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Treatment Of Annuities As Securities

Variable annuities are differentiated from fixed annuities by virtue of how the benefits are funded. In a traditional fixed annuity, an annuitant pays a premium(s) and is guaranteed a certain rate of return over a life expectancy; thus, benefit payments can be determined with precision. In a variable annuity, premium payments are held in a separate account or accounts. The contract holder has a variety of investment options depending upon the account in which the premium is placed. Typically, the investment options involve the purchase of stocks or other equities. The amount of the benefit payments cannot be determined in advance because it is totally dependent upon the investment performance.

Fixed annuities are considered exempt from the registration and prospectus requirements of the Securities Act of 1933. Thus, the Securities and Exchange Commission (SEC) does not have jurisdiction over or regulate fixed annuities. Issuers of fixed annuity contracts do not have to file securities registration statements or provide a prospectus to a potential purchaser. Jurisdiction over the sales of fixed annuities largely lies with state insurance departments under the McCarran-Ferguson Act.

However, the SEC does have jurisdiction over variable annuities because they have been held to be securities that are not exempt under the Securities Act of 1933. The United States Supreme Court explained that “absent some guarantee of fixed income, the variable annuity places all the investment risks on the annuitant and none on the company.” ”'[I]-insurance’ involves a guarantee that at least some fraction of the benefits will be payable in fixed amounts.” Issuers of variable annuities “guarantee nothing to the annuitant except an interest in a portfolio of common stocks or other equities–an interest that has a ceiling but no floor. There is no true underwriting of risks, the one earmark of insurance as it commonly has been conceived of in popular understanding and usage.”
The SEC adopted Rule 151 in the mid-1980’s, which established a “safe harbor” exempting annuity contracts from federal securities laws and regulation. Since then, there has been an explosion of annuity products on the market. With each product offered, there is a question as to whether the product should be regulated as a security. To date, safe harbor is available to an annuity contract when the following conditions are met: (1) the contract is issued by a corporation that is subject to state regulation as an issuer of insurance contracts; (ii) the issuer assumes the investment risk under the contract; and (iii) the contract is not marketed primarily as an investment. Safe harbor treatment may be denied even to an annuity contract that is not variable if it does not feature special accounts. Therefore, issuers of variable annuities do have to file federal registration statements with the SEC, provide a prospectus to a potential purchaser, and adequately disclose the risks of the annuity product, unless they either guarantee some minimum level of payments or otherwise come within the SEC’s “safe harbor” regulation.

As mentioned above, the variable annuity contract holder’s premiums are typically placed in a separate account or accounts. Thus, they are not included in the issuer’s (or insurer’s) general assets. Accordingly, variable annuities are not exempt from regulations under the Investment Company Act of 1940.

Because most state laws still classify variable securities as insurance products, state securities regulators have traditionally been precluded from investigating complaints involving variable annuities. However, a few states have now passed legislation that will allow state securities regulators to handle complaints about variable annuities.

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