SECURITIES & EXCHANGE COM'N v. United Benefit Life Ins. Co.

• Decision Date: 10 March 1966
• Docket Number: No. 19382.,19382.
• Citation: 359 F.2d 619
• Parties: SECURITIES AND EXCHANGE COMMISSION, Appellant, v. UNITED BENEFIT LIFE INSURANCE COMPANY, Appellee.
• Court: U.S. Court of Appeals — District of Columbia Circuit

359 F.2d 619 (1966)

SECURITIES AND EXCHANGE COMMISSION, Appellant, v. UNITED BENEFIT LIFE INSURANCE COMPANY, Appellee.

No. 19382.

United States Court of Appeals District of Columbia Circuit.

Argued October 19, 1965.

Decided March 10, 1966.

Mr. Walter P. North, Associate Gen. Counsel, with whom Mr. Philip A. Loomis, Jr., Gen. Counsel, S. E. C., was on the brief, for appellant. Mr. Robert L. McCloskey, Atty., S. E. C., also entered an appearance for appellant.

Mr. Daniel J. McCauley, Jr., Philadelphia, Pa., of the bar of the Supreme Court of Pennsylvania, pro hac vice, by special leave of court, with whom Mr. M. Joseph Stoutenburgh, Washington, D. C., was on the brief, for appellee.

Mr. Joseph B. Levin, Washington, D. C., with whom Mr. Marc A. White, Washington, D. C., was on the brief, for Investment Company Institute and National Ass'n of Securities Dealers, Inc., as, amici curiae, urging reversal.

Before BAZELON, Chief Judge, EDGERTON, Senior Circuit Judge, and BURGER, Circuit Judge.

BAZELON, Chief Judge:

The basic issue in this case is whether the Flexible Fund Annuity (FFA) issued by appellee United Benefit Life Insurance Company (United) is subject to federal regulation under the Securities Act of 1933 and the Investment Company Act of 1940. The Securities and Exchange Commission sought injunctive relief in the District Court against United on the grounds that the FFA contract is an unregistered "security" within the definition of the 1933 Act¹ and that the separate account, which United created in connection with the FFA, is an unregistered "investment company" within the meaning of the 1940 Act.² The District Court ruled that the FFA was an "insurance product," exempted from regulation under both Acts.³ This appeal followed.

The FFA contract is framed as a deferred annuity policy. The policyholder agrees to pay United a specified gross premium periodically — i.e., once a month — for a certain number of years. These premiums, less deductions for expenses, are accumulated by United during this deferred period in a separate account, known as Flexible Fund A. Unlike a conventional annuity, however, United does not guarantee to accumulate net premiums at a specified rate of interest. Instead, United promises that the annuitant will be credited with a proportionate share of the profits which have resulted from the investment and reinvestment of the money in the Flexible Fund. In addition, United guarantees that at least 100 per cent of the net premiums will stand to the account of the annuitant throughout the deferred period if the investment experience of the Fund is unprofitable.⁴ Cash surrender values equal to the accumulated value or minimum guarantee of the policy, and death benefits equal to the accumulated value or total gross premiums paid, whichever are higher, are also provided during the deferred period. At the maturity date specified in the policy, the annuitant is given the option of withdrawing the accumulated value of his policy in cash or of applying this value to a fixed annuity at rates prescribed in the initial contract. These rates are based upon a guaranteed 2½% per cent interest factor during the pay-out period, and once United begins payments to the annuitant the value of his policy is fixed; the profits made by the Fund are no longer accumulated in favor of the annuitant.

The result in this case, as both parties recognize, is controlled by the Supreme Court's recent decision in the VALIC case.⁵ At issue in VALIC was a variable annuity policy which did not guarantee a fixed monetary value for the annuity either in the deferred or pay-out periods; its value at all times depended directly upon the investment experience of a pool of securities, and the annuitant was, in effect, a direct participant in that pool. The question was whether this variable annuity was a "security" within the meaning of the 1933 and 1940 Acts or a "contract of insurance," which would be exempt from the Acts by their own terms, as well as by the provisions of the McCarran-Ferguson Act.⁶ The majority of the Court found that the issuing company had assumed the mortality and expense risks usually associated with insurance. However, since the company did not guarantee a fixed monetary value for the policy, it placed "all the investment risks on the annuitant, none on the company." Because the concept of insurance required "some investment risk-taking on the part of the company," the Court concluded that the variable annuity was not "insurance" and hence was subject to federal regulation.

In a concurring opinion, Mr. Justice Brennan explained in greater detail why the factor of investment risk was determinative. He pointed out that the purpose of the federal regulatory scheme had only minimal relevance to conventional insurance and annuity policies, which assumed the investment risk by creating fixed monetary obligations, and that state regulation of reserves and solvency offered truly meaningful protection to the policyholder. Mr. Justice Brennan reasoned that since the variable annuity in VALIC did not include substantial fixed dollar guarantees, federal regulation was quite relevant to the variable annuity contract, while state regulation was not; he therefore found the contract a "security," subject to the 1933 and 1940 Acts. In sum, both the majority and concurring opinions implicitly held that a company must bear a substantial part of the investment risk associated with the contract, as well as the mortality and expense risks, in order to qualify its products as "insurance."

In most respects the FFA and the traditional deferred annuity are identical. Both guarantee interest on principal during the pay-out period; both assume all mortality and expense risks throughout the term of the contract; and both provide death benefits and cash surrender values.⁷ The only meaningful difference between the FFA and the conventional deferred annuity is that the FFA does not guarantee interest on the accumulation of net premiums during the deferred period, but instead promises 100 per cent of net premiums plus a share in any profits made by the investment and reinvestment of the money in the Flexible Fund.

The SEC would minimize the similarities between the FFA and the deferred annuity first by asserting jurisdiction only over the deferred portion of the contract. The SEC then contends that the "investment risk" referred to in VALIC is the risk of not earning interest on the principal sum invested and that a contract is not "insurance" unless interest as well as principal is guaranteed. In support of this position the SEC emphasizes the extent to which the fortunes of the annuitant depend upon the investment policies and experience of the Fund and argues that the court should not treat the minimum guarantee of 100 per cent of net premiums as a substantial assumption of investment risk because it is extremely unlikely that the Fund's investment experience will be so disastrous as to call the guarantee into effect.

We note initially that adoption of the SEC's position that interest must be guaranteed during the deferred, as well as the pay-out, period would restrict annuity...