[Federal Register Volume 59, Number 21 (Tuesday, February 1, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-2122]
[[Page Unknown]]
[Federal Register: February 1, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Rel. No. IC-20033; File No. 812-8086]
The Prudential Insurance Company of America et al.
January 25, 1994.
AGENCY: Securities and Exchange Commission (``SEC'' or ``Commission'').
ACTION: Notice of application for an order under the Investment Company
Act of 1940 (the ``1940 Act'').
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APPLICANTS: The Prudential Insurance Company of America
(``Prudential''), Pruco Life Insurance Company (``PrucoLife''), Pruco
Life Insurance Company of New Jersey (``Pruco Life of New Jersey''),
and The Prudential Variable Appreciable Account, The Proco Life
Variable Appreciable Account, The Pruco Life Variable Universal
Account, The Pruco Life PRUvider Variable Appreciable Account, and The
Pruco Life of New Jersey Variable Appreciable Account (collectively,
the ``Accounts'').
RELEVANT 1940 ACT SECTIONS: Order requested under Section 6(c) of the
1940 Act for exemptions from Section 27(c)(2) and from Rule 6e-3(T)
under the 1940 Act.
SUMMARY OF APPLICATION: Applicants request an order to permit them to
impose a premium based charge under certain flexible premium variable
life insurance policies in an amount that is reasonably related to
Prudential's increased federal income tax burden resulting from the
application of Section 848 of the Internal Revenue Code of 1986, as
amended.
FILING DATES: The application was filed on September 11, 1992 and
amended on September 10, 1993.
HEARING OR NOTIFICATION OF HEARING: An order granting the application
will be issued unless the Commission orders a hearing. Interested
persons may request a hearing by writing to the Secretary of the SEC
and serving Applicants with a copy of the request, personally or by
mail. Hearing requests should be received by the SEC by 5:30 p.m. on
February 22, 1994, and should be accompanied by proof of service on the
Applicants in the form of an affidavit or, for lawyers, a certificate
of service. Hearing requests should state the nature of the writer's
interest, the reason for the request, and the issues contested. Persons
who wish to be notified of a hearing may request notification by
writing to the SEC's Secretary.
ADDRESSES: Secretary, SEC, 450 5th Street, NW., Washington, DC 20549.
Applicants: The Prudential Insurance Company of America, Prudential
Plaza, Newark, NJ 07102, Attn: John P. Gualtieri, Jr.
FOR FURTHER INFORMATION CONTACT: Joyce M. Pickholz, Senior Attorney, or
Wendell M. Faria, Deputy Chief, at (202) 272-2060, Office of Insurance
Products, Division of Investment Management.
SUPPLEMENTARY INFORMATION: Following is a summary of the application.
The complete application is available for a fee at the Commission's
Public Reference Branch.
Applicants' Representations
1. Prudential is a mutual life insurance company organized under
the laws of New Jersey. Pruco Life, a direct, wholly-owned subsidiary
of Prudential, is a stock life insurance company organized under the
laws of Arizona. Pruco Life of New Jersey, an indirect, wholly-owned
subsidiary of Prudential, is a stock life insurance company organized
under the laws of New Jersey.
2. The Prudential Variable Appreciable Account is a separate
account established by Prudential. The Pruco Life Variable Appreciable
Account, Pruco Life PRUvider Variable Appreciable Account and Pruco
Life Variable Universal Account are separate accounts established by
Pruco Life. The Pruco Life of New Jersey Variable Appreciable Account
is a separate account established by Pruco Life of New Jersey. All of
the Accounts meet the 1940 Act definition of separate account. The
Accounts issue variable life insurance contracts to the public and may,
in the future, issue other variable lie insurance contracts that rely,
for exemption form certain provisions of the Act, upon Rule 6e-3(T).
The three life insurance company Applicants may, in the future,
establish additional separate accounts which will issue variable life
insurance contracts that rely, for exemption from certain provisions of
the Act, upon Rule 6e-3(T).
3. Applicants request exemptions from Section 27(c) of the 1940 Act
and Rule 6e-3(T) thereunder to permit them to deduct from premium
payments received under certain variable life insurance contracts an
amount that is reasonable in relation to the increased income taxes
payable by Prudential as the result of Section 848 of the Internal
Revenue Code. The insurance company Applicants also request that other
similar separate accounts that may be established by them in the future
be permitted to rely on any order issued with respect to the subject
application.
4. Applicants assert that Section 848 was added to the Internal
Revenue Code by Congress in 1990 in order to increase federal revenues
by increasing federal income taxes paid by life insurance companies, as
explained in the section's legislative history. Although the committee
reports suggest that the basis for Section 848 was that the expenses
incurred when a life insurance policy is sold should properly be
capitalized rather than treated as expenses deductible from gross
income in the year in which incurred, all actual expenses incurred in
connection with such sales continue to be deductible in the year in
which incurred. Rather than capitalizing actual policy acquisition
expenses, Section 848 reduces the ``general'' (aggregate) deductions of
a life insurance company by a specified arbitrary percentage of the net
premiums received during the taxable year. This amount is then
capitalized and allowed as a deduction ratably over a 10-year period.
In the case of individual life insurance contracts, whether fixed or
variable, the specified percentage of net premiums is 7.7%.
5. Applicants submit that since the corporate tax rate allocable to
Prudential's income is 34%, the immediate effect of Section 848 is an
increase in tax equal to 2.487% of the aggregate amount of premiums
received on individual life insurance contracts during the taxable
year. However, this increase will be offset by decreases in the
Company's federal income tax in each of the subsequent 10 years.
Although the aggregate amount of these decreases is equal to the tax
increase in the year in which the premiums are received, the value of
the annual decreases is less because they take place in the future.
Applicants assert that the burden resulting from Section 848 is
therefore, determined by reducing the amount of the immediate increase
in federal income taxes by the sum of the present value of the
decreases in the tax in each of the next 10 years. In order to
determine that present value, it is necessary to use an appropriate
discount rate.
6. Applicants submit that 10% is an appropriate discount rate to be
used in determining the net tax burden resulting from Section 848.
Applicants assert that for a stock life insurance company the
appropriate discount rate would be equal to the cost of raising
capital, which is generally referred to as the ``cost of capital.''
Since Prudential is a mutual life insurance company, without
stockholders, it has not sought to raise capital in the public equity
markets, or by issuing long-term public debt securities. Applicants
suggest, therefore, an analogous concept to ``cost of capital'' that
should be used for a mutual life insurance company. Prudential, like
other mutual life insurance companies, seeks to maintain a surplus, the
primary objective of which is to insure that its contractual
obligations to all policy and contract owners will be met.
Nevertheless, Prudential and state insurance departments regard it as
appropriate for part of that surplus to be used to create new products,
such as new forms of variable life insurance. For this process to
continue, the development expenses incurred must be recovered from the
persons who buy those products; thus products are priced so that they
are expected to produce enough revenues to pay all anticipated benefits
and expenses and a reasonable addition to surplus. In determining what
a reasonable addition to surplus should be, Prudential takes into
account a number of factors including market interest rates, its
anticipated long-term growth rate, inflation, information about the
rates of return obtained by other mutual life insurance companies, and
the risks associated with a particular product. The greater the risk of
a particular product, the higher after-tax return that Prudential seeks
to earn upon the portion of its surplus that it has ``invested'' in the
development of the product. Applicants represent that these factors are
appropriate ones to consider in determining what may be thought of as
its equivalent of cost of capital.
7. Prudential also seeks to maintain a ratio of surplus to assets
that will ensure stability of the company and the maintenance of its
competitive position. It seeks generally to have its surplus grow at
least at the same rate as its assets. Taking all these factors into
account, and with particular emphasis upon the risks involved in the
variable life insurance contracts that it and its subsidiaries issue,
Prudential has determined that an appropriate after-tax rate of return
on these contracts is 10% and, accordingly, that the appropriate
discount rate to use in determining the net burden imposed by Section
848 is also 10%.
8. If the decrease in tax in each of the 10 years following the
receipt of a particular premium is discounted at 10%, the immediate
increase in taxes of 2.487% would be reduced by the present value of
the subsequent decreases in taxes, which aggregate 1.588% of the
premium. The remainder, or 0.929% of the premiums received, is the
before-tax burden imposed by Section 848. This is the equivalent of an
after-tax increase of 1.4%.
Applicants represent that Prudential is willing to absorb a portion
of this burden and has determined to make a charge of 1.25% of the
premiums received in each year. Since this charge is made only to
recover the tax burden resulting from Section 848, Applicants assert
that the charge is equivalent to a premium tax. Prudential represents
that the 1.25% deduction from premiums is reasonably related to its
increased tax burden under Section 848 of the Code, taking into account
the benefit to Prudential of the amortization permitted by Section 848,
and the use of a 10% discount rate in computing the future deductions
resulting from such amortization.
9. Prudential believes that a charge of 1.25% of premium payments
would reimburse it for most of the impact of Section 848 (as currently
written) on its federal tax liabilities. Prudential submits, however,
that it would have to increase this charge if future changes in, or
interpretations, of, Section 848 or any successor provision result in a
further increased tax burden due to the receipt of premiums. Such an
increase could result from a change in the corporate tax rate, a change
in the 7.7% of premiums set forth in Section 848, or a change in the
amortization period required by that section. Such an increase could
also result if it became necessary or appropriate to increase the
discount rate. Changes in any of these factors could also make a
decrease in the charge appropriate. Prudential will reserve the right
to increase or decrease the 1.25% charge in response to future changes
in, or interpretations of, Section 848 or in any successor provision,
or changes in the cost of capital generally, that result in an increase
or decrease in its tax burden.
Applicants' Legal Analysis
1. Section 27(c)(2) of the 1940 Act prohibits a registered
investment company or a depositor or underwriter for such company from
making any deduction from purchase payments made under periodic payment
plan certificates other than a deduction for sales load. Section
2(a)(35) of the 1940 Act defines ``sales load'' as the difference
between the price of a security to the public and that portion of the
proceeds from its sale which is received and invested or held for
investment by the issuer (or in the case of a unit investment trust, by
the depositor or trustee), less any portion of such difference deducted
for trustee's or custodian's fees, insurance premiums, issue taxes, or
administrative expenses or fees which are not properly chargeable to
sales or promotional activities. Applicants contend that their proposed
tax burden charge is not properly chargeable to sales or promotional
activities, and therefore does not constitute sales load under Section
2(a)(35).
2. Sub-paragraph (b)(13)(iii)(E) of Rule 6e-3(T) provides an
exemption from Section 27(c)(2) to permit an insurer to make a
deduction other than for sales load, including charges to cover premium
or other taxes imposed by any state or other governmental entity.
Applicants request an exemption from Section 27(c)(2) only to preclude
the possibility that a charge related to the increased burden resulting
from Section 848 is not covered by the exemption for premium taxes
provided by Rule 6e-3(T)(b)(13)(iii)(E).
3. Paragraphs (b)(1) and (c)(4) of Rule 6e-3(T) together provide an
exemption from the Section 2(a)(35) definition of sales load by
substituting a new definition for use throughout the Rule. The
alternative definition, found in paragraph (c)(4) of Rule 6e-3(T),
defines sales load during a contract period as the excess of any
payments made during that period over the sum of certain specified
charges. Under paragraph (c)(4)(v), one of such charges is a deduction
for, and approximately equal to, state premium taxes. The Section 848
charge relates to federal taxes, rather than state premium taxes, and
therefore is not a deduction expressly permitted by Section (c)(4)(v)
of Rule 6e-3(T). Applicants seek an exemption from Section (c)(4)(v) so
that they may deduct the Section 848 charge in the manner that Rule 6e-
3(T)(c)(4)(v) currently permits state premium taxes to be deducted.
4. Because the proposed tax burden charge does not fall squarely
into any of the non-sales load charges or adjustments set out in
paragraph (c)(4) of Rule 6e-3(T), it might be considered as part of the
sales load charged on the variable life insurance contracts. Applicants
maintain, however, that there is no public policy reason why a tax
burden charge designed to cover the expense of federal taxes should be
treated as sales load or otherwise subject to the sales load limits of
Rule 6e-3(T). Applicants also assert that nothing in the administrative
history of the Rule (or, for that matter, in the administrative history
of Rule 6e-2, its predecessor rule) suggests that the Commission
intended to treat tax charges as sales load and that if Section 848 had
been enacted prior to the adoption of Rule 6e-3(T), a charge of the
kind described above would surely have been included among the charges
described in paragraph (c)(4) of Rule 6e-3(T).
5. Section 6(c) of the 1940 Act, in relevant part, authorizes the
Commission, by order upon application, to exempt any person, security
or transaction or any class or classes of persons, securities or
transactions from any provision or provision of the 1940 Act or any
rule or regulation thereunder, if and to the extent that the 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 the 1940 Act. Applicants request an order
pursuant to Section 6(c) of the 1940 Act, exempting them and any future
separate accounts that may be established by any of the three insurance
company Applicants from the provisions of Section 27(c)(2) of the 1940
Act and paragraph (c)(4)(v) of Rule 6e-3(T) under the 1940 Act, to the
extent necessary to permit them to deduct from premium payments made
under flexible premium variable life insurance contracts, a charge in
an amount that is reasonable in relation to Prudential's increased
federal tax burden related to the receipt of such premium payments.
6. Applicants state that the exemption requested is necessary in
order for them and any future separate accounts to rely on sub-
paragraph (b)(13)(i) of Rule 6e-3(T), which provides critical
exemptions from the sales load limitations of Sections 27(a)(1) and
27(h)(1) of the 1940 Act. Applicants are exempted from those sales load
limitations only if they adhere to the alternate sales load limitations
set out in paragraph (b)(13)(i), and Applicants state that it is unfair
and inappropriate to include the proposed tax burden charge as a part
of the sales load when applying the provisions of Rule 6e-
3(T)(b)(13)(i). Applicants state that the public policy that underlies
sub-paragraph (b)(13)(i), like that which underlies Sections 27(a)(1)
and 27(h)(1), is to prevent excessive sales loads from being charged in
connection with the sale of periodic payment plan certificates. The
treatment of a tax burden charge attributable to the receipt of premium
payments as sales load would not in any way further this legislative
purpose, because such a deduction has no relation to the payment of
sales commissions or other distribution expenses.
Applicant's Conditions
Applications agree to comply with the following as conditions to
the exemptions requested herein:
1. Prudential will monitor the reasonableness of the 1.25% charge.
2. The registration statement for any variable life insurance
contract under which the 1.25% charge is deducted will include (a)
disclosure of the charges, (b) disclosure explaining the purposes of
the charge, and (c) a statement that the charge is reasonable in
relation to Prudential's increased tax burden as a result of Section
848 of the Code.
3. Prudential will also include as an exhibit to the registration
statement for any variable life insurance contract under which the
1.25% charge is deducted an actuarial opinion as to (a) the
reasonableness of the charge in relation to Prudential's increased tax
burden as a result of Section 848 of the Code, (b) the reasonableness
of the after tax rate of return used in calculating the charge, and (c)
the appropriateness of the factors taken into account by Prudential in
determining the after tax rate of return.
Conclusion
Applicants submit that for the reasons and upon the facts set forth
above, the requested exemptions from Sections 27(c)(2) of the 1940 Act
and paragraph (c)(4)(v) of Rule 6e-3(T) under the 1940 Act to permit
them to deduct 1.25% of premium payments meet the standards in Section
6(c) of the 1940 Act. In this regard, Applicants assert that granting
the relief requested in this application would be appropriate in the
public interest and consistent with the protection of investors and the
purposes fairly intended by the policy and provisions of the 1940 Act.
For the Commission, by the Division of Investment Management,
under delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-2122 Filed 1-31-94; 8:45 am]
BILLING CODE 8010-01-M
