On Petitions for Review of an Order of the Securities & Exchange Commission.
The opinion of the court was delivered by: Sentelle, Chief Judge
Before: SENTELLE, Chief Judge, and GINSBURG and ROGERS, Circuit Judges.
The Securities Act of 1933, 15 U.S.C. §§ 77a et seq. (the Act), exempts from federal regulation annuity contracts issued by a corporation subject to regulation by state insurance laws. Petitioners seek review of a rule promulgated by the Securities and Exchange Commission (SEC or Commission) stating that fixed indexed annuities (FIAs) are not annuity contracts within the meaning of the Act. As a result of this new rule, FIAs are subject to the full panoply of requirements set forth by the Act, instead of being subject solely to state insurance laws. Petitioners argue that the Commission unreasonably interpreted the term "annuity contract" not to include FIAs. Petitioners also assert that the SEC failed to fulfill its statutory responsibility under the Act to consider the effect of the new rule on efficiency, competition, and capital formation. Because we hold that the SEC's interpretation of "annuity contract" is reasonable under Chevron, we deny the petitions with respect to this issue. We grant the petitions, however, with respect to petitioners' alternate ground that the SEC failed to properly consider the effect of the rule upon efficiency, competition, and capital formation. Accordingly, we vacate the rule.
The Securities Act of 1933 governs the offer or sale of any security through interstate commerce. The Act defines the term "security" as including any "investment contract." 15 U.S.C. § 77b(a)(1); SEC v. Variable Annuity Life Ins. Co. of Am. (VALIC), 359 U.S. 65, 67-68 (1959). Section 3(a)(8) of the Act, however, provides an exemption under the Act for an "annuity contract" or "optional annuity contract" subject to state insurance laws. 15 U.S.C. § 77c(a)(8).
A traditional fixed annuity is a contract issued by a life insurance company, under which the purchaser makes a series of premium payments to the insurer in exchange for a series of periodic payments from the insurer to the purchaser at agreed upon later dates. In a fixed annuity, the insurance company guarantees that the purchaser will earn a minimum rate of interest over time. Fixed annuities are subject to state insurance law regulation, and are exempt from federal securities laws. See id. State insurance laws governing fixed annuity contracts require insurance companies to guarantee a minimum of the contract value after any costs and charges are applied. These state laws generally require the minimum guarantee be at least 87.5 percent of the premiums paid, accumulated at an annual interest rate of 1 to 3 percent. Indexed Annuities and Certain Other Insurance Contracts (Final FIA Rule), 74 Fed. Reg. 3138, 3141 (Jan. 16, 2009) (to be codified at 17 C.F.R. Parts 230 and 240). The laws also generally impose disclosure and suitability requirements, which vary from state to state.
A fixed index annuity (FIA) is a hybrid financial product that combines some of the benefits of fixed annuities with the added earning potential of a security. Like traditional fixed annuities, FIAs are subject to state insurance laws, under which insurance companies must guarantee the same 87.5 percent of purchase payments. Unlike traditional fixed annuities, however, the purchaser's rate of return is not based upon a guaranteed interest rate. In FIAs the insurance company credits the purchaser with a return that is based on the performance of a securities index, such as the Dow Jones Industrial Average, Nasdaq 100 Index, or Standard & Poor's 500 Index. Depending on the performance of the securities index to which a particular FIA is tied, the return on an FIA might be much higher or lower than the guaranteed rate of return offered by a traditional fixed annuity. Due to the fact that the purchaser's actual return is linked to the performance of a securities index, however, the purchaser's return cannot be calculated until the end of the crediting period. Insurance companies typically apply an annual crediting period; that is, the index-linked interest of an FIA is typically calculated on an annual basis after each one-year period ends.
While this is the first case in which we have had occasion to address the § 3(a)(8) annuity exemption as it regards FIAs, the Supreme Court has offered guidance on the scope of the exemption in VALIC, 359 U.S. 65, and SEC v. United Benefit Life Ins. Co., 387 U.S. 202 (1967). In VALIC, the Supreme Court considered whether a variable annuity fell within the § 3(a)(8) exemption. A variable annuity is a financial product under which purchasers pay premiums that are invested in common stocks and other equities to a greater degree than traditional annuities, and the benefit payments vary with the success of the investment management. See VALIC, 359 U.S. at 69. The Court explained that a variable annuity did not fall within the § 3(a)(8) exemption because it placed "all the investment risks on the [purchaser], none on the company." Id. at 71. As the Court said, "the concept of 'insurance' involves some investment risk-taking on the part of the company." Id. "'[I]nsurance' involves a guarantee that at least some fraction of the benefits will be payable in fixed amounts." Id. Therefore, an issuer of an annuity "that has no element of a fixed return assumes no true risk in the insurance sense." Id. The fact that there exists a risk of declining returns in difficult economic times is not sufficient to show that the insurer has assumed more risk under the contract. See id. Accordingly, because the variable annuity at issue did not offer a "true underwriting of risks, the one earmark of insurance," the Court held that it did not fall within the exemption offered to traditional fixed annuities offered by insurers. Id. at 73. In a concurring opinion later approved by the full Court in United Benefit, Justice Brennan explained that when "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 . . . 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." Id. at 76 (Brennan, J., concurring); see United Benefit, 387 U.S. at 210.
In United Benefit, the Court concluded that another product similar to a variable annuity called a "Flexible Fund Annuity" was not exempt under § 3(a)(8) of the Act. A Flexible Fund functioned in much the same way as a variable annuity. Most notably, the purchaser paid premiums into a separate account that was primarily invested in common stocks, with the object of producing capital gains as well as an interest return. United Benefit, 387 U.S. at 205. Unlike the variable annuity in VALIC, however, the insurer guaranteed that the purchaser would receive a percentage of his premiums back. This percentage gradually increased from 50 percent of net premiums in the first year to 100 percent after 10 years. Id. United Benefit argued that, under VALIC, the existence vel non of substantial investment risk by the insurer ultimately determined whether a product fell within the § 3(a)(8) exemption.
The Court disagreed that VALIC should be interpreted so narrowly. Id. at 210. Rather, the critical inquiry under § 3(a)(8) was whether the product at issue "'involve[d] considerations of investment not present in the conventional contract of insurance.'" Id. (quoting Prudential Ins. Co. v. SEC, 326 F.2d 383, 388 (3d Cir. 1964)). In concluding that the Flexible Fund did not fall within § 3(a)(8), the Court relied significantly on the fact that the Flexible Fund "appeal[ed] to the purchaser not on the usual insurance basis of stability and security but on the prospect of 'growth' through sound investment management." United Benefit, 387 U.S. at 211. Though the Court acknowledged that the "guarantee of cash value based on net premiums reduces substantially the investment risk of the contract holder," it reasoned further that "the assumption of an investment risk [by the insurer] cannot by itself create an insurance provision under the federal definition." Id. (citing Helvering v. Le Gierse, 312 U.S. 531, 542 (1941)). The Court recognized that a "basic difference" exists between "a contract which to some degree is insured and a contract of insurance."
United Benefit, 387 U.S. at 211. In the case of the Flexible Fund, the insurer's assumption of risk was minimal. The insurer was "obligated to produce no more than the guaranteed minimum at maturity, and this amount is substantially less than that guaranteed by the ...