[Federal Register Volume 60, Number 25 (Tuesday, February 7, 1995)]
[Notices]
[Pages 7259-7262]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-2903]
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SECURITIES AND EXCHANGE COMMISSION
[Rel. No. IC-20873; No. 812-8854]
Golden American Life Insurance Company, et al.
January 31, 1995.
AGENCY: Securities and Exchange Commission (``SEC'' or ``Commission'').
ACTION: Notice of Application for an Order under the Investment Company
Act of 1940 (``1940 Act'').
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APPLICANTS: Golden American Life Insurance Company (``Golden
American''), Separate Account A of Golden American (``Account A''), Any
Other Separate Account Established By Golden American In The Future To
Support Variable Life Insurance Contracts Issued by Golden American
(``Future Accounts''), and Directed Services, Inc. (``DSI'').
RELEVANT 1940 ACT SECTIONS: Order requested under section 6(c) granting
exemptions from the provisions of Sections 26(a)(2)(C), 27(c)(1) and
27(c)(2) of the 1940 Act and from paragraphs (b)(1), (b)(12)(i),
(b)(13)(iv) and (c)(4)(v) of Rule 6e-2 and of Rule 6e-3(T), and from
Rule 22c-1 thereunder.
SUMMARY OF APPLICATION: Applicant request an order that would permit
them to deduct a charge from premium payments to compensate Golden
American for its increased federal tax burden resulting from the
application of Section 848 of the Internal Revenue Code of 1986, as
amended, to the receipt of such payments under certain variable life
insurance contracts. Applicants also propose to deduct the charge on a
deferred basis from contract cash value, with the balance of any
unrecovered amount being deducted upon surrender.
FILING DATE: The application was filed on February 23, 1994.
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 Commission's Secretary
and serving Applicants with a copy of the request, personally or by
mail. Hearing requests should be received by the Commission by 5:30
p.m. on February 27, 1995, and should be accompanied by proof of
service on Applicants in the form of an affidavit or, for lawyers, a
certificate of service. Hearing requests should state the nature of the
requestor's interest, the reason for the request, and the issues
contested. Persons may request notification of a hearing by writing to
the Secretary of the Commission.
ADDRESSES: Secretary, Securities and Exchange Commission, 450 5th
Street, NW., Washington, DC 20549. Applicants: c/o Golden American, 280
Park Avenue, New York, New York 10017.
FOR FURTHER INFORMATION CONTACT:
Yvonne M. Hunold, Senior Counsel, or Wendy F. Friedlander, Deputy
Chief, at (202) 942-0670, Office of Insurance Products (Division of
Investment Management).
SUPPLEMENTARY INFORMATION: The following is a summary of the
application; the complete application is available for a fee from the
Commission's Public Reference Branch.
Applicant's Representations
1. Golden American is a stock life insurance company and an
indirect subsidiary of Bankers Trust Company (``Bankers'').
2. Account A is a separate account established by Golden American
and registered under the 1940 Act as a unit investment trust. Each of
Account A's 10 divisions invests in a corresponding portfolio of The
GCG Trust (``GCG Trust''), a registered open-end management company.
Account A is, and any Future Account will be, used to fund certain
variable life insurance contracts issued by Golden American, including
the GoldenSelect VLI and GoldenSelect VL10 Contracts (``Contracts''). A
registration statement to register the Contracts under the Securities
Act of 1933 has been filed with the Commission. Applicants state that
the Contracts will be issued in reliance on the applicable provisions
of either Rule 6e-2 or Rule 6e-3(T).
3. DSI, the principal underwriter for the Contracts, is an indirect
wholly-owned subsidiary of Bankers and an affiliate of Golden American.
DSI is a registered broker-dealer under the Securities Exchange Act of
1934 and a member of the National Association of Securities Dealers,
Inc.
4. Applicants propose to deduct a charge to reimburse Golden
American for the increase in its federal income taxes resulting from
the application of Section 848 of the Internal Revenue Code of 1986
(``Code''), as amended, to the receipt of premium payments under the
Contracts. The charge will be reasonably related to Golden American's
increased federal tax burden. The charge will be deducted either from
(a) premiums received, or (b) Contract cash value on a deferred basis
in a series of equal periodic installments, with the balance of any
unrecovered amount to be deducted upon early surrender of a Contract.
The deduction will be the same notwithstanding the manner in which it
is deducted.
5. The Omnibus Budget Reconciliation Act of 1990 (``OBRA 1990''),
amending Section 848 of the Code, requires life insurance companies of
capitalize and amortize over ten years certain general expenses for the
current year. Prior law allowed these expenses to be deducted in full
from the current year's gross income. Section 848, as amended,
effectively accelerates the realization of income from specified
contracts and, consequently, the payment of taxes on that income.
Taking into account the time value of money, Section 848 increases the
insurance company's tax burden because the [[Page 7260]] amount of
general deductions that must be capitalized and amortized is measured
by the premiums received under the Contracts.
6. The amount of deductions subject to Section 848 equals a
percentage of the current year's net premiums received (i.e., gross
premiums minus return premiums and reinsurance premiums) under life
insurance or other contracts categorized under this Section. The
Contracts will be categorized under Section 848 as life insurance
contracts requiring 7.7% of the net premiums received to be capitalized
and amortized under the schedule set forth in Section 848(c)(1).
7. The increased tax burden on every $10,000 of net premiums
received under the Contracts is quantified by Applicants as follows.
For each $10,000 of net premiums received in a given year, Golden
American must capitalize $770 (i.e., 7.7% of $10,000), and $38.50 of
this amount may be deducted in the current year. The remaining $731.50
($770 less $38.50) is subject to taxation at the corporate tax rate of
35% and results in $256.03 (.35% x $731.50) more in taxes for the
current year than Golden American otherwise would have owed prior to
OBRA 1990. However, the current tax increase will be offset partially
by deductions allowed during the next ten years, which result from
amortizing the remainder of the $770 ($77 in each of the following nine
years and $38.50 in year ten).
8. It is Golden American's business judgment that it is appropriate
to use a discount rate of at least 10% in evaluating the present value
of its future tax deductions for the following reasons. Capital that
Golden American must use to pay its increased federal tax burden under
Section 848 will be unavailable for investment. The cost of capital
used to satisfy this increased tax burden essentially will be Golden
American's targeted rate of return (i.e., the return sought on invested
capital), which is in excess of 10%. Accordingly, Applicants submit
that the targeted rate of return is appropriate for use in this present
value calculation. To the extent that the 10% discount rate is lower
than Golden American's actual targeted rate of return, the calculation
of this increased tax burden will continue to be reasonable over time,
even if the corporate tax rate applicable to Golden American is
reduced, or its targeted rate of return is lowered.
9. In determining the targeted rate of return used in arriving at
the discount rate, Golden American considered a number of factors,
which it represents are appropriate factors to consider. First, Golden
American identified the level of investment return that can be expected
to be earned risk-free over the long term. This rate is based upon the
expected yield on a 30-year U.S. Treasury Bond. Golden American then
increased this rate by the market risk premium demanded by equity
investors as compensation for the risks associated with equity
investments. The market risk premium is based on the average excess
return earned by investing in equities as compared to that earned by
investing in risk-free instruments (i.e., long-term U.S. Treasury
Bonds). Finally, the resulting rate was modified to reflect the
relative volatility of an equity investments in Bankers, Golden
American's indirect parent.
10. Using a federal corporate tax rate of 35% and assuming a
discount rate of 10%, the present value of the tax effect of the
increased deductions allowable in the following ten years, which
partially offsets the increased tax burden, comes to $160.40. The
effect of Section 848 on the Contracts is therefore an increased tax
burden with a present value of $95.63 for each $10,000 of net premiums
(i.e., $256.03 less $160.40).
11. Golden American does not incur incremental federal income tax
when it passes on state premium taxes to Contract Owners because state
premium taxes are deductible in computing federal income taxes.
Conversely, federal income taxes are not deductible in computing Golden
American's federal income taxes. To compensate Golden American fully
for the impact of Section 848, Golden American must impose an
additional charge to make it whole for the $95.63 additional tax burden
attributable to Section 848, as well as the tax on the additional
$95.63 itself, which can be determined by dividing $95.63 by the
complement of 35% federal corporate income tax rate (i.e., 65%),
resulting in an additional charge of $147.12 for each $10,000 of net
premiums, or 1.47%.
12. Based on its prior experience, Golden American reasonably
expects to fully take almost all future deductions. It is Golden
American's judgment that a 1.38% charge would reimburse it for the
increased federal income tax liabilities under Section 848. Applicants
represent that the 1.38% charge will be reasonably related to Golden
American's increased federal income tax burden under Section 848. This
representation takes into account the benefit to Golden American of the
amortization permitted by Section 848 and the use of a 10% discount
rate (which is equivalent to Golden American's targeted rate of return)
in computing the future deductions resulting from such amortization.
Golden American believes that the 1.38% charge would have to be
increased if future changes in, or interpretations of, Section 848 of
any successor provision result in a further increased tax burden due to
receipt of premiums. The increase could be caused by a change in the
corporate tax rate, or in the 7.7% figure, or in the amortization
period.
Applicants' Legal Analysis
1. Applicants request an order under Section 6(c) of the 1940 Act
granting exemptions from Section 27(c)(2) of the 1940 Act to allow the
deduction of a charge from premiums to compensate Golden American for
its increased federal tax burden based on receipt of these premiums
under the Contracts. The charge will be in an amount that is reasonably
related to Golden American's increased federal tax burden. Applicants
also request exemptions from subparagraph (c)(4)(v) of Rules 6e-2 and
6e-3(T) under the 1940 Act to permit the proposed deductions to be
treated as other than ``sales load,'' as defined under Section 2(a)(35)
of the 1940 Act, for purposes of Section 27 and the exemptions from
various provisions of that Section found in Rules 6e-2 and 6e-3(T),
respectively. Applicants assert that it is appropriate to deduct a
charge for an insurer's increased tax burden attributable to premiums
received, and to exclude the deduction of this charge from sales load,
because it is a legitimate expense of the company and not for sales and
distribution expenses.
2. Applicants further request an order under Section 6(c) for
exemptions from Sections 26(a)(2)(C), 27(c)(1) and 27(c)(2) of the 1940
Act, paragraphs (b)(1), (b)(12)(i), (b)(13)(iv) of Rules 6e-2 and 6e-
3(T) and Rule 22c-1 thereunder, to permit the deduction of the charge
from Contract cash value in deferred, equal periodic installments, as
an alternative to a deduction of the charge from premium payments, to
compensate Golden American for its increased tax burden under Section
848. Any unrecovered amount of the deferred charge will be deducted
from such assets upon an early surrender of a Contract.
3. Section 6(c) authorizes the Commission, by order and upon
application, to exempt any person, security, or transaction, or class
of persons, securities, or transactions, from any provisions of the
1940 Act. The Commission grants relief under Section 6(c) to the extent
an 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].''
[[Page 7261]]
4. Account A is, and the Future Accounts will be, regulated under
the 1940 Act as issuers of periodic payment plan certificates.
Accordingly, Account A, the Future Accounts, Golden American (as
depositor), and DSI (as principal underwriter) are deemed to be subject
to Section 27 of the 1940 Act.
5. Section 27(c)(2) prohibits the sale of periodic payment plan
certificates unless the following conditions are met. The proceeds of
all payments (except amounts deducted for ``sales load'') must be held
by a trustee or custodian having the qualifications established under
Section 26(a)(1) for the trustees of unit investment trusts. These
proceeds also must be held under an indenture or agreement that
conforms with the provisions of Section 26(a)(2) and Section 26(a)(3)
of the 1940 Act.
6. ``Sales load'' is defined under Section 2(a)(35), in relevant
part, 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.
Sales loads on periodic payment plan certificates are limited by
Sections 27(a)(1) and 27(h)(1) to a maximum of 9% of total payments.
7. Certain provisions of Rules 6e-2 and 6e-3(T) provides a range of
exemptive relief. Rule 6e-2 provides exemptive relief if the separate
account issues scheduled premium variable life insurance contracts as
defined in Rule 6e-2(c)(1). Rule 6e-3(T) provides exemptive relief if
the separate account issues flexible premium variable life insurance
contracts, as defined in subparagraph (c)(1) of that Rule.
8. Applicants state that paragraph (b)(13)(iii) of Rule 6e-2
implicitly provides, and paragraph (b)(13)(iii) of Rule 6e-3(T)
explicitly provides, exemptive relief from Section 27(c)(2) permit an
insurer to make certain deductions, other than sales load, including
the insurer's tax liabilities from receipt of premium payments imposed
by states or by other governmental entities. Applicants assert that the
proposed deduction with respect to Section 848 of the Code arguably is
covered by subparagraph (b)(13)(iii) of each Rule. Applicants note,
however, that the language of paragraph (c)(4) of the Rules appears to
require that deductions for federal tax obligations from receipt of
premium payments be treated as ``sales load.''
9. Applicants state that paragraph (b)(1), together with paragraph
(c)(4), of each Rule provides an exemption from the Section 2(a)(35)
definition of ``sales load'' by substituting a new definition to be
used for purposes of each respective Rule. Rule 6e-2(c)(4) defines
``sales load'' charged on any payment as the excess of the payment over
certain specified charges and adjustments, including a deduction for
state premium taxes. Rule 6e-3(T)(c)(4) defines ``sales load'' during a
period as the excess of any payments made during that period over
certain specified charges and adjustments, including a deduction for
state premium taxes. Under a literal reading of paragraph (c)(4) of the
Rules, a deduction for an insurer's increased federal tax burden does
not fall squarely into those itemized charges or deductions, arguably
causing the deduction to be treated as part of ``sales load.''
10. Applicants state that the public policy that underlies
paragraph (b)(13) of each Rule, and particularly subparagraph
(b)(13)(i), like that which underlies paragraphs (a)(1) and (h)(1) of
Section 27, is to prevent excessive sales loads from being charged for
the sale of periodic payment plan certificates. Applicants submit that
this legislative purpose is not furthered by treating a federal income
tax charge based on premium payments as a sales load because the
deduction is not related to the payment of sales commissions or other
distribution expenses. Applicants assert that the Commission has
concurred with this conclusion by excluding deductions for state
premium taxes from the definition of sales load in paragraph (c)(4) of
each Rule.
11. Applicants submit that the source for the definition of ``sales
load'' found in paragraph (c)(4) of each Rule supports this analysis.
Applicants believe that, in adopting paragraph (c)(4) of each Rule, the
Commission intended to tailor the general terms of Section 2(a)(35) to
variable life insurance contracts to ease verification by the
Commission of compliance with the sales load limits of subparagraph
(b)(13)(i) of each Rule. Just as the percentage limits of Section
27(a)(1) and 27(h)(1) depend on the definition of sales load in Section
2(a)(35) for their efficacy, Applicants assert that the percentage
limits in subparagraph (b)(13)(i) of each Rule depend on paragraph
(c)(4) of each Rule, which does not depart, in principal, from Section
2(a)(35).
12. Applicants submit that the exclusion from the definition of
``sales load'' under Section 2(a)(35) of deductions from premiums for
``issue taxes'' suggests that it is consistent with the policies of the
1940 Act to exclude from the definition of ``sales load'' in Rules 6e-2
and 6e-3(T) deductions made to pay an insurer's costs attributable to
its federal tax obligations. Additionally, the exclusion of
administrative expenses or fees that are ``not properly chargeable to
sales or promotional activities'' also suggests that the only
deductions intended to fall within the definition of ``sales load'' are
those that are properly chargeable to sales or promotional activities.
Applicants state that the proposed deductions will be used to
compensate Golden American for its increased federal tax burden
attributable to the receipt of premiums and not for sales or
promotional activities. Therefore, Applicants believe the language in
Section 2(a)(35) further indicates that not treating such deductions as
sales load is consistent with the policies of the 1940 Act.
13. Finally, Applicants submit that it is probably an historical
accident that the exclusion of premium tax in subparagraph (c)(4)(v) of
Rules 6e-2 and 6e-3(T) from the definition of ``sales load'' is limited
to state premium taxes. When these Rules were each adopted and, in the
case of Rule 6e-3(T), later amended, the additional Section 848 tax
burden attributable to the receipt of premiums did not yet exist.
14. As noted above, Section 27(c)(2) prohibits the sale of periodic
payment plan certificates unless the proceeds, other than sales loads,
are deposited with and held by a qualified trustee or custodian, as
defined in Section 26(a)(1), under a trust agreement that satisfies the
requirements of Sections 26(a)(2) and (a)(3). Section 26(a)(2)
prohibits payments from the assets of a registered unit investment
trust to its depositor or principal underwriter, or their affiliates or
agents, unless the payment is reasonable compensation for performing
certain bookkeeping and other administrative duties.
15. Section 27(c)(1) prohibits the sale of a period payment plan
certificate by any registered investment company, its depositor or its
underwriter, unless the certificate is a redeemable security.
``Redeemable security'' is defined in Section 2(a)(32) as any security
which entities the holder to receive a proportionate share of the
issuer's current net assets, or the cash equivalent. Rule 22c-1, in
part, prohibits a registered investment company from selling, redeeming
or repurchasing a redeemable security it has issued except at a price
based on the current net asset value of the security. [[Page 7262]]
16. Rule 6e-3(T)(b)(1) provides an exemption from Sections 26(a)
and 27(c)(1) and Rule 22c-1 in connection with any sales load deducted
under Rule 6e-3(T), other than from premiums. Rule 6e-2 does not have a
corresponding provision. Rule 6e-3(T)(12(i) provides, in relevant part,
an exemption from Section 27(c)(1) and Rule 22c-1 provided that, to the
extent that the calculation of cash value reflects deductions for
administrative expenses and fees or sales loads, such deductions need
only be made at such times as specified in the Contracts. Although Rule
6e-2(b)(12) provides similar exemptions, it does not provide for the
deduction of deferred administrative expenses and fees or deferred
sales load. Finally, Rule 6e-3(T)(b)(13)(iv)(C) provides that, subject
to other provisions of that Rule, sales loads and administrative
expenses or fees may be deduced upon redemption. Rule 6e-
2(b)(b)(13)(iv) does not provide similar exemptions. Applicants believe
that the omissions noted herein reflect the Commission's assumption at
the time it promulgated Rule 6e-2 that sales loads would only be
deducted from premiums, rather than a policy decision to forbid other
arrangements.
17. Applicants state that it is appropriate to deduct the 1.38%
charge on a deferred basis for the same reasons that it is proper to
deduct the charge directly from premiums. Nevertheless, Applicants
believe they may not be able to rely on paragraphs (b)(1), (b)(12)(i),
or (b)(13)(i) of Rules 6e-2 and 6e-3(T) because the deferred charge may
be deemed other than an ``administrative charge'' or other than sales
load under Rule 6e-3(T), and because the imposition of deferred charges
was not contemplated when Rule 6e-2 was adopted.
18. Applicants submit that the deferred charge is more favorable to
a Contract Owner than the direct charge from premiums for the following
reasons. First, the premium payments available for investment and,
thus, the investment itself, will be greater than it would be if such a
charge was deducted from premiums. Second, the total amount charged to
any Contract Owner is not more than it would be if it was taken
directly from premiums paid. Finally, Contract Owners will obtain these
advantages without incurring any additional cost.
19. Applicants further submit that it is equally proper to deduct
any remaining amount of the deferred charge upon early surrender of a
Contract, and that the deduction will not violate Sections 2(a)(32) or
27(c)(1) or Rule 22c-1. First, any remaining amount of the charge
deducted upon early surrender is the same amount that would have been
deducted if the Contract had not been surrendered. Further, this charge
represents a burden borne by Golden American for which it is entitled
to be reimbursed. Applicants assert that the deduction upon surrender
of any unrecovered amount should not be construed as a restriction on
redemption. Finally, Applicants maintain that the Contract are and will
be redeemable securities, and that the deduction of any remaining
charge upon surrender represents a legitimate deduction under the
Contracts.
20. Applicants believe that the exemptions provided by paragraph
(b)(1), (b)(12)(i), and (b)(13)(iv) of Rules 6e-2 and 6e-3(T) do not
appear to embrace the deduction of the proposed charge on a deferred
basis. Rule 6e-2 was adopted when there was less flexibility regarding
premium payments and fewer policy features were available to issuers
than have subsequently been permitted. In contrast, Rule 6e-3(T)
contemplated deferred sales loads and deferred administrative charges,
but not the proposed charge.
Applicants submit that: (a) No policy reason exists for the
omission of relief for such a deferred charge from the provisions of
Rules 6e-2 or 6e-3(T); (b) the deferred charge structure has been
accepted as an appropriate feature of life insurance products under
Rule 6e-3(T), as well as pursuant to exemptive relief granted by the
Commission; (c) the existence of products with deferred charges
provides investors a valuable choice; and (d) the Commission has
supported efforts to expand investor choice without sacrificing
investor protection.
21. Applicants assert that the standards of Section 6(c) are
satisfied because the requested relief is appropriate in the public
interest and consistent with the purposes of the 1940 Act and the
protection of investors. The exemptive relief would: (a) Permit a
larger portion of each premium to be immediately invested under a
Contract; (b) eliminate the need for Golden American to file additional
exemptive applications for each Contract to be issued through a Future
Account with respect to the same issues under the 1940 Act that have
been addressed in this Application; thus (c) promoting competitiveness
in the variable life insurance market by avoiding delay, reducing
administrative expenses and maximizing efficient use of resources; and
thereby (d) enhancing Golden American's ability to effectively take
advantage of business opportunities as they arise. If Golden American
were required to repeatedly seek exemptive relief with respect to the
same issues addressed in this Application, investors would not receive
any benefit or additional protection thereby and might be disadvantaged
as a result of increased overhead expenses.
Conditions for Relief
1. Golden American will monitor the reasonableness of the charge to
be deducted pursuant to the requested exemptive relief.
2. The registration statement for each Contract under which the
above-referenced charge is deducted will: (a) Disclose the charge; (b)
explain the purpose of the charge; and (c) state that the charge is
reasonable in relation to Golden American's increased federal tax
burden under Section 848 of the Code.
3. The registration statement for each Contract providing for the
above-referenced deduction will contain as an exhibit an actuarial
opinion as to: (a) The reasonableness of the charge in relation to
Golden American's increased federal tax burden under Section 848 of the
Code resulting from the receipt of premiums; (b) the reasonableness of
the targeted rate of return that is used in calculating such charge;
and (c) the appropriateness of the factors taken into account by Golden
American in determining such targeted rate of return.
Conclusion
For the reasons and upon the facts set forth above, Applicants
submit that the requested exemptions to permit Golden American to
deduct 1.38% of premium payments under the Contracts are 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,
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-2903 Filed 2-6-95; 8:45 am]
BILLING CODE 8010-01-M
