insurance laws and the laws regulating the sale of securities. He concluded that much of the type of regulation provided for insurance companies is inappropriate to variable annuities, even those involving insurance elements as in the case of the two District of Columbia companies. The regulation of securities, on the other hand, has been especially designed to cope with a company managing other people's money where no question of insolvency is involved for this very purpose. In discussing the purpose of the Securities Act of 1933, Mr. Justice Brennan stated: 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. Detailed schedules, set forth in the Act, list the material that the registration statement and the prospectus are to contain. 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 his money should be made so that he can intelligently appraise the risks involved.98 This system is to be contrasted with the regulation of life insurance companies designed to preserve the solvency of the insurance company and to assure the maintenance of adequate reserves to meet the company's obligations. Where the company guarantees benefits, disclosure to the public becomes unimportant, while careful examination by insurance examiners becomes more important. One of the basic premises of state regulation of insurance companies is that the annuitant would not directly share in the investments of the company. This may be just another way of saying that where annuities are furnished by life insurance companies the person of the grantor only (the insurance company) should be charged with an obligation, and that the underlying securities belong to the company; that the relationship is one of debtor-creditor and not one resting on property law. The Investment Company Act of 1940 has not received sufficient attention from those in the insurance industry, and the detailed regulation of investments found therein is often overlooked. One of the elements that is regulated is the statement of "investment policy." Life insurance companies are not required to state their investment policy as the investment policy is of primary concern to the company rather than the policyholders. Insurance statutes state broadly the types of investments that may be made by a life insurance company and within these broad limits the company may adopt and change its investment policy at any 96 Id. at 76-77 (concurring opinion). (Footnotes omitted.) 97 54 Stat. 811 (1940), 15 U.S.C. § 80a-13 (1958). time. Mutual funds, on the other hand, are required to state their investment policy in the prospectus, and they may not change this policy without the affirmative vote of a majority of the participants. Mr. Justice Brennan considered that this difference in regulations was most significant, stating: 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 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.98 Although VALIC and EALIC were stock life insurance companies, they pressed the argument on the Supreme Court that in a mutual life. insurance company the ultimate ownership rests in the policyholders as distinguished from the company, and, therefore, in an indirect sense there is no essential difference between a mutual fund and a mutual life insurance company. Stated differently, if a mutual life insurance company becomes insolvent, the loss falls on the policyholders. The concurring opinion conceded that in both instances there were investment risks, but that these risks differed widely; that the prevention of insolvency and the maintenance of a sound financial condition in terms of a fixed number of dollars is the goal of state insurance department regulations.99 The broad sweep of the majority and concurring opinions is perfectly clear. The regulatory system designed for fixed-dollar insurance annuity contracts lacks certain elements of protection that the public needs under a variable annuity. Conversely, the statutes designed to regulate the sale of mutual-fund shares seems peculiarly fitted to the variable annuity and furnish the type of protection the public needs. Even a cursory examination of the system of state insurance regulation of life insurance companies tends to support the views expressed by the Supreme Court. For example, all life insurance companies must meet the minimum-reserve valuation requirements for annuity contracts. These requirements specify that the reserves of the company supporting annui98 359 U.S. at 79-80 (concurring opinion). 99 Id. at 90-91 (concurring opinion). ties must be at least equal to those produced by a specified mortality table and a specified interest rate.100 These restrictions were obviously designed to protect the guarantee of a fixed number of annuity dollars in the future. They are meaningless for variable annuities, even of the type furnished by VALIC and EALIC. There the assumed interest rate has a different purpose than for fixed-dollar annuities. It is customary for actuaries in establishing the rates for fixed-dollar annuities to set an interest rate below that which the company expects to earn. Even in a mutual life insurance company the interest dividend does not equal the excess of the actual interest earned over the guaranteed rate. It is customary for a participating life insurance company to hold back about one-half percent of the excess interest as a surplus builder. In a variableannuity company there is no need for a guaranteed interest rate during the deferred period before annuity payments begin. After such payments begin, the assumed interest rate should be as realistic as possible (without an element of conservatism) in order to distribute more evenly the annuity payments among those who die early and those who live for a long time. The minimum-reserve valuation standards in state insurance laws may actually result in inequity rather than equity among the policyholders of variable-annuity companies. This principle was clearly recognized by the Teachers Insurance and Annuity Association (TIAA) and the College Retirement Equities Fund (CREF). These two companies offer fixed-dollar annuities and variable annuities in combination under one system. When the system was established in 1952, the guaranteed interest rate under TIAA fixed-dollar annuities was 24 percent per year, while the interest rate assumed for CREF variable annuities was 4 percent per year. In actual practice the earnings of CREF have exceeded 4 percent so that the assumption of a lesser rate would have been inequitable among annuitants. This is but one illustration of the special problems faced by state insurance commissioners attempting to regulate variable annuities under statutes designed to regulate fixed-dollar annuities. As a policy matter there is no need to complicate the life of state insurance commissioners by attempting to change the laws to permit them to regulate annuities which are not "charged against the person of the grantor only," i.e., where the "insurer" does not indemnify or guarantee anything and cannot become insolvent. There is no need for an actuarial department or actuarial supervision 100 See Ill. Ann. Stat. ch. 73, § 835 (Supp. 1959), for a representative example of these requirements. by state insurance commissioners where annuities are not a charge against the person of the grantor. Actuarial science is so much a part of the insurance industry that many people in the insurance industry hold the mistaken belief that the use of actuarial science is confined to their industry. The fact is otherwise, and this is especially true in the lifeannuity field. Fewer than half of the annuitants in this country are receiving their annuity payments from life insurance companies. At the end of 1958 the reserves for individual and group annuities furnished by life insurance companies amounted to $19 billion.101 The reserves under the three federal plans (Social Security, Railroad Retirement Board, and Civil Service) amounted to $34.3 billion.102 The reserve for state and municipal retirement plans amounted to $15.2 billion.103 The reserve for trusteed pension plans amounted to $22.1 billion.104 These do not include all of the funded plans nor any of the unfunded plans outside the insurance field. There are many actuaries in government service, and there are many actuaries operating on a consulting basis in the pension trust field. The actuarial science used in cases where there are no fixed-dollar guarantees can be extremely simple. Take, for example, the proposed method to be used under the United Variable Annuities program. Annuity-unit values can be determined from electrical accounting machine cards and are easily checked by standard accounting methods. Anyone with simple bookkeeping experience can understand the procedure after a short instruction period and can check results with absolute certainty. The methods used are essentially those now used by mutual funds which involve simple arithmetic and conventional accounting methods. In mutual-fund accounting, the value of a mutual-fund share is determined by dividing the net assets of the mutual fund by the number of shares outstanding. Similarly, the value of the "units" in the United Variable Annuities program will be determined by dividing the net assets of the unit investment trust by the number of units outstanding. During the annuity payment period the value of the annuity payments at any time will be furnished by electrical accounting machine cards using the present value of an annuity of one per year. This is the conventional method used for valuing annuities under any pension or retirement system or wherever it is important to derive the value of a life annuity. This 101 1959 Fact Book at 35. 102 SEC Release at 6. 103 Ibid. 104 Ibid. method of valuing annuities is explained in most elementary college textbooks on the mathematics of finance.105 The table of annuity values is no more difficult to use than a table of compound-interest or bond-interest rates. As stated above, there is no need for an actuarial department. The function of the actuary under this system is solely to recommend the tables to be used which will result in the equitable distribution among the participants. Even this function is relatively simple compared with the function performed by the actuary for a conventional life insurance company with obligations guaranteed in a fixed number of dollars. Where the annuity is chargeable solely on trust assets, as in the United Variable Annuities program, the liabilities are automatically adjusted to the resources available. Solvency is never in question. Any deviation of actual mortality experience of the group from the assumed mortality experience of the tables will only affect the incidence of the payments of the annuitants. It will not affect the aggregate amount received by the annuitants. 2. The Merging Mortality Myth The idea has sometimes been advanced that the "merging of mortality" is an insurance function and that any life annuity which involves a merging of mortality should be regulated and supervised by the state insurance commissioner. Surprisingly, this merging-of-mortality theory has been expressed by counsel for several large life insurance companies, although never in a formal statement of any kind. No case has been found specifically enunciating the merger-of-mortality theory, and search has failed to reveal any real support for this theory. The merging-of-mortality concept seems to be a myth without any foundation. The mathematical laws of probability are among the greatest discoveries of modern times. They were originally developed in the field of biology and play an important role in the modern sciences of genetics, electronics, atomic energy and insurance. Briefly, scientists have found that what is pure random chance in one instance tends to follow a definite probability pattern in many instances. In one instance we "guess"; in many instances we know of a certainty, or at least a near certainty. The man who makes one bet at a roulette table "gambles," but the owner can predict his profits within a narrow margin. These mathematical laws of probability are not only known but are definite. A life insur 105 E.g., Hummell & Seebeck, Mathematics of Finance 158 (2d ed. 1956); Smail, Mathematics of Finance 54-55 (1953). 29-313 0-64- -9 |