STATES DISAPPOINTED
WITH RULE 151A
FROM THE STATES
David Giusti

David Giusti is a Director of Client Services, State Net Financial Services Division (Washington, DC)

ON DEC. 17, 2008, the Securities and Exchange Commission (SEC) added Rule 151A to the Securities Act of 1933. That rule defines fixed index annuities, which were regulated by state insurance regulators, as securities. As a result, brokers who sell this product will be governed under federal securities law in two years.

The ruling is expected to have a significant impact on how financial institutions develop, market, and sell these products from this point forward. The approved rule is also a noteworthy challenge to state regulatory oversight of insurance. Although passed by 4-1 vote, the rule was not adopted without controversy and significant opposition.

The regulation was initially proposed in June by the SEC in response to growing complaints of fraud and abusive sales practices. The original comment deadline was Sept. 10, but the comment period was reopened after the Commission received numerous letters from members of Congress and state insurance commissioners that called for an extension. Even though the deadline was extended until mid-November and thousands of letters were received, many still believe the timing was insufficient for adequate analysis and appropriate comments.

At odds with recent court decisions

Fixed index annuities have become increasingly popular during the last several years, but they have never been explicitly classified until now. Proponents of the SEC ruling argue that they resemble investment vehicles because their performance is linked to equity indexes. Those who disagree with the decision point out that this product provides a minimum guarantee of interest while the principle is protected from market risk. In fact, recent court cases have indicated that indexed annuities should not be considered securities. Knowing this precedent, the insurance community may pursue legal action to fight back.

The ruling signifies that the federal versus state turf war to regulate certain insurance and investment products will continue for some time.

Those who disagree with the ruling believe the states have responded to recent annuity sales abuses with strong consumer protections. Thus far 33 states have adopted the Suitability in Annuity Transactions Model Regulation proposed by the National Association of Insurance Commissioners (NAIC). The regulation prohibits the sales of products that are unsuitable for senior investors, strengthens agent supervision, and requires periodic review of sales records. Other state agencies continue to maintain strict licensing and continuing education requirements for agents and brokers who sell index annuities. State legislators have also proposed and enacted legislation to address surrender charges, senior specialist designations, and sales seminars that target and mislead senior investors.

Several members of Congress also felt the pursuit of Rule 151A was unwarranted. Many sent letters to SEC Chairman Christopher Cox urging him to focus his attention on the current financial crisis instead of seeking a departure from the existing state regulatory scheme. They also expressed concern that the rule as written was too broad and could apply to traditional annuity products.

Extra compliance costs

There are thousands of self-employed independent insurance agents and small businesses that sell fixed index annuities. Most are state regulated and would now be subject to dual regulation by federal securities law if they wished to continue selling these products. The dual oversight is likely to result in extra compliance costs; plus, the additional registration and filing requirements could become an onerous administrative obligation. Fortunately the effective date of the ruling was extended an extra year so insurers who sell index annuities will not have to comply with the new rule until Jan. 12, 2011. Even so, the pending rule is likely to discourage local agents and brokers from continuing to sell fixed index annuities. As a result, product availability and consumer choice may be limited.

The ruling also signifies that the federal versus state turf war to regulate certain insurance and investment products will continue for some time. SEC chief appointee Mary Schapiro, was supportive of Rule 151A, and federal lawmakers are expected to extend their reach to other financial transactions that are traditionally regulated by the states.