SEC Staff Letter on Post-Effective Amendments for Variable Life and Annuity Contracts

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UNITED STATES Á'VAILABILlI PUBLIC / / If /t1 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

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 high-

yield financing, highly leveraged transactions or non-

investment 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 be classified as modified endowment contracts. The staff

recommends the following:

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) .

be classified as modified endowment contracts, registrants should 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.

A statement that 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 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. Office of Disclosure and Review iS Industrv Comment Letter

The Division intends, to circulate an industry comment letter to assist registrants of public mutual funds in their preparation of post-effective amendments. Registrants of

variable insurance products should consult that letter for

relevant comments.

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.

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)

Fund ,A Fund B Fund C Fund D Management Fees, 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

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

All of the fees

, , and charges attributable to a contract, including sales load, should be set 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.

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
i￾1. Use of Simplified Underwriting

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 cost o.f insurance charges (which may be viewed as substandard risk . 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

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

l
'. - 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) . 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 .

to maintain a continuous public offering must, file a post- effective amendment to the registration 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

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

ii ) . ("underlying portfolio company

The registrant is responsible for determining whether any

changes in its registration statement warrant filing a post

.. - 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

. the exact 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~ 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

March 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

date.

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 basis for the opinion, should be submitted to the staff in writing. The staff reserves the right to comment further on any subsequent amendments or letters. 5 . Selective Review

. The staff encourages registrants to review Investment

Company Act Release No. 13768 (Feb. 15, 1984), governing procedures for selective review. If 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

~ .._ ,:.1 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 post-

effective 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 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 assessable.o , If a registrant proposes to cease its operations, it must file a 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.

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

l
. .
.
..... - 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

Attorney
Office of Insurance Products

and Leg~ Compl iance