SEC ruling casts shadow of federal control over US insurance industry

Moves by the Securities and Exchange Commission (SEC) to regulate indexed annuities federally, instead of at state level, have met with fierce resistance at what is regarded as the first stage in bringing all insurance regulation under federal control.

Indexed annuities are effectively unit-linked policies with a guarantee that gives customers downside protection and the option of receiving a lump sum or annuity at maturity. Until now these have been classified as an insurance product and so regulated by state insurance commissions. However, an SEC ruling on December 17, 2008, means indexed annuities are now classified as a security and as a result will be regulated federally.

The move has prompted a lawsuit by a six-strong group of insurers called the Coalition for Indexed Products to overturn the ruling. One senior figure in the US insurance industry who is not part of the coalition argued that its success was vital to ensure the continuation of state regulation.

"Recent issues in the financial markets have created the perfect conditions for the federal authorities to take over all regulation, and this move by the SEC is the first step in that process."

One third of all indexed annuities are sold in the state of Iowa, and two Iowan firms - Equity Investment Life Insurance and Midland National Life Insurance - are part of the lawsuit.

The state's deputy commissioner James Mumford declined to comment on whether the SEC's move represented federal regulation of insurance by the back door. However, he did question the right of the securities regulator to unilaterally take away state responsibilities.

"There is clearly a mandate to examine the way in which the financial system as a whole is regulated, and insurance will clearly be a part of that debate. But how much state responsibility will be shifted to a federal level is anyone's guess.

"The process has been going for years now but has heated up in the last few months. It is up to congress to decide whether something is regulated at state or federal level, not federal agencies like the SEC."

The difference between an insurance product and a security is where the risk falls - with the former it is the insurer and with the latter the investor. Mumford argued that the guarantee component which means each year's gains are locked in, exposing investors only to 12 months' investment risk, meant they are clearly insurance products.

In any case, according to Stephen Horvat, chief legal officer at Midland National Life Insurance, the changeover in regulatory oversight would increase costs but leave the solvency regulation in the hands of the state regulator. "The capital to support and preserve these products will remain the same but effectively they will be regulated twice. The only real difference is that the costs of the policy will increase to meet this increased regulatory burden."

According to David Sandberg, corporate actuary at Minneapolis-based Allianz Life, a significant issuer of indexed annuities, the splitting of regulatory oversight between two bodies would create ambiguities undermining the very intention of the SEC's move - to increase oversight.

"The matter of who regulates what is a significant one and begs the question as to why it is necessary to move responsibilities when all is working well anyway.

"There haven't been insurance failure in the area of indexed annuities, so why is a change needed? The states have a lot of experience in regulating these products and it would be better to build on this than move some of the responsibilities to the federal level."

Iowa's Mumford added that although the SEC's initial interest in indexed annuities was sparked by consumer complaints - with a handful of people alleging they had lost money investing in indexed annuities - this has proved not to be the case.

"The SEC spoke to state securities regulators and got a biased view of what was actually happening; they should have talked to the insurance regulators. In any case, when the SEC originally proposed changing the regulation they mentioned issues over how these products were being sold, and yet this formed no part of the final reasoning behind their decision."

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