[Federal Register: July 1, 2008 (Volume 73, Number 127)]
[Proposed Rules]
[Page 37751-37774]
[DOCID:fr01jy08-16]

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Part VI

Securities and Exchange Commission

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17 CFR Parts 230 and 240

Indexed Annuities and Certain Other Insurance Contracts; Proposed Rule

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 230 and 240

[Release Nos. 33-8933, 34-58022; File No. S7-14-08]
RIN 3235-AK16

Indexed Annuities and Certain Other Insurance Contracts

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: We are proposing a new rule that would define the terms
``annuity contract'' and ``optional annuity contract'' under the
Securities Act of 1933. The proposed 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 proposed rule would apply on a prospective basis
to contracts issued on or after the effective date of the rule. We are
also proposing to exempt 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 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: Comments should be received on or before September 10, 2008.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/proposed.shtml);
     Send an e-mail to<EMAIL_ADDRESS>Please include
File Number S7-14-08 on the subject line; or
     Use the Federal eRulemaking Portal (http://
www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.
    All submissions should refer to File Number S7-14-08. This file
number should be included on the subject line if e-mail is used. To
help us process and review your comments more efficiently, please use
only one method. The Commission will post all comments on the
Commission's Internet Web site (http://www.sec.gov/rules/
proposed.shtml). Comments are also available for public inspection and
copying in the Commission's Public Reference Room, 100 F Street, NE.,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. All comments received will be posted without change; we
do not edit personal identifying information from submissions. You
should submit only information that you wish to make available
publicly.

FOR FURTHER INFORMATION CONTACT: Michael L. Kosoff, Attorney, or Keith
E. Carpenter, Senior Special Counsel, Office of Disclosure and
Insurance Products 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 proposing to add 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. Marketing of Indexed Annuities
    C. Section 3(a)(8) Exemption
III. DISCUSSION OF THE PROPOSED AMENDMENTS
    A. Definition of Annuity Contract
    B. Exchange Act Exemption for Securities that Are Regulated as
Insurance
IV. GENERAL REQUEST FOR COMMENTS
V. PAPERWORK REDUCTION ACT
VI. COST/BENEFIT ANALYSIS
VII. CONSIDERATION OF PROMOTION OF EFFICIENCY, COMPETITION, AND
CAPITAL FORMATION; CONSIDERATION OF BURDEN ON COMPETITION
VIII. INITIAL REGULATORY FLEXIBILITY ANALYSIS
IX. CONSIDERATION OF IMPACT ON THE ECONOMY
X. STATUTORY AUTHORITY
TEXT OF PROPOSED RULES

I. Executive Summary

    We are proposing a new rule that 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. Section 3(a)(8) of the Securities Act provides an
exemption under the Securities Act for certain insurance contracts. The
proposed rule would prospectively define 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.
    The proposed definition would hinge 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 promise to offer market-related gains. Thus, these
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, the majority of the investment risk for the fluctuating,
equity-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 equity-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 securities 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 and sales
practice protections.
    We have determined that providing greater clarity with regard to
the status of indexed annuities under the federal securities laws would
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 are
proposing a new definition of ``annuity contract'' that, on a
prospective basis, would define a class of indexed annuities that are
outside the scope of section 3(a)(8). With respect to these annuities,
investors would be entitled to all the protections of the federal
securities laws, including full and fair disclosure and sales practice
protections.
    We are aware that many insurance companies, 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
release. Under these circumstances, we do not believe that insurance
companies should be subject to any additional legal risk relating to
their past offers and sales of indexed annuities as a result of our
proposal today or its eventual adoption. Therefore, we are also
proposing that the new definition 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 proposing a new exemption from Exchange Act
reporting that would 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. Rather, investors who purchase these
securities are primarily affected by issues relating to the insurer's
financial ability to satisfy its contractual obligations--issues that
are addressed by state law and regulation.

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. 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.\3\ Insurers have typically
marketed and sold indexed annuities without complying with the federal
securities laws, and sales of the products have grown dramatically in
recent years. This growth has, unfortunately, been accompanied by
growth in 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 particularly unsuitable for seniors and others who
may need ready access to their assets.
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    \3\ 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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    We have observed the development of indexed annuities for some
time, and we have become persuaded that guidance is needed with respect
to their status under the federal securities laws. Today, we are
proposing rules that are intended to provide greater clarity regarding
the scope of the exemption provided by section 3(a)(8). We believe our
proposed action is consistent with Congressional intent in that the
proposed definition would afford the disclosure 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
proposed rules are intended to provide regulatory certainty and 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 our proposed 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.\4\
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    \4\ Financial Industry Regulatory Authority, Inc. (``FINRA''),
Equity-Indexed Annuities--A Complex Choice (updated Apr. 22, 2008),
available at: http://www.finra.org/InvestorInformation/
InvestorAlerts/AnnuitiesandInsurance/Equity-IndexedAnnuities-
AComplexChoice/P010614; National Association of Insurance
Commissioners, Buyer's Guide to Fixed Deferred Annuities with
Appendix for Equity-Indexed Annuities, at 9 (2007); 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/pdfs/White%20Paper%20Final_11-10-06_
All%20Inquiries.pdf; Jack Marrion, Index Annuities: Power and
Protection, at 13 (2004).
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    Life insurance companies began offering indexed annuities in the
mid-1990s.\5\ Sales of indexed annuities for 1998 totaled $4 billion
and grew each year through 2005, when sales totaled $27.2 billion.\6\
Indexed annuity sales for 2006 totaled $25.4 billion and $24.8 billion
in 2007.\7\ In 2007, indexed annuity assets totaled $123 billion, 58
companies were issuing indexed annuities, and there were a total of 322
indexed annuities offered.\8\ The specific features of indexed
annuities vary from product to product. Some of the key features are as
follows.
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    \5\ See National Association for Fixed Annuities, supra note 4,
at 4.
    \6\ NAVA, 2008 Annuity Fact Book, 57 (2008).
    \7\ Id.
    \8\ Id.
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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.\9\ 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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    \9\ National Association for Fixed Annuities, supra note 4, 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.\10\ 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. Another method, sometimes
referred to as ``monthly point-to-point,'' combines both positive and
negative changes in the index values from one month to the next during
the crediting period and recognizes the aggregate change as the amount
of index credit for the period, if it is positive. Another method
compares an average of index values at periodic intervals during the
crediting period to the index value at the beginning of the 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.\11\
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    \10\ See FINRA, supra note 4; National Association of Insurance
Commissioners, supra note 4, at 12-14; National Association for
Fixed Annuities, supra note 4, at 9-10; Marrion, supra note 4, at
38-59.
    \11\ National Association of Insurance Commissioners, supra note
4, at 11; National Association for Fixed Annuities, supra note 4, at
5 and 9; Marrion, supra note 4, 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.\12\ 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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    \12\ See FINRA, supra note 4; National Association of Insurance
Commissioners, supra note 4, at 10-11; National Association for
Fixed Annuities, supra note 4, at 10; Marrion, supra note 4, at 38-
59.
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Surrender Charges
    Surrender charges are commonly deducted from withdrawals taken by a
purchaser.\13\ The maximum surrender charges, which may be as high as
15-20%,\14\ 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. 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.\15\ 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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    \13\ See FINRA, supra note 4; National Association of Insurance
Commissioners, supra note 4, at 3-4 and 11; National Association for
Fixed Annuities, supra note 4, at 7; Marrion, supra note 4, at 31.
    \14\ 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.
    \15\ FINRA, supra note 4; Marrion, supra note 4, 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.
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%.\16\ 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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    \16\ National Association for Fixed Annuities, supra note 4, 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.\17\
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    \17\ 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. Marketing of Indexed Annuities

    In the years after indexed annuities were first introduced, sales
volumes were relatively small. In 1998, when sales totaled $4 billion,
the impact of these products on both purchasers and issuing insurance
companies was limited. As sales have grown in more recent years, with
sales of $24.8 billion and total indexed annuity assets of $123 billion
in 2007, these products have affected larger and larger numbers of
purchasers. They have also become an increasingly important business
line for some insurers.\18\ In addition, in recent

years, guarantees provided by indexed annuities have been reduced. In
the years immediately following their introduction, indexed annuities
typically guaranteed 90% of purchase payments accumulated at 3% annual
interest.\19\ More recently, however, following changes in state
insurance laws,\20\ guarantees in indexed annuities have been as low as
87.5% of purchase payments accumulated at 1% annual interest.\21\
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    \18\ 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.,
Jul. 10, 2007) (Indexed annuities represent over eighty percent of
annuity premiums and almost half of annuity reserves.); Aviva USA
Group (Best's Company Reports, AmerUs Life Insurance Company, Nov.
6, 2007) (Indexed annuity sales represent more than 90% of total
annuity production.); Conseco Insurance Group (CIG) (Best's Company
Reports, Conseco Ins. Group, Nov. 7, 2008) (CIG's business was
heavily weighted toward indexed annuities, which contributed
approximately 77% of new first year premiums.); Investors Insurance
Corporation (IIC) (Best's Company Reports, Investors Ins. Corp.,
Aug. 20, 2007) (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, Jun. 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 has been the principal driver of growth in
annuity deposits.).
    \19\ Securities Act Release No. 7438 (Aug. 20, 1997) [62 FR
45359, 45360 (Aug. 27, 1997)] (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) (``1997 Concept Release''). 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). Some of the comment letters are also available on the
Commission's Web site at http://www.sec.gov/rules/concept/
s72297.shtml.
    \20\ See, e.g., Cal. Ins. Code Sec.  10168.25 (West 2007)
(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) (former requirements,
providing for guarantee for single premium annuities based on 90% of
premium accumulated at minimum of 3% annual interest).
    \21\ See A Producer's Guide to Indexed Annuities 2006, Life
Insurance Selling (Jun. 2006), available at: http://
www.lifeinsuranceselling.com/Media/MediaManager/
6IAsurveyforweb3.pdf.
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    At the same time that sales of indexed annuities have increased and
guarantees within the products have been reduced, concerns about
potentially abusive sales practices and inadequate disclosure have
grown. In August 2005, NASD \22\ issued a Notice to Members in which it
cited its concerns about the manner in which persons associated with
broker-dealers were marketing unregistered indexed annuities and the
absence of adequate supervision of those sales practices.\23\ The
Notice to Members also expressed NASD's concern with indexed annuity
sales materials that do not fully describe the features and risks of
the products. Citing uncertainty as to whether indexed annuities are
subject to the federal securities laws, NASD encouraged member firms to
supervise transactions in these products as though they are securities.
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    \22\ In July 2007, NASD and the member regulation, enforcement,
and arbitration functions of the New York Stock Exchange were
consolidated to create FINRA. The NASD materials cited in this
release were issued prior to the creation of FINRA.
    \23\ 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.
    See also FINRA, supra note 4 (investor alert on indexed
annuities, stating that indexed annuities are ``anything but easy to
understand'').
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    At the Senior Summit held at the Commission in July 2006, at which
securities regulators and others met to explore how to coordinate
efforts to protect older Americans from abusive sales practices and
securities fraud, concerns were cited about sales of indexed annuities
to seniors.\24\ Patricia Struck, then President of the North American
Securities Administrators Association (``NASAA''), identified indexed
annuities as among the most pervasive products involved in senior
investment fraud.\25\ In a joint examination conducted by the
Commission, NASAA, and the Financial Industry Regulatory Authority,
Inc. (``FINRA'') of ``free lunch'' seminars that are aimed at selling
financial products, often to seniors, with a free meal as enticement,
examiners identified potentially misleading sales materials and
potential suitability issues relating to the products discussed at the
seminars, which commonly included indexed annuities.\26\
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    \24\ The average age of issuance for indexed annuities has been
reported to be 64. Advantage Compendium, 4th Quarter Index Annuity
Sales Slip (Mar. 2008), available at: http://www.indexannuity.org/
ic2008.htm#4q07.
    \25\ 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.
    \26\ 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.
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C. 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 3, 359 U.S. 65; United Benefit, supra
note 3, 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\
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    \29\ VALIC, supra note 3, 359 U.S. at 71-73.
    \30\ United Benefit, supra note 3, 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\ 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 protections of the Securities
Act assume importance.
---------------------------------------------------------------------------

    \32\ VALIC, supra note 3, 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 3, 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,
    (1) The insurer, for the life of the contract,
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    (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.
    The only judicial decision that we are aware of regarding the
status of indexed annuities under the federal securities laws is a
district court case that concluded that the contracts at issue in
the case fell within the Commission's Rule 151 safe harbor
notwithstanding the fact that they apparently did not meet the
limited test described above, i.e., specifying an index that would
be used to determine a rate that would remain in effect for at least
one year. Instead, the contracts appear to have guaranteed the
index-based formula, but not the actual rate of interest. See Malone
v. Addison Ins. Marketing, Inc., 225 F.Supp.2d 743, 751-754 (W.D.
Ky. 2002).
---------------------------------------------------------------------------

III. Discussion of the Proposed Amendments

    The Commission has determined that providing greater clarity with
regard to the status of indexed annuities under the federal securities
laws would 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 proposing a
new definition of ``annuity contract'' that, on a prospective basis,
would define a class of indexed annuities that are outside the scope of
section 3(a)(8). With respect to these annuities, investors would be
entitled to all the protections of the federal securities laws,
including full and fair disclosure and sales practice protections. We
are also proposing a new exemption under the Exchange Act that would
apply 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 proposing new rule 151A, which would define 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 3, 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 annuities did not exist and were not contemplated by Congress
when it enacted the insurance exemption.
---------------------------------------------------------------------------

    \40\ See VALIC, supra note 3, 359 U.S. at 69.
    \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 Concept Release, supra note 19, 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.C., 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 3, 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 would be included in our
proposed 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 3, 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 3, 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 exposure to 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 3, 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 3, 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 would be included in our proposed definition 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. Thus, individuals who purchase such indexed
annuities are ``vitally interested in the investment experience.'' \54\
However, indexed annuities historically have not been registered with
us as securities. Insurers have treated these 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\ Id. at 91 (Brennan, J., concurring).
    \54\ Id. at 89 (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.
    Accordingly, 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 proposing a rule that would define such
contracts as falling outside the insurance exemption.
2. Proposed Definition
Scope of the Proposed Definition
    Proposed rule 151A would apply 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.\55\ This language is the same language used in Section
3(a)(8) of the Securities Act. Thus, the insurance companies that will
be covered by the proposed rule are the same as those covered by
Section 3(a)(8). In addition, in order to be covered by the proposed
rule, a contract must be subject to regulation as an annuity under
state insurance law.\56\ As a result, the proposed rule does 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.
---------------------------------------------------------------------------

    \55\ Proposed rule 151A(a).
    \56\ Id. We note that the majority of states include in their
insurance laws provisions that define annuities. See, e.g., ALA.
CODE section 27-5-3 (2008); CAL. INS. CODE section 1003 (West 2007);
N.J. ADMIN. CODE tit. 11, section 4-2.2 (2008); N.Y. INS. LAW
section 1113 (McKinney 2007). Those states that do not expressly
define annuities typically have regulations in place that address
annuities. See, e.g., KAN. ADMIN. REGS. section 40-2-12 (2008);
MISS. CODE ANN. Sec.  83-1-151 (2008).
---------------------------------------------------------------------------

    The proposed rule would expressly state that it does not apply to
any contract whose value varies according to the investment experience
of a separate account.\57\ The effect of this provision is to eliminate
variable annuities from the scope of the rule.\58\ 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, we do
not propose to cover them under the new definition or affect their
regulation in any way.\59\
---------------------------------------------------------------------------

    \57\ Proposed rule 151A(c).
    \58\ 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).
    \59\ See, e.g., VALIC, supra note 3, 359 U.S. 65; United
Benefit, supra note 3, 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).
---------------------------------------------------------------------------

    We request comment on the scope of the proposed definition and in
particular on the following issues:
     Should the rule apply only to contracts that are issued by
the same insurance companies that are covered by section 3(a)(8) of the
Securities Act, or should the proposed definition apply with respect to
contracts of different issuers than those covered by section 3(a)(8)?
     What contracts should be covered by the proposed
definition? Should the scope of contracts covered be articulated by
reference to state law? Should the proposed definition extend to all
annuity contracts, or should any annuity contracts be excluded? Should
variable annuity contracts be covered by the proposed definition?
Should the proposed definition apply to forms of insurance other than
annuities, such as life insurance or health insurance? Should the
proposed definition apply to a contract issued by an insurance company
if the contract is not itself regulated as insurance under state law?
     Should we permit insurance companies to register indexed
annuities, as well as any other annuities that are securities, on Form
N-4,\60\ the form that is currently used by insurance companies to
register variable annuities under the Securities Act? If so, should we
modify Form N-4, which is also used by insurance company separate
accounts to register under the Investment Company Act, in any way?
---------------------------------------------------------------------------

    \60\ 17 CFR 239.17b and 274.11c.
---------------------------------------------------------------------------

Definition of ``Annuity Contract'' and ``Optional Annuity Contract''
    We are proposing 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 the following two characteristics. First, 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. Second, amounts payable by the insurance
company under the contract are more likely than not to exceed the
amounts guaranteed under the contract.
    The first characteristic, that amounts payable by the insurance
company under the contract are calculated by reference to the
performance of a security or securities, defines a class of contracts
that we believe, in all cases, require further scrutiny because they
implicate the factors articulated by the U.S. Supreme Court as
important in determining whether the section 3(a)(8) exemption is
applicable. When payments under a contract are calculated by reference
to the performance of a security or securities, rather than being paid
in a fixed amount, at least some investment risk relating to the
performance of the securities is assumed by the purchaser. In addition,
the contract may be marketed on the basis of the potential for growth
offered by investments in the securities.
    The proposed rule would define the class of contracts that is
subject to scrutiny broadly. The rule would apply whenever any amounts
payable under

the contract under any circumstances, including full or partial
surrender, annuitization, or death, are calculated, in whole or in
part, by reference to the performance of a security or securities. If,
for example, the amount payable under a contract upon a full surrender
is not calculated by reference to the performance of a security or
securities, but the amount payable upon annuitization is so calculated,
then the contract would need to be analyzed under the rule. As another
example, if amounts payable under a contract are partly fixed in amount
and partly dependent on the performance of a security or securities,
the contract would need to be analyzed under the rule.
    We note that the proposed rule would apply to contracts under which
amounts payable are calculated by reference to a security, including a
group or index of securities. Thus, the proposed rule would, by its
terms, apply to indexed annuities but also to other annuities where
amounts payable are calculated by reference to a single security or any
group of securities. The federal securities laws, and investors'
interests in full and fair disclosure and protection from abusive sales
practices, are equally implicated, whether amounts payable under an
annuity are calculated by reference to a securities index, another
group of securities, or a single security.
    The term ``security'' in proposed rule 151A would have the same
broad meaning as in section 2(a)(1) of the Securities Act. Proposed
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.\61\
---------------------------------------------------------------------------

    \61\ 17 CFR 230.100(b).
---------------------------------------------------------------------------

    The second characteristic, that amounts payable by the insurance
company under the contract are more likely than not to exceed the
amounts guaranteed under the contract, sets forth the test that would
define a class of 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
explained above, by purchasing this type of indexed annuity, the
purchaser assumes the risk of an uncertain and fluctuating financial
instrument, in exchange for exposure to future, securities-linked
returns.\62\ As a result, the purchaser assumes many of the same risks
that investors assume when investing in mutual funds, variable
annuities, and other securities. Our proposal is intended to 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 protection from abusive
sales practices and the recommendation of unsuitable transactions.
---------------------------------------------------------------------------

    \62\ See supra Part III.A.1.
---------------------------------------------------------------------------

    Under proposed rule 151A, amounts payable by the insurance company
under a contract would be more likely than not to exceed the amounts
guaranteed under the contract if this were the expected outcome more
than half the time. In order to determine whether this is the case, it
would 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 would be the amounts that the
purchaser \63\ would be entitled to receive from the insurer under
those facts and circumstances. The facts and circumstances would
include, among other things, the particular features of the annuity
contract (e.g., in the case of an indexed annuity, the relevant index,
participation rate, and other features), the particular options
selected 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 would 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, were to guarantee that, on
surrender, a purchaser would receive 87.5% of purchase payments, plus
1% interest compounded annually, and that any additional payout would
be based exclusively on the performance of a securities index, the
amount guaranteed after 3 years would be 90.15% of purchase payments
(87.5% x 1.01 x 1.01 x 1.01).
---------------------------------------------------------------------------

    \63\ For simplicity, we are referring to payments to the
purchaser. The proposed 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 would be included.
---------------------------------------------------------------------------

    We request comment on the proposed definition and in particular on
the following issues:
     Should we define a class of annuities that are not
``annuity contracts'' or ``optional annuity contracts'' under the
Securities Act? If so, should we adopt the proposed definition or
should the proposed definition be modified?
     Should we provide greater clarity with respect to the
status under the Securities Act of annuities under which amounts
payable by the insurance company are calculated, in whole or in part,
by reference to the performance of a security, including a group or
index of securities? Should we, as proposed, adopt a definitional rule
that would apply to all such annuities? Or should we adopt a
definitional rule that applies to a more limited subset of annuities,
such as annuities under which amounts payable are calculated by
reference to the performance of a securities index?
     Is the proposed test that defines a class of contracts
that are not ``annuity contracts'' or ``optional annuity contracts,''
i.e., that amounts payable by the insurance company under the contract
are more likely than not to exceed the amounts guaranteed under the
contract, an appropriate test? Should the test be modified in any way,
e.g., should the threshold be higher or lower than ``more likely than
not?'' Should we provide further clarification with respect to the
meaning of any of the elements of that test, including ``amounts
payable by the insurance company under the contract'' and ``amounts
guaranteed under the contract?''
     Should we specify a particular point in time as of which
``amounts payable by the insurance company under the contract'' and
``amounts guaranteed under the contract'' should be determined under
the rule? If so, what would be an appropriate time, e.g., contract
maturity, the point where the surrender charge period ends, a specified
number of years (5 years, 10 years, 15 years, 20 years, or some other
period), or a specified age of the annuitant or a joint annuitant under
the contract (60 years, 65 years, 75 years, or some other age)?
Determining Whether an Annuity Is Not an ``Annuity Contract'' or
``Optional Annuity Contract'' Under Proposed Rule 151A
    Proposed rule 151A addresses the manner in which a determination
would

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. The proposed rule is principles-based,
providing that a determination made by the insurer at or prior to
issuance of a contract would 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 and not more than three years prior to the date on which
the particular contract is issued.\64\ The proposed rule would,
however, specify the treatment of charges that are imposed at the time
of payments under the contract by the insurer.\65\
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    \64\ Proposed rule 151A(b)(2).
    \65\ Proposed rule 151A(b)(1).
---------------------------------------------------------------------------

    We are proposing this principles-based approach because we believe
that an insurance company should be able to evaluate anticipated
outcomes under an annuity that it issues. Insurers routinely undertake
such analyses for purposes of pricing and hedging their contracts.\66\
In addition, we believe that it is important to provide reasonable
certainty to insurers with respect to the application of the proposed
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.
---------------------------------------------------------------------------

    \66\ See generally, Black and Skipper, supra note 39, at 26-47,
890-99.
---------------------------------------------------------------------------

    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.\67\ 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 proposed rule
would--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.
---------------------------------------------------------------------------

    \67\ 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 proposed rule provides that an insurer's determination under
the rule would be conclusive only if it is made at or prior to issuance
of the contract. Proposed rule 151A is intended to provide certainty to
both insurers and investors, and we believe that this certainty would
be undermined unless insurance companies undertake the analysis
required by the rule no later than the time that an annuity is issued.
The proposed 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 proposed rule that is based on computations that are
materially inaccurate. For this purpose, we intend that computations
would 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
would be required to 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 would be
appropriate to look to methods commonly used for 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 would 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
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
hedging their contracts, and for similar purposes. We would expect
that, in making a determination under proposed rule 151A, an insurer
would use assumptions that are consistent with the assumptions that it
uses for other purposes. Generally, assumptions that are inconsistent
with the assumptions that an insurer uses for other purposes would not
be reasonable under proposed rule 151A.
    We note that an insurer may offer a particular form of contract
over a significant period of time. Assumptions that are reasonable when
a contract is originally offered may or may not continue to be
reasonable at a subsequent time when the insurer continues to offer the
contract. For this reason, the rule would provide that an insurer's
determination would be conclusive if it is sufficiently current.
Specifically, the determination must be made not more than six months
prior to the date on which the form of contract is first offered and
not more than three years prior to the date on which a particular
contract is issued. For example, if a form of contract were first
offered on January 1, 2011, the insurer

would be required to make the determination not earlier than July 1,
2010. If the same form of contract were issued to a particular
individual on January 1, 2014, the insurer's determination would be
required to be made not earlier than January 1, 2011, in order to be
conclusive for this transaction. This approach is intended to address
the changing nature of reasonable assumptions, while permitting an
insurer to rely on its determination for a significant period of time
(three years) once made.
    Proposed rule 151A would require that, in determining whether
amounts payable by the insurance company under the contract are more
likely than not to exceed the amounts guaranteed under the contract,
amounts payable under the contract be determined without reference to
any charges that are imposed at the time of payment. For example, the
calculation of amounts payable upon surrender would be computed without
deduction of any surrender charges, which typically decline over time.
We are proposing this calculation methodology in order to eliminate the
differential impact that such charges would have on the determination
depending on the assumptions made about contract holding periods.
However, the proposed rule would require that charges imposed at the
time of payment be reflected in computing the amounts guaranteed under
the contract. 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.\68\ However, in the case of an annuity
where the amounts guaranteed are affected by charges imposed at the
time payments are made,\69\ the determination under proposed rule 151A
would be made using the actual amounts guaranteed under the contract
(which reflect the impact of these charges).
---------------------------------------------------------------------------

    \68\ 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.
    \69\ 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).
---------------------------------------------------------------------------

    We request comment on the manner in which a determination would be
made under proposed rule 151A regarding whether amounts payable by the
insurance company under a contract are more likely than not to exceed
the amounts guaranteed under the contract and, in particular, on the
following issues:
     Should we, as proposed, adopt a principles-based approach
to this determination? Would the principles-based approach facilitate
our goal of providing certainty?
     Should the insurer's determination be conclusive? If so,
are the conditions in the proposed rule (i.e., determination at or
prior to contract issuance, reasonable methodology and assumptions,
materially accurate computation) appropriate, or should we modify these
conditions in any way?
     Should we expressly specify the circumstances under which
a computation is materially accurate? If so, should the rule, as
proposed, provide that an insurer's computation is 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? Or should we provide a different guideline for
determining whether the computation is ``materially accurate?'' For
example, should the rule provide that an insurer's computation is
materially accurate if any computational errors do not materially
affect the insurer's determination of the likelihood that amounts
payable by the insurer under the contract exceed the amounts guaranteed
under the contract?
     Should the rule prescribe the assumptions to be used by an
insurer in making its determination? What factors should affect a
determination of whether an insurer's assumptions are reasonable?
Should the rule specify how the determination should be made with
respect to securities, including indices, that have little or no
history?
     Should we, as proposed, provide that, in order for an
insurer's determination to be conclusive, it must be made not more than
six months prior to the date on which the form of contract is first
offered? Should this period be shorter or longer, e.g., 30 days, 3
months, 9 months, 1 year?
     Should we, as proposed, provide that, in order for an
insurer's determination to be conclusive, it must not be made more than
three years prior to the date on which a particular contract is issued?
Should this period be shorter or longer, e.g., 1 year, 2 years, or 5
years?
     Should an insurer's determination, once made for a
particular form of contract, be conclusive with respect to every
particular contract of that form that is sold provided that the
determination meets the standards required for conclusiveness at the
time of the insurer's original determination, i.e., reasonable
methodology and assumptions and materially accurate computation? Or
should an insurer's determination only be conclusive with respect to
any particular sale of a contract if the methodology and assumptions
are reasonable at the time of the particular sale?
     How should surrender charges and other charges imposed at
the time of payout under an annuity be treated in making the
determination required under the proposed rule? Should amounts payable
under the contract be determined with or without reference to such
charges? Should amounts guaranteed under the contract be computed with
or without reference to such charges? Should we define with greater
specificity the concept of charges imposed at the time of payment under
a contract?
     Should we provide any guidance with respect to the
principles-based approach of the rule?
     Should we provide guidance on the circumstances under
which it is reasonable to rely on historical experience? Would it be
reasonable to use other asset prices (such as derivative prices) to
form expectations about the future, as long as the use of these prices
is supported by historical experience?
     Should we provide guidance about the circumstances under
which it is reasonable to rely on insurer expectations about the
future? Would it be reasonable to rely on these expectations for
factors over which insurers have control (e.g., changes in contract
features) or about which they have particular expertise (e.g., rates of
annuitization, mortality rates)? Would it be reasonable to rely on
these expectations for factors over which insurers do not have control,
such as market behavior?
     Should we provide guidance that would specify how insurers
should consider interactions between various factors that may affect
the determination (such as interactions between market returns and
surrender behavior)?
     Should the rule specify how the determination should be
made in the case of contracts that offer more than one investment
option, e.g., multiple indices or multiple crediting formulas or the
availability of a guaranteed interest rate option in addition to
indexed investment options? In such a

case, should we require a separate determination under each available
option? If so, should we provide that the entire annuity is not an
``annuity contract'' or ``optional annuity contract'' if it is
determined that the annuity would not be an ``annuity contract'' or
``optional annuity contract'' under any one or more of the available
options?
     Should the rule require separate determinations with
respect to the various benefits available under an annuity, such as
lump sum payments, annuity payments, and death benefits? If so, should
the rule prescribe that if the amounts payable under any one of these
options are more likely than not to exceed the amounts guaranteed under
that option, then the entire contract is not an ``annuity contract'' or
``optional contract''?
3. Effective Date
    We propose to have the new definition apply prospectively--that is,
only to indexed annuities issued on or after the effective date of a
final rule. We are using our definitional rulemaking authority under
Section 19(a) of the Securities Act, and the explicitly prospective
nature of our proposed rule is consistent with similar prospective
rulemaking that we have undertaken in the past when doing so was
appropriate and fair under the circumstances.\70\
---------------------------------------------------------------------------

    \70\ 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, 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
release. Under these circumstances, we do not believe that insurance
companies should be subject to any additional legal risk relating to
their past offers and sales of indexed annuity contracts as a result of
our proposal or its eventual adoption.
    We also recognize that, if our proposal is adopted, the industry
will need sufficient time to conduct the analysis required by the new
definitional rule and comply with any applicable requirements under the
federal securities laws. Therefore, we propose that if we adopt a final
rule, the effective date of that rule would be a date that is 12 months
after publication in the Federal Register.
    We request comment on the proposed effective date of the rule and
in particular on the following issue:
     Should the effective date of the new definitional rule, if
adopted, be 12 months after publication in the Federal Register, or
should it be effective sooner (e.g., 60 days after publication, six
months after publication) or later (e.g., 18 months after publication,
2 years after publication)?
4. Annuities Not Covered by the Proposed Definition
    Proposed rule 151A would apply to annuities under which amounts
payable by the insurance company are calculated by reference to the
performance of a security. The proposed rule would define 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 proposed
rule, however, would not provide a safe harbor under section 3(a)(8)
for any other annuities, including any other annuities under which
amounts payable by the insurance company are calculated by reference to
the performance of a security. The status under the Securities Act of
any annuity, other than an annuity that is determined under proposed
rule 151A to be not an ``annuity contract'' or ``optional annuity
contract,'' would continue 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.\71\
---------------------------------------------------------------------------

    \71\ As noted in Part II.C., above, indexed annuities are not
entitled to rely on the rule 151 safe harbor.
---------------------------------------------------------------------------

    We request comment on the proposal not to include a safe harbor in
the proposal and in particular on the following issues:
     Should we provide a safe harbor under section 3(a)(8) of
the Securities Act for any annuities under which amounts payable by the
insurance company are calculated by reference to the performance of a
security? If so, what should the safe harbor be?
     Should we modify the Commission's existing safe harbor for
certain annuities, rule 151, to address indexed annuities or other
annuities under which amounts payable by the insurance company are
calculated by reference to the performance of a security? If so, how?

B. Exchange Act Exemption for Securities That Are Regulated as
Insurance

    The Commission is also proposing new rule 12h-7, which would
provide 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.\72\ We are
proposing this exemption 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.\73\ We are also
proposing to impose 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.
---------------------------------------------------------------------------

    \72\ The Commission has 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.
    \73\ 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.\74\ 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.\75\ 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.\76\
---------------------------------------------------------------------------

    \74\ Black and Skipper, supra note 39, at 949.
    \75\ Id. at 949 and 956-59.
    \76\ Id. at 949.
---------------------------------------------------------------------------

    State insurance regulation, like Exchange Act reporting, relates to
an entity's financial condition. We are of the view that, as a general
matter, 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 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 would be 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.
    Our conclusion in this regard 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 limited circumstances,\77\ 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.
---------------------------------------------------------------------------

    \77\ Insurance contracts may be assigned either as a complete
assignment or as collateral. Insurance contracts that are assignable
typically provide that the insurer need not recognize the assignment
until it receives written notice. See Black and Skipper, supra note
39, at 234.
---------------------------------------------------------------------------

    We request comment on whether we should provide insurance companies
with exemptions from Exchange Act reporting with respect to securities
that are regulated as insurance under state law and in particular on
the following issues:
     Does the existence of state insurance regulation, and, in
particular, state regulation of insurance company financial condition
and solvency, support providing an exemption from Exchange Act
reporting? Does Exchange Act reporting serve any purpose, in the
context of insurance contracts that are also securities, that is not
served by state insurance regulation?
     Does the lack of trading interest in insurance contracts
support providing an exemption from Exchange Act reporting for
securities that are regulated as insurance under state law? Should
Exchange Act reporting be required notwithstanding the absence of
trading interest and, if so, why? Are there any circumstances where
trading interest in insurance contracts that are securities is
significant enough that Exchange Act reporting should be required?
1. The Exemption
    Proposed rule 12h-7 would provide 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.\78\
---------------------------------------------------------------------------

    \78\ Introductory paragraph to proposed 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 proposed Exchange Act exemption would apply 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.\79\ In the case of a variable annuity contract or variable life
insurance policy, the exemption would apply to the insurance company
that issues the contract or policy. However, the exemption would 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.\80\
---------------------------------------------------------------------------

    \79\ Proposed 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 proposed rule 12h-7 has the same meaning as
in the Exchange Act. Proposed 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)].
    \80\ This approach is consistent with the historical practice of
insurance companies that issue variable annuities and do not file
Exchange Act reports. The associated separate accounts, however, are
required to file Exchange Act reports. These 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 proposed exemption would apply 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.\81\ 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 stock company \82\
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
stock company. Similarly, if an insurer raises capital through a debt
offering, the proposed exemption would not apply with respect to the
debt securities.
---------------------------------------------------------------------------

    \81\ Proposed rule 12h-7(b).
    \82\ 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 policyowners. Black and Skipper, supra note 39, at
577-78.
---------------------------------------------------------------------------

    We are proposing that the exemption be 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.\83\ We are proposing a broad
exemption that would apply 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 proposed 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.
---------------------------------------------------------------------------

    \83\ 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).
---------------------------------------------------------------------------

    The proposed Exchange Act exemption would apply 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 proposed exemption would apply to indexed
annuities that are registered under the Securities Act. However, the
proposed Exchange Act exemption is independent of proposed rule 151A
and would apply to types of contracts in addition to those that are
covered by proposed rule 151A. There are at least two types of existing
insurance contracts with respect to which we intend that the proposed
Exchange Act exemption would apply, contracts with so-called ``market
value adjustment'' (``MVA'') features and insurance contracts that
provide certain 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.\84\ Insurance companies issuing
contracts with these features have also complied with Exchange Act
reporting requirements.\85\ MVA features have historically been
associated with annuity and life insurance contracts that guarantee a
specified rate of return to purchasers.\86\ 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 sometime 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. As a
result, if a purchaser makes a withdrawal at a time when interest rates
are higher than at the time of contract issuance (and the market value
of the insurer's assets has decreased), the proceeds payable upon
surrender are adjusted downwards. By contrast, if interest rates are
lower than at the time of contract issuance (and the market value of
the insurer's assets has increased), the proceeds payable upon
surrender are adjusted upwards.
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    \84\ Securities Act Release. No. 6645, supra note 35, 51 FR at
20256-58.
    \85\ 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)).
    \86\ 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).
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    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.\87\ 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. An
example of a guaranteed living benefit is a contract that guarantees
regular income payments for the life of the purchaser to the extent
that the value of the purchaser's investment in the relevant account is
not sufficient to provide such payments. Such a contract could, for
example, guarantee that if the purchaser withdraws no more than five
percent per year of the amount invested, and if withdrawals and market
performance reduce the account value to a zero balance, the insurer
will thereafter make annual payments to the purchaser in an amount
equal to five percent of the amount invested.
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    \87\ 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).
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    As noted above, the proposed Exchange Act exemption would also
apply with respect to a guarantee of a security if the guaranteed
security is subject to regulation under state insurance law.\88\ We are
proposing this provision because we believe that it would be
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.\89\
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    \88\ 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.
    \89\ 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.
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    Finally, the proposed exemption would be unavailable 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 would not be covered by the proposed exemption because it would
not be subject to regulation under state insurance law and often would
be 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 proposed
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.

    We request comment on the proposed exemption and in particular on
the following issues:
     Should we provide insurance companies 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 that are also regulated as insurance? Should we modify the
exemption in any way?
     What securities should be covered by the proposed
exemption? Should the exemption, as proposed, only be available with
respect to securities that are either subject to regulation under state
insurance law or are guarantees of securities that are subject to
regulation under state insurance law? Should the exemption apply to
indexed annuities, contracts with MVA features, and insurance contracts
that provide certain guaranteed benefits in connection with assets held
in an investor's account, such as a mutual fund, brokerage, or
investment advisory account? Should we limit the exemption to all or
any of those three types of securities, or should we also make the
exemption available to types of securities that may be issued by
insurance companies in the future?
     If we adopt the proposed Exchange Act exemption, should
the adopted rule expressly provide that the exemption is unavailable
with respect to any security that constitutes an equity interest in the
issuing insurance company? Should the rule expressly provide that the
exemption is unavailable with respect to debt securities? If so, how
should we define the term ``debt securities'' so that it does not cover
insurance obligations?
2. Conditions to Exemption
    As described above, we believe that the proposed 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. We are proposing that the
Exchange Act exemption be 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.
Regulation of Insurer's Financial Condition
    In order to rely on the proposed 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.\90\ 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 proposed exemption would not be available.
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    \90\ Proposed 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).
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Absence of Trading Interest
    The proposed Exchange Act exemption would be subject to two
conditions intended to insure that there is no trading interest in
securities with respect to which the exemption applies. First, the
securities may not be listed, traded, or quoted on an exchange,
alternative trading system,\91\ inter-dealer quotation system,\92\
electronic communications network, or any other similar system,
network, or publication for trading or quoting.\93\ 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 not develop, including requiring written notice to, and acceptance
by, the insurance company prior to any assignment or other 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.\94\ This condition is designed to ensure that the insurer takes
reasonable steps to ensure the absence of trading interest in the
securities. We recognize that insurance contracts typically permit
assignment in some circumstances. The proposed condition is intended to
permit these assignments to continue while requiring the insurer to
monitor assignments and, if it observes development of trading interest
in the securities, to step in and refuse assignments related to this
trading interest. We understand that it is commonplace for insurers
today to include restrictions on assignments in their contracts similar
to those that would be required by the proposed rule.\95\
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    \91\ 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'').
    \92\ 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'').
    \93\ Proposed rule 12h-7(d).
    \94\ Proposed rule 12h-7(e).
    \95\ See Roth, supra note 72, at 4 n. 4.
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    We request comment generally on the proposed conditions to the
Exchange Act exemption and specifically on the following issues:
     Are the proposed conditions appropriate? Will they help to
ensure that the proposed exemption is necessary or appropriate in the
public interest and consistent with the protection of investors?
     Should we, as proposed, condition the exemption on the
insurer filing an annual statement of its financial condition with its
home state insurance regulator? Should we require more or less frequent
filings relating to financial condition, e.g., quarterly, semi-
annually, every two years, etc.?
     Should we require, as a condition to the exemption, any
public disclosure of the insurer's financial condition, either through
filing with us or by posting on the insurer's Web site? Should we
require that an insurer post on its Web site, or make available to
investors on request, any reports of financial condition that it files
with state insurance regulators or any third-party ratings of its
claims-paying ability? Should we require, as a condition to the
exemption, an insurer to report to the Commission, disclose to its
contract owners, and/or publicly disclose any material disciplinary
action undertaken, or material deficiency identified by, a state
insurance regulator that relates to the insurer's financial condition
or any other matter?
     Should we require, as a condition to the exemption, that
the insurer be subject to supervision and periodic examination of its
financial condition by its home state regulator, as proposed? Is the
proposed condition consistent with state insurance regulation? Are
there other conditions that should be imposed relating to supervision
by the state insurance regulator?
     Should the Exchange Act exemption include conditions
designed to limit trading interest in the securities? If so, are the
proposed conditions appropriate? Does the proposed rule place
appropriate restrictions on transfers of securities with respect to
which the exemption is claimed without unduly restricting transfers in
a manner that would be harmful to investors' interests?

IV. General Request for Comments

    The Commission requests comment on the rules proposed in this
release,

whether any further changes to our rules are necessary or appropriate
to implement the objectives of our proposed rules, and on other matters
that might affect the proposals contained in this release.

V. Paperwork Reduction Act

A. Background

    Proposed rule 151A contains no new ``collection of information''
requirements within the meaning of the Paperwork Reduction Act of 1995
(``PRA'').\96\ However, we believe that proposed rule 151A would, if
adopted, result in an increase in the disclosure burden associated with
existing Form S-1 as a result of additional filings that would be made
on Form S-1.\97\ Form S-1 contains ``collection of information''
requirements within the meaning of the PRA. Although we are not
proposing to amend Form S-1, we are submitting the Form S-1
``collection of information'' (``Form S-1 (OMB Control No. 3235-0065)),
which we estimate would increase as a result of proposed rule 151A, to
the Office of Management and Budget (``OMB'') for review and approval
in accordance with the PRA.\98\
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    \96\ 44 U.S.C. 3501 et seq.
    \97\ 17 CFR 239.11.
    \98\ 44 U.S.C. 3507(d); 5 CFR 1320.11.
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    We adopted existing 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 indexed annuities that
register under the Securities Act would generally register on Form S-
1.\99\
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    \99\ Some Securities Act offerings are registered on Form S-3
[17 CFR 239.13]. We do not believe that proposed rule 151A would
have any significant impact on the disclosure burden associated with
Form S-3 because we believe that very few insurance companies that
issue indexed annuities would 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 today are currently eligible to file Form S-3. Further, if
we adopt the proposed Exchange Act reporting exemption, insurance
companies that issue indexed annuities and rely on the exemption
would not meet the eligibility requirements for Form S-3.
    We also do not believe that the proposed rules would 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 proposed rule 12h-7, insurance companies would not be
required to file Exchange Act reports on these forms in connection
with indexed annuities that are registered under the Securities Act.
While proposed rule 12h-7 would 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.
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    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
would be made publicly available on the EDGAR filing system.

B. Summary of Information Collection

    Because proposed rule 151A would affect the number of filings on
Form S-1 but not the disclosure required by this form, we do not
believe that the amendments 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, proposed rule
151A would 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 would 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 would increase if proposed rule 151A
were adopted.

C. Paperwork Reduction Act Burden Estimates

    For purposes of the PRA, we estimate that our proposal will result