Case Brought Before the Court
When it was brought before the Supreme Court on January 15th, 1959, it had passed through the United States District Court for the District of Columbia with the decision falling in the defendant’s favor. They concluded that variable annuity contracts were not securities due to the “insurance” exemption. which appeared in the Securities Act of 1933 and the Investment Company Act of 1940. Certiorari– where a higher court reviews the decision of a lower court– was granted and the case was placed in the hands of the Warren Court. The Court would review Securities and Exchange Commission v. Variable Annuity Life Insurance Co. of America et al.
Petition
As the petitioner, the Securities and Exchange Commission argued that variable annuities should fall under regulation of the Securities Act and the companies providing the contract should therefore be regulated by the Investment Company Act. Companies offering these contracts would then be obligated to register their annuities with the SEC.
Historical Applications
Variable annuities were a new financial product which had evolved from fixed annuities. One of their first uses was in 1952 with the Teachers Insurance and Annuity Association. Seeking to provide an alternative retirement plan which would combat inflation for their educators they created their College Retirement Equities Fund. As the contracts continued to gain popularity, insurance companies across the industry were divided on whether the product could be considered insurance and where regulation lay.
Government Action
Originally, Paul v Virginia placed the responsibility and regulation upon the states by limiting the government’s constitutional power to regulate the insurance industry in 1896. But these limits were removed in 1944 due to United States v. South Eastern Underwriters Association. The decision of this case stated that the insurance industry was indeed subject to federal regulation. Moving quickly, Congress passed the McCarran-Ferguson Act a year later in 1945 which exempted the industry from many federal regulations. The Act reiterated the belief at the time: insurance regulation was the state’s responsibility.
Rationality Across the Court
The Court reasoned that the contracts didn’t meet the definition of insurance. Insurance is the promise to pay a guaranteed sum of money. But variable annuities’ sum is in constant fluctuation due to the underlying securities. Since the sum isn’t guaranteed, they couldn’t be treated similarly to fixed annuity contracts. In addition, insurance implies some risk taken on by the company providing it. But companies issuing variable annuities placed all the risk on the annuitant instead of upon the company.
Justice Douglas, when delivering the Opinion of the Court stated:
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.
Supporters:
Justices who agreed with the Court’s opinion were:
- Earl Warren
- Hugo L. Black
- William O. Douglas
- William J. Brennan Jr.
- Potter Stewart
Justice Brennan, joined by Justice Stewart, concurred with the Court, but had additional supporting reasons. As mentioned by the petitioner, he stated the similarities between the annuity’s accumulation units and a portfolio’s shares. The cash value of the contract increases as more and more accumulation units are bought and each unit has its own share of the market value. Similar to a portfolio, as the underlying securities fluctuate in price, so does the unit. Brennan also called out that if the Securities Act did not include the insurance exemption, an annuity contract could fall under the “investment contract” definition of a security.
Dissenters:
Dissenters of the ruling were the remaining four:
- Felix Frankfurter
- Tom C. Clark
- John M. Harlan II
- Charles E. Whittaker
The dissenters, lead by Justice Harlan, spoke of historic action taken. They cited the many attempts the government had made to ensure states had regulation oversight for the insurance industry such as:
- Paul v. Virginia which gave states power to regulate the insurance industry and placed constitutional regulation power limits on the government
- The inclusion of an insurance exemption in the Securities and Investment Company Acts
- Passage of the McCarran-Ferguson Act which exempted insurance companies from most federal regulations after the Court’s decision for insurance to be subject to federal regulation in United States v. South-Eastern Underwriters Association
With Harlan stating:
Here tradition, perhaps more than constitutional doubt, explains the exemption of insurance companies from the [Investment Company] Act.
Furthermore, they included in their statement that the defendants’ had their annuity policies approved by the Superintendent of Insurance of the District of Columbia and were qualified for business in various states with their policies being approved by those same states. Harlan was in agreement that protection against the contract risks for the annuitants was not satisfactory. But although variable annuities were a new product, they argued that it did not mean the regulation of this insurance product was no longer up to the state. Instead of altering regulation once again, it should be left to the state to evolve their rules and regulations to better fit the ever-changing financial environment.
Court Decision
Two months later on March 23rd, 1959, the Court ruled that variable annuity contracts were to be defined as “securities” and fell under regulation of the SEC through the Securities Act. With the companies providing them being regulated by the Investment Company Act.