SECURITIES & EXCH. COM'N v. Variable Annuity L. Ins. Co.

• Citation: 155 F. Supp. 521
• Decision Date: 03 September 1957
• Docket Number: Civ. No. 2549-56.
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff and National Association of Securities Dealers, Inc., Intervenor-Plaintiff v. THE VARIABLE ANNUITY LIFE INSURANCE COMPANY OF AMERICA, Defendant The Equity Annuity Life Insurance Company, Intervenor-Defendant.
• Court: United States District Courts. United States District Court (Columbia)

155 F. Supp. 521

SECURITIES AND EXCHANGE COMMISSION, Plaintiff and National Association of Securities Dealers, Inc., Intervenor-Plaintiff v. THE VARIABLE ANNUITY LIFE INSURANCE COMPANY OF AMERICA, Defendant

The Equity Annuity Life Insurance Company, Intervenor-Defendant.

Civ. No. 2549-56.

United States District Court District of Columbia.

September 3, 1957.

Thomas G. Meeker, General Counsel for SEC, Washington, D. C., Daniel J. McCauley, Assoc. Gen. Counsel, Philadelphia, Pa., Myer Feldman, New York City, Special Counsel for SEC, Pace Reich, Philadelphia, Pa., for plaintiff Securities and Exchange Commission.

John H. Dorsey, Bolling R. Powell, John W. Lindsey, Blum, Lindsey & Powell, Washington, D. C., for intervenor-plaintiff.

James M. Earnest and George R. Jacobi, Washington, D. C., Roy W. McDonald, Donovan Leisure, Newton & Irvine, New York City, for defendant The Variable Annuity Life Ins. Co. of America.

Brookhart, Becker & Dorsey, Benjamin H. Dorsey, Washington, D. C., for defendant-Intervenor The Equity Annuity Life Ins. Co.

WILKIN, District Judge.

This case came on for trial and was submitted on the pleadings, stipulations, evidence and briefs. Jurisdiction is based on 15 U.S.C.A. § 77a et seq., and § 80a-1 et seq. The defendants are chartered life insurance companies in the District of Columbia. The Equity Annuity Life Insurance Company, on its own motion, was made an intervenor-defendant. The National Association of Securities Dealers, Inc., (organized under 15 U.S.C.A. § 780-3 et seq.) on its motion, was made an intervenor-plaintiff.

Throughout the trial, the plaintiff was referred to as "SEC", and the intervenor-plaintiff was referred to as "NASD". The defendant was referred to as "VALIC", and the intervenor-defendant was referred to as "EALIC".

The Complaint prays for a preliminary and final injunction restraining VALIC from selling or offering for sale certain contracts denominated "variable annuity" contracts or policies, unless and until they are registered with SEC in accordance with the provisions of the Securities Act of 1933, and the Company complies with the provisions of the Investment Company Act of 1940.

It is the contention of the plaintiff that the very nature, and the express provisions, of the variable annuity contracts make the companies and the contracts amenable to the enactments of Congress and the regulations of SEC with reference to the sale of securities or interests in securities.

The defendants oppose that contention and insist that they are insurance companies, that the variable annuity contracts which they issue are insurance policies, that the defendant companies are licensed and regulated by the District Insurance Superintendent and the State Insurance Commissioners where they operate, and that they are expressly exempt from the jurisdiction of the Federal agency established for the regulation of the sale of securities.

The defendants further assert that the McCarran-Ferguson Insurance Regulation Act (Act, March 9, 1945, 59 Stat. 33, as amended, Act, July 25, 1947, c. 326, 61 Stat. 448, 15 U.S.C.A. §§ 1011-1015) gives the State and District authorities exclusive jurisdiction over them and their business.

The issue in the case is,—Are the defendants and their equity or variable annuity contracts subject to the State and District laws exclusively, or are they subject to the Federal regulations as administered by the SEC, or are they subject to both State and Federal regulations? That issue must be determined first by a consideration of the contracts. Are such contracts insurance policies, or are they securities evidencing investments or interests in investments?

The evidence in this case makes it clear to this Court that they cannot be classified as either, exclusively. The variable annuity contracts contain provisions which must be classified as insurance, and also provisions which bring them within the statutory definition of securities.

The contracts issued by the defendants differ in certain details. The amount and terms of payment are different; some contracts include decreasing term life insurance, others do not; some, but not all, include a waiver of further payments to the company in case of the permanent and total disability of the holder of the contract.

The essential characteristic of all the contracts, and the characteristic which gives rise to this litigation, is found in the provisions which create a reserve fund of the amounts paid by contract holders for the purpose of investing it mainly in common stocks under the management of the company, and from which annuity and other payments due to contract holders shall be made in amounts determined by the investment experience, i. e., profits and losses of the fund.

Plaintiff's Exhibit No. 1, entitled "Deferred Variable Annuity Policy", was received in evidence as a specimen of all the contracts that employ such investment practice (Appendix 1). It was issued and sold by VALIC. For purposes of clarity and convenience, it and VALIC will be referred to with the understanding that what is said applies to all similar contracts and the companies issuing them.¹

The contract provides for two periods: (1) the accumulation or pay-in period, and (2) the annuity or withdrawal period. During the first period, the contract holder makes "premium" payments for which he receives an equitable interest in VALIC's investment fund, and for which VALIC credits him with a number of "accumulation units". The number of units is determined by dividing the amount of the payment by the value of one accumulation unit as of the last day of the month in which the payment is received. The value of one unit is, of course, determined by dividing the amount of the fund (market value of stock) by the number of accumulation units issued against it. The amount paid by the contract holder is subject to a deduction for management expense and the cost (premiums) of decreasing term life insurance and total permanent disability insurance, and the remainder is then applied to the purchase of accumulation units.

The variable annuity period (2) is the term during which VALIC makes variable annuity payments, according to the terms of the contract, to the contract holder who has elected to participate in the plan. The contract holder is credited with a sum of money determined by multiplying the number of accumulation units credited to his account by the value of one unit as of that time. The first annuity payment is computed on the sum so credited by using the Progressive Annuity Table with a rate of interest of 3½ per cent per annum, in the same way that any life insurance company would compute it. VALIC then credits the contract holder with a number of annuity units, the number being determined by dividing the amount of the first payment by the value of a unit. The number of units then remains constant for the term of the contract, but the value of an annuity unit varies thereafter according to VALIC's investment experience. And subsequent variable annuity payments are computed by multiplying number of units by the value of a unit at time of payment.

This analysis of the variable annuity shows that, while the contract has certain definite features of insurance, it has a marked difference from the conventional insurance contract. Whereas the money paid for conventional insurance becomes the absolute property of the insurance company, the money paid for a variable annuity goes into an investment fund which becomes, by operation of law if not by express terms of the contract, a trust fund for the equitable interests of the contract holders. And, whereas the conventional insurance policy obligates the insurance company to pay the policy holder a definite fixed amount at specified times, the variable annuity contract obligates the company issuing it to pay at stipulated times, not fixed dollar amounts, but only such amounts as are warranted by the investment experience of the company managing the fund.

The evidence was clear and undisputed that the variable annuity contract was devised for the very purpose of providing contract holders with payments adjusted to the fluctuating purchasing power of the dollar. The evidence revealed that the value of the dollar (measured by purchasing power) had declined about 70% in the last 70 years, and that holders of policies and securities yielding a fixed-dollar return were deprived of the security which they had expected. The variable annuity contract was based on the economic theory (questioned by some economists) that common stocks tend to fluctuate in value with business conditions, and to rise generally with price levels and the cost of living. It was, therefore, deemed advisable by some insurance companies to abandon the traditional practice of investing in debt securities which provide certain, but fixed, interest rates, and create instead a reserve fund segregated from other company assets, invested in diversified stocks, and offer to their annuitants an undivided interest in such fund, evidenced by annuity units, the value of which fluctuates with the rise and fall of common stock prices.

It seems clear to this Court that such an arrangement would, if the fund is well managed, tend to increase payments due to annuitants in general, in accordance with the rise in the cost of living at times of inflation. But contract holders whose annuity payments came due at a time of severe economic depression would realize that they had no insurance against the fate of stock, "securities" or "investments", that fail with the decline or collapse of the stock market. While the contract would provide a kind of hedge against the effect of inflation, it would give no insurance against the effect of depression.

Extensive testimony was offered at trial as to the nature and practices of insurance business and of investment business for the purpose of incorporating in the record a basis for arguments...