insurance industry in the mid-1990s, indexed annuities have been
the subject of a regulatory conundrum: should they be treated as an
insurance product or as a security?
With few exceptions indexed annuities have been registered as
insurance products, a situation the US Securities and Exchange
Commission (SEC) is taking decisive action to end.
The SEC’s approach is simple; its proposed definition of an indexed
annuity as being either an insurance product or security hinges
upon the allocation of risk between insurer and indexed annuity
In its explanation the SEC said: “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.”
In turn the SEC added that is has also recognised that allocation
of investment risk is significant in determining whether a contract
that is regulated as insurance under state law is insurance for
purposes of the federal securities laws.
The SEC continued that individuals who purchase indexed annuities
are exposed to “a significant investment” risk in the form of
volatility of an underlying securities index.
“Insurance companies have successfully utilised this investment
feature, which appeals to purchasers not on the usual insurance
basis of stability and security, but on the prospect of investment
growth,” stressed the SEC.
“Thus, these purchasers obtain indexed annuity contracts for many
of the same reasons that individuals purchase mutual funds and
variable annuities and open [stock] brokerage accounts.”
Against this background the SEC has proposed a new rule that would
define an indexed annuity as a security based on two
• Amounts payable by the issuer 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; and
• Amounts payable by the issuer under the contract are more likely
than not to exceed the amounts guaranteed under the contract.
The new rule defining indexed annuities as securities would, added
the SEC, provide investors with all the current protections of the
federal securities laws, including full and fair disclosure and
sales practice protections.
The SEC’s new definition will apply only to indexed annuities
issued on or after the effective date of the proposed rule’s