[Federal Register: July 1, 2008 (Volume 73, Number 127)] [Proposed Rules] [Page 37751-37774] From the Federal Register Online via GPO Access [wais.access.gpo.gov] [DOCID:fr01jy08-16] [[Page 37751]] ----------------------------------------------------------------------- Part VI Securities and Exchange Commission ----------------------------------------------------------------------- 17 CFR Parts 230 and 240 Indexed Annuities and Certain Other Insurance Contracts; Proposed Rule [[Page 37752]] ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 230 and 240 [Release Nos. 33-8933, 34-58022; File No. S7-14-08] RIN 3235-AK16 Indexed Annuities and Certain Other Insurance Contracts AGENCY: Securities and Exchange Commission. ACTION: Proposed rule. ----------------------------------------------------------------------- SUMMARY: We are proposing a new rule that would define the terms ``annuity contract'' and ``optional annuity contract'' under the Securities Act of 1933. The proposed rule is intended to clarify the status under the federal securities laws of indexed annuities, under which payments to the purchaser are dependent on the performance of a securities index. The proposed rule would apply on a prospective basis to contracts issued on or after the effective date of the rule. We are also proposing to exempt insurance companies from filing reports under the Securities Exchange Act of 1934 with respect to indexed annuities and other securities that are registered under the Securities Act, provided that the securities are regulated under state insurance law, the issuing insurance company and its financial condition are subject to supervision and examination by a state insurance regulator, and the securities are not publicly traded. DATES: Comments should be received on or before September 10, 2008. ADDRESSES: Comments may be submitted by any of the following methods: Electronic Comments Use the Commission's Internet comment form (http:// www.sec.gov/rules/proposed.shtml); Send an e-mail to rule-comments@sec.gov. Please include File Number S7-14-08 on the subject line; or Use the Federal eRulemaking Portal (http:// www.regulations.gov). Follow the instructions for submitting comments. Paper Comments Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090. All submissions should refer to File Number S7-14-08. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (http://www.sec.gov/rules/ proposed.shtml). Comments are also available for public inspection and copying in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. FOR FURTHER INFORMATION CONTACT: Michael L. Kosoff, Attorney, or Keith E. Carpenter, Senior Special Counsel, Office of Disclosure and Insurance Products Regulation, Division of Investment Management, at (202) 551-6795, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-5720. SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission (``Commission'') is proposing to add rule 151A under the Securities Act of 1933 (``Securities Act'') \1\ and rule 12h-7 under the Securities Exchange Act of 1934 (``Exchange Act'').\2\ --------------------------------------------------------------------------- \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. Marketing of Indexed Annuities C. Section 3(a)(8) Exemption III. DISCUSSION OF THE PROPOSED AMENDMENTS A. Definition of Annuity Contract B. Exchange Act Exemption for Securities that Are Regulated as Insurance IV. GENERAL REQUEST FOR COMMENTS V. PAPERWORK REDUCTION ACT VI. COST/BENEFIT ANALYSIS VII. CONSIDERATION OF PROMOTION OF EFFICIENCY, COMPETITION, AND CAPITAL FORMATION; CONSIDERATION OF BURDEN ON COMPETITION VIII. INITIAL REGULATORY FLEXIBILITY ANALYSIS IX. CONSIDERATION OF IMPACT ON THE ECONOMY X. STATUTORY AUTHORITY TEXT OF PROPOSED RULES I. Executive Summary We are proposing a new rule that is intended to clarify the status under the federal securities laws of indexed annuities, under which payments to the purchaser are dependent on the performance of a securities index. Section 3(a)(8) of the Securities Act provides an exemption under the Securities Act for certain insurance contracts. The proposed rule would prospectively define certain indexed annuities as not being ``annuity contracts'' or ``optional annuity contracts'' under this insurance exemption if the amounts payable by the insurer under the contract are more likely than not to exceed the amounts guaranteed under the contract. The proposed definition would hinge upon a familiar concept: The allocation of risk. Insurance provides protection against risk, and the courts have held that the allocation of investment risk is a significant factor in distinguishing a security from a contract of insurance. The Commission has also recognized that the allocation of investment risk is significant in determining whether a particular contract that is regulated as insurance under state law is insurance for purposes of the federal securities laws. Individuals who purchase indexed annuities are exposed to a significant investment risk--i.e., the volatility of the underlying securities index. Insurance companies have successfully utilized this investment feature, which appeals to purchasers not on the usual insurance basis of stability and security, but on the prospect of investment growth. Indexed annuities are attractive to purchasers because they promise to offer market-related gains. Thus, these purchasers obtain indexed annuity contracts for many of the same reasons that individuals purchase mutual funds and variable annuities, and open brokerage accounts. When the amounts payable by an insurer under an indexed annuity are more likely than not to exceed the amounts guaranteed under the contract, the majority of the investment risk for the fluctuating, equity-linked portion of the return is borne by the individual purchaser, not the insurer. The individual underwrites the effect of the underlying index's performance on his or her contract investment and assumes the majority of the investment risk for the equity-linked returns under the contract. The federal interest in providing investors with disclosure, antifraud, and sales practice protections arises when individuals are offered indexed annuities that expose them to securities investment risk. Individuals who purchase such indexed annuities assume many of the same risks and rewards that investors assume when investing their money in mutual funds, variable annuities, and other securities. However, a fundamental difference [[Page 37753]] between these securities and indexed annuities is that--with few exceptions--indexed annuities historically have not been registered as securities. As a result, most purchasers of indexed annuities have not received the benefits of federally mandated disclosure and sales practice protections. We have determined that providing greater clarity with regard to the status of indexed annuities under the federal securities laws would enhance investor protection, as well as provide greater certainty to the issuers and sellers of these products with respect to their obligations under the federal securities laws. Accordingly, we are proposing a new definition of ``annuity contract'' that, on a prospective basis, would define a class of indexed annuities that are outside the scope of section 3(a)(8). With respect to these annuities, investors would be entitled to all the protections of the federal securities laws, including full and fair disclosure and sales practice protections. We are aware that many insurance companies, in the absence of definitive interpretation or definition by the Commission, have of necessity acted in reliance on their own analysis of the legal status of indexed annuities based on the state of the law prior to this release. Under these circumstances, we do not believe that insurance companies should be subject to any additional legal risk relating to their past offers and sales of indexed annuities as a result of our proposal today or its eventual adoption. Therefore, we are also proposing that the new definition apply prospectively only--that is, only to indexed annuities that are issued on or after the effective date of our final rule. Finally, we are proposing a new exemption from Exchange Act reporting that would apply to insurance companies with respect to indexed annuities and certain other securities that are registered under the Securities Act and regulated as insurance under state law. We believe that this exemption is necessary or appropriate in the public interest and consistent with the protection of investors. Where an insurer's financial condition and ability to meet its contractual obligations are subject to oversight under state law, and where there is no trading interest in an insurance contract, the concerns that periodic and current financial disclosures are intended to address are generally not implicated. Rather, investors who purchase these securities are primarily affected by issues relating to the insurer's financial ability to satisfy its contractual obligations--issues that are addressed by state law and regulation. II. Background Beginning in the mid-1990s, the life insurance industry introduced a new type of annuity, referred to as an ``equity-indexed annuity,'' or, more recently, ``fixed indexed annuity'' (herein ``indexed annuity''). Amounts paid by the insurer to the purchaser of an indexed annuity are based, in part, on the performance of an equity index or another securities index, such as a bond index. The status of indexed annuities under the federal securities laws has been uncertain since their introduction in the mid-1990s. Under existing precedents, the status of each indexed annuity is determined based on a facts and circumstances analysis of factors that have been articulated by the U.S. Supreme Court.\3\ Insurers have typically marketed and sold indexed annuities without complying with the federal securities laws, and sales of the products have grown dramatically in recent years. This growth has, unfortunately, been accompanied by growth in complaints of abusive sales practices. These include claims that the often-complex features of these annuities have not been adequately disclosed to purchasers, as well as claims that rapid sales growth has been fueled by the payment of outsize commissions that are funded by high surrender charges imposed over long periods, which can make these annuities particularly unsuitable for seniors and others who may need ready access to their assets. --------------------------------------------------------------------------- \3\ SEC v. Variable Annuity Life Ins. Co., 359 U.S. 65 (1959) (``VALIC''); SEC v. United Benefit Life Ins. Co., 387 U.S. 202 (1967) (``United Benefit''). --------------------------------------------------------------------------- We have observed the development of indexed annuities for some time, and we have become persuaded that guidance is needed with respect to their status under the federal securities laws. Today, we are proposing rules that are intended to provide greater clarity regarding the scope of the exemption provided by section 3(a)(8). We believe our proposed action is consistent with Congressional intent in that the proposed definition would afford the disclosure and sales practice protections of the federal securities laws to purchasers of indexed annuities who are more likely than not to receive payments that vary in accordance with the performance of a security. In addition, the proposed rules are intended to provide regulatory certainty and relief from Exchange Act reporting obligations to the insurers that issue these indexed annuities and certain other securities that are regulated as insurance under state law. We base our proposed exemption on two factors: First, the nature and extent of the activities of insurance company issuers, and their income and assets, and, in particular, the regulation of these activities and assets under state insurance law; and, second, the absence of trading interest in the securities. A. Description of Indexed Annuities An indexed annuity is a contract issued by a life insurance company that generally provides for accumulation of the purchaser's payments, followed by payment of the accumulated value to the purchaser either as a lump sum, upon death or withdrawal, or as a series of payments (an ``annuity''). During the accumulation period, the insurer credits the purchaser with a return that is based on changes in a securities index, such as the Dow Jones Industrial Average, Lehman Brothers Aggregate U.S. Index, Nasdaq 100 Index, or Standard & Poor's 500 Composite Stock Price Index. The insurer also guarantees a minimum value to the purchaser.\4\ --------------------------------------------------------------------------- \4\ Financial Industry Regulatory Authority, Inc. (``FINRA''), Equity-Indexed Annuities--A Complex Choice (updated Apr. 22, 2008), available at: http://www.finra.org/InvestorInformation/ InvestorAlerts/AnnuitiesandInsurance/Equity-IndexedAnnuities- AComplexChoice/P010614; National Association of Insurance Commissioners, Buyer's Guide to Fixed Deferred Annuities with Appendix for Equity-Indexed Annuities, at 9 (2007); National Association for Fixed Annuities, White Paper on Fixed Indexed Insurance Products Including `Fixed Indexed Annuities' and Other Fixed Indexed Insurance Products, at 1 (2006), available at: http:// www.nafa.us/pdfs/White%20Paper%20Final_11-10-06_ All%20Inquiries.pdf; Jack Marrion, Index Annuities: Power and Protection, at 13 (2004). --------------------------------------------------------------------------- Life insurance companies began offering indexed annuities in the mid-1990s.\5\ Sales of indexed annuities for 1998 totaled $4 billion and grew each year through 2005, when sales totaled $27.2 billion.\6\ Indexed annuity sales for 2006 totaled $25.4 billion and $24.8 billion in 2007.\7\ In 2007, indexed annuity assets totaled $123 billion, 58 companies were issuing indexed annuities, and there were a total of 322 indexed annuities offered.\8\ The specific features of indexed annuities vary from product to product. Some of the key features are as follows. --------------------------------------------------------------------------- \5\ See National Association for Fixed Annuities, supra note 4, at 4. \6\ NAVA, 2008 Annuity Fact Book, 57 (2008). \7\ Id. \8\ Id. --------------------------------------------------------------------------- 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 [[Page 37754]] advance of the period for which return is to be credited, and the crediting period is generally at least one year long.\9\ The rate of the index-based return is computed at the end of the crediting period, based on the actual performance of a specified securities index during that period, but the computation is performed pursuant to a mathematical formula that is guaranteed in advance of the crediting period. Common indexing features are described below. --------------------------------------------------------------------------- \9\ National Association for Fixed Annuities, supra note 4, 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.\10\ For example, the ``point-to-point'' method compares the index level at two discrete points in time, such as the beginning and ending dates of the crediting period. Another method, sometimes referred to as ``monthly point-to-point,'' combines both positive and negative changes in the index values from one month to the next during the crediting period and recognizes the aggregate change as the amount of index credit for the period, if it is positive. Another method compares an average of index values at periodic intervals during the crediting period to the index value at the beginning of the period. Typically, in determining the amount of index change, dividends paid on securities underlying the index are not included. Indexed annuities typically do not apply negative changes in an index to contract value. Thus, if the change in index value is negative over the course of a crediting period, no deduction is taken from contract value nor is any index-based return credited.\11\ --------------------------------------------------------------------------- \10\ See FINRA, supra note 4; National Association of Insurance Commissioners, supra note 4, at 12-14; National Association for Fixed Annuities, supra note 4, at 9-10; Marrion, supra note 4, at 38-59. \11\ National Association of Insurance Commissioners, supra note 4, at 11; National Association for Fixed Annuities, supra note 4, at 5 and 9; Marrion, supra note 4, at 2. --------------------------------------------------------------------------- Portion of Index Change to be Credited. The portion of the index change to be credited under an indexed annuity is typically determined through the application of caps, participation rates, spread deductions, or a combination of these features.\12\ Some contracts ``cap'' the index-based returns that may be credited. For example, if the change in the index is 6%, and the contract has a 5% cap, 5% would be credited. A contract may establish a ``participation rate,'' which is multiplied by index growth to determine the rate to be credited. If the change in the index is 6%, and a contract's participation rate is 75%, the rate credited would be 4.5% (75% of 6%). In addition, some indexed annuities may deduct a percentage, or spread, from the amount of gain in the index in determining return. If the change in the index is 6%, and a contract has a spread of 1%, the rate credited would be 5% (6% minus 1%). --------------------------------------------------------------------------- \12\ See FINRA, supra note 4; National Association of Insurance Commissioners, supra note 4, at 10-11; National Association for Fixed Annuities, supra note 4, at 10; Marrion, supra note 4, at 38- 59. --------------------------------------------------------------------------- Surrender Charges Surrender charges are commonly deducted from withdrawals taken by a purchaser.\13\ The maximum surrender charges, which may be as high as 15-20%,\14\ are imposed on surrenders made during the early years of the contract and decline gradually to 0% at the end of a specified surrender charge period, which may be in excess of 15 years. Imposition of a surrender charge may have the effect of reducing or eliminating any index-based return credited to the purchaser up to the time of a withdrawal. In addition, a surrender charge may result in a loss of principal, so that a purchaser who surrenders prior to the end of the surrender charge period may receive less than the original purchase payments.\15\ Many indexed annuities permit purchasers to withdraw a portion of contract value each year, typically 10%, without payment of surrender charges. --------------------------------------------------------------------------- \13\ See FINRA, supra note 4; National Association of Insurance Commissioners, supra note 4, at 3-4 and 11; National Association for Fixed Annuities, supra note 4, at 7; Marrion, supra note 4, at 31. \14\ The highest surrender charges are often associated with annuities in which the insurer credits a ``bonus'' equal to a percentage of purchase payments to the purchaser at the time of purchase. The surrender charge may serve, in part, to recapture the bonus. \15\ FINRA, supra note 4; Marrion, supra note 4, at 31. --------------------------------------------------------------------------- Guaranteed Minimum Value Indexed annuities generally provide a guaranteed minimum value, which serves as a floor on the amount paid upon withdrawal, as a death benefit, or in determining the amount of annuity payments. The guaranteed minimum value is typically a percentage of purchase payments, accumulated at a specified interest rate, and may not be lower than a floor established by applicable state insurance law. Indexed annuities typically provide that the guaranteed minimum value is equal to at least 87.5% of purchase payments, accumulated at annual interest rate of between 1% and 3%.\16\ Assuming a guarantee of 87.5% of purchase payments, accumulated at 1% interest compounded annually, it would take approximately 13 years for a purchaser's guaranteed minimum value to be 100% of purchase payments. --------------------------------------------------------------------------- \16\ National Association for Fixed Annuities, supra note 4, 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.\17\ --------------------------------------------------------------------------- \17\ In a few instances, insurers have registered indexed annuities as securities as a result of particular features, such as the absence of any guaranteed interest rate or the absence of a guaranteed minimum value. See, e.g., Pre-Effective Amendment No. 4 to Registration Statement on Form S-1 of PHL Variable Insurance Company (File No. 333-132399) (filed Feb. 7, 2007); Pre-Effective Amendment No. 1 to Registration Statement on Form S-3 of Allstate Life Insurance Company (File No. 333-105331) (filed May 16, 2003); Initial Registration Statement on Form S-2 of Golden American Life Insurance Company (File No. 333-104547) (filed Apr. 15, 2003). --------------------------------------------------------------------------- B. Marketing of Indexed Annuities In the years after indexed annuities were first introduced, sales volumes were relatively small. In 1998, when sales totaled $4 billion, the impact of these products on both purchasers and issuing insurance companies was limited. As sales have grown in more recent years, with sales of $24.8 billion and total indexed annuity assets of $123 billion in 2007, these products have affected larger and larger numbers of purchasers. They have also become an increasingly important business line for some insurers.\18\ In addition, in recent [[Page 37755]] years, guarantees provided by indexed annuities have been reduced. In the years immediately following their introduction, indexed annuities typically guaranteed 90% of purchase payments accumulated at 3% annual interest.\19\ More recently, however, following changes in state insurance laws,\20\ guarantees in indexed annuities have been as low as 87.5% of purchase payments accumulated at 1% annual interest.\21\ --------------------------------------------------------------------------- \18\ See, e.g., Allianz Life Insurance Company of North America (Best's Company Reports, Allianz Life Ins. Co. of N. Am., Dec. 3, 2007) (Indexed annuities represent approximately two-thirds of gross premiums written.); American Equity Investment Life Holding Company (Annual Report on Form 10-K, at F-16 (Mar. 14, 2008)) (Indexed annuities accounted for approximately 97% of total purchase payments in 2007.); Americo Financial Life and Annuity Insurance Company (Best's Company Reports, Americo Fin. Life and Annuity Ins. Co., Jul. 10, 2007) (Indexed annuities represent over eighty percent of annuity premiums and almost half of annuity reserves.); Aviva USA Group (Best's Company Reports, AmerUs Life Insurance Company, Nov. 6, 2007) (Indexed annuity sales represent more than 90% of total annuity production.); Conseco Insurance Group (CIG) (Best's Company Reports, Conseco Ins. Group, Nov. 7, 2008) (CIG's business was heavily weighted toward indexed annuities, which contributed approximately 77% of new first year premiums.); Investors Insurance Corporation (IIC) (Best's Company Reports, Investors Ins. Corp., Aug. 20, 2007) (IIC's primary product has been indexed annuities.); Life Insurance Company of the Southwest (``LSW'') (Best's Company Reports, Life Ins. Co. of the Southwest, Jun. 28, 2007) (LSW specializes in the sale of annuities, primarily indexed annuities.); Midland National Life Insurance Company (Best's Company Reports, Midland Nat'l Life Ins. Co., Jan. 24, 2008) (Sales of indexed annuities in recent years has been the principal driver of growth in annuity deposits.). \19\ Securities Act Release No. 7438 (Aug. 20, 1997) [62 FR 45359, 45360 (Aug. 27, 1997)] (concept release requesting comments on structure of equity indexed insurance products, the manner in which they are marketed, and other matters the Commission should consider in addressing federal securities law issues raised by these products) (``1997 Concept Release''). See also Letter from American Academy of Actuaries (Jan. 5, 1998); Letter from Aid Association for Lutherans (Nov. 19, 1997) (comment letters in response to 1997 Concept Release). The comment letters on the 1997 Concept Release are available for public inspection and copying in the Commission's Public Reference Room, 100 F Street, NE, Washington, DC (File No. S7-22-97). Some of the comment letters are also available on the Commission's Web site at http://www.sec.gov/rules/concept/ s72297.shtml. \20\ See, e.g., Cal. Ins. Code Sec. 10168.25 (West 2007) (current requirements, providing for guarantee based on 87.5% of purchase payments accumulated at minimum of 1% annual interest); Cal. Ins. Code Sec. 10168.2 (West 2003) (former requirements, providing for guarantee for single premium annuities based on 90% of premium accumulated at minimum of 3% annual interest). \21\ See A Producer's Guide to Indexed Annuities 2006, Life Insurance Selling (Jun. 2006), available at: http:// www.lifeinsuranceselling.com/Media/MediaManager/ 6IAsurveyforweb3.pdf. --------------------------------------------------------------------------- At the same time that sales of indexed annuities have increased and guarantees within the products have been reduced, concerns about potentially abusive sales practices and inadequate disclosure have grown. In August 2005, NASD \22\ issued a Notice to Members in which it cited its concerns about the manner in which persons associated with broker-dealers were marketing unregistered indexed annuities and the absence of adequate supervision of those sales practices.\23\ The Notice to Members also expressed NASD's concern with indexed annuity sales materials that do not fully describe the features and risks of the products. Citing uncertainty as to whether indexed annuities are subject to the federal securities laws, NASD encouraged member firms to supervise transactions in these products as though they are securities. --------------------------------------------------------------------------- \22\ In July 2007, NASD and the member regulation, enforcement, and arbitration functions of the New York Stock Exchange were consolidated to create FINRA. The NASD materials cited in this release were issued prior to the creation of FINRA. \23\ NASD, Equity-Indexed Annuities, Notice to Members 05-50 (Aug. 2005), available at: http://www.finra.org/web/groups/rules_ regs/documents/notice_to_members/p014821.pdf. See also FINRA, supra note 4 (investor alert on indexed annuities, stating that indexed annuities are ``anything but easy to understand''). --------------------------------------------------------------------------- At the Senior Summit held at the Commission in July 2006, at which securities regulators and others met to explore how to coordinate efforts to protect older Americans from abusive sales practices and securities fraud, concerns were cited about sales of indexed annuities to seniors.\24\ Patricia Struck, then President of the North American Securities Administrators Association (``NASAA''), identified indexed annuities as among the most pervasive products involved in senior investment fraud.\25\ In a joint examination conducted by the Commission, NASAA, and the Financial Industry Regulatory Authority, Inc. (``FINRA'') of ``free lunch'' seminars that are aimed at selling financial products, often to seniors, with a free meal as enticement, examiners identified potentially misleading sales materials and potential suitability issues relating to the products discussed at the seminars, which commonly included indexed annuities.\26\ --------------------------------------------------------------------------- \24\ The average age of issuance for indexed annuities has been reported to be 64. Advantage Compendium, 4th Quarter Index Annuity Sales Slip (Mar. 2008), available at: http://www.indexannuity.org/ ic2008.htm#4q07. \25\ Statement of Patricia Struck, President, NASAA, at the Senior Summit of the United States Securities and Exchange Commission, July 17, 2006, available at: http://www.nasaa.org/ IssuesAnswers/Legislative Activity/Testimony/4999.cfm. \26\ Office of Compliance Inspections and Examinations, Securities and Exchange Commission, et al., Protecting Senior Investors: Report of Examinations of Securities Firms Providing ``Free Lunch'' Sales Seminars, at 4 (Sept. 2007), available at: http://www.sec.gov/spotlight/seniors/freelunchreport.pdf. --------------------------------------------------------------------------- C. Section 3(a)(8) Exemption Section 3(a)(8) of the Securities Act provides an exemption for any ``annuity contract'' or ``optional annuity contract'' issued by a corporation that is subject to the supervision of the insurance commissioner, bank commissioner, or similar state regulatory authority.\27\ The exemption, however, is not available to all contracts that are considered annuities under state insurance law. For example, variable annuities, which pass through to the purchaser the investment performance of a pool of assets, are not exempt annuity contracts. --------------------------------------------------------------------------- \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 3, 359 U.S. 65; United Benefit, supra note 3, 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 3, 359 U.S. at 71-73. \30\ United Benefit, supra note 3, 387 U.S. at 211. \31\ Id. at 211. --------------------------------------------------------------------------- In analyzing investment risk, Justice Brennan's concurring opinion in VALIC applied a functional analysis to determine whether a new form of [[Page 37756]] investment arrangement that emerges and is labeled ``annuity'' by its promoters is the sort of arrangement that Congress was willing to leave exclusively to the state insurance commissioners. In that inquiry, the purposes of the federal securities laws and state insurance laws are important. Justice Brennan noted, in particular, that the emphasis in the Securities Act is on disclosure and that the philosophy of the Act is that ``full disclosure of the details of the enterprise in which the investor is to put his money should be made so that he can intelligently appraise the risks involved.'' \32\ Where an investor's investment in an annuity is sufficiently protected by the insurer, state insurance law regulation of insurer solvency and the adequacy of reserves are relevant. Where the investor's investment is not sufficiently protected, the disclosure protections of the Securities Act assume importance. --------------------------------------------------------------------------- \32\ VALIC, supra note 3, 359 U.S. at 77. --------------------------------------------------------------------------- Marketing is another significant factor in determining whether a state-regulated insurance contract is entitled to the Securities Act ``annuity contract'' exemption. In United Benefit, the U.S. Supreme Court, in holding an annuity to be outside the scope of section 3(a)(8), found significant the fact that the contract was ``considered to appeal to the purchaser not on the usual insurance basis of stability and security but on the prospect of `growth' through sound investment management.'' \33\ Under these circumstances, the Court concluded ``it is not inappropriate that promoters' offerings be judged as being what they were represented to be.'' \34\ --------------------------------------------------------------------------- \33\ United Benefit, supra note 3, 387 U.S. at 211. \34\ Id. at 211 (quoting SEC v. Joiner Leasing Corp., 320 U.S. 344, 352-53 (1943)). For other cases applying a marketing test, see Berent v. Kemper Corp., 780 F. Supp. 431 (E.D. Mich. 1991), aff'd, 973 F. 2d 1291 (6th Cir. 1992); Associates in Adolescent Psychiatry v. Home Life Ins. Co., 729 F.Supp. 1162 (N.D. Ill. 1989), aff'd, 941 F.2d 561 (7th Cir. 1991); and Grainger v. State Security Life Ins. Co., 547 F.2d 303 (5th Cir. 1977). --------------------------------------------------------------------------- In 1986, given the proliferation of annuity contracts commonly known as ``guaranteed investment contracts,'' the Commission adopted rule 151 under the Securities Act to establish a ``safe harbor'' for certain annuity contracts that are not deemed subject to the federal securities laws and are entitled to rely on section 3(a)(8) of the Securities Act.\35\ Under rule 151, an annuity contract issued by a state-regulated insurance company is deemed to be within section 3(a)(8) of the Securities Act if (1) the insurer assumes the investment risk under the contract in the manner prescribed in the rule; and (2) the contract is not marketed primarily as an investment.\36\ Rule 151 essentially codifies the tests the courts have used to determine whether an annuity contract is entitled to the section 3(a)(8) exemption, but adds greater specificity with respect to the investment risk test. Under rule 151, an insurer is deemed to assume the investment risk under an annuity contract if, among other things, (1) The insurer, for the life of the contract, --------------------------------------------------------------------------- \35\ 17 CFR 230.151; Securities Act Release No. 6645 (May 29, 1986) [51 FR 20254 (June 4, 1986)]. A guaranteed investment contract is a deferred annuity contract under which the insurer pays interest on the purchaser's payments at a guaranteed rate for the term of the contract. In some cases, the insurer also pays discretionary interest in excess of the guaranteed rate. \36\ 17 CFR 230.151(a). --------------------------------------------------------------------------- (a) guarantees the principal amount of purchase payments and credited interest, less any deduction for sales, administrative, or other expenses or charges; and (b) credits a specified interest rate that is at least equal to the minimum rate required by applicable state law; and (2) The insurer guarantees that the rate of any interest to be credited in excess of the guaranteed minimum rate described in paragraph 1(b) will not be modified more frequently than once per year.\37\ --------------------------------------------------------------------------- \37\ 17 CFR 230.151(b) and (c). In addition, the value of the contract may not vary according to the investment experience of a separate account. --------------------------------------------------------------------------- Indexed annuities are not entitled to rely on the safe harbor of rule 151 because they fail to satisfy the requirement that the insurer guarantee that the rate of any interest to be credited in excess of the guaranteed minimum rate will not be modified more frequently than once per year.\38\ --------------------------------------------------------------------------- \38\ Some indexed annuities also may fail other aspects of the safe harbor test. In adopting rule 151, the Commission declined to extend the safe harbor to excess interest rates that are computed pursuant to an indexing formula that is guaranteed for one year. Rather, the Commission determined that it would be appropriate to permit insurers to make limited use of index features, provided that the insurer specifies an index to which it would refer, no more often than annually, to determine the excess interest rate that it would guarantee for the next 12-month or longer period. For example, an insurer would meet this test if it established an ``excess'' interest rate of 5% by reference to the past performance of an external index and then guaranteed to pay 5% interest for the coming year. Securities Act Release No. 6645, supra note 35, 51 FR at 20260. The Commission specifically expressed concern that index feature contracts that adjust the rate of return actually credited on a more frequent basis operate less like a traditional annuity and more like a security and that they shift to the purchaser all of the investment risk regarding fluctuations in that rate. The only judicial decision that we are aware of regarding the status of indexed annuities under the federal securities laws is a district court case that concluded that the contracts at issue in the case fell within the Commission's Rule 151 safe harbor notwithstanding the fact that they apparently did not meet the limited test described above, i.e., specifying an index that would be used to determine a rate that would remain in effect for at least one year. Instead, the contracts appear to have guaranteed the index-based formula, but not the actual rate of interest. See Malone v. Addison Ins. Marketing, Inc., 225 F.Supp.2d 743, 751-754 (W.D. Ky. 2002). --------------------------------------------------------------------------- III. Discussion of the Proposed Amendments The Commission has determined that providing greater clarity with regard to the status of indexed annuities under the federal securities laws would enhance investor protection, as well as provide greater certainty to the issuers and sellers of these products with respect to their obligations under the federal securities laws. We are proposing a new definition of ``annuity contract'' that, on a prospective basis, would define a class of indexed annuities that are outside the scope of section 3(a)(8). With respect to these annuities, investors would be entitled to all the protections of the federal securities laws, including full and fair disclosure and sales practice protections. We are also proposing a new exemption under the Exchange Act that would apply to insurance companies that issue indexed annuities and certain other securities that are registered under the Securities Act and regulated as insurance under state law. We believe that this exemption is necessary or appropriate in the public interest and consistent with the protection of investors because of the presence of state oversight of insurance company financial condition and the absence of trading interest in these securities. A. Definition of Annuity Contract The Commission is proposing new rule 151A, which would define a class of indexed annuities that are not ``annuity contracts'' or ``optional annuity contracts'' \39\ for purposes of section 3(a)(8) of the Securities Act. Although we recognize that these instruments are issued by insurance companies and are treated as annuities under state law, these facts are not conclusive for purposes of the analysis under the federal securities laws. --------------------------------------------------------------------------- \39\ An ``optional annuity contract'' is a deferred annuity. See United Benefit, supra note 3, 387 U.S. at 204. In a deferred annuity, annuitization begins at a date in the future, after assets in the contract have accumulated over a period of time (normally many years). In contrast, in an immediate annuity, the insurer begins making annuity payments shortly after the purchase payment is made; i.e., within one year. See Kenneth Black, Jr., and Harold D. Skipper, Jr., Life and Health Insurance, at 164 (2000). --------------------------------------------------------------------------- [[Page 37757]] 1. Analysis ``Insurance'' and ``Annuity'': Federal Terms under the Federal Securities Laws Our analysis begins with the well-settled conclusion that the terms ``insurance'' and ``annuity contract'' as used in the Securities Act are ``federal terms,'' the meanings of which are a ``federal question'' under the federal securities laws.\40\ The Securities Act does not provide a definition of either term, and we have not previously provided a definition that applies to indexed annuities.\41\ Moreover, indexed annuities did not exist and were not contemplated by Congress when it enacted the insurance exemption. --------------------------------------------------------------------------- \40\ See VALIC, supra note 3, 359 U.S. at 69. \41\ The last time the Commission formally addressed indexed annuities was in 1997. At that time, the Commission issued a concept release requesting public comment regarding indexed insurance contracts. The concept release stated that ``depending on the mix of features * * * [an indexed insurance contract] may or may not be entitled to exemption from registration under the Securities Act'' and that the Commission was ``considering the status of [indexed annuities and other indexed insurance contracts] under the federal securities laws.'' See Concept Release, supra note 19, at 4-5. The Commission has previously adopted a safe harbor for certain annuity contracts that are entitled to rely on section 3(a)(8) of the Securities Act. However, as discussed in Part II.C., indexed annuities are not entitled to rely on the safe harbor. --------------------------------------------------------------------------- We therefore analyze indexed annuities under the facts and circumstances factors articulated by the U.S. Supreme Court in VALIC and United Benefit. In particular, we focus on whether these instruments are ``the sort of investment form that Congress was * * * willing to leave exclusively to the State Insurance Commissioners'' and whether they necessitate the ``regulatory and protective purposes'' of the Securities Act.\42\ --------------------------------------------------------------------------- \42\ See VALIC, supra note 3, 359 U.S. at 75 (Brennan, J., concurring) (``* * * if a brand-new form of investment arrangement emerges which is labeled `insurance' or `annuity' by its promoters, the functional distinction that Congress set up in 1933 and 1940 must be examined to test whether the contract falls within the sort of investment form that Congress was then willing to leave exclusively to the State Insurance Commissioners. In that inquiry, an analysis of the regulatory and protective purposes of the Federal Acts and of state insurance regulation as it then existed becomes relevant.''). --------------------------------------------------------------------------- Type of Investment We believe that the indexed annuities that would be included in our proposed definition are not the sort of investment that Congress contemplated leaving exclusively to state insurance regulation. According to the U.S. Supreme Court, Congress intended to include in the insurance exemption only those policies and contracts that include a ``true underwriting of risks'' and ``investment risk-taking'' by the insurer.\43\ Moreover, the level of risk assumption necessary for a contract to be ``insurance'' under the Securities Act must be meaningful--the assumption of an investment risk does not ``by itself create an insurance provision under the federal definition.''\44\ --------------------------------------------------------------------------- \43\ Id. at 71-73. \44\ See United Benefit, supra note 3, 387 U.S. at 211 (``[T]he assumption of investment risk cannot by itself create an insurance provision. * * * The basic difference between a contract which to some degree is insured and a contract of insurance must be recognized.''). --------------------------------------------------------------------------- The annuities that ``traditionally and customarily'' were offered at the time Congress enacted the insurance exemption were fixed annuities that typically involved no investment risk to the purchaser.\45\ These contracts offered the purchaser ``specified and definite amounts beginning with a certain year of his or her life,'' and the ``standards for investments of funds'' by the insurer under these contracts were ``conservative.''\46\ Moreover, these types of annuity contracts were part of a ``concept which had taken on its coloration and meaning largely from state law, from state practice, from state usage.''\47\ Thus, Congress exempted these instruments from the requirements of the federal securities laws because they were a ``form of `investment' * * * which did not present very squarely the problems that [the federal securities laws] were devised to deal with,'' and were ``subject to a form of state regulation of a sort which made the federal regulation even less relevant.''\48\ --------------------------------------------------------------------------- \45\ See VALIC, supra note 3, 359 U.S. at 69. \46\ Id. (``While all the States regulate `annuities' under their `insurance' laws, traditionally and customarily they have been fixed annuities, offering the annuitant specified and definite amounts beginning with a certain year of his or her life. The standards for investment of funds underlying these annuities have been conservative.''). \47\ Id. (``Congress was legislating concerning a concept which had taken on its coloration and meaning largely from state law, from state practice, from state usage.''). \48\ Id. at 75 (Brennan, J., concurring). --------------------------------------------------------------------------- In contrast, when the amounts payable by an insurer under an indexed annuity contract are more likely than not to exceed the amounts guaranteed under the contract, the purchaser assumes substantially different risks and benefits. Notably, at the time that such a contract is purchased, the risk for the unknown, unspecified, and fluctuating securities-linked portion of the return is primarily assumed by the purchaser. By purchasing this type of indexed annuity, the purchaser assumes the risk of an uncertain and fluctuating financial instrument, in exchange for exposure to future, securities-linked returns. The value of such an indexed annuity reflects the benefits and risks inherent in the securities market, and the contract's value depends upon the trajectory of that same market. Thus, the purchaser obtains an instrument that, by its very terms, depends on market volatility and risk. Such indexed annuity contracts provide some protection against the risk of loss, but these provisions do not, ``by [themselves,] create an insurance provision under the federal definition.'' \49\ Rather, these provisions reduce--but do not eliminate--a purchaser's exposure to investment risk under the contract. These contracts may to some degree be insured, but that degree may be too small to make the indexed annuity a contract of insurance. \50\ --------------------------------------------------------------------------- \49\ See United Benefit, supra note 3, 387 U.S. at 211 (finding that while a ``guarantee of cash value'' provided by an insurer to purchasers of a deferred annuity plan reduced ``substantially the investment risk of the contract holder, the assumption of investment risk cannot by itself create an insurance provision under the federal definition.''). \50\ Id. at 211 (``The basic difference between a contract which to some degree is insured and a contract of insurance must be recognized.''). --------------------------------------------------------------------------- Thus, the protections provided by indexed annuities may not adequately transfer investment risk from the purchaser to the insurer when amounts payable by an insurer under the contract are more likely than not to exceed the amounts guaranteed under the contract. Purchasers of these annuities assume the investment risk for investments that are more likely than not to fluctuate and move with the securities markets. The value of the purchaser's investment is more likely than not to depend on movements in the underlying securities index. The protections offered in these indexed annuities may give the instruments an aspect of insurance, but we do not believe that these protections are substantial enough. \51\ --------------------------------------------------------------------------- \51\ See VALIC, supra note 3, 359 U.S. at 71 (finding that although the insurer's assumption of a traditional insurance risk gives variable annuities an ``aspect of insurance,'' this is ``apparent, not real; superficial, not substantial.''). --------------------------------------------------------------------------- Need for the Regulatory Protections of the Federal Securities Acts We also analyze indexed annuities to determine whether they implicate the regulatory and protective purposes of the federal securities laws. Based on that analysis, we believe that the indexed annuities that would be included in our proposed definition present many of the concerns that Congress intended the federal securities laws to address. Indexed annuities are similar in many ways to mutual funds, variable annuities, and other securities. [[Page 37758]] Although these contracts contain certain features that are typical of insurance contracts,\52\ they also may contain ``to a very substantial degree elements of investment contracts.'' \53\ Indexed annuities are attractive to purchasers precisely because they offer participation in the securities markets. Thus, individuals who purchase such indexed annuities are ``vitally interested in the investment experience.'' \54\ However, indexed annuities historically have not been registered with us as securities. Insurers have treated these annuities as subject only to state insurance laws. --------------------------------------------------------------------------- \52\ The presence of protection against loss does not, in itself, transform a security into an insurance or annuity contract. Like indexed annuities, variable annuities typically provide some protection against the risk of loss, but are registered as securities. Historically, variable annuity contracts have typically provided a minimum death benefit at least equal to the greater of contract value or purchase payments less any withdrawals. More recently, many contracts have offered benefits that protect against downside market risk during the purchaser's lifetime. \53\ Id. at 91 (Brennan, J., concurring). \54\ Id. at 89 (Brennan, J., concurring). --------------------------------------------------------------------------- There is a strong federal interest in providing investors with disclosure, antifraud, and sales practice protections when they are purchasing annuities that are likely to expose them to market volatility and risk. We believe that individuals who purchase indexed annuities that are more likely than not to provide payments that vary with the performance of securities are exposed to significant investment risks. They are confronted with many of the same risks and benefits that other securities investors are confronted with when making investment decisions. Moreover, they are more likely than not to experience market volatility. Accordingly, we believe that the regulatory objectives that Congress was attempting to achieve when it enacted the Securities Act are present when the amounts payable by an insurer under an indexed annuity contract are more likely than not to exceed the guaranteed amounts. Therefore, we are proposing a rule that would define such contracts as falling outside the insurance exemption. 2. Proposed Definition Scope of the Proposed Definition Proposed rule 151A would apply to a contract that is issued by a corporation subject to the supervision of the insurance commissioner, bank commissioner, or any agency or officer performing like functions, of any State or Territory of the United States or the District of Columbia.\55\ This language is the same language used in Section 3(a)(8) of the Securities Act. Thus, the insurance companies that will be covered by the proposed rule are the same as those covered by Section 3(a)(8). In addition, in order to be covered by the proposed rule, a contract must be subject to regulation as an annuity under state insurance law.\56\ As a result, the proposed rule does not apply to contracts that are regulated under state insurance law as life insurance, health insurance, or any form of insurance other than an annuity, and it does not apply to any contract issued by an insurance company if the contract itself is not subject to regulation under state insurance law. --------------------------------------------------------------------------- \55\ Proposed rule 151A(a). \56\ Id. We note that the majority of states include in their insurance laws provisions that define annuities. See, e.g., ALA. CODE section 27-5-3 (2008); CAL. INS. CODE section 1003 (West 2007); N.J. ADMIN. CODE tit. 11, section 4-2.2 (2008); N.Y. INS. LAW section 1113 (McKinney 2007). Those states that do not expressly define annuities typically have regulations in place that address annuities. See, e.g., KAN. ADMIN. REGS. section 40-2-12 (2008); MISS. CODE ANN. Sec. 83-1-151 (2008). --------------------------------------------------------------------------- The proposed rule would expressly state that it does not apply to any contract whose value varies according to the investment experience of a separate account.\57\ The effect of this provision is to eliminate variable annuities from the scope of the rule.\58\ It has long been established that variable annuities are not entitled to the exemption under Section 3(a)(8) of the Securities Act, and, accordingly, we do not propose to cover them under the new definition or affect their regulation in any way.\59\ --------------------------------------------------------------------------- \57\ Proposed rule 151A(c). \58\ The assets of a variable annuity are held in a separate account of the insurance company that is insulated for the benefit of the variable annuity owners from the liabilities of the insurance company, and amounts paid to the owner under a variable annuity vary according to the investment experience of the separate account. See Black and Skipper, supra note 39, at 174-77 (2000). \59\ See, e.g., VALIC, supra note 3, 359 U.S. 65; United Benefit, supra note 3, 387 U.S. 202. In addition, an insurance company separate account issuing variable annuities is an investment company under the Investment Company Act of 1940. See Prudential Ins. Co. of Am. v. SEC, 326 F.2d 383 (3d Cir. 1964). --------------------------------------------------------------------------- We request comment on the scope of the proposed definition and in particular on the following issues: Should the rule apply only to contracts that are issued by the same insurance companies that are covered by section 3(a)(8) of the Securities Act, or should the proposed definition apply with respect to contracts of different issuers than those covered by section 3(a)(8)? What contracts should be covered by the proposed definition? Should the scope of contracts covered be articulated by reference to state law? Should the proposed definition extend to all annuity contracts, or should any annuity contracts be excluded? Should variable annuity contracts be covered by the proposed definition? Should the proposed definition apply to forms of insurance other than annuities, such as life insurance or health insurance? Should the proposed definition apply to a contract issued by an insurance company if the contract is not itself regulated as insurance under state law? Should we permit insurance companies to register indexed annuities, as well as any other annuities that are securities, on Form N-4,\60\ the form that is currently used by insurance companies to register variable annuities under the Securities Act? If so, should we modify Form N-4, which is also used by insurance company separate accounts to register under the Investment Company Act, in any way? --------------------------------------------------------------------------- \60\ 17 CFR 239.17b and 274.11c. --------------------------------------------------------------------------- Definition of ``Annuity Contract'' and ``Optional Annuity Contract'' We are proposing that an annuity issued by an insurance company would not be an ``annuity contract'' or an ``optional annuity contract'' under section 3(a)(8) of the Securities Act if the annuity has the following two characteristics. First, amounts payable by the insurance company under the contract are calculated, in whole or in part, by reference to the performance of a security, including a group or index of securities. Second, amounts payable by the insurance company under the contract are more likely than not to exceed the amounts guaranteed under the contract. The first characteristic, that amounts payable by the insurance company under the contract are calculated by reference to the performance of a security or securities, defines a class of contracts that we believe, in all cases, require further scrutiny because they implicate the factors articulated by the U.S. Supreme Court as important in determining whether the section 3(a)(8) exemption is applicable. When payments under a contract are calculated by reference to the performance of a security or securities, rather than being paid in a fixed amount, at least some investment risk relating to the performance of the securities is assumed by the purchaser. In addition, the contract may be marketed on the basis of the potential for growth offered by investments in the securities. The proposed rule would define the class of contracts that is subject to scrutiny broadly. The rule would apply whenever any amounts payable under [[Page 37759]] the contract under any circumstances, including full or partial surrender, annuitization, or death, are calculated, in whole or in part, by reference to the performance of a security or securities. If, for example, the amount payable under a contract upon a full surrender is not calculated by reference to the performance of a security or securities, but the amount payable upon annuitization is so calculated, then the contract would need to be analyzed under the rule. As another example, if amounts payable under a contract are partly fixed in amount and partly dependent on the performance of a security or securities, the contract would need to be analyzed under the rule. We note that the proposed rule would apply to contracts under which amounts payable are calculated by reference to a security, including a group or index of securities. Thus, the proposed rule would, by its terms, apply to indexed annuities but also to other annuities where amounts payable are calculated by reference to a single security or any group of securities. The federal securities laws, and investors' interests in full and fair disclosure and protection from abusive sales practices, are equally implicated, whether amounts payable under an annuity are calculated by reference to a securities index, another group of securities, or a single security. The term ``security'' in proposed rule 151A would have the same broad meaning as in section 2(a)(1) of the Securities Act. Proposed rule 151A does not define the term ``security,'' and our existing rules provide that, unless otherwise specifically provided, the terms used in the rules and regulations under the Securities Act have the same meanings defined in the Act.\61\ --------------------------------------------------------------------------- \61\ 17 CFR 230.100(b). --------------------------------------------------------------------------- The second characteristic, that amounts payable by the insurance company under the contract are more likely than not to exceed the amounts guaranteed under the contract, sets forth the test that would define a class of contracts that are not ``annuity contracts'' or ``optional annuity contracts'' under the Securities Act and that, therefore, are not entitled to the section 3(a)(8) exemption. As explained above, by purchasing this type of indexed annuity, the purchaser assumes the risk of an uncertain and fluctuating financial instrument, in exchange for exposure to future, securities-linked returns.\62\ As a result, the purchaser assumes many of the same risks that investors assume when investing in mutual funds, variable annuities, and other securities. Our proposal is intended to provide the purchaser of such an annuity with the same protections that are provided under the federal securities laws to other investors who participate in the securities markets, including full and fair disclosure regarding the terms of the investment and the significant risks that he or she is assuming, as well as protection from abusive sales practices and the recommendation of unsuitable transactions. --------------------------------------------------------------------------- \62\ See supra Part III.A.1. -------------------------------