[Federal Register: January 16, 2009 (Volume 74, Number 11)]
[Rules and Regulations]
[Page 3137-3176]
[DOCID:fr16ja09-30]

-----------------------------------------------------------------------

Part II

Securities and Exchange Commission

-----------------------------------------------------------------------

17 CFR Parts 230 and 240

Indexed Annuities and Certain Other Insurance Contracts; Final Rule

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 230 and 240

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

Indexed Annuities And Certain Other Insurance Contracts

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

-----------------------------------------------------------------------

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

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

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

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission
(``Commission'') is adding rule 151A under the Securities Act of 1933
(``Securities Act'') \1\ and rule 12h-7 under the Securities Exchange
Act of 1934 (``Exchange Act'').\2\
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 77a et seq.
    \2\ 15 U.S.C. 78a et seq.
---------------------------------------------------------------------------

Table of Contents

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

I. Executive Summary

    We are adopting new rule 151A under the Securities Act of 1933 in
order to clarify the status under the federal securities laws of
indexed annuities, under which payments to the purchaser are dependent
on the performance of a securities index.\3\ Section 3(a)(8) of the
Securities Act provides an exemption under the Securities Act for
certain ``annuity contracts,'' ``optional annuity contracts,'' and
other insurance contracts. The new rule prospectively defines certain
indexed annuities as not being ``annuity contracts'' or ``optional
annuity contracts'' under this exemption if the amounts payable by the
insurer under the contract are more likely than not to exceed the
amounts guaranteed under the contract.
---------------------------------------------------------------------------

    \3\ 17 CFR 230.151A. Rule 151A was proposed by the Commission in
June 2008. See Securities Act Release No. 8933 (June 25, 2008) [73
FR 37752 (July 1, 2008)] (``Proposing Release'').
---------------------------------------------------------------------------

    The definition hinges upon a familiar concept: the allocation of
risk. Insurance provides protection against risk, and the courts have
held that the allocation of investment risk is a significant factor in
distinguishing a security from a contract of insurance. The Commission
has also recognized that the allocation of investment risk is
significant in determining whether a particular contract that is
regulated as insurance under state law is insurance for purposes of the
federal securities laws.
    Individuals who purchase indexed annuities are exposed to a
significant investment risk--i.e., the volatility of the underlying
securities index. Insurance companies have successfully utilized this
investment feature, which appeals to purchasers not on the usual
insurance basis of stability and security, but on the prospect of
investment growth. Indexed annuities are attractive to purchasers
because they offer the promise of market-related gains. Thus,
purchasers obtain indexed annuity contracts for many of the same
reasons that individuals purchase mutual funds and variable annuities,
and open brokerage accounts.
    When the amounts payable by an insurer under an indexed annuity are
more likely than not to exceed the amounts guaranteed under the
contract, this indicates that the majority of the investment risk for
the fluctuating, securities-linked portion of the return is borne by
the individual purchaser, not the insurer. The individual underwrites
the effect of the underlying index's performance on his or her contract
investment and assumes the majority of the investment risk for the
securities-linked returns under the contract.
    The federal interest in providing investors with disclosure,
antifraud, and sales practice protections arises when individuals are
offered indexed annuities that expose them to investment risk.
Individuals who purchase such indexed annuities assume many of the same
risks and rewards that investors assume when investing their money in
mutual funds, variable annuities, and other securities. However, a
fundamental difference between these securities and indexed annuities
is that--with few exceptions--indexed annuities historically have not
been registered as securities. As a result, most purchasers of indexed
annuities have not received the benefits of federally mandated
disclosure, antifraud, and sales practice protections.
    In a traditional fixed annuity, the insurer bears the investment
risk under the contract. As a result, such instruments have
consistently been treated as insurance contracts under the federal
securities laws. At the opposite end of the spectrum, the purchaser
bears the investment risk for a traditional variable annuity that
passes through to the purchaser the performance of underlying
securities, and we have determined and the courts have held that
variable annuities are securities under the federal securities laws.
Indexed annuities, on the other hand, fall somewhere in between--they
possess both securities and insurance features. Therefore, we have
determined that providing greater clarity with regard to the status of
indexed annuities under the federal securities laws will enhance
investor protection, as well as provide greater certainty to the
issuers and sellers of these products with respect to their obligations
under the federal securities laws. Accordingly, we

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

    \4\ NASAA is the association of all state, provincial, and
territorial securities regulators in North America.
    \5\ FINRA is the largest non-governmental regulator for
registered broker-dealer firms doing business in the United States.
FINRA was created in July 2007 through the consolidation of NASD and
the member regulation, enforcement, and arbitration functions of the
New York Stock Exchange.
    \6\ ICI is a national association of investment companies,
including mutual funds, closed-end funds, exchange-traded funds, and
unit investment trusts.
---------------------------------------------------------------------------

II. Background

    Beginning in the mid-1990s, the life insurance industry introduced
a new type of annuity, referred to as an ``equity-indexed annuity,''
or, more recently, ``fixed indexed annuity'' (herein ``indexed
annuity''). Amounts paid by the insurer to the purchaser of an indexed
annuity are based, in part, on the performance of an equity index or
another securities index, such as a bond index.
    The status of indexed annuities under the federal securities laws
has been uncertain since their introduction in the mid-1990s.\7\ Under
existing precedents, the status of each indexed annuity is determined
based on a facts and circumstances analysis of factors that have been
articulated by the U.S. Supreme Court.\8\ Insurers have typically
marketed and sold indexed annuities without registering the contracts
under the federal securities laws.
---------------------------------------------------------------------------

    \7\ See Securities Act Release No. 7438 (Aug. 20, 1997) [62 FR
45359, 45360 (Aug. 27, 1997)] (``1997 Concept Release''); NASD,
Equity-Indexed Annuities, Notice to Members 05-50 (Aug. 2005),
available at: http://www.finra.org/web/groups/rules_regs/documents/
notice_to_members/p014821.pdf (``NTM 05-50''); Letter of William
A. Jacobson, Esq., Associate Clinical Professor, Director,
Securities Law Clinic, and Matthew M. Sweeney, Cornell Law School
'10, Cornell University Law School (Sept. 10, 2008) (``Cornell
Letter''); Letter of FINRA (Aug. 11, 2008) (``FINRA Letter'');
Letter of Investment Company Institute (Sept. 10, 2008) (``ICI
Letter'').
    \8\ SEC v. Variable Annuity Life Ins. Co., 359 U.S. 65 (1959)
(``VALIC ''); SEC v. United Benefit Life Ins. Co., 387 U.S. 202
(1967) (``United Benefit'').
---------------------------------------------------------------------------

    In the years after indexed annuities were first introduced, sales
volumes and the number of purchasers were relatively small. Sales of
indexed annuities for 1998 totaled $4 billion and grew each year
through 2005, when sales totaled $27.2 billion.\9\ Indexed annuity
sales for 2006 totaled $25.4 billion and $24.8 billion in 2007.\10\ In
2007, indexed annuity assets totaled $123 billion, 58 companies were
issuing indexed annuities, and there were a total of 322 indexed
annuity contracts offered.\11\ As sales have grown in more recent
years, these products have affected larger and larger numbers of
purchasers. They have also become an increasingly important business
line for some insurers.\12\
---------------------------------------------------------------------------

    \9\ NAVA, 2008 Annuity Fact Book, at 57 (2008).
    \10\ Id.
    \11\ Id.
    \12\ See, e.g., Allianz Life Insurance Company of North America
(Best's Company Reports, Allianz Life Ins. Co. of N. Am., Dec. 3,
2007) (Indexed annuities represent approximately two-thirds of gross
premiums written.); American Equity Investment Life Holding Company
(Annual Report on Form 10-K, at F-16 (Mar. 14, 2008)) (Indexed
annuities accounted for approximately 97% of total purchase payments
in 2007.); Americo Financial Life and Annuity Insurance Company
(Best's Company Reports, Americo Fin. Life and Annuity Ins. Co.,
Sept. 5, 2008) (Indexed annuities represent over 90% of annuity
premiums and almost 60% of annuity reserves.); Aviva USA Group
(Best's Company Reports, Aviva Life Insurance Company, July 14,
2008) (Indexed annuity sales represent more than 85% of total
annuity production.); Investors Insurance Corporation (IIC) (Best's
Company Reports, Investors Ins. Corp., July 10, 2008) (IIC's primary
product has been indexed annuities.); Life Insurance Company of the
Southwest (``LSW'') (Best's Company Reports, Life Ins. Co. of the
Southwest, June 28, 2007) (LSW specializes in the sale of annuities,
primarily indexed annuities.); Midland National Life Insurance
Company (Best's Company Reports, Midland Nat'l Life Ins. Co., Jan.
24, 2008) (Sales of indexed annuities in recent years have been the
principal driver of growth in annuity deposits.).
---------------------------------------------------------------------------

    The growth in sales of indexed annuities has, unfortunately, been
accompanied by complaints of abusive sales practices. These include
claims that the often-complex features of these annuities have not been
adequately disclosed to purchasers, as well as claims that rapid sales
growth has been fueled by the payment of outsize commissions that are
funded by high surrender charges imposed over long periods, which can
make these annuities unsuitable for seniors and others who may need
ready access to their assets.\13\
---------------------------------------------------------------------------

    \13\ See Letter of Susan E. Voss, Commissioner, Iowa Insurance
Division (Nov. 18, 2008) (``Voss Letter'') (acknowledging sales
practice issues and ``great deal'' of concern about suitability and
disclosures in indexed annuity market). See also FINRA, Equity
Indexed Annuities--A Complex Choice (updated Apr. 22, 2008),
available at: http://www.finra.org/InvestorInformation/
InvestorAlerts/AnnuitiesandInsurance/Equity-IndexedAnnuities-
AComplexChoice/P010614 (``FINRA Investor Alert'') (investor alert on
indexed annuities); Office of Compliance Inspections and
Examinations, Securities and Exchange Commission, et al., Protecting
Senior Investors: Report of Examinations of Securities Firms
Providing `Free Lunch' Sales Seminars, at 4 (Sept. 2007), available
at: http://www.sec.gov/spotlight/seniors/freelunchreport.pdf (joint
examination conducted by Commission, North American Securities
Administrators Association (``NASAA''), and FINRA identified
potentially misleading sales materials and potential suitability
issues relating to products discussed at sales seminars, which
commonly included indexed annuities); Statement of Patricia Struck,
President, NASAA, at the Senior Summit of the United States
Securities and Exchange Commission, July 17, 2006, available at:
http://www.nasaa.org/IssuesAnswers/Legislative_Activity/Testimony/
4999.cfm (identifying indexed annuities as among the most pervasive
products involved in senior investment fraud); NTM 05-50, supra note
7 (citing concerns about marketing of indexed annuities and the
absence of adequate supervision of sales practices).

---------------------------------------------------------------------------

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

A. Description of Indexed Annuities

    An indexed annuity is a contract issued by a life insurance company
that generally provides for accumulation of the purchaser's payments,
followed by payment of the accumulated value to the purchaser either as
a lump sum, upon death or withdrawal, or as a series of payments (an
``annuity''). During the accumulation period, the insurer credits the
purchaser with a return that is based on changes in a securities index,
such as the Dow Jones Industrial Average, Lehman Brothers Aggregate
U.S. Index, Nasdaq 100 Index, or Standard & Poor's 500 Composite Stock
Price Index. The insurer also guarantees a minimum value to the
purchaser.\14\ The specific features of indexed annuities vary from
product to product. Some key features, found in many indexed annuities,
are as follows.
---------------------------------------------------------------------------

    \14\ FINRA Investor Alert, supra note 13; National Association
of Insurance Commissioners, Buyer's Guide to Fixed Deferred
Annuities with Appendix for Equity-Indexed Annuities, at 9 (2007)
(``NAIC Guide''); National Association for Fixed Annuities, White
Paper on Fixed Indexed Insurance Products Including 'Fixed Indexed
Annuities' and Other Fixed Indexed Insurance Products, at 1 (2006),
available at: http://www.nafa.us/
index.php?act=attach&type=post&id=68 (``NAFA Whitepaper''); Jack
Marrion, Index Annuities: Power and Protection, at 13 (2004)
(``Marrion'').
---------------------------------------------------------------------------

Computation of Index-Based Return
    The purchaser's index-based return under an indexed annuity depends
on the particular combination of features specified in the contract.
Typically, an indexed annuity specifies all aspects of the formula for
computing return in advance of the period for which return is to be
credited, and the crediting period is generally at least one year
long.\15\ The rate of the index-based return is computed at the end of
the crediting period, based on the actual performance of a specified
securities index during that period, but the computation is performed
pursuant to a mathematical formula that is guaranteed in advance of the
crediting period. Common indexing features are described below.
---------------------------------------------------------------------------

    \15\ NAFA Whitepaper, supra note 14, at 13.
---------------------------------------------------------------------------

     Index. Indexed annuities credit return based on the
performance of a securities index, such as the Dow Jones Industrial
Average, Lehman Brothers Aggregate U.S. Index, Nasdaq 100 Index, or
Standard & Poor's 500 Composite Stock Price Index. Some annuities
permit the purchaser to select one or more indices from a specified
group of indices.
     Determining Change in Index. There are several methods for
determining the change in the relevant index over the crediting
period.\16\ For example, the ``point-to-point'' method compares the
index level at two discrete points in time, such as the beginning and
ending dates of the crediting period. Typically, in determining the
amount of index change, dividends paid on securities underlying the
index are not included. Indexed annuities typically do not apply
negative changes in an index to contract value. Thus, if the change in
index value is negative over the course of a crediting period, no
deduction is taken from contract value nor is any index-based return
credited.\17\
---------------------------------------------------------------------------

    \16\ See FINRA Investor Alert, supra note 13; NAIC Guide, supra
note 14, at 12-14; NAFA Whitepaper, supra note 14, at 9-10; Marrion,
supra note 14, at 38-59.
    \17\ NAIC Guide, supra note 14, at 11; NAFA Whitepaper, supra
note 14, at 5 and 9; Marrion, supra note 14, at 2.
---------------------------------------------------------------------------

     Portion of Index Change to be Credited. The portion of the
index change to be credited under an indexed annuity is typically
determined through the application of caps, participation rates, spread
deductions, or a combination of these features.\18\ Some contracts
``cap'' the index-based returns that may be credited. For example, if
the change in the index is 6%, and the contract has a 5% cap, 5% would
be credited. A contract may establish a ``participation rate,'' which
is multiplied by index growth to determine the rate to be credited. If
the change in the index is 6%, and a contract's participation rate is
75%, the rate credited would be 4.5% (75% of 6%). In addition, some
indexed annuities may deduct a percentage, or spread, from the amount
of gain in the index in determining return. If the change in the index
is 6%, and a contract has a spread of 1%, the rate credited would be 5%
(6% minus 1%).
---------------------------------------------------------------------------

    \18\ See FINRA Investor Alert, supra note 13; NAIC Guide, supra
note 14, at 10-11; NAFA Whitepaper, supra note 14, at 10; Marrion,
supra note 14, at 38-59.
---------------------------------------------------------------------------

Surrender Charges
    Surrender charges are commonly deducted from withdrawals taken by a
purchaser.\19\ The maximum surrender charges, which may be as high as
15-20%,\20\ are imposed on surrenders made during the early years of
the contract and decline gradually to 0% at the end of a specified
surrender charge period, which may be in excess of 15 years.\21\

Imposition of a surrender charge may have the effect of reducing or
eliminating any index-based return credited to the purchaser up to the
time of a withdrawal. In addition, a surrender charge may result in a
loss of principal, so that a purchaser who surrenders prior to the end
of the surrender charge period may receive less than the original
purchase payments.\22\ Many indexed annuities permit purchasers to
withdraw a portion of contract value each year, typically 10%, without
payment of surrender charges.
---------------------------------------------------------------------------

    \19\ See FINRA Investor Alert, supra note 13; NAIC Guide, supra
note 14, at 3-4 and 11; NAFA Whitepaper, supra note 14, at 7;
Marrion, supra note 14, at 31.
    \20\ The highest surrender charges are often associated with
annuities in which the insurer credits a ``bonus'' equal to a
percentage of purchase payments to the purchaser at the time of
purchase. The surrender charge may serve, in part, to recapture the
bonus.
    \21\ See A Producer's Guide to Indexed Annuities 2007, LIFE
INSURANCE SELLING (June 2007), available at: http://
www.lifeinsuranceselling.com/Media/MediaManager/0607_IASurvey_
1.pdf; Equity Indexed Annuities, ANNUITYADVANTAGE, available at:
http://datafeeds.annuityratewatch.com/annuityadvantage/fixed-
indexed-accounts.htm.
    \22\ FINRA Investor Alert, supra note 13; Marrion, supra note
14, at 31.
---------------------------------------------------------------------------

Guaranteed Minimum Value
    Indexed annuities generally provide a guaranteed minimum value,
which serves as a floor on the amount paid upon withdrawal, as a death
benefit, or in determining the amount of annuity payments. The
guaranteed minimum value is typically a percentage of purchase
payments, accumulated at a specified interest rate, and may not be
lower than a floor established by applicable state insurance law. In
the years immediately following their introduction, indexed annuities
typically guaranteed 90% of purchase payments accumulated at 3% annual
interest.\23\ More recently, however, following changes in state
insurance laws,\24\ indexed annuities typically provide that the
guaranteed minimum value is equal to at least 87.5% of purchase
payments, accumulated at annual interest rate of between 1% and 3%.\25\
Assuming a guarantee of 87.5% of purchase payments, accumulated at 1%
interest compounded annually, it would take approximately 13 years for
a purchaser's guaranteed minimum value to be 100% of purchase payments.
---------------------------------------------------------------------------

    \23\ 1997 Concept Release, supra note 7 (concept release
requesting comments on structure of equity indexed insurance
products, the manner in which they are marketed, and other matters
the Commission should consider in addressing federal securities law
issues raised by these products). See also Letter from American
Academy of Actuaries (Jan. 5, 1998); Letter from Aid Association for
Lutherans (Nov. 19, 1997) (comment letters in response to 1997
Concept Release). The comment letters on the 1997 Concept Release
are available for public inspection and copying in the Commission's
Public Reference Room, 100 F Street, NE., Washington, DC (File No.
S7-22-97). Those comment letters that were transmitted
electronically to the Commission are also available on the
Commission's Web site at http://www.sec.gov/rules/concept/
s72297.shtml.
    \24\ See, e.g., CAL. INS. CODE Sec.  10168.25 (West 2007) & IOWA
CODE Sec.  508.38 (2008) (current requirements, providing for
guarantee based on 87.5% of purchase payments accumulated at minimum
of 1% annual interest); CAL. INS. CODE Sec.  10168.2 (West 2003) &
IOWA CODE Sec.  508.38 (2002) (former requirements, providing for
guarantee for single premium annuities based on 90% of premium
accumulated at minimum of 3% annual interest).
    \25\ NAFA Whitepaper, supra note 14, at 6.
---------------------------------------------------------------------------

Registration
    Insurers typically have concluded that the indexed annuities they
issue are not securities. As a result, virtually all indexed annuities
have been issued without registration under the Securities Act.\26\
---------------------------------------------------------------------------

    \26\ In a few instances, insurers have registered indexed
annuities as securities as a result of particular features, such as
the absence of any guaranteed interest rate or the absence of a
guaranteed minimum value. See, e.g., Pre-Effective Amendment No. 4
to Registration Statement on Form S-1 of PHL Variable Insurance
Company (File No. 333-132399) (filed Feb. 7, 2007); Pre-Effective
Amendment No. 1 to Registration Statement on Form S-3 of Allstate
Life Insurance Company (File No. 333-105331) (filed May 16, 2003);
Initial Registration Statement on Form S-2 of Golden American Life
Insurance Company (File No. 333-104547) (filed Apr. 15, 2003).
---------------------------------------------------------------------------

 B. Section 3(a)(8) Exemption

    Section 3(a)(8) of the Securities Act provides an exemption for any
``annuity contract'' or ``optional annuity contract'' issued by a
corporation that is subject to the supervision of the insurance
commissioner, bank commissioner, or similar state regulatory
authority.\27\ The exemption, however, is not available to all
contracts that are considered annuities under state insurance law. For
example, variable annuities, which pass through to the purchaser the
investment performance of a pool of assets, are not exempt annuity
contracts.
---------------------------------------------------------------------------

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

    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.
---------------------------------------------------------------------------

    \28\ VALIC, supra note 8, 359 U.S. 65; United Benefit, supra
note 8, 387 U.S. 202.
---------------------------------------------------------------------------

    With regard to investment risk, beginning with SEC v. Variable
Annuity Life Ins. Co. (``VALIC''),\29\ the Court has considered whether
the risk is borne by the purchaser (tending to indicate that the
product is not an exempt ``annuity contract'') or by the insurer
(tending to indicate that the product falls within the Section 3(a)(8)
exemption). In VALIC, the Court determined that variable annuities,
under which payments varied with the performance of particular
investments and which provided no guarantee of fixed income, were not
entitled to the Section 3(a)(8) exemption. In SEC v. United Benefit
Life Ins. Co. (``United Benefit''),\30\ the Court extended the VALIC
reasoning, finding that a contract that provides for some assumption of
investment risk by the insurer may nonetheless not be entitled to the
Section 3(a)(8) exemption. The United Benefit insurer guaranteed that
the cash value of its variable annuity contract would never be less
than 50% of purchase payments made and that, after ten years, the value
would be no less than 100% of payments. The Court determined that this
contract, under which the insurer did assume some investment risk
through minimum guarantees, was not an ``annuity contract'' under the
federal securities laws. In making this determination, the Court
concluded that ``the assumption of an investment risk cannot by itself
create an insurance provision under the federal definition'' and
distinguished a ``contract which to some degree is insured'' from a
``contract of insurance.'' \31\
---------------------------------------------------------------------------

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

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

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

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

    Marketing is another significant factor in determining whether a
state-regulated insurance contract is entitled to the Securities Act
``annuity contract'' exemption. In United Benefit, the U.S. Supreme
Court, in holding an annuity to be outside the scope of Section
3(a)(8), found significant the fact that the contract was ``considered
to appeal to the purchaser not on the usual insurance basis of
stability and security but on the prospect of `growth' through sound
investment management.'' \33\ Under these circumstances, the Court
concluded ``it is not inappropriate that promoters' offerings be judged
as being what they were represented to be.'' \34\
---------------------------------------------------------------------------

    \33\ United Benefit, supra note 8, 387 U.S. at 211.
    \34\ Id. at 211 (quoting SEC v. Joiner Leasing Corp., 320 U.S.
344, 352-53 (1943)). For other cases applying a marketing test, see
Berent v. Kemper Corp., 780 F. Supp. 431 (E.D. Mich. 1991), aff'd,
973 F. 2d 1291 (6th Cir. 1992); Associates in Adolescent Psychiatry
v. Home Life Ins. Co., 729 F.Supp. 1162 (N.D. Ill. 1989), aff'd, 941
F.2d 561 (7th Cir. 1991); and Grainger v. State Security Life Ins.
Co., 547 F.2d 303 (5th Cir. 1977).
---------------------------------------------------------------------------

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

    \35\ 17 CFR 230.151; Securities Act Release No. 6645 (May 29,
1986) [51 FR 20254 (June 4, 1986)]. A guaranteed investment contract
is a deferred annuity contract under which the insurer pays interest
on the purchaser's payments at a guaranteed rate for the term of the
contract. In some cases, the insurer also pays discretionary
interest in excess of the guaranteed rate.
    \36\ 17 CFR 230.151(a).
---------------------------------------------------------------------------

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

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

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

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

III. Discussion of the Amendments

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

A. Definition of Annuity Contract

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

material in determining the likelihood that amounts payable under the
contract exceed the amounts guaranteed.
    In determining whether assumptions are reasonable, insurers should
generally be guided by both history and their own expectations about
the future. An insurer may look to its own, and to industry, experience
with similar or otherwise comparable contracts in constructing
assumptions about both insurer behavior and investor behavior. In
making assumptions about future market behavior, an insurer may be
guided, for example, by historical market characteristics, such as
historical returns and volatility, provided that the insurer bases its
assumptions on an appropriate period of time and does not have reason
to believe that the time period chosen is likely to be
unrepresentative. As a general matter, assumptions about insurer,
investor, or market behavior that are not consistent with historical
experience would not be reasonable unless an insurer has a reasonable
basis for any differences between historical experience and the
assumptions used.
    In addition, an insurer may look to its own expectations about the
future in constructing reasonable assumptions. As noted above, insurers
routinely analyze anticipated outcomes for purposes of pricing and
valuing their contracts. We expect that, in making a determination
under rule 151A, an insurer will use assumptions that are consistent
with the assumptions that it uses for other purposes, such as pricing
and valuation. In addition, an insurer generally should use assumptions