[Federal Register Volume 61, Number 148 (Wednesday, July 31, 1996)]
[Notices]
[Pages 40035-40040]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-19373]
=======================================================================
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Rel. No. IC-22097; File No. 812-9992]
Continental Assurance Company, et al.
July 25, 1996.
AGENCY: Securities and Exchange Commission (``SEC'' or ``Commission'').
ACTION: Notice of application for exemptions under the Investment
Company Act of 1940 (``1940 Act'').
-----------------------------------------------------------------------
APPLICANTS: Continental Assurance Company (``CAC''), Valley Forge Life
Insurance Company (``VFL,'' together with CAC, the ``Companies''),
Continental Assurance Company Variable Life Separate Account (``CAC
Account''), Valley Forge Life Insurance Company Variable Life Separate
Account (``VFL Account''), and CNA Investor Services, Inc.
Relevant 1940 Act Sections: Sections 6(c), 27(a)(3), 27(c)(2), and
27(e), and Rules 6e-3(T)(b)(13)(ii), 6e-3(T)(b)(13)(vii), 6e-
3(T)(c)(4)(v), and 27e-1 thereunder.
SUMMARY OF APPLICATION: Applicants seek an order to the extent
necessary to permit them or any other variable life insurance separate
account established in the future by the Companies (``Future
Accounts,'' collectively with the CAC Account and the VFL Account, the
``Accounts'') to support certain flexible premium variable life
insurance policies offered currently or in the future through the
Accounts (collectively, ``Policies'') to: (1) deduct from premium
payments received under the Policies a charge that is reasonable in
relation to each Company's increased federal tax burden related to the
receipt of such premium payments that results from the application of
Section 848 of the Internal Revenue Code of 1986, as amended,
(``Code''); (2) deduct sales charges from premium payments received in
connection with Policies in a manner that results, in some instances,
in sales charges on subsequent premium payments exceeding sales charges
on prior premium payments; (3) compute sales surrender charges on such
premium payments in a manner that results, in some instances, in sales
surrender charges on subsequent premium payments exceeding sales
surrender charges on prior premium payments; and (4) refrain from
sending owners of Policies a written notice of certain refund and
withdrawal rights.
Filing Date: The application was filed on February 14, 1996.
Hearing or Notification of Hearing: An order granting the application
will be issued unless the SEC 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 August 16, 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 writer's interest, the reason
for the request, and the issues contested.
[[Page 40036]]
Persons who wish to be notified of a hearing may request notification
by writing to the Secretary of the SEC.
ADDRESSES: Secretary, SEC, 450 Fifth Street, N.W., Washington, D.C.
20549: Applicants. Donald M. Lowry, Esq., Senior Vice President and
General Counsel, CNA Insurance Companies, CNA Plaza, 43 South, Chicago,
Illinois 60685.
FOR FURTHER INFORMATION CONTACT:
Edward P. Macdonald, Staff Attorney, or Wendy F. Friedlander, Deputy
Chief, Division of Investment Management (Office of Insurance
Products), at (202) 942-0670.
SUPPLEMENTARY INFORMATION: Following is a summary of the application.
The complete application is available for a fee from the Public
Reference Branch of the SEC.
Applicants' Representations
1. CAC, a stock life insurance company organized under the laws of
Illinois in 1911, has been a registered investment adviser since 1966.
CAC is authorized to transact business in all 50 states, the District
of Columbia, all provinces of Canada, Guam, Puerto Rico, and the U.S.
Virgin Islands. CAC is a wholly-owned subsidiary of Continental
Casualty Company, all of the voting securities of which are owned by
CNA Financial Corporation, a Delaware corporation. Loews Corporation, a
publicly traded Delaware corporation, owns a majority of the
outstanding voting securities of CNA Financial Corporation.
2. VFL, a stock life insurance company organized under the laws of
Pennsylvania in 1956, is authorized to transact business in the
District of Columbia, Puerto Rico, Guam and all states except New York.
Valley Forge is a wholly-owned subsidiary of CAC.
3. The CAC Account was established by CAC as a separate account
pursuant to Illinois insurance law on January 30, 1996, to be a funding
medium for variable life insurance contracts. The CAC Account is
registered as a unit investment trust with 18 subaccounts, each of
which invests exclusively in the shares of a designated investment
portfolio.
4. The VFL Account was established by VFL as a separate account
under Pennsylvania insurance law on October 18, 1995, to be a funding
medium for variable life insurance contracts. It is registered as a
unit investment trust with 18 subaccounts each of which invest
exclusively in the shares of a designated investment portfolio.
5. CNA Investor Services, Inc., an affiliate of the Companies, is
the principal underwriter of the Policies. It is registered under the
Securities Exchange Act of 1934 as a broker-dealer and is a member of
the National Association of Securities Dealers, Inc.
6. The Policies are flexible premium variable life insurance
contracts. The Companies will deduct 1.25% from each premium payment of
the Policies to cover each Company's federal income tax costs
attributable to the amount of premium received.
7. The Companies will deduct a sales charge from each premium
payment. For Policy years 1 through 10 the sales charge is 4% of
premium payments made in that Policy year, up to the target premium
payment\1\ for the initial specified amount. For Policy years 11 and
later, the sales charge is 2% of premium payments made in that Policy
year, up to the target premium payment for the initial specified
amount. The target premium payment is an amount of premium payments,
computed separately for each increment of specified amount under a
Policy, used to compute sales charges and surrender charges. Any
premium payments received in excess of the target premium payment for
the specified amount in any year are not subject to a sales charge.
---------------------------------------------------------------------------
\1\ A target premium payment is an amount of premium shown in
the Policy that is based on the insured's age sex, rate class, the
specified amount under the Policy, and certain assumptions made by
the Companies. It is never larger than the corresponding guideline
annual premium payment under a Policy.
---------------------------------------------------------------------------
8. If the Policy owner increases the specified amount, a target
premium payment is established for the increase. Therefore, there is a
target premium payment for each increment of specified amount and the
Companies deduct the sales charge from premium payments attributable to
an increase. For purposes of computing and deducting sales charges, all
premium payments made after an increase in specified amount are
apportioned to each increment of specified amount on the basis of the
relative guideline annual premium payments, as defined in Rule 6e-
3(T)(c)(8), for each such increment. For the first ten 12-month periods
following an increase in specified amount, the charge is 4% of premium
payments made in that 12-month period attributable to the increase, up
to the target premium for the increase. For subsequent 12 Policy month
periods, the sales charge is 2% of premium payments made during the 12
month period attributable to the increase up to the target premium for
the increase.
9. If an owner surrenders the Policy, makes a withdrawal, decreases
the specified amount, or if the Policy lapses, each Company may deduct
a surrender charge from any Policy value. The surrender charge has two
components: an administrative surrender charge and a contingent
deferred sales charge (``CDSC'').
10. The CDSC in connection with the initial specified amount is
calculated in Policy years 1 through 6 based on premium payments up to
the target premium. Specifically, the CDSC is 34% of premium payments
made in the first Policy year up to the target premium payment for the
initial specified amount, and 33% of premium payments made in each of
Policy years 2 through 6 up to the target premium payment for the
initial specified amount in each such year until the total CDSC equals
100% of a single target premium payment of the initial specified
amount.
11. The CDSC in connection with the initial specified amount during
the first two Policy years will not exceed the sum of: (1) 26% of the
first guideline annual premium payment for the initial specified
amount, (2) 6% of the second guideline annual premium payment for the
initial specific amount, and (3) 5% of all additional premium payments
attributable to the initial specified amount.
12. After the first six Policy years, the total surrender charge in
connection with the initial specified amount to which a Policy may be
subject is reduced on a Policy year basis. The total surrender charge
decrease 10% per year from 80% of total surrender charges in Policy
year 7 to no charge in Policy years 15 and later.
13. If the initial specified amount is decreased during the first
fourteen Policy years, the surrender charge imposed will equal the
portion of the total surrender charge that corresponds to the
percentage by which the initial specified amount is decreased. In the
event of a decrease in the initial specified amount, the pro-rated
surrender charge will be allocated to each subaccount and to the fixed
account based on the proportion of Policy value in each subaccount and
in the fixed account. A surrender charge imposed in connection with a
reduction in the initial specified amount reduces the remaining
surrender charge that may be imposed in connection with a surrender of
a Policy.
14. The surrender charge is computed and assessed separately for
the initial specified amount and for each increase in specified amount.
Only the CDSC component of the surrender charge, however, is assessed
in connection with an increase in specified amount. For purposes of
computing and assessing the CDSC attributable to an increase in
[[Page 40037]]
specified amount, all premiums made after an increase in specified
amount are apportioned to each increment of specified amount on the
basis of the relative guideline annual premium payments of each such
increment. Likewise, Policy value is apportioned to each increment of
specified amount on the basis of the relative guideline annual premium
payments for each such increment.
15. The CDSC for an increase in specified amount is as follows: in
the first 12 Policy months following the increase, the CDSC is 34% of
premium payments received up to the first target premium payment for
the increase in specified amount, and, in each of the five subsequent
12 Policy month periods following the increase, the charge is 33% of
premium payments received up to the first target premium payment for
the increase in specified amount in each such 12 month period until the
total CDSC for the increase equals 100% of a single target premium
payment for the increase in specified amount. Notwithstanding the
foregoing, the CDSC during the first 24 Policy months following an
increase in specified amount is never more than the sum of: (1) 26% of
the first guideline annual premium payment for the increase in
specified amount, (2) 6% of the second guideline annual premium payment
for the increase in specified amount, and (3) 5% of all additional
premium payments attributable to the increase in specified amount.
Beginning with the 73rd Policy month following an increase in specified
amount, the CDSC computed in connection with the increase grades off
during the subsequent 96 Policy months in the same manner as does the
surrender charge associated with the initial specified amount.
Deferred Acquisition Cost
16. In the Omnibus Budget Reconciliation Act of 1990, Congress
amended the Code by, among other things, enacting Section 848 thereof
which requires that life insurance companies capitalize and amortize
over a period of ten years part of their general expenses for the
current year. Upon prior law, these expenses were deductible in full
from the current year's gross income. Section 848, in effect,
accelerates the realization of income from specified insurance
contracts for federal income tax purposes and, therefore, the payment
of taxes on the income generated by those contracts. Taking into
account the time value of money, Section 848 increases the tax burden
borne by the insurance company because the amount of general deductions
that must be capitalized and amortized is measured by premium payments
received under specified contracts, such as the Policies (the ``DAC tax
charge''). In this respect, the impact of Section 848 can be compared
with that of a state premium tax.
17. The Policies to which the tax burden charge will apply fall
into the category of life insurance contracts identified under Section
484 as those for which the percentage of net premiums that determines
the amount of otherwise currently deductible general expenses to be
capitalized and amortized is 7.7 percent.
18. The increased tax burden resulting from the applicability of
Section 848 to every $10,000 of net premiums received may be qualified
as follows. In the year when the premiums are received, each Company's
general deductions are reduced by $731.50--i.e., an amount equal to (a)
7.7 percent of $10,000 ($770) minus (b) one-half year's portion of the
ten-year amortization ($38.50). Using a 35 percent corporate tax rate,
this computes to an increase in tax for the current year of $256.03
(i.e., $731.50 multiplied by .35). This increase in tax will be
partially offset by increased deductions that will be allowed during
the next ten years as a result of amortizing the remainder of the
$770--$77 in each of the following nine years, and $38.50 in the tenth
year.
19. Capital which must be used by each Company to satisfy its
increased federal tax burden under Section 848 (resulting from the
receipt of premiums) is not available to the Companies for investment.
Because they seek an after tax rate of return of at least 10 percent on
their invested capital,\2\ each Company submits that a discount rate of
at least 10 percent is appropriate for use in calculating the present
value of its future tax deductions resulting from the amortization
described above.
---------------------------------------------------------------------------
\2\ Both Companies have computed their cost of capital as the
after tax rate of return that each seeks to earn on its surplus. The
Companies took into account a number of factors in computing this
rate. First, they 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 30-year Treasury bonds. Then, this
rate was increased by market risk premium that is demanded by equity
investors to compensate such investors for the risks associated with
equity investment. This 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 Treasury bonds).
Finally, the resulting rate was modified to reflect the relative
volatility of portfolio investments. Both Companies represent that
these are appropriate factors to consider in determining their cost
of capital.
---------------------------------------------------------------------------
20. Using a corporate tax rate of 35 percent, and assuming a
discount rate of 10 percent, the present value of the tax effect of the
increased deductions allowable in the following ten years comes to
$160.40. Because this amount partially offsets the increased tax
burden, applying Section 848 to the specified contracts imposes an
increased tax burden on each Company equal to a present value of $95.63
(i.e., $256.03 minus $160.40) for each $10,000 of net premiums.
21. Each Company does not incur incremental income tax when it
passes on state premium taxes to Policy owners, because state premium
taxes are deductible when computing federal income taxes. In contract,
federal income taxes are not tax-deductible when computing each
Company's federal income taxes. Therefore, to offset fully the impact
of Section 848, each Company must impose an additional charge that
would make it whole not only for 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 computed by dividing $95.63 by
the complement of the 35 percent federal corporate income tax rate
(i.e. 65 percent), resulting in an additional charge of $147.12 for
each $10,000 of net premiums, or 1.47 percent.
22. Tax deductions are of value to the Companies only to the extent
that it has sufficient gross income to fully utilize the deductions.
Based upon its prior experience, both Companies submit that it is
reasonable to expect that virtually all future deductions will be fully
taken.
23. Each Company submits that a DAC tax charge of 1.25 percent of
premium payments would reimburse it for the impact of Section 848 on
its federal tax liabilities. Each Company represents that a 1.25
percent charge is reasonably related to its increased tax burden under
Section 848, taking into account the benefit to each Company of the
amortization permitted by Section 848, and the use by each Company of a
10 percent discount rate in computing the future deductions resulting
from such amortization, such rate being the equivalent of each
Company's cost of capital.
Applicants' Legal Analysis
1. Section 6(c) of the 1940 Act authorizes the SEC by order upon
application, conditionally or unconditionally to exempt any person,
security, or transaction, or any class or classes of persons,
securities or transactions, from any provision(s) of the 1940 Act or
from any rule or regulation thereunder, if and to the extent that such
exemption is necessary or appropriate in the public interest and
consistent with the protection of
[[Page 40038]]
investors and the purposes fairly intended by the policy and provisions
of the 1940 Act.
Exemption From Section 27(c)(2) of the 1940 Act and From Rule 6e-
3(T)(c)(4)(v)
2. Section 2(a)(35) of the 1940 Act defines ``sales load'' as the
difference between the price of a security offered to the public and
that portion of the proceeds from its sale which is received and
invested or held 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.
3. 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.
4. Rule 6e-3(T)(b)(13)(iii), among other things, provides relief
from Section 27(c)(2) of the 1940 Act to the extent necessary to permit
the deduction of certain charges other than sales load, including
``[t]he deduction of premium or other taxes imposed by any state or
other governmental entity.'' Applicants represent that the requested
exemption is necessary if they are to rely on certain provisions of
Rule 6e-3(T)(b)(13).
5. Rule 6e-3(T)(c)(4) defines ``sales load'' during a contract
period as the excess of any payments made during that period over
certain specified charges and adjustments, including ``[a] deduction
for and approximately equal to state premium taxes.'' Applicants submit
that the proposed DAC tax charge is akin to a state premium tax charge
and, therefore, should be treated as other than sales load for purposes
of the 1940 Act and the rules thereunder.
6. Applicants acknowledge that the proposed DAC tax charge does not
fall squarely into any of the itemized categories of charges or
adjustments set forth in Rule 6e-3(T)(c)(4); a literal reading of that
rule arguably does not exclude such a ``tax burden charge'' from sales
load. 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. Applicant also assert that
nothing in the administrative history of Rule 6e-3(T) suggests that the
SEC intended to treat tax charges as sales load.
7. Applicants assert that the public policy that underlies Rule 6e-
3(T)(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.
Applicants submit that the treatment of a tax burden charge
attributable to the receipt of purchase payments as sales load would in
no way further this legislative purpose because such a charge has no
relation to the payment of sales commissions or other distribution
expenses. Applicants further submit that the Commission has concurred
with this conclusion by excluding deductions for state premium taxes
from the definition of sales load in Rule 6e-3(T)(c)(4).
8. applicants assert that the genesis of Rule 6e-3(T)(c)(4)
supports this analysis. In this regard, Applicants note that Section
2(a)(35) of the 1940 Act provides a scale against which the percent
limits of Sections 27(a)(1) and 27(h)(1) thereof may be measured.
Applicants submit that the intent of the SEC in adopting Rule 6e-
3(T)(c)(4) was to tailor the general terms of Section 2(a)(35) to
flexible premium variable life insurance contracts in order, among
other things, to facilitate verification by the SEC of compliance with
the sales load limits set forth in Rule 6e-3(T)(b)(13)(i). Applicants
submit that Rule 6e-3(T)(c)(4) does not depart, in principal, from
Section 2(a)(35).
9. Applicants further assert that Section 2(a)(35) excludes from
the definition of sales load under the 1940 Act deductions from
premiums for ``issue taxes.'' Applicants submit that, by extension, the
exclusion from ``sales load'' (as defined in Rule 6e-3(T) of charges to
cover an insurer's expenses attributable to its federal tax obligations
is consistent with the protection of investors and the purposes
intended by the policies and provisions of the 1940 Act.
10. Applicants also submit that the reference in Section 2(a)(35)
to administrative expenses or fees that are ``not properly chargeable
to sales or promotional activities'' suggests that the only deductions
intended to fall within the definition of sales load are those that are
properly chargeable to such activities. Because the proposed DAC tax
charge will be used to compensate each Company for its increased
federal tax burden attributable to the receipt of premiums, and such
deductions are not properly chargeable to sales or promotional
activities. Applicants assert that the language of Section 2(a)(35) is
another indication that not treating such deductions as sales load is
consistent with the purposes intended by the policies of the 1940 Act.
11. Applicants agree to comply with the following conditions for
relief: (a) Each Company will monitor the reasonableness of the 1.25
percent proposed DAC tax charge; (b) the registration statement for the
Policies under which the 1.25 percent charge is deducted will: (i)
Disclose the charge; (ii) explain the purposes of the charge; and (iii)
state that the charge is reasonable in relation to each Company's
increased federal tax burden resulting from the application of Section
848 of the Code; and (c) the registration statement for the Policies
under which the 1.25 percent charge is deducted will contain as an
exhibit an actuarial opinion as to: (a) The reasonableness of the
charge in relation to each Company's increased federal tax burden
resulting from the application of Section 848 of the Code; (ii) the
reasonableness of the targeted rate of return that is used in
calculating such charge; and (iii) the appropriateness of the factors
taken into account by each Company in determining such targeted rate of
return.
12. Applicants also request exemptions for any Future Account that
either Company may establish to support flexible premium variable life
insurance contracts as defined in Rule 6e-3(T)(c)(1). Applicants
believe that the terms of any exemption sought for Future Accounts to
permit the deduction of a tax burden charge would be substantially
identical to those in this application. Applicants assert that any
additional requests for exemptive relief for such Future Accounts would
present no issues under the 1940 Act that have not already been
addressed in this application. Nevertheless, unless such relief were
granted, the Companies would have to obtain exemptions for each Future
Account that either establishes unless that relief is granted in
response to this application.
13. The requested exemptions are appropriate in the public interest
because they would promote competitiveness in the variable life
insurance market by eliminating the need for the Companies to file
redundant exemptive applications, thereby reducing its administrative
expenses and maximizing the efficient use of its resources. The delay
and expense involved in having to repeatedly seek the same exemptions
would impair both Companies' ability to effectively take advantage of
business opportunities as they arise. Likewise, the requested
exemptions are consistent with the protection of investors and the
purposes intended by the policy and provisions of the 1940 Act for the
same
[[Page 40039]]
reasons. Investors would receive no benefit or additional protection if
each Company were required to repeatedly seek Commission orders with
respect to the same issues. In fact they might be disadvantaged as a
result of the Companies' increased overhead expenses.
Exemption From Section 27(a)(3) of the 1940 Act and From Rule 6e-
3(T)(b)(13)(ii)
14. Section 27(a)(3) provides that the amount of sales charge
deducted from any of the first twelve monthly purchase payments on a
periodic payment plan certificate by any registered investment company
issuing such certificates or any depositor or underwriter for such
company may not exceed proportionately the amount deducted from any
other such payment, and that the amount deducted from any subsequent
payment may not exceed proportionately the amount deducted from any
other subsequent payment.
15. Rule 6e-3(T)(b)(13)(ii) provides an exemption from Section
27(a)(3) in connection with flexible premium variable life insurance
contracts, provided that the proportionate amount of sales charge
deducted from any premium payment for such a contract does not exceed
the proportionate amount deducted from any prior premium payment,
unless an increase is caused by reductions in the annual cost of
insurance or reductions in sales load for amounts transferred to a
variable life insurance contract from another plan of insurance.
16. The Policies have both a sales charge deducted from certain
premium payments and a CDSC that is computed as a percentage of certain
premium payments. For any increment of specified amount, the sales
charge deducted from any premium payments is a percentage of the
payments made in a Policy year up to the target premium for that
increment in that Policy year. No sales charge is deducted from premium
payments made in a Policy year in excess of that target premium. Thus,
where an owner of a Policy makes premium payments in any Policy year in
excess of the target premium and makes any premium payment during the
next Policy year, the sales charge on the first dollar paid in the next
Policy year will always exceed that paid on the last dollar paid in the
prior Policy year.
17. Likewise for any increment of specified amount, the CDSC is
computed as a percentage of premium payments made in a Policy year up
to the target premium for that increment and no CDSC is associated with
premium payments made in a policy year in excess of that target
premium. Thus, where an owner of a Policy makes premium payments in
excess of the target premium during any of the first five Policy years
and makes any premium payment during the next Policy year, the CDSC
associated with the first dollar paid in the next Policy year will
always exceed that associated with the last dollar paid in the prior
Policy year. Applicants state that this sales charge structure appears
to violate the ``stair-step'' provisions in Section 27(a)(3) of the
Act. Moreover, the exemption provided by Rule 6e-3(T)(b)(13)(ii) does
not appear to cover this type of charge structure.
18. Because Section 27(a)(3) and Rule 6e-3(T)(b)(13)(ii) appear to
prohibit this structure, Applicants apply for an order under Section
6(c) of the Act exempting them and any Future Accounts from these
provisions to the extent necessary to: (1) Permit the deduction of
sales charges from premium payments up to one target premium paid
during any Policy year (or, in connection with an increase in specified
amount, any 12 month period) to exceed the sales charge deducted on
premium payments made in excess of one target premium in any prior
Policy year (or 12 month period), and (2) to permit the deduction of
the CDSC computed on the same basis with a similar result.
19. Applicants state that the Policies could continue to comply
with all of the other sales charge limitations and requirements in Rule
6e-3(T), if the sales charges were deducted from, and the CDSC were
computed on the basis of, all premium payments. Applicants assert that
such charges, however, would be less favorable to Policy owners than
that provided under the Policies. Under such a sales charge structure
Applicants argue, sales charges would be recovered by the companies
earlier than is the case under the Policies' sales charge structure.
Under such a surrender charge structure, CDSCs could be greater than
under the Policies' CDSC. Applicants submit that the sales charge
structure under the Policies benefits Policy owners by spreading the
sales charges over a longer period of time, thereby permitting a
greater portion of a Policy owner's premium payments in excess of a
target premium to be invested in the Policy.
20. Applicants assert that the imposition of a sales charge only on
premiums paid up to the target premium in any Policy year in part
reflects the fact that the Companies will usually incur lower overall
distribution costs in connection with premium payments in excess of the
targets over the life of the Policies. Applicants argue that to impose
the sales charge on such ``excess'' premium payments could generate
more revenue than the Companies believe is necessary to cover such
costs. Thus, the sales charge design provides a significant benefit to
Policy owners by passing through to them a portion of the Companies'
lower distribution costs with respect to ``excess'' premiums. The same
can generally be said of the CDSC. Applicants submit that it would not
be in the best interest of Policy owners to require the imposition of a
sales charge on ``excess'' premiums that is higher than Applicants
consider necessary.
21. Applicants further argue that Section 27(a)(3) was designed to
address the perceived abuse of periodic payment certificates that
deducted large amounts of front-end sales charges so early in the life
of the plan that an investor redeeming in the early period would recoup
little of his or her investment. Applicants assert that, by imposing no
sales charge on ``excess'' premium payments made in any Policy year,
the Company will cause a greater proportion of total sales charges to
be deducted later than otherwise would be the case under the Policies.
Likewise, by assessing no CDSC in connection with ``excess'' premium
payments, the CDSC would, in certain circumstances, be less than
otherwise would be the case under the Policies.
22. Applicants argue that one purpose behind Section 27(h)(3) of
the 1940 Act, as provision similar to Section 27(a)(3), is to
discourage unduly complicated sales charges. This purpose also may be
deemed to be a purpose of Section 27(a)(3) and Rule 6e-3(T)(b)(13)(ii).
Therefore, Applicants submit that the sales charge structure under the
Policies is straightforward, easily understood, and less complicated
than that of any many variable life insurance products that currently
are being offered and sold.
23. Applicants submit that, under the Policies, premium payments up
to the target premium have higher levels of actual sales expenses
associated with them than premium payments made in excess of such a
target premium. Because the ``excess'' premium payments have a lower
level of sales expenses, Applicants argue that it is entirely
appropriate that the sales charge structures for the two types of
payments be analyzed separately, the sales charge or CDSC related to
premium payments up to the target premium each year will comply with
Rule 6e-3(T)(b)(13)(ii), and the sales charge or CDSC related to
``excess'' premium payments will remain level at
[[Page 40040]]
zero and therefore never increase from one excess premium payment to
the next.
24. Moreover, Applicants concede that the Companies could avoid the
potential ``stair-step'' issue simply by imposing the higher sales
charges equally on premium payments in any Policy year, subject to the
overall sales charge limits under the 1940 Act; Applicants argue,
however, that Policy owners benefit from the lower sales charge imposed
in connection with ``excess'' premium payments under the sales charge
structure of the Policy.
Exemption From Section 27(e) of the 1940 Act and Rule 27e-1 Thereunder,
and From Rule 6e-3(T)(b)(13)(vii)
25. Section 27(e) requires, with respect to any periodic payment
plan certificate sold subject to Section 27(d), written notification of
the right to surrender and receive a refund of the excess sales load.
Rule 27e-1 establishes the requirements for the notice mandated by
Section 27(e) and prescribes from N-27E-1 for that purpose. Rule 6e-
3(T)(b)(13) in essence modifies the requirements of Section 27 of the
1940 Act and the rules thereunder. Rule 6e-3(T)(b)(13)(vii) adopts Form
N-27I-1 and requires it to be sent to a Policy owner upon issuance of
the Policy and again during any lapse period in the first two Policy
years. The Form requires statements of: (a) the Policy owner's right to
receive back the excess sales load for a surrender during the first two
Policy years, (b) the date that the right expires, and (c) the
circumstances in which the right may not apply upon lapse. Thus Section
27(e) of the 1940 Act, and Rules 27e-1 and 6e-3(T)(b)(13)(vii)
thereunder, require a notice of right of withdrawal, and refund on Form
N-27I-1 to be provided to owners of the Policies entitled to a refund
of sales load in excess of the limits stated in paragraph (b)(13)(v)(A)
of Rule 6e-3(T).
26. The Policies have a sales charge and a CDSC that does not,
during the first two Policy years (or, as to an increase in specified
amount, during the first twenty-four months after the increase), exceed
the limits described by paragraph (b)(13)(v)(A) of Rule 6e-3(T) beyond
which sales charges are characterized as ``excess sales charge'' is
ever paid by an owner surrendering, withdrawing, reducing his or her
specified amount, or lapsing in the first two Policy years (or, as to
an increase in specified amount, during the first twenty-four months
after the increase).
27. Applicants represent that the sales charge and the CDSC on
premium payments (and with respect to the CDSC applicable to an
increase in specified amount, after the first twenty-four months
following that increase) may exceed the limits described by paragraph
(b)(13)(v)(A) of Rule 6e-3(T). Therefore, Applicants are requesting the
relief sought in this application.
28. Rule 27e-1, pursuant to which Form N-27I-1 was first
prescribed, specifies in paragraph (e) that no notice need be mailed
when there is otherwise no entitlement to receive any refund of sales
charges. Applicants stat that Rules 27e-1 and 6e-2 (from which Rule 6e-
3(T) was derived) were adopted in the context of front-end loaded
products only and in the broader context of the companion requirements
in Section 27 for the depositor or underwriter to maintain segregated
funds as security to assure the refund of any excess sales charges.
29. Applicants assert that requiring delivery of a Form N-27I-1
could confuse Policy owners at best, and, at worst, encourage them to
surrender during the first two Policy years (or surrender or decrease
to specified amount of their Policies during the first twenty-four
Policy months following a specified amount increase) when it may not be
in their best interests to do so. Applicants submit that an owner of a
Policy with a declining CDSC, unlike a policy with a front-end sales
charge, does not foreclose his or her opportunity, at the end of the
first two Policy years (or twenty-four Policy months following a
specified amount increase), to receive a refund of most monies spent.
Not only has such an owner not paid any excess sales charges, but
because the deferred charge declines over the life of the policy, the
owner may never have to pay the deferred charge. Applicants thus assert
that encouraging a surrender during the first two Policy years could,
in the end, cost such an owner more in total sales charges (relative to
total premium payments) than he or she would otherwise pay if the
Policy, which is designed as a long-term investment vehicle, were held
for the period originally intended.
30. Applicants submit that the absence of ``excess sales charges,''
and, therefore, the absence of an obligation to assure repayment of
that amount, do not create a right in an owner which Form N-27I-1 was
designed to highlight. In the absence of this right, Applicant's argue
that the notification contemplated by Form N-27I-1 is an unnecessary
and counter-productive administrative burden the cost of which appears
unjustified, and any other purpose potentially served by the Form N-
27I-1 would already be addressed by the required Form N-27I-2 Notice of
Withdrawal Right, generally describing the charges associated with the
Policy, and prospectus disclosure detailing the sales charge design.
Applicant's submit that neither Congress, in enacting Section 27, nor
the Commission, in adopting Rule 27e-1, could have contemplated the
applicability of Form N-27I-1 in the context of an insurance policy
with a declining contingent deferred sales charge.
Conclusion
For the reasons summarized above, the Applicants represent that the
requested relief from Sections 27(a)(3), 27(c)(2), and 27(e) of the
1940 Act, paragraphs (b)(13)(ii), (b)(13)(vii), and (c)(4)(v) of Rule
6e-3(T) thereunder, and 27e-1 thereunder, is necessary or appropriate
in the public interest and otherwise meets the standards of Section
6(c) of the 1940 Act.
For the Commission, by the Division of Investment Management,
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-19373 Filed 7-30-96; 8:45 am]
BILLING CODE 8010-01-M
