Equity indexed annuities—later to be known as fixed indexed annuities or FIAs—were first introduced around 1995. What began as a novel product soon caught on and became a leading seller, reaching annual sales of nearly $30 billion 15 years later.
When FIAs first came on the scene, most lawyers opined that indexed annuities were not securities, based on the Securities and Exchange Commission (SEC) Rule 151 safe harbor which said annuities escape securities regulation if they meet three basic tests: (1) the product is subject to state insurance supervision, (2) the insurer assumes the investment risk, and (3) the product is not marketed primarily as an investment.
All that changed abruptly on June 25, 2008 at an open meeting of the SEC in which then Chairman Christopher Cox unleashed an assault on indexed annuities alleging widespread sales practice abuses. Pointing to supposed complaint data gathered by North American Securities Administrators Association, he offered as “exhibit A” some hidden camera footage from a television exposé program purportedly depicting agents conning elderly consumers into buying indexed annuities. In what was an unusually theatrical moment in the relatively staid world of securities regulation, the SEC unveiled its new regulation on indexed annuities dubbed Rule 151A.
What ensued would be a long battle between the FIA industry and SEC that played out on several fronts including a court challenge as well as a legislative skirmish, both of which ultimately resulted in turning back the SEC’s proposed rule.
When the dust finally settled, Rule 151A was vacated by the courts and a new law was adopted by Congress specifying more clearly what insurance and annuity products are exempt from securities laws. The new law—known as the Harkin Amendment—would be viewed as a significant victory for the FIA industry. But it would also leave questions in its wake.
Mounting the Legislative Effort
The FIA industry expended considerable resources to overturn Rule 151A through the judicial system but always knew the scales were tipped in favor of regulatory agencies in that venue. Not wanting to put all its eggs in the judicial basket, the FIA industry took to the halls of Congress as well. The industry mounted a classic grass roots lobbying campaign leveraging a network of agents and independent marketing organizations across the country to build support for legislation to reverse Rule 151A.
Against long odds, the industry recruited potential co-sponsors for its legislation one by one, using tried and true methods of political persuasion, including constituent letters, home office visits, and Capitol Hill fly-ins over a 12 month period starting in early 2009.
Although a long climb, when all was said and done, the industry succeeded in garnering 88 sponsors in the House and 16 in the Senate, a relatively impressive feat given the arcane nature of the issue and multitude of priorities competing for Congressional attention.
The industry’s companion bills, HR 2733 and SB 1389, known also as the Fixed Indexed Annuities and Insurance Products Classification Act, were introduced in June 2009 with the chief House author being Greg Meeks of New York and the primary Senate author being Ben Nelson of Nebraska. The legislation established a bright line test by declaring annuities and insurance policies exempt from securities regulation if the products satisfied a two-part test. The first part being compliance with state non-forfeiture laws and the second being that values were not derived from separate accounts. The bills also expressly repealed Rule 151A.
As with any good grass roots campaign, the industry carefully developed and shaped its key messages aimed at Congress, focusing on jobs, consumer value and regulatory rationalization. The FIA industry argued that Rule 151A would dislocate jobs in the insurance industry at a time when jobs were scarce; potentially deprive consumers of a guaranteed product at a time when markets were in turmoil; and distract securities regulators from their core mission at a time they had their hands full with the likes of Bernie Madoff as well as shaky investment markets. The messages seemed to resonate with Congress, and support grew slowly but steadily for the legislation.
Senator Harkin Takes the Lead
Despite a strong lobbying campaign, the effort seemed to stall as the House and Senate passed their respective comprehensive financial reform bills and neither included the FIA legislation. In fact, Senator Tom Harkin of Iowa, who would emerge a pivotal player championing the FIA legislation, made a play to include the provisions of SB 1389 in the Senate reform package, but was rebuffed in large part because of opposition by “consumer groups” such as AARP and the Consumer Federation of America.
At that point prospects for adopting FIA legislation in 2010 looked gloomy. But then the legislation’s advocates caught a big break. Members of the conference committee—the committee charged with reconciling the House and Senate reform bills—were announced and included a number of co-sponsors of the FIA legislation, none more important than Tom Harkin. As a member of the conference committee, Senator Harkin would have another chance at adding the FIA amendment to the omnibus financial reform package, except this time Senator Harkin intended to address consumer concerns relating to marketing indexed products.
Senator Harkin’s office needed to move fast to come up with provisions addressing consumer group concerns because committee deliberations were to begin soon. Working with Iowa Insurance Commissioner Susan Voss, who had been a strong advocate for protecting the jurisdiction of state insurance departments, Senator Harkin’s office recast the legislation so that it would not only shield FIAs from securities regulation but also give encouragement to states to adopt the NAIC’s newly revised model suitability regulation for annuities.
The Harkin Amendment—as it would come to be known—turned the simple two-prong test into a three-prong test. The new prong being that the issuing company’s state of domicile adopt the new model suitability law by 2013 or the issuing company comply voluntarily with the new model law on a nationwide basis. The thought was that linking the securities exemption for annuities with adoption of state suitability laws would ensure that exempt insurance products were subject to equivalent suitability standards applicable to securities.
The Harkin Amendment Is Adopted
The Harkin Amendment went on to be adopted by the conference committee as section 989J of the massive financial services reform bill, notwithstanding opposition by committee co-chairs Senator Chris Dodd and Representative Barney Frank. Senate conferees voted 8 to 4 in favor of the amendment and House conferees acceded by a vote of 12 to 4 during televised deliberations. Perhaps to the amazement of supporters and opponents alike, legislation to reverse SEC Rule 151A was suddenly part of the landmark Dodd-Frank Wall Street Reform Act of 2010 and would go on to be signed by the President, effective July 21, 2010.
Now the law of the land, the Harkin Amendment differs from the original proposed legislation HR 2733 and SB 1389 in two important respects. First, the Harkin Amendment contains the complex third prong, which makes the securities exemption for non-separate account products that comply with non-forfeiture laws contingent on adoption of the newly revised NAIC model suitability requirements either by states or companies. Second, the Harkin amendment by its own terms does not reverse or pre-empt Rule 151A.
The addition of the third prong is particularly notable because it turns what had been a bright line test—saying insurance and annuity products are exempt from securities laws based on a product’s intrinsic attributes—into a more intricate analysis.
Now in order to be exempt under this statutory safe harbor, the product must also be issued either:
• In a state that adopts the model suitability law by June 16, 2013.
• By a company domiciled in a state that adopts the model suitability law by June 16, 2013.
• Or by a company that adopts and implements practices on a nationwide basis that meets or exceeds the model suitability law requirements. When one parses these provisions, it becomes evident there are subtle ambiguities and uncertainties, perhaps the result of hastiness in crafting the Harkin Amendment provisions toward the end of the legislative process.
The Bright Line Gets a Little Blurred
Here are a few of the questions that the Harkin Amendment leaves in its wake by virtue of the delicate interplay between the newly created exemption from securities laws and the contemplated adoption of NAIC suitability guidelines by states and companies.
What will happen if a domiciliary state does not adopt the model suitability law by June 16, 2013? Would that mean products issued by a company domiciled in such a state—that does not necessarily comply with the model suitability laws nationwide—are exempt from securities laws in some states but not others, depending on whether the state of issue has adopted the model law by June 16, 2013? That seems illogical—that is, that products might be exempt from federal securities laws in some states and not others—and yet that seems to be what the law contemplates.
What exactly is meant by the Harkin Amendment when it says a state must adopt rules by June 16, 2013 that “substantially meet or exceed the minimum requirements” of the NAIC model regulation adopted in March 2010? Obviously, for states that adopt the revised model regulation in toto there is no issue, but the extent to which states may deviate will obviously invoke subjective interpretations of the law’s safe harbor. In fact, one wonders whether the 40 states that have the existing model law on the books could assert they comply with the “substantially meet or exceed” standard.
Should the Harkin Amendment’s reference to rules governing suitability “in the sale of an insurance or endowment policy or annuity contract or optional annuity contract” be interpreted to mean a state must adopt the NAIC model requirements not just for annuities but also for all other insurance products?
That could mean even for states that have already adopted the recently revised NAIC model, like Iowa, it may be necessary to broaden the scope of those rules to cover other insurance products lest domiciled companies might not be able to avail themselves of the safe harbor. Or can the wording be read more literally in the disjunctive so as to say a state must merely adopt suitability laws to govern the sale of insurance or endowment policies or annuities.
Will the SEC be looking over the shoulders of companies that voluntarily comply with the NAIC model suitability law? It may prove dicey for companies to rely on the voluntary alternative given that such compliance may be subject to second guessing by the SEC or plaintiff’s attorneys, and does not provide the relatively absolute protection afforded by adoption of the model law by the company’s domiciliary state.
As one ponders the intricacies of this legislation, the court decision to vacate Rule 151A—handed down literally just days before passage of the Harkin Amendment—takes on additional significance.
Had the court left the rule standing, given the contingencies contained in the third prong of the Harkin Amendment, questions would be lurking about whether the remnants of the rule apply to annuities and life insurance products falling potentially outside the new safe harbor because of the suitability considerations described above. Since the Harkin Amendment created what might be considered a suitability minefield, but did not reverse Rule 151A, the importance of the court decision to wipe Rule 151A off the books is significantly magnified.
The End or a Beginning?
Certainly other questions may emerge over time as regulators and insurers more closely assess the importance of this new legislation and its exemption for indexed products under securities laws. Among other things, it is unknown what position the SEC will take going forward, and whether the SEC finally will concede certain annuity and life products are beyond the scope of securities regulation or whether the SEC might continue looking for ways to interpret the law more narrowly given the idiosyncrasies of the Harkin Amendment.
One thing seems clear: Today’s FIA products have escaped securities regulation for the time being. However, uncertainty lingers as to exactly what this legislation means for other products such as indexed life insurance and innovative products yet to be developed. It remains unknown how widely the NAIC model suitability law will be adopted and how that might affect the exemption created by the Harkin Amendment. Insurance lawyers have cause for celebration today with their victories in the courts and in Congress, but they would be well advised to stay on their toes as these various questions and issues play out over time.
