# UNITED STATES Á'VAILABILlI > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/agency%3Asec%3Afdc81c2039cd04e0 ## Record - **Collection:** Agency decision - **Document type:** Agency decision ## Text Am rLYt - ~ =ON ;2 ttl! ~ :2, " PUBLIC / / If /t1 UNITED STATES Á'VAILABILlI SECURITIES AND EXCHANGE COMMISSION WASHINGTON. D.C. 20549 DIVISIOH OF INVESTMENT MANAGEMENT November 8, 1989 Dear Sir/Madam: This letter provides general guidance to insurance companies filing post-effective amendments in connection with the offering of variable life and variable annuity contracts. These comments represent the informal views of the staff of the Office of Insurance Products and not necessarily those of the Commission. They are intended only to assist registrants in the preparation of disclosure documents and are not to be considered of precedential value in any court or other official action. This letter is divided into two parts. The first part deals with substantive matters and the second part deals with procedural matters that may arise during your preparation of post-effective amendments. ~ SUBSTANTIVE COMMENTS A. Recent Developments 1. High Yield Bond Disclosure A recent Commission release discusses appropriate disclosure by certain registrants as to participation in high yield, highly leveraged or non-investment grade loans and investments. ' ..See ana ement's Discussion and Anal sis of Financial Condition and Results of Operations: Certain Investment Companv DisClosures, Release Nos. 33-6835, 34-26831, IC-16961 (May 18, 1989). That release also discusses appropriate disclosure by investment companies that invest, or are permitted to invest, all or a portion of their portfolios in high-yield or non-invest grade securities~ ' In addition, the Division of Investment Management (the "Division") recently circulated a letter supplementing the 2 Commissions release. iJ See Letter attached. Accordingly, we recommend the following: a) Underlying Funds: Underlying funds of insurance company separate accounts, registered on Form N-lA, should consult the release and the letter to ensure compliance with their disclosure obligations. b) Managed Separate Accounts: Managed separate accounts, registered on Form N-3, should consult the release and the letter to ensure compliance with their disclosure obligations to the same extent required by underlying funds. c) Reqistered Guaranteed Investment Contracts: The Commission release addresses disclosure obligations of certain financial institutions participating in highyield financing, highly leveraged transactions or noninvestment grade loans and investments. That release should be consulted by insurance companies registering fixed annuity contra~ts under the Securities Act, of 1933. 2 ~ Tax Discl6sure i- The Technical and Miscellaneous Revenue Act of 1988 ("TAM"), as well as the 1986 amendments to the Internal Revenue Code, altered certain tax matters relating to variable annuity and variable life insurance contracts. Y Prospectuses and/or SAI tax disclosure reflecting these changes should be updated accordingly. ' SpecificallYi .registrants should review contracts that may classified as modified endowment contracts. The staff recommends the following: be a) For single premium variable life contracts that could JJ Please be advised that the staff anticipates receiving a, no-action letter seeking clarification on certain matters, raised in the letter. Any such staff clarification should be consulted by registrants. iJ Registrants should also note that on March 2, 1989, the Internal Revenue Service issued final regulations on investment company diversification requirements for variable life insurance and variable annul ty contracts under: Internal Revenue Code Section 817 (h) . 3 should be classified as modified endowment contracts, registrants consider including the following prospectus disclosure: ,Cover Page A statement that the contract is or may be a modified endowment contract. If the contract is classified as a modified endowment contract, a statement that any policy loan, partial wi thdrawal or surrender may result in adverse tax consequences and/or penalties. SummarY Paqe A brief definition of a modified endowment contract, including a description of the "seven-pay" test, or an appropriate cross-reference to the definition. the ~mount of certain distributions made during the insured's lifetime, such as policy loan~, partial withdrawals or surrenders, that exceed the contractowner' s 'investment in the contract might be included in the owner's gross income (Wincome-first ' basis"), and that a 10% penalty tax may be imposed on such income distributed before the contractowner attains age 59-1/2. A statement that \. A cross-reference to the tax disclosure contained in the prospec'tus. Tax section A detailed explanation of the tax implications of modified endowment contract status. , b). For flexible premium variable life insurance contracts that could be classified as modified endowment contracts, the registrant should indicate whether it has adequate safeguards established for monitoring whether a contract may become a modified endowment contract. If the company has not established adequate safeguards, the staff would recommend the same summary page disclosure as above. 3. Sinqle Premium Variable Life Contracts The staff recently issued a no-action letter concerning the ability of a single premium variable life contract to r~ly on Rule 6e-3 (T). See Equitable Variable Life Insurance Company (pub. avail. Aug. 9, 1989). 4 4. Office of Disclosure and Review iS Industrv Comment Letter to circulate an industry comment letter of public mutual funds in their preparation of post-effective amendments. Registrants of variable insurance products should consult that letter for relevant comments. The Division intends, to assist registrants 5. Life Insurance Product's Depositor Financial statements The staff would not recommend withholding acceleration of the effective date of the registration statement filed on Form S-6 if the financial statements of the depositor (life insurance company) are not updated in conformity with the requirements of Rule 3-12 of Regulation S-X, l/ provided that (1) the registrant makes a written requ~st to the staff explaining in detail the basis for excluding the financial statements; (2) the request is approved by the staff; and (3) the registrant inserts the following statement in the prospectus: The most current financial statements of the Company (deposi tor) are those as of the end of the most recent fiscal year. The Company does not prepare financial statements more often than annually and believes that any incremental benefit to prospective policyh~ders that may result from preparing and delivering more current financial statements, though unaudited, does not justify the additional cost that would be incurred. In addition, the Company represents that the~e have been no adverse changes in the financial condition:'or operations of the Company between the end of the most current fiscal year and the date of this prospectus. 6. Variable Annuity Fee Table On January '23, 1989, the Commission issued a release amending Forms N-3, and N-4 to' requ~re the consolidation' of 'all expense .information in a tablelocåted near the front of the prospectus. See Investment Company Act Release No. 16766. The following points may be of interest in preparing registration statements for the upcoming year: a) A separate account investing in a portfolio company with multiple series may include a single table in its Form N-4 registration statement instead of individual tables for each v ( In pertinent part, Rule 3-12 of Regulation S-X requires the updating of financial statements in a filing where such statements are as of a date 135 days or more prior to the date the filing is expected to become effective. 5 series. For example, portfolio company annual expenses for the various underlying funds can be reflected in matrix form as follows: (Portfolio CompanvJ Annual Expenses (as a percentage of (portfolio company) average net assets) Management Fees, Fund ,A Fund B Fund C Fund D Other Expenses Total Annual Expenses Registrants also may want to use a matrix format in the Example. b) The expense figure listed in the Example should include the percentage of the annual contract fee that is deducted from a $1,000 investment. Only where the average account size is $1,000 should the entire annual contract fee be included in the figure. If the average account size is $3,000 and the annual contract fee is $30, only 1/3 or $10, of the contract fee is included in the estimate, of expenses that a contractowner would pay on a $1,000 investment. c) The staff has taken a no-action, position regarding the calculation of the annual contract fee in the fee table example for issuers of variable annuity~co'ñt:räts-l:natotfêFõõt:li'-fixed and variable funding operations within a single' contract, provided it is done in one of the two alternative ways set forth in the, letter. See wet:ic~n .euncll' .of Life Insurance (pub. avail. Apr. 21,-I89). .. B. Charges 1. Administrative Expenses . Rules 6e-3 (T) (C)(4) (iv) and 6e-2 (c) (4) (iv) provide 'exemptive relief from certain-provisions of the 1940 Act to permit the deduction of administrative expense charges from separate account assets in connection with variable life insurance contracts. Rule 26a~i provides similar relief for variable annuity contracts. Registrants relying on these rules may continue to deduct administrative expense charges only so long as the amounts collected meet the requirements set forth in these rules. Disclosure of these administrative expense charges should state that the charges have been set at a level to recover no more than the actual cost associated with administering the contract. 2. withdrawals Administrative fees for withdrawals are limited to a maximum of 2% of the amount withdrawn (subject to the at-cost standard). The staff will raise redeemability issues on deductions that - 6 ­ exceed this requirement. See Investment Company Act Release No. 15651, at note 74 (Mar. 30, 1987). , , 3. Fees and Charqes Associated with Variable Life Contracts and charges attributable to a contract, forth riot further back than page three of the prospectus. (See Form S-6, Instructions as to the Prospectus, Instruction 2, Presentation of Information). Disclosure should include fees and charges assessed against the separate account, as well as those assessed against the underlying portfolio company. All of the fees including sales load, should be set 4. Disclosure Reqarding Sales Load "Shortfall" The registrant must disclose in the prospectus whether the sales load imposed on a variable life or variable annuity contract is 4esigned to recover all distribution costs associated with the contract. If not, the registrant must disclose how it will recover the. shortfall (e. g., from the general account assets consisting of , among other things, amounts derived from mortality and expense risk charges). ' c. Miscellaneous 1. Use of Simplified Underwriting i­ If an insurance company intends to use simplified underwriting that would, result in the actual or guaranteed cost of insurance charges ëxceedinq the maximum allowed by the 1980 CSO Tables, provide Summary Page disclosure of the following: (1) a statement indicating the amount by which the actual or guaranteed cost of insurance charges will exceed, the maximum allowed by the 1980 CSO tables; and (2) a statement that the o.f insurance charges (which may be viewed as substandard riskcost . charges) are generally higher for healthy individ~als when this method of underwriting is used. (Note that unless the registrant can substantiate a claim that the portion of the' charge exceeding 100% of the 1980 CSO is properly attributable to a substandard risJlcharge , it must be treated as sales load). 2. Mixed and Shared Funding Where a fund underlying variable contracts sells its shares to both variable annuity and variable life insurance separate accounts of the same insurance company or of affiliated insurance companies ("niixed funding"), or to variable annuity or variable life insurance separate accounts of unaffiliated insurance, companies (" shared funding"), the fund i s prospectus must disclose the risks involved in mixed and/or shared funding. This disclosure should include a statement indicating that if a - 7 ­ material irreconcilable conflict arises between separate accounts, a separate account may have to withdraw its participation in the fund. The separate account prospectus should include disclosure or provide a c'ross-referenceto the fund IS risk disclosure regarding mixed and/or shared funding. A separate account investing in a fund under a shared funding arrangement should ensure that a copy of the shared funding participation agreement has been filed as an exhibit to the separate account's registration statement. 3. Variable Life Illustrations The following points should be considered in preparing variable life illustrations: a) All separate account expenses, as well as the underlying fund expenses, must be reflected in the illustrations. For funds past the start-up stage, an amount no less than the actual operating expenses incurred should be used. The staff considers the start-up period to be one year after the fund has commenced operations/sales. For funds adding a new series, it would be a~ropriate to estimate expense~ that will be incurred in that new series, so long as the estimate is reasonable, i.e., they should be consistent with or conform to the actual expenses incurred by the other series. b) For underlying funds with multiple series, a simple average' of the. investment advisory fees of the underlying fund(s) must be reflected in the illustration. c) In the narrative,disclose the existence and operation. of any expense reimbursement arrangement. The narrative must disclose the amount of expenses that would have been incurred absent the reimbursement agreement, and the likelihood that the expense reimb\1rsement agreement wiii continue past the current year, as well as the effect of discontinuing the agreement. d) An actuarial opinion pertaining to the illustrations should be filed with each post-effective amendment. 4. Allocations of Initial Purchase PaYments for Variable Annui tv Products During The Free Look Period The staff recently has issued three no-action letters concerning the allocation of an initial purchase payment for a variable annuity contract to a money market subaccount during the - 8 ­ '. free look period. See Fidelity Investments Variable Annuity Account I (pub. avail. Dec. 8, 1987), LBVIP Variable Annuity Account I (pub. avail. Jan. 22, 1988), and MONY America Variable Account A (pub. avail. Oct. 26, 1988). 5. Section 403 (bl No-Action Letter The staff has taken a no-action position relating to compliance with section 403 (b) (11) of the Internal Revenue Code and sections 22 (e),' 27 (c) (1) and 27 (d) of the 1940 Act for registrants offering variable annuity contracts. See American Council of Life Insurance (pub. avail Nov. 28, 1988). The conditions in the no-action letter include, among other things, prospectus and sales literature disclosure requirements and certain registration statement representations. Representations may be made in Part C of Forms N-3 or N-4. Please provide appropriate disclosure regarding the redemption restrictions imposed by Section 403 (b) (11) . l PROCEDURAL COMMENTS RELATING TO FILING POST-EFF~TIVE AMENDMENTS 1. Updatinq Reauirement section 10 (a) (3) of the Securities Act of 1933("1933 Act") requires that any prospectus used more than nine months after the effective date of the registration statement contain information as of a date not more than sixteen months prior to such use. Therefore, any separate account and its sponsor/depositor wishing . must, file a post- to maintain a continuous public offering statement of the separate account (and, where appropriate, its underlying portfolio company) containing updated financial statements and other information. Rules 485 and 486 under the 1933 Act govern this effective amendment to the registration process. 2. Updating Procedures Rule 486 specifies the procedures for updating the registration statement of any separate account registered under the 1940 Act either as a unit investment trust ("trust account") or as a management investment company ("management account"). Rule 485, as relevant here, specifies the procedures for updattng the registration statement of any management investment company serving as an underlying portfolio company for a trust account ("underlying portfolio company ii ) . The registrant is responsible for determining whether any changes in its registration statement warrant filing a post­ .. -­ - 9 ­ effective amendment under paragraph (a) of Rule 485 or Rule 486 rather than under paragraph (b) of these rules. staff review of amendments filed under paragraph (a) rather than paragraph (b) of Rules 485 or 486 will be facilitated if, in addition to providing a redlined copy, the transmittal letter enumerates the material changes requiring the amendment to be filed under paragraph (a) rather than under paragraph (b). The staff will attempt to provide timely comments on post- effective amendments filed pursuant to Rules 485 (a) or 486 (a) . If the registrant has not received comments within 45 days after filing, it would be appropriate to inquire of the staff as to the status of the ,post-effective_amendment. Registrants printing disclosure documents before comments have been provided do so at their own risk. Post-effective amendments filed pursuant to paragraph (b) of Rules 485 or '486 must include the appropriate certification of the registrant on the signaturè page and be accompanied by counsel's representation that the post-effective amendment does not contain disclosure that would render it ineligible to become \. effective pursuant to paragraph (b). See para~ph (e) of Rules 485 and 486. Filings must be sent directly. to the Commission and should not be addressed or sent to members of the staff. Rule 497 (b) requires that ten copies of the prospectus, in form in which it is being, used, be filed with the Commission within five days after the, effective date. Rule 497 (c) specifies that investment companies filing on Forms N-1~ . the exact N-3, orN-4 must file ten copies of both the prospectus and the Statement of Additional Information ("SAIIt) in the exact form in which It is used. 3. Effective Date and Request for Acceleration Registrants relying on the automatic effective date provided by Rules 485 (a) and 486 (a) should note that a filing made on 2 will have a May 1 effective date. Generally, an acceleration request is necessary only if a post-effective amendment, filed pursuant to Rules 485 (a) or 486 (a), mus.t become effective before the earliest automatic effective date, which is the sixtieth day following filing, or a later date between the sixtieth and eightieth day after filing, if such date is specified on the facing page of the post-effectiv~ amendment. A request for acceleration will bè necessary if a post-effective amendment is filed after March 2 requesting a May 1 effective March date. - 10 ­ Registrants that file after March 2 should be aware that due to heavy staff workload during the months of March and April, there is no assurance that the staff will be able to accelerate the filing. If acceleration is necessary, the registrant should notify the staff as soon as possible of the reason why the filing cannot be made by March 2, 'the nature of the material changes, and an estimate of the date the filing will be made. In accordance with Rule 461 of Regulation C under the 1933 Act, requests for acceleration of the effective date of a registration statement shall be made in writing by both the registrant and the principal underwriter. 4. Respondingt6 Staff Comments To expedite review of post-effective amendments, the following steps should be followed: a) When drafting a written response to staff comments, the registrant should respond:to each. comment individually by repeating the staff comment, stating the response, and making a, cross-reference to any changes in the registration statement. "­ ~ b) Prompt responses to staff comments and, if required, prompt filing of subsequent amendments, will greatly facilitate the process. If an amendment to the registration statement is required, it should be marked to highlight the changes. c) If the registrant believes that no change in the registration' statement is necessary or appropriate in response to any statf comment, this opinion, along with the should be submitted to the staff in for the opinion, writing. The staff reserves the right to comment further on any subsequent amendments or letters. basis 5 . Selective Review . The staff encourages registrants to review Investment Company Act Release No. 13768 (Feb. 15, 1984), governing the registrant believes that selective review is appropriate, a request for selective review should be made in the transmittal letter accompanying the filing. The request for selective review should include: (i) a statement whether the disclosure in the amendment has been reviewed by the staff in some other context; (ii) a statement identifying rrior filings that the registrant considers similar to, or intends as precedent for, the current filing; (iii) a summary of the material changes made in the current registration statement from the previous filings; and (iv) any specific areas that warrant procedures for selective review. If ~ .._ ,:.1 - 11 ­ particular attention. The registrant should provide the staff with a red-lined courtesy copy of the current filing marked to show the changes from the previously reviewed filings. 6. Rule 24f-2 Requirements . Rule 24f-2 (a) (1) of the 1940 Act requires that any posteffective amendment to a registration statement that has registered an indefinite number or amount of securities in reliance on Rule 24f-2 must include: (a) a statement to the effect that the issuer has registered an indefinite numer or amount of securities in accordance with Rule 24f-2 ("24f-2 Notice"), and (b) the date on which the 24f-2 Notice for the issuer's most recent fiscal year was filed or will be filed, or a statement that the issuer need not fil~ a Rule 24f-2 Notice because it did not sell any securities pursuant to the Rule 24f-2 declaration during the most recent fiscal year. When preparing the 24f-2 Notice, carefully review the method of fee calculation described in' paragraph (c) of Rule 24f-2. Note that the registration fee calculation can be .based on the actual price of sales less redemptions and repurchases only if the 24f-2 Notice is filed within two months afte~he close of the registrant. s fiscal year. If the Rule 24f-2 Notice for a company with a fiscal year-end of December 31 is not received by the Commission by February 28, redemptions cannot' be netted assessable.o , against sales in calculating the fee. All 24f~2 Notices must include an opinion of counsel stating whether the securities being registered were legally issued, fully paid, and non­ If a registrant proposes to cease its operations, it must post-effective amendment terminating the declaration and file the Rule 24f-2 (Fin,al) Notice prior to its cessation of operations. If a final Rule '24f-2 Notice is not timely received, a registrant 'will be unable to use then~tting procedures. file a 7. Exhibi ts to Registration statements Registrants filing amendments to registration statements must list all exhibits, lettered or numered for convenient reference. See Item 24 of Form N-1A, Item 24 of Form N-4, Item 28 of Form N-3, and Instructions as to Exhibits of Form S-6. See also Rule 483 of the Securities Act of 1933. Where the exhibits are incorporated by reference, reference must be made in the list of exhibits' as to where the documents can be found. 8. N-SAR Filing Requirements Registrants are reminded of their annual and semi-annual requirement to file their N-SAR report. See Rules 30a-1 and .. . - 12 ­ ..... 30b1-1 of the 1940 Act. The staff intends to monitor these filings to assure that registrants comply with these requirements. We trust that this letter will assist you in preparing your ,forthcoming filings. Sincerely yours, l1~;-.ß~ Robert L. Dorsey Assistant Chief Office of Insurance Products and Legal Compliance tj:;ff tt Jeffrey M. Ulness l Attorney Office of Insurance Products and Leg~ Compl iance --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Asec%3Afdc81c2039cd04e0. Public record. Not legal advice.