By George H. Friedman, SAA Publisher & Editor-in-Chief
While the arbitration agreement in a variable annuity was enforceable because the investment was a security, once the annuitant converted the product to a fixed annuity it became an insurance product and the PDAA was not enforceable, a unanimous Kentucky Supreme Court holds.
The virtually unlimited reach of Federal Arbitration Act (“FAA”) preemption can be checked by a contrary federal statute, such as the McCarran-Ferguson Act, 15 U.S.C. § 1012(b). The Act protects State laws regulating the business of insurance from federal preemption, in effect “reverse-preempting” the FAA: “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….”
The Core Issue: Security or Insurance?
The Act was at issue in Legacy Consulting Group, LLC v. Gutzman, No. 2020-SC-0288-DG (Ky. Dec. 16, 2021), a case involving a predispute arbitration agreement (“PDAA”) in a variable annuity that was converted to a fixed annuity. What was the issue? The unanimous Court says: “If the investment product which Ms. McGaughey selected, with the advice of Legacy Consulting and Money Concepts, was ‘insurance,’ which under KRS 304-1.030 includes a fixed payment annuity, then the arbitration agreement is unenforceable. KRS 417.050(2); see also Ernst & Young, LLP v. Clark, 323 S.W.3d 682, 688 (Ky. 2010) (stating that the McCarran-Ferguson Act, 15 U.S.C. § 1012(b), ‘establishes a doctrine of “reverse preemption” that expressly exempts from federal preemption state statutes enacted to regulate insurance, leaving the regulation of insurance to the individual state’). Conversely, if the investment product was a security, including a variable rate annuity, then the arbitration agreement applies” (brackets in original).
Fixed Annuity is an Insurance Product
What applies here? The Court continues: “The annuity in this case was initially set up as a variable rate annuity. Under case law, that initial investment was not insurance, but rather a security. The issue, however, in this case is whether, following the Income Date, when Ms. McGaughey elected a fixed income annuity, did the annuity become insurance? The question seems to answer itself…. In this case, her investment in December 2015 was insurance. As a result, KRS 417.050(2) provides that the arbitration provision is unenforceable.”
(ed: Seems right to us, and we can’t see SCOTUS being interested in reviewing a unanimous State Supreme Court holding interpreting and applying State law. Also, as described in this Feature Article, SCOTUS has a pretty full arbitration plate right now!)