement will impose costs associated with contracting with the 
registered broker-dealer regarding the terms, conditions, and 
obligations of each party to the arrangement. We anticipate that a 
distributor will incur legal costs in connection with entering into a 
networking arrangement with a registered broker-dealer, as well as 
ongoing costs associated with monitoring compliance with the terms of 
the networking arrangement. However, while there are costs of entering 
into a networking arrangement and monitoring compliance with the terms 
of the arrangement, distributors in networking arrangements will not be 
subject to the full range of costs associated with obtaining and 
maintaining broker-dealer registration.
    One commenter estimated that the cost of registering as a broker-
dealer, taking into account only the legal and regulatory work of 
initial setup,\265\ licensing, and staffing could be between $250,000-
$500,000.\266\ Another commenter estimated the cost of forming a 
registered broker-dealer at $800,000.\267\ The same commenter cites a 
cost of $3 million for ``BD startup'' in a separate comment.\268\ As we 
discuss above, however, we believe it is more likely that distributors 
will enter into networking arrangements with registered broker-dealers, 
rather than register as broker-dealers.
---------------------------------------------------------------------------

    \265\ Allianz Letter, supra note 54. Initial setup includes 
registering the broker-dealer with the Commission, developing 
extensive written policies and procedures tailored to its business, 
obtaining a fidelity bond, registering its offices as branch 
offices, and setting up a procedure for a principal review of all 
applications, as well as review of advertisements, business cards, 
letterhead, office signage, correspondence, and e-mails.
    \266\ Allianz Letter, supra note 54.
    \267\ Memorandum from the Division of Investment Management 
Regarding a November 10, 2008 Meeting with Representatives of the 
National Association for Fixed Annuities (Nov. 26, 2008). One 
commenter stated that the costs of registering and operating as a 
broker-dealer include FINRA registration and examination fees of up 
to $4,000. The commenter further stated that the legal cost 
associated with registering and applying for membership with FINRA, 
the cost of completing the necessary forms, and the costs of ongoing 
compliance could result in start-up costs of $25,000 and between 
$50,000 to $100,000 annually to maintain the registration. Coalition 
Letter, supra note 54.
    \268\ Second NAFA Letter, supra note 191.
---------------------------------------------------------------------------

    Some commenters disagreed that distributors would enter into 
networking arrangements with registered broker-dealers, stating that 
the cost of networking would be too high.\269\ One of these commenters 
stated that networking would be inordinately expensive.\270\ The 
commenter stated that under current industry practice, a distributor 
would bear expenses when using a networking arrangement that include 
examination fees, state registration fees, and possibly a pro rata 
share of the associated broker-dealer's increased compliance costs, and 
would have to share a portion of his commissions with the registered 
broker-dealer.\271\ Commenters did not provide estimates of the cost of 
networking. We recognize that a distributor will incur costs in 
entering into networking arrangement. We estimate the upper bound of 
entering into a networking agreement to be the equivalent of the cost 
of establishing a registered broker-dealer. Commenters provided a range 
of cost estimates for establishing a registered broker-dealer from 
$250,000 to $3 million. However, these costs are not unique to indexed 
annuities. For example, issuers of insurance products registered as 
securities, such as variable annuities, may incur networking costs, as 
do banks involved in networking arrangements. Moreover, while we would 
expect networking to be generally more cost-effective than registration 
as a broker-dealer, to the extent that it is not, broker-dealer

[[Page 3168]]

registration remains an option for indexed annuity distributors.
---------------------------------------------------------------------------

    \269\ See, e.g., American Equity Letter, supra note 54; 
Coalition Letter, supra note 54.
    \270\ Coalition Letter, supra note 54.
    \271\ Coalition Letter, supra note 54. One commenter indicated 
its belief that insurance agencies are only permitted to enter into 
networking arrangements with affiliated broker-dealers. Therefore, 
the commenter stated that insurance agencies without an affiliated 
broker-dealer would not appear to be able to take advantage of 
networking arrangements. We disagree with the commenter's 
interpretation and note that, in our view, insurance agencies may 
enter into networking arrangements with unaffiliated broker-dealers.
---------------------------------------------------------------------------

    Commenters also cited additional costs that agents will incur as a 
result of the rule.\272\ For example, commenters cited annual 
securities registration and licensing fees, including FINRA fees and 
state securities fees, that agents would be required to pay. With 
regard to state registration fees, one commenter estimated that an 
agent selling in all 50 states would pay approximately $3,100 in 
initial state securities registration fees and nearly $3,000 annually 
in ongoing state securities fees.\273\ We recognize that agents may 
incur additional registration and licensing costs and are sensitive to 
the impact of such costs. However, these fees are paid by all sellers 
of securities and are not unique to those selling indexed annuities. 
The fees are a product of the regulatory structure mandated by Congress 
under the federal securities laws, which is intended to provide sales 
practice and other protections to investors.
---------------------------------------------------------------------------

    \272\ See, e.g., Allianz Letter, supra note 54; Coalition 
Letter, supra note 54; Southwest Letter, supra note 136.
    \273\ Allianz Letter, supra note 54.
---------------------------------------------------------------------------

    Several commenters cited an industry source that estimated loss to 
distributors as a result of the rule as approximately $800 
million.\274\ This source estimates that agents would lose about $200 
million in income by having to share commissions with the broker-
dealers with which the agent is associated. The source estimates that 
fees charged by the broker-dealer and by FINRA would amount to another 
$22.5 million. The sharing of commissions, as well as the fees charged 
by the broker-dealer and by FINRA are necessary expenses of selling 
registered securities. For marketing organizations, the source 
estimates that indexed annuity sales would drop by 60% and marketing 
organization compensation would be reduced from around $500 million-
$700 million a year today to $60 million-$200 million as a result of 
the rule. However, the source does not explain the basis for the 
estimate of the decline in sales. Moreover, if the marketing 
organization registers as, or enters into a networking arrangement 
with, a broker-dealer, it would have opportunities to sell other types 
of securities, and may be able to compensate for any declines in sales 
of indexed annuities that may occur. We believe that even at the high 
end of costs suggested by commenters, given the imperative of the 
federal securities laws and the size of the industry, these costs are 
nonetheless justified.
---------------------------------------------------------------------------

    \274\ Letter of Advisors Excel (Aug. 20, 2008); Coalition 
Letter, supra note 54; Letter of Courtney A. Juhl (Aug. 15, 2008), 
citing Jack Marrion, The Proposed Rule Will Sock it to Index Annuity 
Distributors, National Underwriter Life & Health/Financial Services 
Edition, Aug. 4, 2008, at 13, available at: http://www.lifeandhealthinsurancenews.com/cms/nulh/Weekly%20Issues/issues/2008/29/Focus/L29cover2.
---------------------------------------------------------------------------

Possible Loss of Revenue
    Insurance companies that determine that indexed annuities are 
outside the insurance exemption under rule 151A could either choose to 
register those annuities under the Securities Act or to cease selling 
those annuities. If an insurer ceases selling such annuities, the 
insurer may experience a loss of revenue. Commenters agreed that some 
insurers may stop selling indexed annuities as a result of the rule and 
that they would experience a loss of revenue.\275\ One commenter 
estimated a total first year loss to insurance companies of 
approximately $300,000,000 as a result of the rule.\276\ The commenter 
argued that industry experts state indexed annuity sales will drop from 
approximately $30 billion of premium per year (projected for 2008) to 
$10 billion per year as a result of the rule.\277\ However, the 
commenter does not explain how this estimate was determined. We believe 
that even at the high end of costs suggested by commenters, given the 
imperative of the federal securities laws and the size of the industry, 
these costs are nonetheless justified.
---------------------------------------------------------------------------

    \275\ See, e.g., Allianz Letter, supra note 54; National 
Western, supra note 54.
    \276\ Second NAFA Letter, supra note 191.
    \277\ Id., citing ``The Advantage Compendium, Jack Marrion, 
President.'' The commenter does not provide a specific citation, and 
we have been unable to find the source of the estimate provided by 
the commenter.
---------------------------------------------------------------------------

    The amount of lost revenue for insurance companies would depend on 
actual revenues prior to effectiveness of the rules and to the 
particular determinations made by insurers regarding whether to 
continue to issue registered indexed annuities. However, the loss of 
revenue may be offset, in whole or in part, by gains in revenue from 
the sale of other financial products, as purchasers' need for financial 
products will not diminish. These gains could be experienced by the 
same insurers who exit the indexed annuity business or they could be 
experienced by other insurance companies or other issuers of securities 
or other financial products.
    Commenters also stated that sellers of indexed annuities may lose 
revenue because rule 151A may cause them to cease selling these 
products.\278\ One commenter estimated a first-year income loss to 
distributors of $1.5 billion, based on an estimated decline in indexed 
annuity sales from approximately $30 billion (projected for 2008) to 
$10 billion per year, as a result of the rule.\279\
---------------------------------------------------------------------------

    \278\ See, e.g., Second Old Mutual Letter, supra note 76; 
Southwest Letter, supra note 136.
    \279\ Second NAFA Letter, supra note 191. This commenter also 
estimated a first-year income loss of $300 million for independent 
marketing organizations.
---------------------------------------------------------------------------

    The amount of lost revenue for sellers of indexed annuities would 
depend on actual revenues prior to effectiveness of the rules and to 
the particular determinations made by distributors regarding whether to 
continue to sell registered indexed annuities. The loss of revenue may 
be offset, in whole or in part, by gains in revenue from the sale of 
other financial products, as purchasers' need for financial products 
will not diminish.
    Commenters also cited indirect or collateral costs associated with 
the rule.\280\ For example, if insurers exit the indexed annuities 
business; this will result in a reduction in personnel of those who are 
no longer needed to administer the products.\281\ Commenters also 
stated that if insurers chose to stop offering indexed annuities 
because of the rule, third-party service providers who helped support 
the administration and/or sale of the insurer's indexed annuities may 
also incur costs.\282\
---------------------------------------------------------------------------

    \280\ Allianz Letter, supra note 54; Aviva Letter, supra note 
54; National Western Letter, supra note 54.
    \281\ See, e.g., Allianz Letter, supra note 54.
    \282\ See, e.g., Allianz Letter, supra note 54.
---------------------------------------------------------------------------

    A number of commenters cited job loss as a consequence of the rule. 
Loss of employment, these commenters argued, would affect current 
employees of insurance companies, agents, and others.\283\ Demand for 
financial products is relatively fixed in the aggregate. Within the 
insurance industry, some employees of insurance companies and agents 
will likely find employment in other areas of the insurance industry.
---------------------------------------------------------------------------

    \283\ E.g., Letter of Todd F. Gregory (Aug. 5, 2008); Letter of 
Terry R. Lucas (Sept. 9, 2008); National Western Letter, supra note 
54; Letter of Randall L. Whittle (Aug. 8, 2008).
---------------------------------------------------------------------------

Possible Diminished Competition
    There could be costs associated with diminished competition as a 
result of our rules. In order to issue indexed annuities that are 
outside the insurance exemption under rule 151A, insurers would be 
required to register those annuities as securities. If some insurers 
determine to cease issuing indexed annuities rather than undertake the 
analysis required by rule 151A and register those annuities that are 
outside the insurance exemption under the rule,

[[Page 3169]]

there will be fewer issuers of indexed annuities, which may result in 
reduced competition. Any reduction in competition may affect investors 
through potentially less favorable terms of insurance products and 
other financial products, such as increases in direct or indirect fees. 
A number of commenters agreed that diminished competition would result 
in indexed annuity purchasers receiving less favorable terms. However, 
the commenters did not provide data in this regard.\284\
---------------------------------------------------------------------------

    \284\ See, e.g., American Equity, supra note 54; American 
National, supra note 54; National Western, supra note 54.
---------------------------------------------------------------------------

    It is currently unknown whether new providers will enter the market 
for indexed annuities. We note, however, that the possibility for new 
entrants created by this rule is beneficial to competition, even if 
they do not enter the market. If the indexed annuity market becomes 
sufficiently uncompetitive and economic profits increase, new entrants 
will likely arrive, putting downward pressure on prices. Thus, any 
reduction in regulatory barriers to entry created by increased 
regulatory certainty can have the effect of increasing competition and 
reducing prices, a direct benefit to investors. It is currently unknown 
whether new providers will enter the market for indexed annuities. We 
note, however, that the possibility for new entrants created by this 
rule is beneficial to competition, even if they do not enter the 
market. If the indexed annuity market becomes sufficiently 
uncompetitive and economic profits increase, new entrants will likely 
arrive, putting downward pressure on prices. Thus, any reduction in 
regulatory barriers to entry created by increased regulatory certainty 
can have the effect of increasing competition and reducing prices, a 
direct benefit to investors.
Additional Costs
    Commenters provided further information on costs for insurance 
companies. One commenter estimated a total first-year cost to insurance 
companies of $237,000,000.\285\ Components of this cost are identified 
as broker-dealer startup, broker-dealer annual maintenance, new 
compliance costs, legal start-up costs, FINRA implementation, FINRA 
maintenance, state fees, Form S-1 fees, including registration 
statement preparation, state filing, annual audit, operations/
administration/systems, printing prospectus supply chain, and 
additional fees paid to FINRA impacting product pricing. Much of these 
costs appear to be attributable to setting up a broker-dealer. As noted 
above, however, we do not believe that insurers would need to establish 
a broker-dealer to continue to sell indexed annuities. An insurer could 
make use of existing broker-dealers and avoid the costs of starting a 
broker-dealer. If those costs are avoided, the commenter's estimate 
could be reduced by at least $135,727,000 (the total cost attributable 
to the costs of starting a broker-dealer as estimated by the 
commenter). This still leaves a total first-year cost to insurance 
companies of over $100,000,000. We recognize this is a substantial 
cost. However, these costs are not unique to indexed annuities but are 
the costs of offering and selling any registered securities. All 
issuers of securities must incur such costs, and issuers of indexed 
annuities will not incur higher costs as a result of the rule than any 
other issuer of securities.
---------------------------------------------------------------------------

    \285\ Second NAFA Letter, supra note 191.
---------------------------------------------------------------------------

    One commenter cited the cost that may be incurred if the insurer 
needs to find additional distributors as a result of existing 
distributors dropping out of the indexed annuity market because of the 
costs they would incur under the rule.\286\ However, this is no 
different from any securities issuer, all of whom must use distribution 
channels subject to the federal securities laws.
---------------------------------------------------------------------------

    \286\ See, e.g., American Equity Letter, supra note 54.
---------------------------------------------------------------------------

    The Commission has carefully considered the costs cited by the 
commenters. These include the costs that the commenters state will be 
incurred by insurers, distributors, and agents. We have also considered 
the collateral costs cited by the commenters, and the possibility of 
loss of employment cited by the commenters. While we have taken the 
costs of the rule into account, we also continue to believe that the 
rule will result in substantial benefits to indexed annuity purchasers, 
in the form of enhanced disclosure and sales practice protections, 
greater regulatory certainty for issuers and sellers of indexed 
annuities, enhanced competition, and relief from reporting obligations. 
While the costs of the rule may be significant, where an annuity 
contract is not entitled to the Section 3(a)(8) exemption, which we 
have concluded is the case with respect to certain indexed annuities, 
the federal securities laws apply, and participants in the indexed 
annuity market will need to bear the costs of compliance with the 
federal securities laws, as do any other participants in the securities 
markets. Furthermore, notwithstanding these costs, our rule imposes no 
greater costs than those imposed on other market participants who issue 
or sell securities.

VI. Consideration of Promotion of Efficiency, Competition, and Capital 
Formation; Consideration of Burden on Competition

    Section 2(b) of the Securities Act \287\ and Section 3(f) of the 
Securities Exchange Act \288\ require the Commission, when engaging in 
rulemaking that requires it to consider or determine whether an action 
is necessary or appropriate in the public interest, to consider, in 
addition to the protection of investors, whether the action will 
promote efficiency, competition, and capital formation. Section 
23(a)(2) of the Exchange Act \289\ requires us, when adopting rules 
under the Exchange Act, to consider the impact that any new rule would 
have on competition. In addition, Section 23(a)(2) prohibits us from 
adopting any rule that would impose a burden on competition not 
necessary or appropriate in furtherance of the purposes of the Exchange 
Act.
---------------------------------------------------------------------------

    \287\ 15 U.S.C. 77b(b).
    \288\ 15 U.S.C. 78c(f).
    \289\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

A. Efficiency

    For the following reasons, we believe that rule 151A will promote 
efficiency by extending the benefits of the disclosure and sales 
practice protections of the federal securities laws to indexed 
annuities that are more likely than not to provide payments that vary 
with the performance of securities.
    The required disclosures will enable investors to make more 
informed investment decisions. As discussed above, disclosures that 
will be required for registered indexed annuities include information 
about costs (such as surrender charges); the method of computing 
indexed return (e.g., applicable index, method for determining change 
in index, caps participation rates, spreads); minimum guarantees, as 
well as guarantees, or lack thereof, with respect to the method for 
computing indexed return; and benefits (lump sum, as well as annuity 
and death benefits). This information will be public and accessible to 
all investors, intermediaries, third party information providers, and 
others through the SEC's EDGAR system. Public availability of this 
information will be helpful to investors in making informed decisions 
about purchasing indexed annuities. The enhancement of investor 
decision-making that will result from the public availability of 
information about indexed annuities

[[Page 3170]]

will ultimately lead to more efficient capital allocation in the 
securities markets.
    Investors will also receive the benefits of the sales practice 
protections, including a registered representative's obligation to make 
only recommendations that are suitable. Under the federal securities 
laws, persons effecting transactions in indexed annuities that fall 
outside the insurance exemption under rule 151A will be required to be 
registered broker-dealers or become associated persons of a broker-
dealer. As a result, investors who purchase these indexed annuities 
after the effective date of rule 151A will receive the benefits 
associated with a registered representative's obligation to make only 
recommendations that are suitable. The registered representatives who 
sell registered indexed annuities will be subject to supervision by the 
broker-dealer with which they are associated. Both the selling broker-
dealer and its registered representatives will be subject to the 
oversight of FINRA. The registered broker-dealers will also be required 
to comply with specific books and records, supervisory, and other 
compliance requirements under the federal securities laws, as well as 
be subject to the Commission's general inspections and, where 
warranted, enforcement powers. These sales practice protections will 
promote suitable recommendations to investors, which will lead to 
enhanced decision-making by investors and, ultimately, to greater 
efficiency in the securities markets.
    Some commenters argued that rule 151A, as proposed, would not 
promote efficiency, because it would be duplicative of state insurance 
regulation of indexed annuities.\290\ These commenters argued that 
disclosure and suitability concerns in connection with indexed annuity 
sales are already addressed by state insurance regulation, and further 
indicated that state insurance regulation is more closely tailored to 
indexed annuities than federal securities regulation.
---------------------------------------------------------------------------

    \290\ See e.g., Coalition Letter, supra note 54; NAFA Letter, 
supra note 54. But see Washington State Letter, supra note 199 
(noting its experience with variable annuities and synergy of 
complementary regulation by the insurance regulator focused on 
solvency and the securities regulator focused on investor 
protection).
---------------------------------------------------------------------------

    We do not believe that these efforts, no matter how strong, can 
substitute for the federal securities law protections that apply to 
instruments that are regulated as securities. The federal securities 
laws were designed to provide uniform protections, with respect to both 
disclosure and sales practices, to investors in securities. State 
insurance laws, enforced by multiple regulators whose primary charge is 
the solvency of the issuing insurance company, cannot serve as an 
adequate substitute for uniform, enforceable investor protections 
provided by the federal securities laws. Indeed, at least one state 
insurance regulator acknowledged the developmental nature of state 
efforts and the lack of uniformity in those efforts.\291\ Where the 
purchaser of an indexed annuity assumes the investment risk of an 
instrument that fluctuates with the securities markets, and the 
contract therefore does not fall within the Section 3(a)(8) exemption, 
the application of state insurance regulation, no matter how effective, 
is not determinative as to whether the contract is subject to the 
federal securities laws, which provide uniform and enforceable 
protections for investors. In addition, during the transition period 
between adoption and the effective date of rule 151A, we intend to 
consider how to tailor disclosure requirements for indexed annuities.
---------------------------------------------------------------------------

    \291\ See Voss Letter, supra note 13 (proposing to accelerate 
NAIC efforts to strengthen the NAIC model laws affecting indexed 
annuity products and urge adoption by more of the member states).
---------------------------------------------------------------------------

    One commenter stated that the Commission cannot claim further 
efficiencies without a comprehensive consideration of the existing 
state law regulatory regime, the efficiencies that regime already 
realizes, and the respects in which that state regime falls short and 
further gains may be achieved by the Commission.\292\ The commenter 
further stated that the proposal would only impose further costs and 
burdens on efficiency with no compensating benefit, adding an 
unnecessary, largely duplicative layer of federal requirements that 
were developed for securities and have not been tailored to annuity 
products and purchasers generally.\293\ We disagree that the Commission 
must undertake a comprehensive consideration of the existing state law 
regulatory regime and that there are no benefits from the federal 
securities laws. Congress has determined that securities investors are 
entitled to the disclosure, antifraud, and sales practice protections 
of the federal securities laws. The burdens that are uniformly imposed 
on issuers and sellers of all types of securities are part of those 
laws, and it is not the Commission's role to reevaluate the 
efficiencies of that regulatory structure for each particular 
instrument that is a security.
---------------------------------------------------------------------------

    \292\ Coalition Letter, supra note 54.
    \293\ Id.
---------------------------------------------------------------------------

B. Competition

    We also anticipate that, because rule 151A will improve investors' 
ability to make informed investment decisions, it will lead to 
increased competition between issuers and sellers of indexed annuities, 
mutual funds, variable annuities, and other financial products, and 
increased competitiveness in the U.S. capital markets. The greater 
clarity that results from rule 151A also may enhance competition 
because insurers who may have been reluctant to issue indexed 
annuities, while their status was uncertain, may decide to enter the 
market. Similarly, registered broker-dealers who currently may be 
unwilling to sell unregistered indexed annuities because of their 
uncertain regulatory status may become willing to sell indexed 
annuities that are registered, thereby increasing competition among 
distributors of indexed annuities.
    We have carefully considered the concerns raised by commenters, and 
we continue to believe that rule 151A will greatly enhance disclosures 
regarding indexed annuities. In addition to the specific benefits 
described above, we anticipate that these enhanced disclosures will 
also benefit the overall financial markets and their participants.
    We anticipate that the disclosure of terms of indexed annuities 
will be broadly beneficial to investors, enhancing the efficiency of 
the market for indexed annuities through increased competition. 
Disclosure will make information on indexed annuity contracts, 
including terms, publicly available. Public availability of terms will 
better enable investors to compare indexed annuities and may focus 
attention on the price competitiveness of these products. It will also 
improve the ability of third parties to price contracts, giving 
purchasers a better understanding of the fees implicit in the products. 
We anticipate that third-party information providers may provide 
services to price or compare terms of different indexed annuities. 
Analogously, we note that public disclosure of mutual fund information 
has enabled third-party information aggregators to facilitate 
comparison of fees.\294\ We believe that increasing the level of price 
transparency and the resulting competition through enhanced disclosure 
regarding indexed annuities would be beneficial to investors. It could 
also expand the size of the

[[Page 3171]]

market, as investors may have increased confidence that indexed 
annuities are competitively priced.
---------------------------------------------------------------------------

    \294\ See, e.g., FINRA, Fund Analyzer, available at: http://www.finra.org/fundanalyzer (``FINRA Fund Analyzer'').
---------------------------------------------------------------------------

    The Commission believes that there could be costs associated with 
diminished competition as a result of rule 151A. As the commenters 
note, some insurance companies may stop issuing indexed annuities, and 
some broker-dealers and agents may determine not to sell indexed 
annuities. We recognize that the impact of rule 151A on competition may 
be mixed, but, on balance, we continue to believe that rule 151A will 
provide the benefits described above and has the potential to increase 
competition. In this regard, the demand for financial products is 
relatively fixed, in the aggregate. Any potential reduction in indexed 
annuities sold under the rule would likely correspond with an increase 
in the sale of other financial products, such as mutual funds or 
variable annuities. Thus, total reductions in competition may not be 
significant, when effects on the financial industry as a whole, 
including insurance companies together with other providers of 
financial instruments, are considered. Within the insurance industry, 
if some insurers cease selling indexed annuities, it is also likely 
that these insurers will sell other products through the same 
distribution channels, such as annuities with fixed interest rates.
    We conclude, in any event, that the importance of providing the 
protections of the federal securities laws to indexed annuity 
purchasers is significant notwithstanding any burden on competition 
that may result from the operation of the rule. In addition, the rule 
will provide other benefits. It will bring about clarity in what has 
been an uncertain area of law. In addition, issuers and sellers of 
these products will no longer be subject to uncertainty and litigation 
risk with respect to the laws that are applicable.
    Some commenters argued that regulation under the federal securities 
laws of indexed annuities will place them at a competitive disadvantage 
to variable annuities and mutual funds because the Commission's 
disclosure scheme is not tailored to these contracts.\295\ Commenters 
cited a number of supposed defects, including the lack of a 
registration form that is well-suited to indexed annuities, questions 
about the appropriate method of accounting to be used by insurance 
companies that issue indexed annuities, and concerns about parity of 
the registration process vis-a-vis mutual funds.
---------------------------------------------------------------------------

    \295\ Allianz Letter, supra note 54; Sammons Letter, supra note 
54; Second Aviva Letter, supra note 54.
---------------------------------------------------------------------------

    We acknowledge that, as a result of indexed annuity issuers having 
historically offered and sold their contracts without complying with 
the federal securities laws, the Commission has not created specific 
disclosure requirements tailored to these products. This fact, though, 
is not relevant in determining whether indexed annuities are subject to 
the federal securities laws. The Commission has a long history of 
creating appropriate disclosure requirements for different types of 
securities, including securities issued by insurance companies, such as 
variable annuities and variable life insurance.\296\ We note that we 
are providing a two-year transition period for rule 151A, and, during 
this period, we intend to consider how to tailor disclosure 
requirements for indexed annuities. We encourage indexed annuity 
issuers to work with the Commission during that period to address their 
concerns.
---------------------------------------------------------------------------

    \296\ See Form N-4 [17 CFR 239.17b and 274.11c] (registration 
form for variable annuities); Form N-6 [17 CFR 239.17c and 274.11d] 
(registration form for variable life insurance).
---------------------------------------------------------------------------

    One commenter indicated that the rule creates a competitive 
disadvantage for indexed annuities to the advantage of fixed annuities 
and suggests that that the Commission improperly failed to consider 
competition between indexed and fixed annuities.\297\ Fixed annuities 
do not involve assumption of significant investment risks by 
purchasers. By contrast, indexed annuities that fall outside the 
insurance exemption under rule 151A do impose significant investment 
risk on purchasers, and, like other securities, they require the 
protections of the federal securities laws. Securities and non-
securities are subject to different regulatory regimes as a result of 
Congressional action; it is not the Commission's role to revisit that 
determination by Congress.
---------------------------------------------------------------------------

    \297\ NAFA Letter, supra note 54.
---------------------------------------------------------------------------

C. Capital Formation

    We also anticipate that the increased market efficiency resulting 
from enhanced investor protections under rule 151A could promote 
capital formation by improving the flow of information among insurers 
that issue indexed annuities, the distributors of those annuities, and 
investors. Public availability of this information will be helpful to 
investors in making informed decisions about purchasing indexed 
annuities. The information will enhance investors' ability to compare 
various indexed annuities and also to compare indexed annuities with 
mutual funds, variable annuities, and other securities and financial 
products. The potential liability for materially false and misleading 
statements and omissions under the federal securities laws will provide 
additional encouragement for accurate, relevant, and complete 
disclosures by insurers that issue indexed annuities and by the broker-
dealers who sell them.\298\
---------------------------------------------------------------------------

    \298\ See, e.g., Section 12(a)(2) of the Securities Act [15 
U.S.C. 77l(a)(2)] (imposing liability for materially false or 
misleading statements in a prospectus or oral communication, subject 
to a reasonable care defense). See also Section 10(b) of the 
Exchange Act [15 U.S.C. 78j(b)]; rule 10b-5 under the Exchange Act 
[17 CFR 240.10b-5]; Section 17 of the Securities Act [15 U.S.C. 77q] 
(general antifraud provisions).
---------------------------------------------------------------------------

    Some commenters criticized the Commission's consideration of 
whether the rule will promote capital formation.\299\ One commenter 
specifically questioned whether the proposed rule would improve the 
flow of information with regard to indexed annuities, suggesting that 
the Commission should delineate where the states' current disclosure 
regime falls short, and how the rule would improve upon it, as well as 
how the benefits of the rule would exceed its costs.\300\ We disagree. 
It is not our intention to question the effectiveness of state 
regulation. We continue to believe that applying the federal securities 
disclosure scheme to indexed annuities will enhance disclosure of 
information needed to make informed investment decisions. The 
information will enhance investors' abilities to compare various 
indexed annuities and also compare indexed annuities with mutual funds, 
variable annuities, and other securities and finanancial products. We 
believe that state insurance laws, enforced by multiple regulators 
whose primary charge is the solvency of the issuing insurance company, 
cannot serve as an adequate substitute for uniform, enforceable 
investor protections provided by the federal securities laws. At least 
one state regulator has acknowledged the developmental nature of state 
efforts and the lack of uniformity in those efforts.\301\ Congress has 
prescribed a uniform federal regulatory scheme for securities having 
already weighed whether the federal securities laws are well-suited to 
securities. In addition, the courts have recognized that labeling a 
product as insurance does not remove it from the federal regulatory 
scheme.
---------------------------------------------------------------------------

    \299\ See, e.g., Coalition Letter, supra note 54; NAFA Letter, 
supra note 54.
    \300\ Coalition Letter, supra note 54.
    \301\ See Voss Letter, supra note 13.
---------------------------------------------------------------------------

    The federal securities laws will further improve upon the state 
structure because of the Commission's long

[[Page 3172]]

history of creating appropriate disclosure requirements for different 
types of securities, including securities issued by insurance 
companies, such as variable annuities and variable life insurance,\302\ 
the federal regulatory scheme's uniformity in application, the 
suitability requirements enforced by FINRA, as well as the Commission 
and FINRA's robust enforcement powers and the private remedies allowed 
under the federal securities laws.
---------------------------------------------------------------------------

    \302\ See e.g., Form N-4 [17 CFR 239.17b and 274.11c] 
(registration form for variable annuities); Form N-6 [17 CFR 239.17c 
and 274.11d] (registration form for variable life insurance).
---------------------------------------------------------------------------

    Another commenter stated that the proposed rule would only promote 
capital formation if it resulted in increased sales of indexed 
annuities, and that the Commission has not analyzed the rule to the 
point where it can determine whether or not it will increase indexed 
annuity sales.\303\ We strongly disagree that the correct measure of 
whether the rule will promote capital formation is if it results in 
increased sales of indexed annuities. We believe that capital formation 
would be enhanced through increased competition among indexed annuities 
and among indexed annuities and other financial products, such as 
variable annuities and mutual funds, and the innovation and better 
terms in indexed annuities for investors that may result from this 
competition. Better information leads to increased competition and 
greater investor confidence in markets which will in turn lead to 
willingness to invest and facilitate capital formation. Moreover, it is 
not possible to predict with certainty whether indexed annuity sales 
will themselves increase or decrease as a result of the rule. The 
Commission has taken both possibilities into account. In any event, we 
believe, first, that the importance of protecting purchasers of these 
products under the federal securities laws is significant 
notwithstanding any reduction in capital formation that may result from 
fewer sales of indexed annuities and second, that any such reduction is 
likely to be offset by an increase in capital formation through sales 
of other financial products.
---------------------------------------------------------------------------

    \303\ NAFA Letter, supra note 54.
---------------------------------------------------------------------------

    Rule 12h-7 provides insurance companies with an exemption from 
Exchange Act reporting with respect to indexed annuities and certain 
other securities that are regulated as insurance under state law. We 
are adopting this exemption because the concerns that Exchange Act 
financial disclosures are intended to address are generally not 
implicated where an insurer's financial condition and ability to meet 
its contractual obligations are subject to oversight under state law 
and where there is no trading interest in an insurance contract. 
Accordingly, we believe that the exemption will improve efficiency by 
eliminating potentially duplicative and burdensome regulation relating 
to insurers' financial condition. Furthermore, we believe that rule 
12h-7 will not impose any burden on competition. Rather, we believe 
that the rule will enhance competition among insurance products and 
between insurance products and other financial products because the 
exemption may encourage insurers to innovate and introduce a range of 
new insurance contracts that are securities, since the exemption will 
reduce the regulatory costs associated with doing so. We also 
anticipate that the innovations in product development could promote 
capital formation by providing new investment opportunities for 
investors.

VII. Final Regulatory Flexibility Analysis

    This Final Regulatory Flexibility Analysis has been prepared in 
accordance with the Regulatory Flexibility Act.\304\ It relates to the 
Commission's rule 151A that defines the terms ``annuity contract'' and 
``optional annuity contract'' under the Securities Act of 1933 and rule 
12h-7 that exempts insurance companies from filing reports under the 
Securities Exchange Act of 1934 with respect to indexed annuities and 
other securities that are registered under the Securities Act, subject 
to certain conditions, both of which we are adopting in this Release. 
The Initial Regulatory Flexibility Analysis (``IRFA'') which was 
prepared in accordance with 5 U.S.C. 603 was published in the Proposing 
Release.
---------------------------------------------------------------------------

    \304\ 5 U.S.C. 604 et seq.
---------------------------------------------------------------------------

A. Need For and Objectives of Rules

    We are adopting the definition of the terms ``annuity contract'' 
and ``optional annuity contract'' to provide greater clarity with 
regard to the status of indexed annuities under the federal securities 
laws. We believe this will enhance investor protection and provide 
greater certainty to the issuers and sellers of these products with 
respect to their obligations under the federal securities laws. We are 
adopting the exemption from Exchange Act reporting because we believe 
that the concerns that periodic financial disclosures are intended to 
address are generally not implicated where an insurer's financial 
condition and ability to meet its contractual obligations are subject 
to oversight under state law and where there is no trading interest in 
an insurance contract.

B. Significant Issues Raised By Public Comment

    In the Proposing Release, we requested comment on the number of 
small entity insurance companies, small entity distributors of indexed 
annuities, and any other small entities that may be affected by the 
rules, the existence or nature of the potential impact and how to 
quantify the impact of the rules. A number of commenters stated that 
costs and burdens arising from rule 151A would have a significant and 
adverse impact on small entities, such as small insurance 
distributors.\305\ Commenters have estimated the number of small 
entities to be adversely affected by this rule to range from thousands 
to tens of thousands of small entities.\306\ Insurance distributors 
that would be affected by the rule are not registered with the 
Commission. For that reason, we do not have information pertaining to 
the number of such distributors, or the number of small distributors. 
While commenters provided a range of numbers of small entities, they 
did not explain the basis for their estimates.
---------------------------------------------------------------------------

    \305\ See, e.g., Letter A, supra note 76; Letter of Dennis 
Absher (Jul. 25, 2008) (``Absher Letter''); Letter of James Brenner 
(Jul. 7, 2008) (``Brenner Letter''); Letter E, supra note 76; Letter 
of Dustin R. Montgomery (Sep. 11, 2008) (``Montgomery Letter''); 
Letter of Raymond J. Ohlson, The Ohlson Group, Inc. (Jul. 22, 2008) 
(``Ohlson Letter''); Letter of Steven A Sewell (Aug. 25, 2008) 
(``Sewell Letter''); Letter of Donna Tupper (Sept. 11, 2009) 
(``Tupper Letter'').
    \306\ See, e.g., Letter of Matthew Coleman (Jul. 11, 2008) 
(``Coleman Letter''); Letter of Bruce E. Dickes (Jul. 16, 2008) 
(``Dickes Letter''); Letter Type K (``Letter K''); Letter of Larry 
A. Kaufman (Aug. 27, 2008) (``Kaufman Letter''); Letter of Dejah F. 
LaMonte (Sep. 3, 2008) (``LaMonte Letter''); Letter of Kyle Mann 
(Sep. 9, 2008) (``Mann Letter'').
---------------------------------------------------------------------------

    Some commenters stated that the estimate of the burden on small 
entities in the proposing release is understated.\307\ In particular, 
one commenter stated that small entities among distributors who network 
with registered broker-dealers will incur not only legal and monitoring 
costs, as the Proposing Release recognized, but will also have to share 
commissions that they earn from the sales of indexed annuities.\308\ 
While we did not specifically address sharing of commissions in the 
Proposing Release, we recognize that networking may cause small 
distributors to share commissions with registered broker-dealers. 
However, we continue to believe that networking may be more cost-
effective than

[[Page 3173]]

registering as a broker-dealer. We recognize that a distributor will 
incur costs in entering into networking arrangement. However, these 
costs are not unique to indexed annuities. For example, issuers of 
insurance products registered as securities, such as variable 
annuities, may incur networking costs, as do banks involved in 
networking arrangements. Moreover, while we would expect networking to 
be generally more cost-effective than registration as a broker-dealer, 
to the extent that it is not more efficient, broker-dealer registration 
remains an option for indexed annuity distributors. We believe that the 
upper bound of the cost of entering into a networking agreement is the 
equivalent of the costs of establishing a registered broker-dealer. 
Commenters provided a range of cost estimates for establishing a 
registered broker-dealer, ranging from $250,000 to $3 million.
---------------------------------------------------------------------------

    \307\ See, e.g., Coalition Letter, supra note 54.
    \308\ Coalition Letter, supra note 54.
---------------------------------------------------------------------------

    As discussed below, it is the view of the Commission that, despite 
any adverse impact to small entities that may result, rule 151A is a 
necessary measure for the protection of purchasers of indexed 
annuities. Rule 151A will result in significant benefits to indexed 
annuity purchasers, including federally mandated disclosure and sales 
practice protections. Moreover, rule 151A offers benefits to all 
entities, large and small, such as greater regulatory certainty with 
regard to the status of indexed annuities under the federal securities 
laws and enhance competition. We do not anticipate that rule 151A will 
impose different or additional burdens on small entities than those 
imposed on other small entities who issue or distribute securities. 
Commenters generally supported rule 12h-7 and did not raise any issues 
regarding the effect of rule 12h-7 on small entities.

C. Small Entities Subject to the Rules

    The Commission's rules define ``small business'' and ``small 
organization'' for purposes of the Regulatory Flexibility Act for each 
of the types of entities regulated by the Commission.\309\ Rule 0-10(a) 
\310\ defines an issuer, other than an investment company, to be a 
``small business'' or ``small organization'' for purposes of the 
Regulatory Flexibility Act if it had total assets of $5 million or less 
on the last day of its most recent fiscal year.\311\ No insurers 
currently issuing indexed annuities are small entities.\312\ In 
addition, no other insurers that would be covered by the Exchange Act 
exemption are small entities.\313\
---------------------------------------------------------------------------

    \309\ See rule 157 under the Securities Act [17 CFR 230.157]; 
rule 0-10 under the Exchange Act [17 CFR 240.0-10].
    \310\ 17 CFR 240.0-10(a).
    \311\ Securities Act rule 157(a) [17 CFR 157(a)] generally 
defines an issuer, other than an investment company, to be a ``small 
business'' or ``small organization'' for purposes of the Regulatory 
Flexibility Act if it had total assets of $5 million or less on the 
last day of its most recent fiscal year and it is conducting or 
proposing to conduct a securities offering of $5 million or less. 
For purposes of our analysis, however, we use the Exchange Act 
definition of ``small business'' or ``small entity'' because that 
definition includes more issuers than does the Securities Act 
definition and, as a result, assures that the definition we use 
would not itself lead to an understatement of the impact of the 
amendments on small entities.
    \312\ The staff has determined that each insurance company that 
currently offers indexed annuities has total assets significantly in 
excess of $5 million. The staff compiled a list of indexed annuity 
issuers from four sources: AnnuitySpecs, Carrier List, http://www.annuityspecs.com/Page.aspx?s=carrierlist; Annuity Advantage, 
Equity Indexed Annuity Data, http://www.annuityadvantage.com/annuitydataequity.htm; Advantage Compendium, Current Rates, http://www.indexannuity.org/rates_by_carrier.htm; and a search of Best's 
Company Reports (available on Lexis) for indexed annuity issuers. 
The total assets of each insurance company issuer of indexed 
annuities were determined by reviewing the most recent Best's 
Company Reports for each indexed annuity issuer.
    \313\ The staff has determined that each insurance company that 
currently offers contracts that are registered under the Securities 
Act and that include so-called market value adjustment features or 
guaranteed benefits in connection with assets held in an investor's 
account has total assets significantly in excess of $5 million. The 
total assets of each such insurance company were determined by 
reviewing the Form 10-K of that company and, in some cases, Best's 
Company Reports (available on Lexis).
---------------------------------------------------------------------------

    While there are no small entities among the insurers who are 
subject to the new rules 151A and 12h-7, we note that there may be a 
substantial number of small entities among distributors of indexed 
annuities.\314\ Rule 0-10(c) \315\ states that the term ``small 
business'' or ``small organization,'' when referring to a broker-dealer 
that is not required to file audited financial statements prepared 
pursuant to rule 17a-5(d) under the Exchange Act,\316\ means a broker 
or dealer that had total capital (net worth plus subordinated 
liabilities) of less than $500,000 on the last business day of the 
preceding fiscal year (or in the time that it has been in business, if 
shorter); and is not affiliated with any person (other than a natural 
person) that is not a small business or small organization. Rule 0-
10(a) \317\ states that the term ``small business'' or ``small 
organization,'' when used with reference to a ``person,'' other than an 
investment company, means a ``person'' that, on the last day of its 
most recent fiscal year, had total assets of $5 million or less.
---------------------------------------------------------------------------

    \314\ See supra note 306 and accompanying text.
    \315\ 17 CFR 240.0-10(c).
    \316\ 17 CFR 240.17a-5(d).
    \317\ 17 CFR 240.0-10(a).
---------------------------------------------------------------------------

D. Reporting, Recordkeeping, and Other Compliance Requirements

    Rule 151A will result in Securities Act filing obligations for 
those insurance companies that, in the future, issue indexed annuities 
that fall outside the insurance exemption under rule 151A, and rule 
12h-7 will result in the elimination of Exchange Act reporting 
obligations for those insurance companies that meet the conditions to 
the exemption. As noted above, no insurance companies that currently 
issue indexed annuities or that would be covered by the exemption are 
small entities.
    However, rule 151A may affect indexed annuity distributors that are 
small entities and that are not currently parties to a networking 
arrangement or registered as broker-dealers. While these entities may 
choose to register as broker-dealers, in order to continue to 
distribute indexed annuities that are registered as securities, these 
distributors would likely enter into a networking arrangement with a 
registered broker-dealer. Under these arrangements, an affiliated or 
third-party broker-dealer provides brokerage services for an insurance 
agency's customers, in connection with transactions in insurance 
products that are also securities. Entering into a networking 
arrangement would impose costs associated with contracting with the 
registered broker-dealer regarding the terms, conditions, and 
obligations of each party to the arrangement. We anticipate that a 
distributor will incur legal costs in connection with entering into a 
networking arrangement with a registered broker-dealer, as well as 
ongoing costs associated with monitoring compliance with the terms of 
the networking arrangement.\318\ Entities that enter into such 
networking arrangements would not be subject to ongoing reporting, 
recordkeeping, or other compliance requirements imposed by the federal 
securities laws. If any of these entities were to choose to register as 
broker-dealers as a result of rule 151A,\319\ they would be subject to 
ongoing reporting, recordkeeping, and other compliance requirements 
applicable to registered broker-dealers. Compliance with these 
requirements, if

[[Page 3174]]

applicable, would impose costs associated with accounting, legal, and 
other professional personnel, and the design and operation of automated 
and other compliance systems.\320\
---------------------------------------------------------------------------

    \318\ See discussion supra Part V.B. The costs borne by 
distributors entering into networking arrangements will be borne by 
both large and small distributors of registered indexed annuities.
    \319\ See, e.g., Submission for OMB Review; Comment Request, OMB 
Control No. 3235-0012 [72 FR 39646 (Jul. 19, 2007)] (discussing the 
total annual burden imposed by Form BD).
    \320\ See supra notes 265-268 and accompanying text.
---------------------------------------------------------------------------

E. Commission Action To Minimize Effect on Small Entities

    The Regulatory Flexibility Act directs us to consider significant 
alternatives that would accomplish the stated objective, while 
minimizing any significant adverse impact on small entities. In 
connection with the adoption of rule 151A and rule 12h-7, we considered 
the following alternatives:
     Establishing different compliance or reporting 
requirements or timetables that take into account the resources 
available to small entities;
     Further clarifying, consolidating, or simplifying the 
requirements for small entities;
     Using performance standards rather than design standards; 
and
     Providing an exemption from the requirements, or any part 
of them, for small entities.
    Because no insurers that currently issue indexed annuities or that 
will be covered by the Exchange Act exemption are small entities, 
consideration of these alternatives for those insurance companies is 
not applicable. Small distributors of indexed annuities that choose to 
enter into networking arrangements with registered broker-dealers, 
which we believe will be likely once rule 151A is adopted, would not be 
subject to ongoing reporting, recordkeeping, or other compliance 
requirements. However, because some small distributors may choose to 
register as broker-dealers, we did consider the alternatives above for 
small distributors.
    Commenters did not suggest any alternatives specifically addressed 
to small entities. Some commenters suggested that the Commission, 
instead of adopting a rule that defines certain indexed annuities as 
not being ``annuity contracts'' under Section 3(a)(8), should instead 
define a safe harbor that would provide that indexed annuities that 
meet certain conditions are entitled to the Section 3(a)(8) 
exemption.\321\ We are not adopting this approach for two reasons. 
First, such a rule would not address in any way the federal interest in 
providing investors with disclosure, antifraud, and sales practice 
protections that arise when individuals are offered indexed annuities 
that expose them to investment risk. A safe harbor would address 
circumstances where purchasers of indexed annuities are not entitled to 
the protections of the federal securities laws; one of our primary 
goals is to address circumstances where purchasers of indexed annuities 
are entitled to the protections of the federal securities laws. We are 
concerned that many purchasers of indexed annuities today should be 
receiving the protections of the federal securities laws, but are not. 
Rule 151A addresses this problem; a safe harbor rule would not. Second, 
we believe that, under many of the indexed annuities that are sold 
today, the purchaser bears significant investment risk and is more 
likely than not to receive a fluctuating, securities-linked return. In 
light of that fact, we believe that is far more important to address 
this class of contracts with our definitional rule than to address the 
remaining contracts, or some subset of those contracts, with a safe 
harbor rule.
---------------------------------------------------------------------------

    \321\ See, e.g., Academy Letter, supra note 54; AIG Letter, 
supra note 128; Aviva Letter, supra note 54; Second Academy Letter, 
supra note 54; Second Aviva Letter, supra note 54; Second 
Transamerica Letter, supra note 54; Letter of Life Insurance Company 
of the Southwest (Sept. 10, 2008) (``Southwest Letter''); Voss 
Letter, supra note 13.
---------------------------------------------------------------------------

    The Commission believes that different registration, compliance, or 
reporting requirements or timetables for small entities that distribute 
registered indexed annuities would not be appropriate or consistent 
with investor protection. The rules will provide investors with the 
sales practice protections of the federal securities laws when they 
purchase indexed annuities that are outside the insurance exemption. 
These indexed annuities would be required to be distributed by a 
registered broker-dealer. As a result, investors who purchase these 
indexed annuities after the effective date of rule 151A would receive 
the benefits associated with a registered representative's obligation 
to make only recommendations that are suitable. The registered 
representatives who sell registered indexed annuities would be subject 
to supervision by the broker-dealer with which they are associated, and 
the selling broker-dealers would be subject to the oversight of FINRA. 
The registered broker-dealers would also be required to comply with 
specific books and records, supervisory, and other compliance 
requirements under the federal securities laws, as well as to be 
subject to the Commission's general inspections and, where warranted, 
enforcement powers.
    Different registration, compliance, or reporting requirements or 
timetables for small entities that distribute indexed annuities may 
create the risk that investors will receive lesser sales practice and 
other protections when they purchase a registered indexed annuity 
through a distributor that is a small entity. We believe that it is 
important for all investors that purchase indexed annuities that are 
outside the insurance exemption to receive equivalent protections under 
the federal securities laws, without regard to the size of the 
distributor through which they purchase. For those same reasons, the 
Commission also does not believe that it would be appropriate or 
consistent with investor protection to exempt small entities from the 
broker-dealer registration requirements when those entities distribute 
indexed annuities that fall outside of the insurance exemption under 
our rules.
    Through our existing requirements for broker-dealers, we have 
endeavored to minimize the regulatory burden on all broker-dealers, 
including small entities, while meeting our regulatory objectives. 
Small entities that distribute indexed annuities that are outside the 
insurance exemption under our rule should benefit from the Commission's 
reasoned approach to broker-dealer regulation to the same degree as 
other entities that distribute securities. In our existing broker-
dealer regulatory framework, we have endeavored to clarify, 
consolidate, and simplify the requirements applicable to all registered 
broker-dealers, and the rules do not change those requirements in any 
way. Finally, we do not consider using performance rather than design 
standards to be consistent with investor protection in the context of 
broker-dealer registration, compliance, and reporting requirements.

VIII. Statutory Authority

    The Commission is adopting the amendments outlined above under 
Sections 3(a)(8) and 19(a) of the Securities Act [15 U.S.C. 77c(a)(8) 
and 77s(a)] and Sections 12(h), 13, 15, 23(a), and 36 of the Exchange 
Act [15 U.S.C. 78l(h), 78m, 78o, 78w(a), and 78mm].

List of Subjects in 17 CFR Parts 230 and 240

    Reporting and recordkeeping requirements, Securities.

Text of Rules

0
For the reasons set forth in the preamble, the Commission amends Title 
17, Chapter II, of the Code of Federal Regulations as follows:

[[Page 3175]]

PART 230--GENERAL RULES AND REGULATONS, SECURITIES ACT OF 1933

0
1. The authority citation for Part 230 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77b, 77c, 77d, 77f, 77g, 77h, 77j, 77r, 
77s, 77z-3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78t, 78w, 
78ll(d), 78mm, 80a-8, 80a-24, 80a-28, 80a-29, 80a-30, and 80a-37, 
unless otherwise noted.
* * * * *

0
2. Add Sec.  230.151A to read as follows:


Sec.  230.151A  Certain contracts not ``annuity contracts'' or 
``optional annuity contracts'' under section 3(a)(8).

    (a) General. Except as provided in paragraph (c) of this section, a 
contract that is issued by a corporation subject to the supervision of 
the insurance commissioner, bank commissioner, or any agency or officer 
performing like functions, of any State or Territory of the United 
States or the District of Columbia, and that is subject to regulation 
under the insurance laws of that jurisdiction as an annuity is not an 
``annuity contract'' or ``optional annuity contract'' under Section 
3(a)(8) of the Securities Act (15 U.S.C. 77c(a)(8)) if:
    (1) The contract specifies that amounts payable by the issuer under 
the contract are calculated at or after the end of one or more 
specified crediting periods, in whole or in part, by reference to the 
performance during the crediting period or periods of a security, 
including a group or index of securities; and
    (2) Amounts payable by the issuer under the contract are more 
likely than not to exceed the amounts guaranteed under the contract.
    (b) Determination of amounts payable and guaranteed. In making the 
determination under paragraph (a)(2) of this section:
    (1) Amounts payable by the issuer under the contract and amounts 
guaranteed under the contract shall be determined by taking into 
account all charges under the contract, including, without limitation, 
charges that are imposed at the time that payments are made by the 
issuer; and
    (2) A determination by the issuer at or prior to issuance of the 
contract shall be conclusive, provided that:
    (i) Both the methodology and the economic, actuarial, and other 
assumptions used in the determination are reasonable;
    (ii) The computations made by the issuer in support of the 
determination are materially accurate; and
    (iii) The determination is made not more than six months prior to 
the date on which the form of contract is first offered.
    (c) Separate accounts. This section does not apply to any contract 
whose value varies according to the investment experience of a separate 
account.

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

0
3. The authority citation for Part 240 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 
80b-11, and 7201 et seq. ; and 18 U.S.C. 1350, unless otherwise 
noted.
* * * * *
0
4. Add Sec.  240.12h-7 to read as follows:


Sec.  240.12h-7  Exemption for issuers of securities that are subject 
to insurance regulation.

    An issuer shall be exempt from the duty under section 15(d) of the 
Act (15 U.S.C. 78o(d)) to file reports required by section 13(a) of the 
Act (15 U.S.C. 78m(a)) with respect to securities registered under the 
Securities Act of 1933 (15 U.S.C. 77a et seq.), provided that:
    (a) The issuer is a corporation subject to the supervision of the 
insurance commissioner, bank commissioner, or any agency or officer 
performing like functions, of any State;
    (b) The securities do not constitute an equity interest in the 
issuer and are either subject to regulation under the insurance laws of 
the domiciliary State of the issuer or are guarantees of securities 
that are subject to regulation under the insurance laws of that 
jurisdiction;
    (c) The issuer files an annual statement of its financial condition 
with, and is supervised and its financial condition examined 
periodically by, the insurance commissioner, bank commissioner, or any 
agency or officer performing like functions, of the issuer's 
domiciliary State;
    (d) The securities are not listed, traded, or quoted on an 
exchange, alternative trading system (as defined in Sec.  242.300(a) of 
this chapter), inter-dealer quotation system (as defined in Sec.  
240.15c2-11(e)(2)), electronic communications network, or any other 
similar system, network, or publication for trading or quoting;
    (e) The issuer takes steps reasonably designed to ensure that a 
trading market for the securities does not develop, including, except 
to the extent prohibited by the law of any State or by action of the 
insurance commissioner, bank commissioner, or any agency or officer 
performing like functions of any State, requiring written notice to, 
and acceptance by, the issuer prior to any assignment or other transfer 
of the securities and reserving the right to refuse assignments or 
other transfers at any time on a non-discriminatory basis; and
    (f) The prospectus for the securities contains a statement 
indicating that the issuer is relying on the exemption provided by this 
rule.

     January 8, 2009.

    By the Commission.
Elizabeth M. Murphy,
Secretary.

Opening Remarks and Dissent by Commissioner Troy A. Paredes

Regarding Final Rule 151A: Indexed Annuities and Certain Other 
Insurance Contracts

Open Meeting of the Securities & Exchange Commission

December 17, 2008

    Thank you, Chairman Cox.
    I believe that proposed Rule 151A addressing indexed annuities 
is rooted in good intentions. For instance, at the time the rule was 
proposed, the Commission watched a television clip from Dateline NBC 
that described individuals who may have been misled by seemingly 
unscrupulous sales practices into buying these products. Part of our 
tripartite mission at the SEC is to protect investors, so there is a 
natural tendency to want to act when we hear stories like this.
    However, our jurisdiction is limited; and thus our authority to 
act is circumscribed. Rule 151A is about this very question: The 
proper scope of our statutory authority.
    In our effort to protect investors, we cannot extend our reach 
past the statutory stopping point. Section 3(a)(8) of the Securities 
Act of 1933 ('33 Act) provides a list of securities that are exempt 
from the '33 Act and thus, by design of the statute, fall beyond the 
Commission's reach. The Section 3(a)(8) exemption includes, in 
relevant part, ``[a]ny insurance or endowment policy or annuity 
contract or optional annuity contract, issued by a corporation 
subject to the supervision of the insurance commissioner * * * of 
any State or Territory of the United States or the District of 
Columbia.'' I am not persuaded that Rule 151A represents merely an 
attempt to provide clarification to the scope of exempted securities 
falling within Section 3(a)(8). Instead, by defining indexed 
annuities in the manner done in Rule 151A, I believe the SEC will be 
entering into a realm that Congress prohibited us from entering. 
Therefore, I cannot vote in favor of the rule and respectfully 
dissent.
    Rule 151A takes some annuity products (indexed annuities), which 
otherwise may be covered by the statutory exemption in Section 
3(a)(8), and removes them from the exemption, thus placing them 
within the Commission's jurisdiction to regulate. If the 
Commission's Rule 151A analysis is wrong--which is to say that 
indexed annuities do fall

[[Page 3176]]

within Section 3(a)(8)--then the SEC has exceeded its authority by 
seeking to regulate them. In other words, the effect of Rule 151A 
would be to confer additional authority upon the SEC when these 
products, in fact, are entitled to the Section 3(a)(8) exemption.
    The Supreme Court has twice construed the scope of Section 
3(a)(8) for annuity contracts in the VALIC and United Benefit 
cases.\1\ I believe the approach embraced by Rule 151A conflicts 
with these Supreme Court cases. Although neither VALIC nor United 
Benefit deals with indexed annuities directly, the cases 
nevertheless are instructive in evaluating whether such a product 
falls within the Section 3(a)(8) exemption. And despite the adopting 
release's efforts to discount its holding, at least one federal 
court applying VALIC and United Benefit has held that an indexed 
annuity falls within the statutory exemption of Section 3(a)(8).\2\
---------------------------------------------------------------------------

    \1\ See generally SEC v. Variable Annuity Life Ins. Co. of Am., 
359 U.S. 65 (1959); SEC v. United Benefit Life Ins. Co., 387 U.S. 
202 (1967).
    \2\ See Malone v. Addison Ins. Mktg., Inc., 225 F. Supp. 2d 743 
(W.D. Ky. 2002).
---------------------------------------------------------------------------

    When fixing the contours of Section 3(a)(8), the relevant 
features of the product at hand should be considered to determine 
whether the product falls outside the Section 3(a)(8) exemption. 
Rule 151A places singular focus on investment risk without 
adequately considering another key factor--namely, the manner in 
which an indexed annuity is marketed.
    Moreover, I believe that Rule 151A misconceptualizes investment 
risk for purposes of Section 3(a)(8). The extent to which the 
purchaser of an indexed annuity bears investment risk is a key 
determinant of whether such a product is subject to the Commission's 
jurisdiction. Rule 151A denies an indexed annuity the Section 
3(a)(8) exemption when it is ``more likely than not'' that, because 
of the performance of the linked securities index, amounts payable 
to the purchaser of the annuity contract will exceed the amounts the 
insurer guarantees the purchaser. This approach to investment risk 
gives short shrift to the guarantees that are a hallmark of indexed 
annuities. In other words, the central insurance component of the 
product eludes the Rule 151A test. More to the point, Rule 151A in 
effect treats the possibility of upside, beyond the guarantee of 
principal and the guaranteed minimum rate of return the purchaser 
enjoys, as investment risk under Section 3(a)(8). I believe that it 
is more appropriate to emphasize the extent of downside risk--that 
is, the extent to which an investor is subject to a risk of loss--in 
determining the scope of Section 3(a)(8). When investment risk is 
properly conceived of in terms of the risk of loss, it becomes 
apparent why indexed annuities may fall within Section 3(a)(8) and 
thus beyond this agency's reach, contrary to Rule 151A.
    Not only does Rule 151A seem to deviate from the approach taken 
by courts, including the Supreme Court, but it also appears to 
depart from prior positions taken by the Commission. For example, in 
an amicus brief filed with the Supreme Court in the Otto case,\3\ 
the Commission asserted that the Section 3(a)(8) exemption applies 
when an insurance company, regulated by the state, assumes a 
``sufficient'' share of investment risk and there is a corresponding 
decrease in the risk to the purchaser, such as where the purchaser 
benefits from certain guarantees. Yet Rule 151A denies the Section 
3(a)(8) exemption to an indexed annuity issued by a state-regulated 
insurance company that bears substantial risk under the annuity 
contract by guaranteeing principal and a minimum return.
---------------------------------------------------------------------------

    \3\ Otto v. Variable Annuity Life Ins. Co., 814 F.2d 1127 (7th 
Cir. 1987). The Supreme Court denied the petition for a writ of 
certiorari.
---------------------------------------------------------------------------

    In addition, Rule 151A seems to diverge from the analysis 
embedded in Rule 151. Rule 151 establishes a true safe harbor under 
Section 3(a)(8) and provides that a variety of factors should be 
considered, such as marketing techniques and the availability of 
guarantees. The Rule 151 adopting release even indicates that the 
rule allows for certain ``indexed excess interest features'' without 
the product falling outside the safe harbor.
    An even more critical difference between Rule 151 and Rule 151A 
is the effect of failing to meet the requirements under the rule. If 
a product does not meet the requirements of Rule 151, there is no 
safe harbor, but the product nevertheless may fall within Section 
3(a)(8) and thus be an exempted security. But if a product does not 
pass muster under the Rule 151A ``more likely than not'' test, then 
the product is deemed to fall outside Section 3(a)(8) and thus is 
under the SEC's jurisdiction. In essence, while Rule 151 provides a 
safe harbor, Rule 151A takes away the Section 3(a)(8) statutory 
exemption.
    I am not aware of another instance in the federal securities 
laws where a ``more likely than not'' test is employed, and for good 
reason. A ``more likely than not'' test does not provide insurers 
with proper notice of whether their products fall within the federal 
securities laws or not. If an insurer applies the test in good faith 
and gets it wrong, the insurer nonetheless risks being subject to 
liability under Section 5 of the Securities Act, even if the insurer 
had no intent to run afoul of the federal securities laws. In 
addition, under the ``more likely than not'' test, the availability 
of the Section 3(a)(8) exemption turns on the insurer's own 
analysis. Accordingly, it is at least conceivable that the same 
product could receive different Section 3(a)(8) treatment depending 
on how each respective insurer modeled the likely returns.
    Further, I am concerned that Rule 151A, as applied, reveals that 
the ``more likely than not'' test, despite its purported balance, 
leads to only one result: The denial of the Section 3(a)(8) 
exemption. In practice, Rule 151A appears to result in blanket SEC 
regulation of the entire indexed annuity market. The adopting 
release indicates that over 300 indexed annuity contracts were 
offered in 2007 and explains that the Office of Economic Analysis 
has determined that indexed annuity contracts with typical features 
would not meet the Rule 151A test. Indeed, the adopting release 
elsewhere expresses the expectation that almost all indexed annuity 
contracts will fail the test. If everyone is destined to fail, what 
is the purpose of a test? Further, there is at least some risk that 
in sweeping up the index annuity market, the rule may sweep up other 
insurance products that otherwise should fall within Section 
3(a)(8).
    The rule has other shortcomings, aside from the legal analysis 
that underpins it. These include, but are not limited to, the 
following.
    First, a range of state insurance laws govern indexed annuities. 
I am disappointed that the rule and adopting release make an 
implicit judgment that state insurance regulators are inadequate to 
regulate these products. Such a judgment is beyond our mandate or 
our expertise. In any event, Section 3(a)(8) does not call upon the 
Commission to determine whether state insurance regulators are up to 
the task; rather, the section exempts annuity contracts subject to 
state insurance regulation.
    Second, as a result of Rule 151A, insurers will have to bear 
various costs and burdens, which, importantly, could 
disproportionately impact small businesses. Some even have predicted 
that companies may be forced out of business if Rule 151A is 
adopted. Such an outcome causes me concern, especially during these 
difficult economic times. Even when the economy is not strained, 
such an outcome is disconcerting because it can lead to less 
competition, ultimately to the detriment of consumers.
    Third, the Commission received several thousand comment letters 
since Rule 151A was proposed in June 2008. Consistent with comments 
we have received, I believe that there are more effective and 
appropriate ways to address the concerns underlying this rulemaking. 
One possible alternative to Rule 151A would be amending Rule 151 to 
establish a more precise safe harbor in light of all the relevant 
facts and circumstances attendant to indexed annuities and how they 
are marketed. A more precise safe harbor would provide better 
clarity and certainty in this area--regulatory goals the Commission 
has identified--and would preserve the ability of insurers to find 
an exemption outside the safe harbor by relying directly on Section 
3(a)(8) and the cases interpreting it. I believe further exploration 
of alternative approaches is warranted, as is continued engagement 
with interested parties, including state regulators.
    In closing, I request that my remarks be included in the Federal 
Register with the final version of the release. My remarks today do 
not give a full exposition of the rule's shortcomings, but rather 
highlight some of the key points that lead me to dissent. I wish to 
note that these dissenting remarks just given represent my view 
after giving careful consideration to the range of arguments 
presented by the Commission's staff, particularly the Office of 
General Counsel, the commenters, and my own counsel, as well as 
those of my fellow Commissioners. Although I cannot support the 
rule, I nonetheless thank the staff for the hard work they have 
devoted to its preparation.

[FR Doc. E9-597 Filed 1-15-09; 8:45 am]
BILLING CODE 8011-01-P