[Federal Register Volume 61, Number 105 (Thursday, May 30, 1996)]
[Notices]
[Pages 27110-27112]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-13544]
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SECURITIES AND EXCHANGE COMMISSION
[Rel. No. IC-21981; No. 812-9848]
Aetna Life Insurance and Annuity Company, et al.
May 23, 1996.
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: Aetna Life Insurance and Annuity Company (``Aetna'') and
Variable Life Account B of Aetna Life Insurance and Annuity Company
(``Separate Account'').
RELEVANT 1940 ACT SECTIONS: Order requested under Section 6(c) granting
exemptions from Section 27(c)(2) of the 1940 Act and Rule 6e-
3(T)(c)(4)(v) thereunder.
SUMMARY OF APPLICATION: Applicants request an order that will permit
the Separate Account, any future separate accounts established by Aetna
(``Future Accounts''), and all other persons, other than Aetna, that
may, in the future serve as a principal underwriter (``Future Broker-
Dealers'') of certain flexible premium variable life insurance policies
issued by Aetna, to deduct from premium payments an amount that is
reasonably related to the Aetna's increased federal tax burden
resulting from the receipt of those premium payments, pursuant to
Section 848 of the Internal Revenue Code of 1986, as amended
(``Code'').
FILING DATE: The application was filed on November 15, 1995 and was
amended on May 17, 1996.
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 June 18, 1996, 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, N.W., Washington, D.C. 20549. Applicants: Susan E. Bryant,
Esq., Aetna Life Insurance and Annuity Company, 151 Farmington Avenue,
Hartford, Connecticut 06156.
FOR FURTHER INFORMATION CONTACT: Pamela K. Ellis, Senior Counsel, or
Wendy Finck Friedlander, Deputy Chief, Office of Insurance Products
(Division of Investment Management), at (202) 942-0670.
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.
Applicants' Representations
1. Aetna is a stock life insurance company, organized in
Connecticut, and is a wholly owned subsidiary of Aetna Life and
Casualty Company.
2. The Separate Account is a separate account established by Aetna
and registered under the 1940 Act as a unit investment trust.
Currently, the Separate Account has 17 subaccounts each of which
invests in a corresponding investment portfolio of an open-end
management investment company registered under the 1940 Act. The
Separate Account funds flexible premium variable life insurance
policies issued by Aetna (``Current Policies'') for which a
registration statement has been filed with the Commission to register
interests in the Current Policies under the Securities Act of 1933, and
flexible premium variable life insurance policies developed by Aetna in
the future (``Future Policies'') (Current Policies, together with
Future Policies, ``Policies''). Aetna anticipates that any Future
Accounts established to fund Current Policies or Future Policies would
be registered under the 1940 Act as unit investment trusts.
3. Aetna is the principal underwriter and distributor for the
Policies. Aetna is a registered broker-dealer under the Securities
Exchange Act of 1934 (``1934 Act''), and is a member of the National
Association of Securities Dealers, Inc. (``NASD''). Any Future Broker-
Dealer will be registered as a broker-dealer under the 1934 Act, and
will be a member of the NASD.
4. Applicants propose to deduct from premium payments received
under the Policies a 1.25% charge to reimburse Aetna for the increase
in its federal income taxes resulting from Section 848 of the Code. The
charge will be reasonably related to Aetna's increased federal tax
burden.
5. The Omnibus Budget Reconciliation Act of 1990 (``OBRA 1990''),
amending Section 848 of the Code, requires life insurance companies to
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 amount of general deductions
that must be capitalized and amortized is measured by the premiums
received under the policies.
[[Page 27111]]
6. The amount of expenses 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
Policies 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 Policies is quantified by Applicants as follows. For
each $10,000 of net premiums received in a given year, Aetna 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 Aetna would have owed prior to the enactment of 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. In Aetna's business judgement, it is appropriate to use a
discount rate of at least 10% in evaluating the present value of its
future tax deductions. Capital that Aetna 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 Aetna's after-tax rate of return (i.e., the
return sought on invested capital), which is at least 10%.\1\
Accordingly, Applicants submit that the targeted rate of return is
appropriate for use in this present value calculation.
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\1\ In determining the rate of return used in arriving at the
discount rate, Aetna considered a number of factors. These factors
included current market interest rates and expected interest rate
trends, inflation, Aetna's anticipated long-term growth rate, the
level of risk acceptable to Aetna, and available information about
rates of return obtained by other life insurance companies.
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9. 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, amounts to $160.40. The
effect of Section 848 on the Policies is, therefore, an increased tax
burden with a present value of $95.63 for each $10,000 of net premium
payments received (i.e., $256.03 minus $160.40).
10. Aetna does not incur incremental federal income tax when it
passes on state premium taxes to Policy owners because state premium
taxes are deductible in computing federal income taxes. In contrast,
federal income taxes are not deductible in computing Aetna's federal
income taxes. To compensate Aetna fully for the impact of Section 848,
Aetna must impose an additional charge to make it whole for not only
the $95.63 additional tax burden attributable to Section 848, but also
the tax on the additional $95.63 itself. This additional charge 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%.
11. Based on its prior experience, Aetna reasonably expects to take
fully almost all future deductions. It is Aetna's judgement that a
1.25% charge would reimburse it for the increased federal income tax
liabilities, under Section 848. Applicants represent that the 1.25%
charge will be reasonably related to Aetna's increased federal income
tax burden under Section 848. This representation takes into account
the benefit to Aetna of the amortization permitted by Section 848 and
the use of a 10% discount rate (which is equivalent to Aetna's targeted
rate of return) in computing the future deductions resulting from such
amortization.
Applicants' Legal Analysis
1. Applicants request an order under Section 6(c) of the 1940 Act
exempting them and any Future Accounts from the provisions of Section
27(c)(2) of the 1940 Act, and Rule 6e-3(T)(c)(4)(v) thereunder, to the
extent necessary to permit Applicants and any Future Accounts to deduct
from premium payments made under the Policies, a charge in an amount
that is reasonable in relation to Aetna's increased federal tax burden
related to the receipt of such premium payments, without treating such
charge as a sales load. 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. In addition, Applicants request
that the order extend the same exemptions granted to Aetna, to any
Future Broker-Dealer that may in the future serve as principal
underwriter for the Current Policies or Future Policies.
2. 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.
3. The Separate Account is, and the Future Accounts will be,
regulated under the 1940 Act as issuers of periodic payment plan
certificates. Accordingly, the Separate Account, the Future Accounts,
and Aetna are subject to Section 27 of the 1940 Act.
4. 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.
5. ``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.
6. Rule 6e-3(T) provides a range of exemptive relief to separate
accounts issuing flexible premium variable life insurance contracts, as
defined in subparagraph (c)(1) of that Rule.
For example, paragraph (b)(13)(iii)(E) of Rule 6e-3(T) provides
exemptive relief from Section 27(c)(2) by permitting 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 tax
burden charge arguably is covered by subparagraph (b)(13)(iii) or Rule
6e-3(T). Applicants note, however, that the language of paragraph
(c)(4) of the Rule appears to require that deductions for federal tax
obligations resulting from receipt of
[[Page 27112]]
premium payments be treated as ``sales load.''
7. 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 Rule, a deduction
for an insurer's increased federal tax burden does not fall squarely
into those itemized charges or deductions, arguably causing the
proposed tax burden charge to be treated as part of ``sales load.''
8. Applicants submit that the Rule 6e-3(T)(c)(4)(v) limitation of
the premium tax exclusion from the definition of ``sales load'' to
state premium taxes probably is an historical accident related to that
fact that when Rule 6e-3(T) was adopted in 1984, and when it was
amended in 1987, the additional Code Section 848 tax burden
attributable to the receipt of premiums did not exist. Applicants
further submit that nothing in the administrative history of Rule 6e-
3(T) suggests that the exclusion from the definition of sales load of
deductions for tax liabilities attributable to the amount of premium
payments received was tied to the type of government entity imposing
such taxes.
9. Applicants also request exemptions for any Future Accounts that
Aetna may establish to support the Current Policies or any Future
Policies, as well as for each Future Broker-Dealer that may distribute
the Current Policies or Future Policies.
10. 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 eliminate the need
for Aetna to file additional exemptive applications for each Current
Policy or Future Policy to be issued through a Future Account with
respect to the same issues under the 1940 Act that have been addressed
in this application, as well as for each Future Broker-Dealer that
distributes the Current Policy or Future Policy, and thus would promote
competitiveness in the variable life insurance market by avoiding
delay, reducing administrative expenses, and maximizing efficient use
of resources. Applicants further assert that the exemptive relief would
enhance Aetna's ability to effectively take advantage of business
opportunities as they arise. If Aetna were required to seek exemptive
relief repeatedly 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.
11. Applicants believe that a charge of 1.25% of premium payments
would reimburse Aetna for the impact of Section 848 of the Code, as
currently written on its federal income tax liabilities. Aetna
believes, however, that it may have to increase this charge if any
change in, or interpretation of, Section 848 or any successor provision
results in a further increased federal income tax burden due to the
receipt of premiums. Such an increase could result from a change in
corporate federal income tax rate, a change in the 7.7% figure, or a
change in the amortization period.
Conditions for Relief
1. Aetna will monitor the reasonableness of the 1.25% charge.
2. The registration statement for each Policy under which the 1.25%
tax burden 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 Aetna's increased federal tax burden under
Section 848 of the Code.
3. The registration statement for each Policy providing for the
1.25% tax burden charge will contain as an exhibit an actuarial opinion
as to: (a) the reasonableness of the charge in relation to Aetna'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 Aetna in
determining such targeted rate of return.
Conclusion
For the reasons and upon the facts set forth above, Applicants
submit that the requested exemptions from Section 27(c)(2) of the 1940
Act and Rule 6e-3(T)(c)(4)(v) thereunder, 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. 96-13544 Field 5-29-96; 8:45 am]
BILLING CODE 8010-01-M
