Respondent corporations, calling themselves "life insurance"
companies and submitting to regulation by the insurance
commissioners of the District of Columbia and several States, offer
for sale in interstate commerce so-called "variable annuity"
contracts, which have some of the features of conventional life
insurance and annuity contracts but which entitle the purchasers
not to a specified definite amount per annum, but only to
fluctuating amounts based upon pro rata participations in
respondents' investment portfolios and the gains and losses
thereon.
Held: such "variable annuity" contracts are
"securities" which must be registered with the Securities and
Exchange Commission under the Securities Act of 1933, and the
issuers are subject to regulation under the Investment Company Act
of 1940, since such contracts are not "insurance" policies or
"annuity" contracts, and respondents are not "insurance" companies
or engaged in the "business of insurance," within the meaning of
the exemption provisions of those Acts or the McCarran-Ferguson
Act. Pp.
359 U. S.
66-73.
(a) While the States have traditionally regulated the business
of insurance, their characterization of particular contracts is not
conclusive, since the construction of the exemption provisions of
the Federal Acts presents federal questions. Pp.
359 U. S.
68-69.
(b) the issuer of a "variable annuity" contract that has no
element of fixed return does not assume any investment risk, which
is inherent in the concepts of "insurance" and "annuity." Pp.
359 U. S.
71-73.
103 U.S.App.D.C. 197, 257 F.2d 201, reversed.
Page 359 U. S. 66
MR. JUSTICE DOUGLAS delivered the opinion of the Court.
This is an action instituted by the Securities and Exchange
Commission [
Footnote 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
et seq. and complying with
the Investment Company Act of 1940, 54 Stat. 789, 15 U.S.C. § 80a-1
et seq. 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
certiorari which we granted, 358 U.S. 812, because of the
importance of the question presented.
Page 359 U. S. 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
et seq., § 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. [
Footnote 2] Moreover, "insurance" or "annuity" contracts
are exempt from the Securities Act when "subject to the supervision
of the insurance commissioner . . . of any State. . . ." [
Footnote 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 insurance . . . and
which is subject to supervision by the insurance commissioner . . .
of a State. . . . [
Footnote
4]"
While the term "security," as defined in the Securities Act,
[
Footnote 5] is broad enough to
include any
Page 359 U. S. 68
"annuity" contract, and the term "investment company," as
defined in the Investment Company Act, [
Footnote 6] 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-Fergusion 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
field of "insurance," they speak with the authority of a long
tradition. For the
Page 359 U. S. 69
regulation of "insurance," though within the ambit of federal
power (
United States v. Underwriters Ass'n, 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." [
Footnote 7]
Others accept them under their "insurance" statutes. [
Footnote 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 Fund
[
Footnote 9] to provide
annuities for teachers.
Page 359 U. S. 70
It came into existence as a result of a search for a device that
would avoid paying annuitants in depreciated dollars. [
Footnote 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 periodically; 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. [
Footnote
11]
Page 359 U. S. 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. [
Footnote 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.
Ass'n, 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; Appleman, Insurance Law and Practice, Vol.
1, § 81. The companies that issue these annuities take the risk of
failure.
Page 359 U. S. 72
But they guarantee nothing to the annuitant except an interest
in a portfolio of common stocks or other equities [
Footnote 13] -- an interest that has a
ceiling, but no floor. [
Footnote
14]
Page 359 U. S. 73
There is no true underwriting of risks, [
Footnote 15] the one earmark of insurance as it
has commonly been conceived of in popular understanding and
usage.
Reversed.
[
Footnote 1]
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.
[
Footnote 2]
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.
[
Footnote 3]
§ 3(a)(8).
[
Footnote 4]
§§ 3(c)(3) and 2(a)(17).
[
Footnote 5]
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 participation in any profit-sharing agreement, collateral trust
certificate, pre-organization 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. § 77b(1).
[
Footnote 6]
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 percentum of the value of such issuer's total
assets (exclusive of Government securities and cash items) on an
unconsolidated basis."
[
Footnote 7]
See 1 CCH, Blue Sky Reporter (1956) No. 4711;
Spellacy v. American Life Ins. Ass'n, 144 Conn. 346, 131
A.2d 834.
[
Footnote 8]
See People v. Supreme Brotherhood, 193 Misc. 996, 86
N.Y.S.2d 127.
[
Footnote 9]
N.Y.Laws 1952, c. 124.
[
Footnote 10]
See Morrisey, Dispute Over the Variable 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.
[
Footnote 11]
See Day, A Variable Annuity is Not a "Security," 32
Notre Dame Law. 642.
[
Footnote 12]
See Bellinger, Hagmann and Martin, The Meaning and
Usage of the Word "Annuity," 9 J.Am.Soc.Ch.L.Under. 261;
Haussermann, The Security in Variable Annuities, Ins.L.J., June
1956, p. 382.
[
Footnote 13]
See Securities and Exchange Comm'n v. W. J. Howey Co.,
328 U. S. 293,
328 U. S.
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 party, it being
immaterial whether the shares in the enterprise are evidenced by
formal certificates or by nominal interests in the physical assets
employed in the enterprise."
See Loss and Cowett, Blue Sky Law (1958), pp. 351,
356-357.
[
Footnote 14]
These companies use an assumed net investment rate of 3 1/2
percent per annum in the actuarial calculation of the initial
annuity payment. If the net investment rate were at all times
precisely 3 1/2 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 1/2 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 held 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 payments is determined by
reference to standard annuity tables, assuming a net investment
return of 3 1/2 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 1/2 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 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.
[
Footnote 15]
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.
MR. JUSTICE BRENNAN, with whom MR. JUSTICE STEWART joins,
concurring.
I join the opinion and judgment of the Court. However, there are
additional reasons which lead me to the Court's result, and, since
the nature of this case lends it to rather extended treatment, I
will express these reasons separately.
First. The facts of this case are quite complex, but
the basic problem involved is much more simple. I will try to point
it up before developing the details of the sort of contracts sold
by the respondents. It is one of the coverage of two Acts of
Congress which concentrated on applying specific forms of
regulatory controls to the various ways in which organizations get
and administer other people's money -- the Securities Act of 1933
[
Footnote 2/1] and the Investment
Company Act of 1940. [
Footnote 2/2]
These Acts were specifically drawn to exclude any "insurance
policy" and any "annuity contract" (Securities Act § 3(a)(8))
Page 359 U. S. 74
and any "insurance company" [
Footnote 2/3] (Investment Company Act § 3(a)(3)) from
their coverage. These exclusions were to take effect where the
issuer of the policy or contract was subject to the supervision of
the state "insurance commissioner, bank commissioner, or any agency
or officer performing like functions" (Securities Act § 3(a)(8)) or
where a company classifiable as an "insurance company" was "subject
to supervision by the insurance commissioner or a similar official
or agency of a State" (Investment Company Act § 2(a)(17)). The
exclusions left these contracts and companies to the sole control
of such state officials. Except for these exclusions, there is
little doubt that these contracts and the companies issuing them
would be subject to the Federal Acts. [
Footnote 2/4]
Page 359 U. S. 75
Why these exclusions? They could not have been made out of some
general desire on the part of Congress to avoid any concurrent
regulation by both the Federal Government and the States of
investments or companies subject to the two Acts. On the contrary,
§ 18 of the Securities Act and § 50 of the Investment Company Act
preserve generally the jurisdiction of state officials over their
subject matter -- the former in terms of "the jurisdiction of the
securities commission (or any agency or office performing like
functions) of any State," and the latter in terms of "the
jurisdiction of any other commission, board, agency, or officer of
. . . any State or political subdivision." Conversely, of course,
however adequately State Securities Commissioners might regulate an
investment, it was not for that reason to be freed from federal
regulation. Concurrent regulation, then, was contemplated by the
Acts as a quite generally prevailing matter. Nor is it rational to
assume that Congress thought that any business whatsoever regulated
by a specific class of officials, the State Insurance
Commissioners, would be, for that reason, so perfectly conducted
and regulated that all the protections of the Federal Acts would be
unnecessary. This approach of personally selective deference to the
state administrators is hardly to be attributed to Congress. The
point must have been that there then was a form of "investment"
known as insurance (including "annuity contracts") which did not
present very squarely the sort of problems that the Securities Act
and the Investment Company Act were devised to deal with, and which
were, in many details, subject to a form of state regulation of a
sort which made the federal regulation even less relevant.
At this time, of course, the sort of "variable annuity" contract
with which we are concerned in this case did not exist. When
Congress made the exclusions provided for in the Acts, it did not
make them with the "variable
Page 359 U. S. 76
annuity" contract before it. Of course, the point is not that,
if the insurance industry seeks to retain its exemption, it must
limit itself to the forms of policies and contracts in effect in
1933 and 1940. But if 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 and 1940
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. In that inquiry,
an analysis of the regulatory and protective purposes of the
Federal Acts and of state insurance regulation as it then existed
becomes relevant. [
Footnote
2/5]
At the core of the 1933 Act are the requirements of a
registration statement and prospectus to be used in connection with
the issuance of "securities" -- that term being very broadly
defined. [
Footnote 2/6] Detailed
schedules, set forth
Page 359 U. S. 77
in the Act, list the material that the registration statement
and the prospectus are to contain. [
Footnote 2/7] The emphasis is on disclosure; the
philosophy of the Act is that full disclosure of the details of the
enterprise in which the investor is to put has money should be made
so that he can intelligently appraise the risks involved.
The regulation of life insurance and annuities by the States
proceeded, and still proceeds, on entirely different principles. It
seems as paternalistic as the Securities Act of 1933 was keyed to
free, informed choice. Prescribed contract clauses are ordained
legislatively or administratively. Solvency and the adequacy of
reserves to meet the company's obligations are supervised by the
establishment of permissible categories of investments and through
official examination. [
Footnote
2/8] The system does not depend on disclosure to the public,
and, once given this form of regulation and the nature of the
"product," it might be difficult in the case of the traditional
life insurance or annuity contract to see what the purpose of it
would be.
This congressional division of regulatory functions is rational
and purposeful in the case of a traditional life insurance or
annuity policy, where the obligations of the company were measured
in fixed-dollar terms and where the investor could not be said, in
any meaningful sense, to be a sharer in the investment experience
of the company.
Page 359 U. S. 78
In fact, one of the basic premises of state regulation would
appear to be that, in one sense, the investor in an annuity or life
insurance company
not become a direct sharer in the
company's investment experience; that his investment in the policy
or contract be sufficiently protected to prevent this. But the
situation changes where the coin of the company's obligation is not
money, but is rather the present condition of its investment
portfolio. To this extent, the historic functions of state
insurance regulation become meaningless. Prescribed limitations on
investment and examination of solvency and reserves become
perfectly circular to the extent that there is no obligation to pay
except in terms measured by one's portfolio. But, beyond
controlling corporate solvency and the adequacy of reserves and
maintaining observance of the legal list of investments, the state
plans of regulation do not go in regulating investment policy.
Where the nature of the obligation assumed is such, the federally
protected interests in disclosure to the investor of the nature of
the corporation to whom he is asked to entrust his money and the
purposes for which it is to be used become obvious and real. The
contract between the investor and the organization no longer
squares with the sort of contract in regard to which Congress, in
1933, thought its "disclosure" statute was unnecessary.
The provisions of the Investment Company Act of 1940, which
passes beyond a simple "disclosure" philosophy, also are informed
by policies that are very relevant to the contracts involved in
this case. While the Act does cover face amount certificate
companies whose obligations are specified in fixed dollar amounts,
[
Footnote 2/9] the majority of its
provisions are of greatest regulatory relevance in the case of the
much more common sort of
Page 359 U. S. 79
investment company, where the investors (or at least certain
categories of them) participate on an "equity" basis in the
investment experience of the enterprise. Salient regulatory
provisions call for registration and recital, by in investment
company, of its investment policies and operating practices;
[
Footnote 2/10] regulate the
relationships between the company and its investment adviser,
including fees and provisions for termination of the contract;
[
Footnote 2/11] regulate trading
practices, [
Footnote 2/12]
changes in investment policy, [
Footnote 2/13] the issuance of senior securities,
[
Footnote 2/14] proxies and
voting trusts, [
Footnote 2/15]
the terms of redemption by investors of their interests in the
company; [
Footnote 2/16]
regulate, in the case of periodic investment plans (which were made
subject to special regulation), the "sales load," or amount of the
investor's payment that does not become part of his interest in the
enterprise; [
Footnote 2/17] and
provide for detailed reports to investors. [
Footnote 2/18] While these controls apply in many cases
to fixed dollar obligations, like face amount certificates and the
bonds of closed end investment companies, they are of particular
relevance to situations where the investor is committing his funds
to the hands of others on an equity basis, with the view that the
funds will be invested in securities and his fortunes will depend
on the success of the investment. The traditional state insurance
department regulation of contract terms, reserves, solvency, and
permissible investments simply does not touch the points of
definition of investment policy and investment technique, and
control over investment policy changes and over the interests of
the men who shape the policies of investment and furnish investment
advice that the 1940 Federal Act provides. These controls may be
largely irrelevant to traditional banks and insurance companies,
which Congress clearly exempted; they were not investing
Page 359 U. S. 80
heavily in equity securities and holding out the possibilities
of capital gains through fund management; but where the investor is
asked to put his money in a scheme for managing it on an equity
basis, it is evident that the Federal Act's controls become
vital.
This is not to say that, because subjection of the contracts in
question here to federal regulation is desirable, it has in fact
been accomplished; but one must apply a test in terms of the
purposes of the Federal Acts as a guide to interpreting the scope
of an exemption from their coverage for "insurance."
Cf.
Securities and Exchange Comm'n v. W. J. Howey Co.,
328 U. S. 293,
328 U. S. 299.
When Congress passed the Securities Act of 1933 and the Investment
Company Act of 1940, no State Insurance Commissioner was, incident
to his duties in regulating insurance companies, engaged in the
sort of regulation, outlined above as provided in the Federal Acts,
that Congress thought would be appropriate for the protection of
people entrusting their money to others to be invested on an equity
basis. There is no reason to suppose that Congress intended to make
an exemption of forms of investment to which its regulatory scheme
was very relevant in favor of a form of state regulation which
would not be relevant to them at all.
Second. Much bewilderment could be engendered by this
case if the issue were whether the contracts in question were
"really" insurance or "really" securities -- one or the other. It
is rather meaningless to view the problem as one of pigeonholing
these contracts in one category or the other. Obviously they have
elements of conventional insurance, even apart from the
fixed-dollar term life insurance and the disability waiver of
premium insurance sold with some of these contracts (both of which
are quite incidental to the main undertaking). They patently
contain a significant annuity feature (unless one defines an
annuity as a contract necessarily providing fixed-sum payments),
[
Footnote 2/19]
Page 359 U. S. 81
and the granting of annuities has been considered part of the
business of life insurance. [
Footnote
2/20] Of course, some urge that even the traditional annuity
has few "insurance" features, and is basically a form of
investment. 1 Appleman, Insurance Law and Practice, § 83;
Prudential Ins. Co. v. Howell, 29 N.J. 116, 121-122,
148 A.2d
145, 148. But the point is that, even though these contracts
contain, for what they are worth, features of traditional annuity
contracts, administering them also involves a very substantial,
and, in fact, predominant element of the business of an investment
company, and that in a way totally foreign to the business of a
traditional life insurance and annuity company, as traditionally
regulated by state law. This is what leads to the conclusion that
it is not within the intent of the 1933 and 1940 statutes to exempt
them.
The individual deferred variable annuity contract of respondent
Variable Annuity Life Insurance Company (VALIC) gives a basis for
exploration of this. A sample
Page 359 U. S. 82
contract, given in evidence in the District Court, is one issued
to a 35-year-old male, providing for his making 30 annual payments
of $1,000 each. Of this, $39.60 is the consideration for an
undertaking by the company by which payment of the annual $1,000 is
waived in the event of disability. Of the remaining $960.40,
designated the "basic annuity premium," specified percentages are
used to credit to the account of the investor certain "accumulation
units." Of the first year's "basic annuity premium," less than 45%
is so used; for the next 4 years, the percentage is in the
approximate range of 85% to 87%; [
Footnote 2/21] for years 6 through 10, the figure is
89%, and for the remainder of the 30-year pay-in period it is 92%.
Declining term life insurance in a fixed dollar amount, beginning
at five times the annual "basic annuity premium" the first year and
declining through a period of 5 years to nil, is provided as a
benefit over and above the "accumulation units" credited to the
account of the investor. [
Footnote
2/22] The contract is said to build up a "cash value" as the
investor's payment "buys" further accumulation units, but, while
the value is one which can and would be finally settled by the
payment of dollars, the obligation owed by the company to the
investor is not one owed to him in dollar terms. It is one which is
measured only in terms of "units" -- the petitioners suggest a
resemblance to "shares" -- in a portfolio. The units are
established by an
Page 359 U. S. 83
arbitrary computation which has the effect of dividing the
company's investment assets as of a starting day into a number of
units, and assigning to each unit its share of the over-all market
value -- though the division is not in fact made. [
Footnote 2/23] Then monthly the value of the units
is recomputed. This is done, broadly, by taking into account all
interest and dividends paid on the company's portfolio and all
realized capital gains and losses, with relevant income taxes,
together with all unrealized capital shrinkage and increase, less a
monthly surcharge of 0.15% (1.8% per annum) of asset value.
[
Footnote 2/24] New dollars from
investors which "buy" units buy them at the new rate, thus
preventing dilution, and those investors who draw down their
accumulated units receive cash for them at such rate. [
Footnote 2/25]
Page 359 U. S. 84
The contract uses insurance terminology throughout, and many of
the common features of life insurance and annuity policies are
operative in regard to it at this "pay-in" stage. There are
"incontestability" and "suicide" clauses (which mainly relate to
the term insurance); a "grace period" allowed for the payment of
premiums; a provision for "policy loans" (the drawing down of
accumulated units in cash, subject to replacement later to the
extent that repayment of the amount of money received will then
permit, the transaction bearing a resemblance to the liquidation by
a common stock investor of his holdings in anticipation of a "bear
market"); and provision for a "cash value" (that, is, for the
cashing in of the accumulated units, subject to a surrender charge
in the early years). And very certainly the commitment of the
Page 359 U. S. 85
company eventually to disburse the accumulated values on a life
annuity basis once the pay-in period is over is present throughout
this period. But what the investor is participating in during this
period, despite its acknowledged "insurance" features, is something
quite similar to a conventional open-end management investment
company under a periodic investment plan. The investor's cash (less
a charge analogous to a loading charge, which is, at least in the
early years, very high, but which, it should be said, has to cover
annuity premium taxes and some quite conventional mortality risks)
goes to buy "units" in a portfolio managed by the persons in
control of the corporation. His "units" fluctuate with the income
and capital gain and loss experience of the management of the
portfolio. He may cash them in, wholly or partially. The amount of
his equity is subjected to a charge, on asset value, of 1.8% per
annum. Except for the temporary term insurance and the waiver of
premium coverage, the entire nature of the company's obligation to
its investor during this period is not in dollars (though, of
course, it will be converted into them, just as a commodity
transaction can be), but solely in terms of the value of its
portfolio. In this sort of operation, examination by state
insurance officials to determine the adequacy of reserves and
solvency becomes less and less meaningful. The disclosure policy of
the Securities Act of 1933 becomes, by comparison, more and more
relevant. And the detailed protections of the 1940 legislation --
disclosure of investment policy, regulation of changes of that
policy, of capital structure, conflicts of interest, investment
advisers -- all become relevant in an acute way here. These are the
basic protections that Congress intended investors to have when
they put their money into the hands of an investment trust; there
is no adequate substitute for them in the traditional regulatory
controls administered by state insurance departments,
Page 359 U. S. 86
because these controls are not relevant to the specific
regulatory problems of an investment trust. [
Footnote 2/26]
The same conclusions follow from a consideration of the next
stage of this contract. Before the maturity date, when the schedule
of payments in on the contract ceases and the payments out
commence, the investor can draw down his "units" in cash, and
dispense with all "annuity" features. Failing this, he is entitled
to elect one of several annuity alternatives. These are, in the
sample policy, a straight life annuity on the life of the investor,
a straight life annuity with 10 years' payments certain, and a
joint and survivor annuity on the life of the investor and another.
Again, while the duration of the company's obligation to pay is
independent of its investment experience, the amount of each
payment is not a direct money obligation, but a function of the
status of the company's portfolio. The amounts of the payments are
calculated in this fashion: the dollar value of the accumulated
units credited to the investor throughout the years is
Page 359 U. S. 87
ascertained. A standard annuity table (including a 3 1/2%
interest assumption) is used to determine the dollar amount of the
first monthly pay-out, based on a capital contribution of the
accumulated amount, under the option selected by the investor. The
number of "annuity units" (which are functions of the fluctuating
asset value of the portfolio of the company) that this amount would
buy is computed, and this number of annuity units in paid
(transmuted into a varying cash payment) to the investor every
subsequent month for the duration of the company's commitment under
the option selected. Like that of an "accumulation unit" during the
pay-in period, the value in dollars of an "annuity unit" is
readjusted monthly to give effect to the investment income of the
securities in the company's portfolio for the period, as well as to
capital gains and losses, realized and unrealized. Since the first
payment (which forms the basis for measurement of the subsequent
payments) contains an assumed interest factor, and since the
monthly valuation change includes income items -- interest and
dividends -- received in respect of the company's portfolio, to
avoid paying double "interest," the 3 1/2% assumed interest factor
is wrung out every month by multiplying the preceding month's
valuation by 0.9971. [
Footnote
2/27] And the 1.8% annual surcharge on asset value is applied
also. [
Footnote 2/28]
Page 359 U. S. 88
The effect of this is that the investor, during the pay-out
period, is in almost every way as much a participant in something
equivalent to an investment trust as before. His monthly payment is
not really a dollar payment, though it is converted into dollars
before it is paid to him; it is a payment in terms of a portfolio
of securities. It is true that the company has a fixed obligation
to continue payments, and that the duration and the amount of the
payments are not affected by collective longevity in excess of the
company's assumptions; the company's obligation to continue
payments is not limited in any way by reference to the number of
units owned by all the investors
Page 359 U. S. 89
at the start of their annuity periods. If the lives of the group
of investors exceed the longevity assumptions of the table, the
proceeds of what might otherwise have been characterized as a very
high "loading charge" (8% at its lowest application, with 11% the
minimum for the first 10 years) and a substantial "annual
management fee" (1.8% of asset value annually) will have to
provide, with the company's other surplus and capital, enough to
continue payments. But the individual payment is still a payment
measured basically in the same way as one's interest in an
investment trust is measured. And, in a very real sense, the
investor is more vitally interested in the investment experience of
the company at this period than he ever was in the pay-in period,
and in a way more vitally than any holder of an open-end investment
company certificate, or share in a publicly traded closed-end
company ever is: he has become completely "locked in." He obviously
cannot draw down the present value of his "units" once the option
to receive annuity payments has been exercised; he cannot "cash in
his chips" that he bought in the faith of the management of the
fund; his rights are technically assignable, but practically
unmarketable, since they depend on his individual lifespan. The
company can radically change investment policies, change advisers,
do whatever it pleases (so long as it does not run afoul of the
minimal investment regulations of the State), and there is nothing
the contract holder can do about it. It is not rational to say that
Congress abandoned the very appropriate protections of the
Investment Company Act in this investor's case in favor of
provisions of state regulation that are quite irrelevant to the
basic problems of protecting him.
The respondents seek to equate this contract with a fixed dollar
"participating" annuity sold by a mutual company, or one sold by a
stock company on a participating basis. This contention is not
persuasive. While
Page 359 U. S. 90
investment experience in a "participating" contract can redound
to the benefit of the policyholder, the contracts are sold as fixed
dollar obligations. The "dividends" are promoted as such. During
the pay-in period, they might be though of as a reduction of
premium. [
Footnote 2/29] They may
very well represent favorable mortality risk experience,
particularly where the company's investments are conservative. And
the annuity-paying insurance company's investments are doubtless
administered in the light of the fixed obligation of the company.
The company is not committed by its literature to perform part of
the job of a common stock investment trust. [
Footnote 2/30] No one has yet tried to follow the
academic suggestion of respondent VALIC, and reduce the fixed
guarantee of a traditional life annuity to the point of
insignificance and make the rest of the return to the contract
holder variable, by selling it on a "participating" basis.
[
Footnote 2/31] The comparison of
the premium cost of such a contract to its fixed return might well
make it unsalable to the public. Even more unpersuasive is the
respondents' argument that, even in a traditional annuity, the
policyholder bears the investment risk in the sense that he stands
the risk of the company's insolvency. The prevention of
insolvency
Page 359 U. S. 91
and the maintenance of "sound" financial condition in terms of
fixed dollar obligations is precisely what traditional state
regulation is aimed at. The protection of share interests in a
fluctuating, managed fund has received the attention of specific
federal legislation. Both are "investment risks" in a sense, but
they differ vastly in kind, and lend themselves to different
regulatory schemes.
Accordingly, while these contracts contain insurance features,
they contain to a very substantial degree elements of investment
contracts as administered by equity investment trusts. They contain
these elements in a way different in kind from the way that
insurance and annuity policies did when Congress wrote the
exemptions for them in the 1933 Act and the 1940 Act. Since
Congress was intending a broad coverage in both these remedial
Acts, and since these contracts present regulatory problems of the
very sort that Congress was attempting to solve by them, I conclude
that Congress did not intend to exclude contracts like these by
reason of the "insurance" exemptions.
Third. The respondents contend that a reversal of the
judgment will put them out of business. The reason given is that,
if the Investment Company Act of 1940 applies to them, they are
probably categorizable under it as open-end management companies,
[
Footnote 2/32] and it is
Page 359 U. S. 92
declared unlawful by § 18 of the Act for an open-end company to
have outstanding any "senior security," that is, any security
senior to any other class of securities. These companies have
capital stock, and the contracts in question would be securities
senior to the stock. [
Footnote
2/33] If one assumes that this is correct, there is, of course,
the possibility that the SEC might use its broad dispensing powers
in this regard, and, in any event, the whole point would be of no
concern at all if the contracts in question were issued by mutual
companies. [
Footnote 2/34] But,
in the final analysis, it is not decisive of the issues here that a
holding that these contracts
Page 359 U. S. 93
are subject to the Federal Acts might require some modification
in the business of issuing them. Since these contracts are in fact
covered by the Acts, there can be no reason why their issuers
should be able to carry on the investment business in a way which
Congress has forbidden.
Similarly, it may be conceded freely that this form of
investment contract may be one of great potential benefit to the
public. So, of course, may be orthodox open-end investment trusts,
and they clearly are regulated by federal law. In short, notions
that this form of arrangement is a desirable one, and that it might
be well to allow it to exist for a while immune from federal
regulation, are not relevant to the matter for decision. Congress
regulates by general statutes. The passage of a federal regulatory
statute is a delicate balancing of many national legislative
interests and political forces. Congress need not go through the
initial travail of reenacting its general regulatory scheme every
time a new form of enterprise is introduced, if that new form falls
within the scheme's coverage. If there is deemed wise any
adjustment of the regulatory scheme in the light of new
developments in the subject matter to which it extends, Congress
may make it.
[
Footnote 2/1]
48 Stat. 74, as amended, 15 U.S.C. §§ 77a-77aa.
[
Footnote 2/2]
54 Stat. 789, as amended, 15 U.S.C. §§ 80a-1 to 80a-52.
The Court's opinion makes it clear why the issue is identical
under the McCarran-Ferguson Act, 59 Stat. 33, as amended, 15 U.S.C.
§§ 1011-1015.
[
Footnote 2/3]
Defined as a
"company which is organized as an insurance company, whose
primary and predominant business activity is the writing of
insurance or the reinsuring of risks underwritten by insurance
companies, and which is subject to supervision by the insurance
commissioner or a similar official or agency of a State. . . ."
Investment Company Act § 2(a)(17). The business of the
respondents here consists solely of issuing contracts of the nature
of those in question here.
[
Footnote 2/4]
Under the Securities Act, it would appear that in the case of
the ordinary insurance policy, the exemption would be just
confirmatory of the policy's noncoverage under the definition of
security.
See H.R.Rep. No. 85, 73d Cong., 1st Sess. 15.
The status of an ordinary annuity contract might be different. But,
in any event, absent the specific insurance exclusion, it would
appear that the variable annuity contract would come under the term
"investment contract," or possibly "certificate of interest or
participation in any profit-sharing agreement," in the definition
of security, § 2(1). On the other hand, even an ordinary insurance
company might be an investment company within the meaning of §
3(a)(1) and § 3(a)(3) of the Investment Company Act were it not for
the specific exemption. The Chief Counsel of the SEC's Investment
Trust Study testified that the specific exemption was necessary in
the light of the definition.
See Hearings before
Subcommittee of the Senate Committee on Banking and Currency on s.
3580, 76th Cong., 3d Sess. 181.
A fortiori, a company
issuing the sort of contracts in question here would be included if
there were no question of the insurance exemption.
[
Footnote 2/5]
No subsequent development in state insurance regulation appears
to have occurred which would better adapt the system to regulation
of companies performing the functions of investment trusts, but, of
course, in any event, the issue is the scope of state regulation in
1933 and 1940. The basic patterns do not appear to have changed,
and present-day regulation (apart from any measures which may have
been taken specifically to deal with the contracts in question) can
be examined to see the sort of regulation that Congress was
deferring to in the Acts.
[
Footnote 2/6]
". . . any note, stock, treasury stock, bond, debenture,
evidence of indebtedness, certificate of interest or participation
in any profit-sharing agreement, collateral trust certificate,
pre-organization 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."
Securities Act § 2(1), 15 U.S.C. § 77b(1).
[
Footnote 2/7]
Securities Act §§ 7 and 10 and Schedules A and B.
[
Footnote 2/8]
A leading text on life insurance outlines the areas of state
life insurance regulation as follows: the establishment of a
standard of solvency for the setting up of minimum reserves; the
organization of domestic companies and the admission of foreign
insurers; the rendition of annual statements and the making
(frequently on a cooperative basis among the States) of periodic
examinations; overseeing the equitable treatment of policyholders
by prescribing contract terms and checking misrepresentation,
discrimination, rebating and "twisting"; licensing and regulating
the conduct of agents; and supervision of investments in accord
with a statutory permissive list. Huebner and Black. Life Insurance
(5th ed. 1958), pp. 518-524.
[
Footnote 2/9]
See § 3(a)(2). Specific regulatory provisions for this
sort of company are found in § 28. Reserve requirements are
established by the Federal Act as a method of regulation.
[
Footnote 2/10]
§ 8.
[
Footnote 2/11]
§ 15.
[
Footnote 2/12]
§ 12.
[
Footnote 2/13]
§ 13.
[
Footnote 2/14]
§ 18.
[
Footnote 2/15]
§ 20.
[
Footnote 2/16]
§ 22.
[
Footnote 2/17]
§ 27.
[
Footnote 2/18]
§ 30(d).
[
Footnote 2/19]
The important insurance State of Connecticut has.
See
Spellacy v. American Life Ins. Ass'n, 144 Conn. 346, 355, 131
A.2d 834, 839. In any event, these contracts are annuities, "life
annuities," in the sense that they provide for payments at periodic
intervals for a period measured by a human life or lives, with the
payments representing both an income element and a liquidation of
contributed capital, with no further return of the investor's
capital after the annuity period runs.
Cf. Huebner and
Black,
op. cit., supra, at 99-100. Of course, there are
annuity contracts which provide payments only for terms of years.
See Vance, Insurance (3d ed. 1951), p. 1020. These have no
mortality factor, and, it would appear, no insurance element at
all. One of the alternative settlement options under one
respondent's policies is a "variable" form of such an
arrangement.
[
Footnote 2/20]
State statutes make it clear that the writing of traditional
annuities is part of the usual business of life insurance
companies.
See, e.g., Cal. Insurance Code § 101;
Conn.Gen.Stat.1949, c. 295, § 6144; Smith-Hurd Ill.Ann.Stat. Ch.
73, § 616; N.Y.Insurance Law, McKinney's Consol.Laws, c. 28 §§ 46,
190.
Cf. Huebner and Black,
op. cit., supra, at
92; Mehr and Osler, Modern Life Insurance (rev. ed. 1956), pp.
69-70.
[
Footnote 2/21]
The precise percentages are: first year, 44.79%; second, 85.27%;
third, 85.82%; fourth, 86.45%; fifth, 87.17%. The pattern for the
second through fifth years would appear to reflect the diminishing
cost of declining term insurance sold as part of the contract.
[
Footnote 2/22]
The cost of such insurance, bought separately, would be about 2%
of the first 5-years' pay-ins. Longer terms than the 5-year are
available. The contract is sold without term life insurance and
without waiver of premium on disability to persons who are deemed
"uninsurable." The fixed dollar term insurance and the disability
waiver risks of VALIC are heavily reinsured in orthodox insurance
companies.
[
Footnote 2/23]
Even before there are contract holders, a "unit" is set up in
terms of the then value of the company's investment portfolio.
While the number of units credited to investors does not
accordingly account for the entire value of the "fund," the value
of the units fluctuates as the value of the company's investment
portfolio fluctuates in the same fashion as if they were shares in
an open-end investment fund.
[
Footnote 2/24]
The surcharge is accounted for in the same way as that part of
the premium gross income that does not go toward the crediting of
accumulation units. The analogy is to an annual "management fee" in
an investment trust. Of course, the surcharge is not, in fact, paid
to anyone as a fee for any specific purpose, but, to the extent
that it is made, a portion of the company's assets is freed from
being charged with the valuation of units credited to investors. To
this extent, the company's assets become available for the payment
of expenses, for the satisfaction of its obligations in the event
the investors as a group outlive their tabular expectancy, and for
dividends to common stockholders.
[
Footnote 2/25]
A concrete example of a few years' hypothetical experience
during the pay-in period may illustrate the workings of these
contracts. It is based on the specific contract described in the
text.
Assume a unit value of $1 at the start of the contract. The
investor's first annual payment of $1,000, less the disability
waiver premium and the "loading charge," buys 430 units at the $1
rate.
Assume a favorable year in the company's portfolio's market
performance; net capital gains (realized and unrealized) of 15% and
interest and dividends of 3% of original value, all net of income
taxes. On the average asset value at month ends during the year,
the 1.8% annual charge would come to about 2% of original value.
This would make the value of a unit after a year about $1.16.
Of the second annual premium of $1,000, $819 goes toward buying
706 units at the new rate of $1.16. Thus, after the second annual
premium, the investor has, 1,136 units to his credit.
Assume a very favorable second year in the market, with net
capital gains of 25% of the year's beginning value (29 cents a
unit) and income items of 5% of beginning value (about 6 cents a
unit), all net of income taxes. The annual charge of 1.8% will come
to about 2.4 cents per unit, and the resulting value at year end
will be about $1.49 per unit.
Of the third annual premium of $1,000, $824 goes toward buying
553 units at the new rate of $1.49. Thus after the third annual
premium, the investor has 1,689 units to his credit.
Assume a bear market the third year, with a 12% net capital
shrinkage in the company's portfolio (about 18 cents a unit) and
income at 2% of beginning value (3 cents a unit), all net of income
taxes. The 1.8% charge would come to about 2.5 cents a unit. These
adjustments would give a year end unit value of about $1.31 a
unit.
If, instead of going on with the contract, the investor then
"cashed in his chips," he would get $2,212.59 for his 1,689 units,
less a $10 surrender charge.
[
Footnote 2/26]
The least subtle example of the absent protections is that
regarding investment policy. The state investment lists are
minima; within the limits of the lists, the companies have
very broad discretion in making investments,
see Mehr and
Osler,
op. cit., supra, at 612, and there appears to be no
control at all over their changing their investment policies. The
difference in emphasis between the two forms of regulation and the
obvious correspondence of the contract in question with an
investment trust in this essential regulatory matter hardly needs
underscoring.
Even the minimal controls over investment policy furnished by
the prescribed lists are administered primarily by one State, the
State of incorporation. New York's Insurance Law, § 90, applying in
terms the local controls at least "in substance," to foreign
companies doing business within the State, appears the exception,
rather than the rule.
See Vance,
op. cit., supra,
at 43. Other States insist on their own requirements as to part of
the assets of a foreign insurance company doing a local business.
See Cal.Insurance Code § 1153. Some States explicitly make
some deference to the State of incorporation.
See
Smith-Hurd Ill.Ann.Stat., ch. 73, § 723(e).
[
Footnote 2/27]
The reciprocal of 1.000 plus monthly interest at the rate of 3
1/2% per annum.
[
Footnote 2/28]
A concrete hypothetical example of the workings of the contract
in the pay-out period may by useful. Assume that the investor
described in the text and in footnote 25 did not cash in his
contract, but kept it during the entire 30-year pay-in period.
Assume that he has accumulated, through premium payment "purchases"
at varying prices throughout the years, 14,000 units, and that the
value of a unit has mounted to $3 over the years. The investor can
now take his $42,000 in cash, if he chooses. But let us assume that
he is healthy and without dependents, so that he is moved to elect
the option of a straight life annuity. This capital contribution of
$42,000 by a 65-year-old male would buy a fixed dollar annuity of
$286 a month. This is, in fact, what our investor will get the
first month. But this first monthly payment will be used to fix the
number of annuity units he will receive monthly for the rest of his
life.
Assume that the value at this time of an annuity unit is $2.
(While the value of an annuity unit tends to move in the same
direction as the value of an accumulation unit, it differs from it
because every month it is multiplied by 0.9971 to "wring out" the
assumed interest factor in the annuity table. So. over the years,
the current values of the two sorts of units will drift apart, even
though they move the same way with the fluctuations of the
company's portfolio). At the $2 rate, the first monthly payment is
143 units, and this number of units will be paid the investor
monthly for life.
Assume that there is a sharp break in the market during the
first month of the pay-out period. (Actually, there is a one-month
lag in computation, but, for the purposes of demonstration, this
can be ignored.) Suppose this market break shrinks the capital
value of the company's portfolio by 8% (16 cents a unit). Assume
income items during the month at 3% per annum (0.5 cents). Then
deduct the omnipresent 1.8% annual charge (0.3 cents). This puts
the current value at $1.842; the 0.9971 multiplier must be applied
to wring out the interest assumption in the annuity table. This
gives an adjusted value of $1.8367. The investor is then paid, for
his second monthly payment, 143 units at this new rate, or
$262.65.
The recomputation of the unit value takes place monthly, and
every month the investor is paid 143 units at the new rate,
whatever this may come to in dollars.
[
Footnote 2/29]
See Mehr and Osler,
op. cit., supra, at 583;
cf. Fuller v. Metropolitan Life Ins. Co., 70 Conn. 647,
666, 41 A. 4, 11.
[
Footnote 2/30]
In the traditional form of insurance, the appreciation potential
of common stocks is said not to be the predominant reason for an
insurer's investing in them. While many States allow investment in
them in varying degrees, commentators emphasize that the purpose of
such investment is primarily diversification of investment; in
certain industries, common stock may be the only sort of available
investment. Huebner and Black,
op. cit., supra, at 505. Of
course, the primary investment aim of the traditional insurer is
preservation of dollar capital with income.
Id. at
507.
[
Footnote 2/31]
VALIC's hypothetical is an annuity based on an investment return
of 1/2% per annum and an average mortality at 110 years.
[
Footnote 2/32]
According to § 5,
"'Open-end company' means a management company [
i.e.,
an investment company other than a unit investment trust or a face
amount certificate company, § 4] which is offering for sale or has
outstanding any redeemable security of which it is the issuer."
The redeemability of these contracts during the pay-in period
would appear to make their issue come under this definition. Even
if the companies were considered closed-end companies, they argue
that other provisions of § 18 would pose very difficult problems
for them.
See § 18(a).
[
Footnote 2/33]
The companies say that this is because their contracts are debt
obligations. It is quite doubtful whether the contracts can be
described as debts; certainly they are not much more of a debt than
a redeemable share in an orthodox open-end company is; here, the
redemption feature is expressed in outright redeemability during
the pay-in period and in liquidation on an annuity basis in the
pay-out period. But, in any event, whether the contracts are debts
or not, they have priority over the companies' stock, and the
provisions dealing with senior securities would appear to cover
them.
[
Footnote 2/34]
The most basic purpose of the provision might be viewed by the
SEC as the protection, in the case of the traditional open-end
company, of the investment certificate holders from the creation of
securities senior to their interest (as well as preventing, in the
interest of their purchasers, the creation of a class of "senior"
securities which would be senior only to freely redeemable junior
securities). Since it is the senior securities here which are the
analogs of open-end investment trust certificates, quite the
contrary situation might be though to be presented. The SEC's
dispensing authority in regard to the Investment Company Act is
found in § 6(c), which provides:
"The Commission, by rules and regulations upon its own motion,
or by order upon application, may conditionally or unconditionally
exempt any person, security, or transaction, or any class or
classes of persons, securities, or transactions, from any provision
or provisions of this title or of any rule or regulation
thereunder, if and to the extent that such exemption is necessary
or appropriate in the public interest and consistent with the
protection of investors and the purposes fairly intended by the
policy and provisions of this title."
MR. JUSTICE HARLAN, whom MR. JUSTICE FRANKFURTER, MR. JUSTICE
CLARK and MR. JUSTICE WHITTAKER join, dissenting.
The issue in these cases is whether Variable Annuity Life
Insurance Company of America (VALIC) and The Equity Annuity Life
Insurance Company (EALIC) are subject to regulation by the
Securities and Exchange Commission under the Securities Act of 1933
and the Investment Company Act of 1940 with respect to their
variable annuity business.
Page 359 U. S. 94
Section 3(a)(8) of the Securities Act, 48 Stat. 74, 76, 15
U.S.C. § 77c(a)(8), provides that the statute shall not apply
to:
"Any insurance or endowment policy or annuity contract or
optional annuity contract, issued by a corporation subject to the
supervision of the insurance commissioner, bank commissioner, or
any agency or officer performing like functions, of any State or
Territory of the United States or the District of Columbia."
Section 3(c)(3) of the Investment Company Act, 54 Stat. 789,
798, 15 U.S.C. § 80a-3(c)(3), puts outside the coverage of the Act
"[a]ny . . . insurance company," and § 2(a)(17), 54 Stat. 789, 793,
15 U.S.C. § 80a-2(a)(17), defines an insurance company as:
"a company which is organized as an insurance company, whose
primary and predominant business activity is the writing of
insurance or the reinsuring of risks underwritten by insurance
companies, and which is subject to supervision by the insurance
commissioner or a similar official or agency of a State; or any
receiver or similar official or any liquidating agent for such a
company, in his capacity as such."
These two insurance companies are organized under the Life
Insurance Act of the District of Columbia, Title 35 D.C.Code 1951,
§§ 35-301 to 35-803, and are subject to regulation by the
Superintendent of Insurance of the District of Columbia, who has
approved the annuity policies written by them. At the time of
trial, VALIC had also qualified to do business in Arkansas,
Kentucky, and West Virginia, and its annuity policies had likewise
been approved by the insurance departments of those States.
[
Footnote 3/1] Both companies in
the District of Columbia,
Page 359 U. S. 95
and VALIC in the other States, offer their policies to the
public only through insurance agents duly licensed by the local
insurance authority.
Variable annuity policies are a recent development in the
insurance business designed to meet inflationary trends in the
economy by substituting for annuity payments in fixed dollar
amounts payments in fluctuating amounts, measured ultimately by the
company's success in investing the premium payments received from
annuitants. One of the early pioneers in this field was Teachers
Insurance and Annuity Association, a New York regulated life
insurance organization engaged in selling annuities to college
personnel. The Association, in 1950, made exhaustive studies into
the feasibility and soundness of variable annuities. Two years
later, it incorporate College Retirement Equities Fund, a companion
company under joint management with Teachers Insurance, which,
subject to regulation under the New York Insurance Law, commenced
offering such annuity contracts in the teaching profession.
[
Footnote 3/2] The first life
insurance company to offer such contracts generally appears to have
been the Participating Annuity Life Insurance Company, which, since
1954, has been selling variable annuity policies under the
supervision of the Arkansas insurance authorities. VALIC and EALIC
entered the field in 1955 and 1956, respectively.
The characteristics of a typical variable annuity contract have
been adumbrated by the majority. It is sufficient to note here
that, as the majority concludes, as the two lower courts found, and
as the SEC itself recognizes, it may fairly be said that variable
annuity contracts contain both "insurance" and "securities"
features. It is
Page 359 U. S. 96
certainly beyond question that the "mortality" aspect of these
annuities -- that is, the assumption by the company of the entire
risk of longevity -- involves nothing other than classic insurance
concepts and procedures, and I do not understand how that feature
can be said to be "not substantial," determining as it does, apart
from options, the commencement and duration of annuity payments to
the policyholder. On the other hand it cannot be denied that the
investment policies underlying these annuities, and the stake of
the annuitants in their success or failure, place the insurance
company in a position closely resembling that of a company issuing
certificates in a periodic payment investment plan. Even so,
analysis by fragmentization is, at best, a hazardous business, and,
in this instance has, in my opinion, led the Court to unsound legal
conclusions. It is important to keep in mind that there are not
cases where the label "annuity" has simply been attached to a
securities scheme, or where the offering companies are traveling
under false colors in an effort to avoid federal regulation. The
bona fides of this new development in the field of
insurance is beyond dispute.
The Court's holding that these two companies are subject to SEC
regulation stems from its preoccupation with a constricted "color
matching" approach to the construction of the relevant federal
statutes which fails to take adequate account of the historic
congressional policy of leaving regulation of the business of
insurance entirely to the States. It would be carrying coals to
Newcastle to reexamine here the history of that policy, which was
fully canvassed in the several opinions of the Justices in
United States v. South-Eastern Underwriters Ass'n,
322 U. S. 533, and
which was again implicitly recognized by this Court as recently as
last Term, when, in
Federal Trade Comm'n v. National Casualty
Co., 357 U. S. 560, we
declined to give a niggardly construction to the McCarran
Page 359 U. S. 97
Act. Suffice it to say that, in consequence of this Court's
decision 90 years ago in
Paul v.
Virginia, 8 Wall. 168, and the many cases following
it, [
Footnote 3/3] there had come
to be "widespread doubt," prior to the time the Securities and
Investment Company Acts were passed, "that the Federal Government
could enter the field [of insurance regulation] at all."
Wilburn Boat Co. v. Fireman's Fund Ins. Co., 348 U.
S. 310,
348 U. S. 318;
see also Prudential Ins. Co. v. Benjamin, 328 U.
S. 408,
328 U. S.
414.
I can find nothing in the history of the Securities Act of 1933
which savors in the slightest degree of a purpose to depart from or
dilute this traditional federal "hands off" policy respecting
insurance regulation. On the contrary, the exemption of insurance
from that Act, which is couched in the broadest terms, reflected
not merely adherence to tradition, but also compliance with a
supposed command of the Constitution. In a study of the proposed
Act, the Department of Commerce concluded that the legislation
could be bottomed on the federal power over commerce, because
securities did have the independent general commercial existence
and value which the
Paul decision had found lacking in
insurance policies.
See A Study of the Economic and Legal
Aspects of the Proposed Federal Securities Act, reprinted in
Hearings before Senate Committee on Banking and Currency on S. 875,
73d Cong., 1st Sess. 312 at 330, and in Hearings before House
Committee on Interstate and Foreign Commerce on H.R. 4314, 73d
Cong., 1st Sess. 87 at 105. This distinction between securities and
insurance, mistaken or not, underlay the passage of the final bill.
When the proposed act was considered by the Senate and House
Committees, it did not contain an express exemption of
Page 359 U. S. 98
insurance. The House Committee explained that the exemption in
the final bill (§ 3(a)(8) of the Act):
"makes clear what is already implied in the act, namely, that
insurance policies are not to be regarded as securities subject to
the provisions of the act. The insurance policy and like contracts
are not regarded in the commercial world as securities offered to
the public for investment purposes. The entire tenor of the act
would lead, even without this specific exemption, to the exclusion
of insurance policies from the provisions of the act, but the
specific exemption is included to make misinterpretation
impossible."
H.R.Rep. No. 85, 73d Cong., 1st Sess. 15. That this distinction
stemmed from the feared implications of the
Paul decision
appears from the House debates.
See 73d Cong., 1st Sess.,
77 Cong.Rec. 2936, 2937, 2938, 2946. Moreover, two days after the
Senate began consideration of the proposed act, Senator Robinson
introduced a resolution (S.J.Res. 51) calling for a constitutional
amendment because, in his view, "the National Government at present
has no authority whatever over insurance companies." 73d Cong., 1st
Sess., 77 Cong.Rec. 3109.
Similarly, I can find nothing in the history of the Investment
Company Act of 1940 which points in any way to a change in federal
policy on this score. Here tradition, perhaps more than
constitutional doubt, explains the exemption of insurance companies
from the Act. In hearings before the House Committee, Commissioner
Healy of the SEC discussed the "face amount installment
certificates" issued by certain investment companies and often
"sold on the basis of the comparison with savings bank deposits and
insurance policies." The major factor appearing to distinguish
these investment
Page 359 U. S. 99
companies from insurance companies for purposes of federal
control was the strict state regulation present over insurance
policies, but absent over investment certificates. Hearings before
House Committee on Interstate and Foreign Commerce on H.R. 10065,
76th Cong., 3d Sess. 61-62. Likewise, in the Senate debates,
preservation of state regulation over insurance companies appears
as the crucial factor distinguishing them from investment trusts.
76th Cong., 3d Sess., 86 Cong.Rec. 10070. Stating that "the bill
has nothing to do with the regulation of insurance companies,"
Senator Byrnes went on to say:
"The platforms of both political parties have urged supervision
of insurance by the several States, but not regulation by the
Federal Government."
Id. at 10071.
See also United States v. South-Eastern
Underwriters Ass'n, supra, at
322 U. S. 584,
322 U. S.
591-592, note 12 (dissenting opinion).
In 1944, this Court removed the supposed constitutional basis
for exemption of insurance by holding, in
United States v.
South-Eastern Underwriters Ass'n, supra, that the business of
insurance was subject to federal regulation under the commerce
power. Congress was quick to respond. It forthwith enacted the
McCarran Act, 59 Stat. 33, 15 U.S.C. §§ 1011-1015, which, on its
face, demonstrates the purpose "broadly to give support to the
existing and future state systems for regulating and taxing the
business of insurance,"
Prudential Ins. Co. v. Benjamin,
supra, at
328 U. S. 429,
and "to assure that existing state power to regulate insurance
would continue."
Wilburn Boat Co. v. Fireman's Fund Ins. Co.,
supra, at
348 U. S. 319.
Thus, rather than encouraging Congress to enter the field of
insurance, the
South-Eastern decision spurred reiteration
of its undeviating policy of abstention.
In this framework of history, the course for us in these cases
seems to me plain. We should decline to admit the SEC into this
traditionally state regulatory domain.
Page 359 U. S. 100
Admittedly, the variable annuity was not in the picture when the
Securities and Investment Company Acts were passed. It is a new
development combining both substantial insurance and securities
features in an experiment designed to accommodate annuity insurance
coverage to contingencies of the present day economic climate.
[
Footnote 3/4] This, however,
should not be allowed to obscure the fact that Congress intended,
when it enacted these statutes, to leave the future regulation of
the business of insurance wholly with the States. This intent,
repeatedly expressed in a history of which the Securities and
Investment Company Acts were only a part, in my view, demands that
bona fide experiments in the insurance field, even though
a particular development may also have securities aspects, be
classed within the federal exemption of insurance, and not within
the federal regulation of securities. [
Footnote 3/5] Certainly these statutes breathe no notion
of concurrent regulation by the SEC and state insurance
authorities. The fact that they do not serves to reinforce the view
that the congressional exemption of insurance was but another
manifestation of the historic federal policy leaving regulation of
the business of insurance exclusively to the States. [
Footnote 3/6]
It is asserted that state regulation, as it existed when the
Securities and Investment Company Acts were passed,
Page 359 U. S. 101
was inadequate to protect annuitants against the risks inherent
in the variable annuity, and that therefore such contracts should
be considered within the orbit of SEC regulation. The Court is
agreed that we should not "freeze" the concept of insurance as it
then existed. By the same token, we should not proceed on the
assumption that the thrust of state regulation is frozen. As the
insurance business develops, new concepts the States adjust and
develop their controls. This is in the tradition of state
regulation and federal abstention. If the innovation of federal
control is nevertheless to be desired, it is for the Congress, not
this Court, to effect.
I would affirm.
[
Footnote 3/1]
Since the trial, VALIC has also qualified in Alabama and New
Mexico, and EALIC in North Dakota.
[
Footnote 3/2]
By the end of 1956, the College Retirement Fund had issued such
annuities to more than 31,000 individuals, and the value of its
annuity units had increased from $10 to $18.51.
[
Footnote 3/3]
The cases are collected in
United States v. South-Eastern
Underwriters Ass'n, supra, at
322 U. S. 544,
note 18.
[
Footnote 3/4]
See Morrissey, Dispute Over the Variable Annuity, 35
Harv.Bus.Rev. 75 (1957).
[
Footnote 3/5]
It is worth observing that, in reporting the proposed Securities
Act of 1933, the House Committee stated that insurance policies
"and like contracts" were to be exempt from federal regulation.
See ante, p.
359 U. S.
98.
[
Footnote 3/6]
In contrast, § 18 of the Securities Act, 48 Stat. 74, 85, 15
U.S.C. § 77r, provides that the Act shall not affect the
jurisdiction of state securities commissions, thus recognizing a
system of dual regulation where the exemptive provisions are not
applicable. The Investment Company Act has a similar provision, §
50. 54 Stat. 789, 846, 15 U.S.C. § 80a-49.