Securities & Exchange Commission v. Variable Annuity Life Insurance

Mr. Justice Douglas

delivered the opinion of the Court.

This is an action instituted by the Securities and Exchange Commission 1 to enjoin respondents from offering their annuity contracts to the public without registering them under the Securities Act of 1933, 48 Stat. 74, 15 U. S. C. § 77a, and complying with the Investment Company Act of 1940, 54 Stat. 789, 15 U. S. C. § 80a. The District Court denied relief, 155 F. Supp. 521; and the Court of Appeals affirmed, 103 U. S. App. D. C. 197, 257 F. 2d 201. The case is here on petitions for writs of cer-tiorari which we granted, 358 U. S. 812, because of the importance of the question- presented.

*67 Respondents are regulated under the insurance laws of the District of Columbia and several other States. It is argued that that fact brings into play the provisions of the McCarran-Ferguson Act, 59 Stat. 33, 15 U. S. C. § 1011, § 2 (b) of which provides that “No Act of Congress shall be construed to invalidate, impair or supersede any law enacted by any State for the purpose of regulating the business of insurance . . . .” It is said that the conditions under which that law is applicable are satisfied here. The District of Columbia and some of the States are “regulating” these annuity contracts, and, if the Commission is right, the Federal Acts would at least to a degree “supersede” the state regulations since the Federal Acts prescribe their own peculiar requirements.2 Moreover, “insurance” or “annuity” contracts are exempt from the Securities Act when “subject to the supervision of the insurance commissioner ... of any State . ...” 3 Respondents are also exempt from the Investment Company Act if they are “organized as an insurance company, whose primary and predominant business activity is the writing of insúrance . . . and which is subject to supervision by the insurance commissioner ... of a State . ...”4 While the term “security” as defined in the Securities Act5 is broad enough to include any *68 “annuity” contract, and the term “investment company” as defined in the. Investment Company Act6 would embrace an “insurance company,” the scheme of the exemptions lifts pro tanto the requirements of those two Federal Acts to the extent that respondents are actually regulated by the States as insurance companies, if indeed they are such. The question common to the exemption provisions of the Securities Act and the Investment Company Act and to § 2 (b) of the McCarran-Ferguson Act is whether respondents are issuing contracts of insurance.

We start.with a reluctance to disturb the state regulatory schemes that are in actual effect, either by displacing them or by superimposing federal requirements on transactions that are tailored to meet state requirements. When the States speak in the fiek). of “insurance,” they speak with the authority of a long tradition. For the *69 regulation of “insurance,” .though within the ambit of federal power (United States v. Underwriters Assn., 322 U. S. 533), has traditionally been under the control of the States.

We deal, however, with federal statutes where the words “insurance” and “annuity” are federal terms. Congress was legislating concerning a concept which had taken on its- coloration and meaning largely from state law, from state practice, from state usage. "Some States deny these “annuity” contracts any status as “insurance.” 7 Others accept them under their “insurance” statutes.8 It is apparent that there is no uniformity in the rulings of the States on the nature of these “annuity” contracts. In any event how the States may have ruled is not decisive. For, as we have said, the meaning of “insurance” or “annuity” under these Federal Acts is a federal question.

While all the States regulate “annuities” under their “insurance” laws, traditionally and customarily they have been fixed annuities, offering the annuitant specified and definite amounts beginning with a certain year of his or her life. The standards for investment of funds underlying these annuities have been conservative. The variable annuity introduced two new features. First, premiums collected are invested to a greater degree in common stocks and other equities. Second, benefit payments vary with the success of the investment policy. The first variable annuity apparently appeared in this country about 1952 when New York created the College Retirement Equities Fund9 to provide annuities for teachers. *70 It came into existence as a result of a search for a device that would avoid paying annuitants in depreciated dollars.10 The theory was that returns from investments in common stocks would over the long run tend to compensate for the mounting inflation. The holder of a variable annuity cannot look forward to a fixed monthly or yearly amount in his. advancing years. It may be greater or less, depending on the wisdom of the investment policy. In some respects the variable annuity has the characteristics of the fixed and conventional annuity: payments are made periodicially; they continue until the annuitant’s death or in case other options are chosen until the end of a fixed term or until the death of the last of two persons; payments are made both from principal and income; and the amounts vary according to the age and sex of the annuitant. Moreover, actuarially both the fixed-dollar annuity and the variable annuity are calculated by identical principles. Each issuer assumes the risk of mortality from the moment the contract is issued That risk is an actuarial prognostication that a certain number of annuitants will survive to specified ages. Even if a substantial number live beyond their predicted demise, the company issuing the annuity — whether it be fixed or variable — is obligated to make the annuity payments on the basis of the mortality prediction reflected in the contract. This is the mortality risk assumed both by respondents and. by those who issue fixed annuities. It is this feature, common -,to . both, that respondents stress when they urge that this is basically an insurance device.11

*71 The difficulty is that, absent some guarantee of.fixed income, the variable annuity places all the investment risks on the annuitant, none on the company.12 The holder gets only a pro rata share of what the portfolio of equity interests reflects — which may be a lot, a little, or nothing. We realize that life insurance is an evolving institution. Common knowledge tells us that the forms have greatly changed even in a generation. And we would not undertake to freeze the concepts of “insurance” or “annuity” into the mold they fitted when these Federal Acts were passed. But we conclude that the concept of “insurance” involves some investment risk-taking on the part of the company. The risk of mortality, assumed here, gives these variable annuities an aspect of insurance. Yet it is apparent, not real; superficial, not substantial. In hard reality the issuer of a variable annuity that has no element of a fixed return assumes no true risk in the insurance sense. It is no answer to say that' the risk of declining returns in times of depression is the reciprocal of the fixed-dollar annuitant’s risk of loss of purchasing power when prices are high and gain of purchasing power when they are low. We deal with a more conventional concept of risk-bearing when we speak of “insurance.” For in common understanding “insurance” involves a guarantee that at least some fraction of the benefits will be payable in fixed amounts. See Spellacy v. American Life Ins. Assn., 144 Conn. 346, 354-355, 131 A. 2d 834, 839; Couch, Cyclopedia of Insurance Law, Vol. 1, § 25; Richards, Law of Insurance, Vol. 1, § 27; Apple-man, Insurance Law and Practice, Vol. 1, § 81. The companies that issue these annuities take the risk of failure. *72 But they guarantee nothing to the annuitant except an interest in a portfolio of common stocks or other equities13 — an interest that has a ceiling but no floor.14 *73 There is no true underwriting of risks,15 the one earmark of insurance as it has commonly been conceived of in popular understanding and usage.

Reversed.

National Association of Securities Dealers, Inc., petitioner in No. 237, and the Equity Annuity Life Ins. Co., a respondent in each ■case, were allowed to intervene.

For example, the Investment Company Act has provisions governing the size of investment companies, § 14; the affiliations of directors, officers, and employees, § 10; the relation of investment advisers and underwriters of investment companies, § 15; the transactions between investment companies and their affiliates and underwriters, §17; the capital structure of investment companies, §18; their dividend policies, § 19; their loans, §21.

§3 (a)(8).

§§ 3 (c)(3) and 2 (a) (17).

Section 2(1) provides:

“When used in this title, unless the context otherwise .requires—

“(1) The term ‘security’ means any note, stock, treasury stock, bond, debenture, .evidence of indebtedness, certificate of interest or *68 participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, or, in general, any interest or instrument commonly known as a 'security,' or any certificate of interest or participation in, temporary or interim certificate' for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.” 15 U. S. C. §77 (b)(1).

Section 3 (a) provides in part:

• “When used in this title, ‘investment company’ means any issuer which—

“(1) is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities;

“(3) is engaged or proposes to engage in the business of investing, reinvesting, owning,, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40 per centum of the value of such issuer’s total assets (exclusive of Government securities and cash items) on an unconsolidated basis.”

See 1 CCH, Blue Sky Reporter (1956) #4711; Spellacy v. American Life Ins. Assn., 144 Conn. 346, 131 A. 2d 834.

See People v. Supreme Brotherhood, 193 Misc. 996, 86 N. Y. S. 2d 127.

N. Y. Laws 1952, c. 124.

See Morrisey, Dispute Over the Variablé Annuity, 35 Harv. Bus. Rev. 75; Johnson, The Variable Annuity: What It is and Why It is Needed, Ins. L. J., June 1956, p. 357; Day and Melnikoff, The Variable Annuity as a Life Insurance Company Product, 10 J. Am. Soc. Ch. L. Under. 45; Barrons, Vol. 36, Jan. 23,1956, p. 3.

See Day, A Variable' Annuity is Not a “Security,” 32 Notre Dame.Law. 649

See Bellinger, Hagmann and Martin, The Meaning and Usage of the Word “Annuity,” 9 J. Am. Soc. Ch. L. Under. 261; Hausser-mann, The Security in Variable Annuities, Ins. L. J., June 1956, p. 382.

See Securities & Exchange Comm’n v. Howey Co., 328 U. S. 293, 298-299:

“. . . an investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led .to expect profits' solely from the efforts of the promoter or a third £arty, it being immaterial whether the shares in the enterprisé are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise.” See Loss and Cowett, Blue Sky Law (Í958), pp: 351, 356-357.

These companies use an assumed net investment rate of 3% percent per annum in the actuarial calculation of the initial annuity payment. If the net investment rate were at all times precisely 3% percent, the amount of annuity payments would not vary. But there is no guarantee as to this. The companies use a reporting device, the annuity unit, the value of which informs the annuity holder of the variations in the company’s actual returns from the assumed investment rate of .3% percent.' To state the matter in more detail: the amount of any payment depends on the value of the “annuity unit” and the number of such units héld by the annuitant. At the time when he has paid all of his premium and is entitled to his first annuity payment, he will have a certain monetary interest in the fund (determined by the number of “accumulation units” he holds). The first payment is determinéd by reference to standard annuity tables, assuming a net investment return of 3% percent per annum. It is the amount per month which a capital contribution of the annuitant’s interest in the fund by a person of his age and sex would buy. This figure is converted into annuity units by dividing it by the then value of an annuity unit. The number of annuity units held by the annuitant remains' constant throughout the payout period.

The value of an annuity unit is determined each month as follows: The value of the unit for the preceding month is multiplied by the net investment factor (adjusted to neutralize the 3% percent interest factor used in the annuity table), which is the sum of one plus the net investment rate. The net investment rate is (after a slight reduction for a margin to cover expenses, and provide for contingency reserves and addition to surplus) the ratio of investment income plus (minus) net realized and unrealized capital gains (losses) less certain *73 taxes to the value of the fund during that month. The number of annuity units held times the value of each unit in a month produces the annuity payment for that month.

There is one true insurance feature to some of these policies, though it is ancillary and secondary to the annuity feature. If the applicant is insurable and 60- years of age or under, he gets life insurance on a decreasing basis for a term.of five years.