Securities and Exchange Commission v. United Benefit Life Insurance Company, 428

• Decision Date: 22 May 1967
• Docket Number: No. 428,428
• Citation: 387 U.S. 202,18 L.Ed.2d 673,87 S.Ct. 1557
• Parties: SECURITIES AND EXCHANGE COMMISSION, Petitioner, v. UNITED BENEFIT LIFE INSURANCE COMPANY
• Court: U.S. Supreme Court

387 U.S. 202

87 S.Ct. 1557

18 L.Ed.2d 673

SECURITIES AND EXCHANGE COMMISSION, Petitioner,

v UNITED BENEFIT LIFE INSURANCE COMPANY.

No. 428.

Argued April 10, 1967.

Decided May 22, 1967.

[Syllabus from pages 202-203 intentionally omitted] ThurgoodMarshall, Sol. Gen., for petitioner.

Daniel J. McCauley, Jr., Philadelphia, Pa., for respondent.

Mr. Justice HARLAN delivered the opinion of the Court.

This action was initiated by the Securities and Exchange Commission to enjoin respondent (United) from offering its 'Flexible Fund Annuity' contract without undertaking the registration required by § 5 of the Securities Act,¹ and to compel United to register the 'Flexible Fund' itself as an 'investment company' pursuant to § 8 of the Investment Company Act of 1940.²

The 'Flexible Fund Annuity' is a deferred, or optional, annuity plan having characteristics somewhat similar to those of the variable annuities this Court held, in S.E.C. v. Variable Annuity Life Insurance Co., 359 U.S. 65, 79 S.Ct. 618, 3 L.Ed.2d 640 (VALIC), to be subject to the Securities Act. Like the variable annuity, it is a recent effort to meet the challenge of inflation by allowing the purchaser to reap the benefits of a professional investment program while at the same time gaining the security of an insurance annuity. ³ There are, however, significant differences between the 'Flexible Fund' contract and the variable annuity, and it is claimed that these differences suffice to bring the 'Flexible Fund' contract within the 'optional annuity contract' exemption of § 3(a)(8) of the Securities Act⁴ and to bring the 'Flexible Fund' itself within the 'insurance company' exemption of § 3(c)(3) of the Investment Company Act, 54 Stat. 798, 15 U.S.C. § 80a—3(c)(3).

The purchaser of a 'Flexible Fund' annuity agrees to pay a fixed monthly premium for a number of years before a specified maturity date. That premium less a deduction for expenses (the net premium), is placed in a 'Flexible Fund' account which United maintains separately from its other funds, pursuant to Nebraska law. Neb.Rev.Stat. § 44—310.06 (1963 Cum.Supp). United undertakes to invest the 'Flexible Fund' with the object of producing capital gains as well as an interest return, and the major part of the fund is invested in common stocks. The purchasers, at all times before maturity, is entitled to his proportionate share of the total fund and may withdraw all or part of this interest. The purchaser is also entitled to an alternative cash value measured by a percentage of his net premiums which gradually increases from 50% of that sum in the first year to 100% after 10 years. Other feature, common to conventional annuity contracts, are also incorporated in United's plan.⁵

At maturity, the purchaser may elect to receive the cash value of his policy, measured either by his interest in the fund or by the net premium guarantee, whichever is larger. He may also choose to convert his interest into a life annuity under conditions specified in the 'Flexible Fund' contract. These conditions relate future benefits to dollars available at maturity so the dollar benefits to be received will vary with the cash value at maturity. However, the net premium guarantee is, because of this conversion system, also a guarantee that a certain amount of fixed-amount payment life annuity will be available at maturity.

After maturity the policyholder has no further interest in the 'Flexible Fund.' He has either received the value of his interest in cash, or converted to a fixed-payment annuity in which case his interest has been transferred from the 'Flexible Fund' to the general reserves of the company, and mingled, on equal terms per dollar of cash value, with the interests of holders of conventional deferred annuities.

Because of the termination of interest in the 'Flexible Fund' at maturity, the SEC contended that the portion of the 'Flexible Fund' contract which dealt with the pre-maturity period was separable and a 'security,' within the meaning of the Securities Act. It was agreed that the provisions dealing with the operation of the fixed-payment annuity were purely conventional insurance provisions, and thus beyond the purview of the SEC. The District Court held that the guarantee of a fixed-payment annuity of a substantial amount gave the entire contract the character of insurance. The Court of Appeals for the District of Columbia Circuit affirmed. 123 U.S.App.D.C. 305, 359 F.2d 619. That court rejected 'the SEC's basic premise that the contract should be fragmented and the risk during the deferred period only should be considered.' Considering the contract as a whole, it found, as the SEC had urged, that this Court's decision in VALIC, supra, was controlling. But it read that decision to hold only 'that a company must bear a substantial part of the investment risk associated with the contract * * * in order to qualify its products as 'insurance." 123 U.S.App.D.C., at 308, 359 F.2d, at 622. Because of the net premium guarantee and the conversion to payments which included an interest element during the fixed-payment period, the court concluded that the 'Flexible Fund' met this test. Because of the importance of the issue, and the need for clarifying the implications of the VALIC decision, we granted certiorari, 385 U.S. 918, 87 S.Ct. 228, 17 L.Ed.2d 142. We now reverse for reasons given below.

First, we do not agree with the Court of Appeals that the 'Flexible Fund' contract must be characterized in its entirety. Two entirely distinct promises are included in the contract and their operation is separated at a fixed point in time. In selling a deferred annuity contract of any type, United must first decide what amount of annuity payment is to be allowed for each dollar paid into the annuity fund at maturity.⁶ In making that calculation United must analyze expected mortality, interest, and expenses of administration. The outcome of that calculation is shown in the conversion table which is included in the 'Flexible Fund' contract.

The second problem United must face in a deferred annuity is to determine what amount will be available for the annuity fund at maturity. In a conventional annuity where a fixed amount of benefits is stipulated it is essential that the premiums both cover expenses and produce a fund sufficient to support the promised benefits.⁷ In fixing the necessary premium mortality experience is a subordinate factor and the planning problem is to decide what interest and expense rates may be expected. There is some shifting of risk from policyholder to insurer, but no pooling of risks among policyholders. In other words, the insurer is acting, in a role similar to that of a savings institution, and state regulation is adjusted to this role.⁸ The policyholder has no direct interest in the fund⁹ and the insurer has a dollar target to meet.

The 'Flexible Fund' program completely reverses the role of the insurer during the accumulation period. Instead of promising to the policyholder an accumulation to a fixed amount of savings at interest, the insurer promises to serve as an investment agency and allow the policyholder to share in its investment experience. The insurer is obligated to produce no more than the guaranteed minimum at maturity, and this amount is substantially less than that guaranteed by the same premiums in a conventional deferred annuity contract. ¹⁰ The fixed-payment benefits are adjusted to reflect the number of dollars available, as opposed to the conventional annuity where the amount available is planned to reflect the promised benefits.

The insurer may plan to meet the minimum guarantee by split funding—that is, treating part of the net pre- mium as it would a premium under a conventional deferred annuity contract with a cash value at maturity equal to the minimum guarantee and investing only the remainder¹¹—or by setting the minimum low enough that the risk of not being able to meet it through investment is insignificant. The latter is the course United seems to have pursued.¹² In either case the guarantee cannot be said to integrate the pre-maturity operation into the post-maturity benefit scheme. United could as easily attach a 'Flexible Fund' option to a deferred life insurance contract or any other benefit which could otherwise be provided by a single payment. And the annuity portion of the contract could be offered independently of the 'Flexible Fund.' ¹³ We therefore conclude that we must assess independently the operation of the 'Flexible Fund' contract during the deferred period to determine whether that separable portion of the contract falls within the class of those exempted by Congress from the requirements of the Securities Act, and, if not, whether the contract constitutes a 'security' within § 2 of that Act, 48 Stat. 74, 15 U.S.C. § 77b.

The provisions to be examined are less difficult of classification than the ones presented to us in VALIC. There it was held that the entire plan under which benefits continued to fluctuate with the fortunes of the fund after maturity, was not a contract of insurance within the § 3(a) exemption. A pooling of mortality risk was operative during the payment period, and the contract was one of insurance under state law, but a majority of this Court held that 'the meaning of 'insurance' * * * under these Federal Acts is a federal question,' 359 U.S., at 69, 79 S.Ct., at 621, and 'that the concept of 'insurance' involves some investment risk-taking on the part of the company.' Id., at 71, 79 S.Ct., at 622. The argument 'that the existence of adequate state regulation was the basis for the exemption (the position taken by four dissenting Justices) * * * was conclusively rejected * * * in VALIC for the reason that variable annuities are 'securities' and involve considerations of investment not present in the conventional contract of insurance.' Prudential Insurance Co. v. S.E.C., 3 Cir., 326 F.2d 383, 388. It was...