Additional Materials for Proposed Rule:
| NAVA and
B. Insurance Companies
of the United States
|New York Life|
| L. Latto and
L. Latto II
On March 13, 1998, the Securities and Exchange Commission (the "Commission") published a release (the "Proposing Release") proposing for public comment a new Form N-6 (the "Proposed Form") for insurance company separate accounts that are registered as unit investment trusts and that offer variable life insurance policies.1 Form N-6 would be used by these separate accounts to register under the Investment Company Act of 1940 (the "Investment Company Act") and to offer their securities under the Securities Act of 1933 (the "Securities Act"). For these registrants, Form N-6 would replace Form N-8B-2, currently used by all unit investment trusts to register under the Investment Company Act, and Form S-6, currently used by all unit investment trusts to offer their securities under the Securities Act.
The following discussion summarizes the commenters' views on the Proposed Form. The Commission's Division of Investment Management prepared this summary.
The Commission received a total of 15 comment letters from 12 commenters on the Proposed Form.2 All of the commenters expressed strong support for the Proposed Form, and many recommended changes to the Proposed Form.
The following chart illustrates the types of commenters responding to the form proposal.
This summary discusses only those Proposed Form items on which the Commission received comments.
1. Item 2 Risk/Benefit Summary: Benefits and Risks
Commenters: 6 of 12; Support with Recommendations: 6
The Proposed Form would require at the beginning of every prospectus a risk/benefit summary that would provide key information about a policy's risks, benefits, and fees. Registrants would be required to present this information in a specific sequence. Six commenters expressed views on the proposed risk/benefit summary.3 Three of these commenters specifically supported the proposal but recommended changes.4 Three commenters recommended changes to the proposed risk/benefit summary, suggesting that they support the proposal to require a summary.5
a. Disclosure and Format Requirements
One commenter that supported the proposal recommended that the Commission revise Item 2 to require a concise description of the policy.6 The commenter stated that the revised item could require that the description include, but not necessarily be limited to, the items currently included in the proposed item. The commenter also stated that the item should not dictate the order or format for disclosure. This commenter argued that granting registrants more discretion to introduce their products will result in more useful disclosure than the proposed approach. Another commenter recommended that the Commission avoid promulgating specific requirements and instead permit issuers themselves to determine how best to describe the material provisions of their policies.7
b. Contract Benefits Item 2(a)
One of the commenters suggested that the Commission clarify in the adopting release that insurers may discuss benefits other than those specifically listed in the proposed item ( e.g., dollar cost averaging, living needs benefits, and other incidental insurance benefits).8 This commenter stated that purchasers will focus heavily on this section of the prospectus in evaluating a policy and comparing it to other policies, and therefore, insurers should be permitted to mention additional benefits of the policy in this section.
c. Use of Premiums Item 2(b)
Two of the commenters recommended that the Commission eliminate the requirement that a registrant disclose that "part of the premium is allocated to insurance coverage, part of the premium is invested, and part of the premium payment is used to pay sales loads and other charges."9 The commenters argued that this may not be an accurate description of the allocation of premium payments under all variable life insurance policies. For example, all of a premium may be invested and charges may be deducted later from the policy's cash value, which includes premiums and investment gains. One of these commenters recommended that the prospectus address this issue in the description of charges and the description of the account values.10
Another commenter stated that Item 2 should not require narrative disclosure about charges since this requirement would conflict with the aim of reducing prospectus length; instead, the registrant should cross-reference the fee table and the narrative charge disclosure required by Item 5.11
d. Contract Risks Item 2(c)
One commenter that supported the risk/benefit summary requirement recommended that Item 2(c) require a registrant to discuss the risk of replacing one policy with another.12 This commenter stated that an investor who exchanges one variable life insurance policy for another often will be subject to a number of unfavorable consequences, including a substantial deferred sales load on the policy that is surrendered, the need to undergo another medical examination, and potentially a higher cost of insurance charge. The commenter also stated that insurers should be permitted to discuss replacement risks elsewhere in the prospectus, including on the cover page.
e. Portfolio Company Information
One commenter agreed with the Commission that prospective investors are better served by consulting the prospectuses for the underlying funds in which the registrant invests (the "Portfolio Companies") for risk information relating to the funds offered through the policy.13
Two commenters stated that insurers should be permitted to include in the risk/benefit summary information about the Portfolio Companies offered through a policy.14 One of these commenters stated that insurers should be required to list all of the Portfolio Companies, their investment objectives, and advisers in a tabular format.15 The other commenter stated that because the investment risks peculiar to each fund are a crucial part of the overall risks of investing in a variable life insurance policy, Item 2(c) should permit registrants to discuss briefly the investment risks of each Portfolio Company if they can do so without impairing the readability of the prospectus.16 This commenter also recommended that, if this approach is taken, registrants state that the comprehensive discussion of fund risks is contained in the fund prospectus.
2. Item 3 Risk/Benefit Summary: Fee Table
The Proposed Form would require a fee table immediately following the summary of risks and benefits required by Item 2. The proposed fee table consists of three separate sections. The first section would show policyholder transaction fees, such as sales loads, surrender charges, and transfer fees. The second section would show annual charges, excluding annual Portfolio Company operating expenses. The third section would show annual Portfolio Company operating expenses, including management fees, distribution fees, and other expenses.
a. Fee Table Requirement and Placement
Commenters: 10 of 12; Support: 4; Oppose: 6
Four commenters supported the proposed requirement to include a fee table at the beginning of all variable life insurance policy prospectuses.17 One of these commenters stated that a "fee table will facilitate comparison shopping between products."18 Another commenter stated that a "standardized fee table would bring VLI Policy fee disclosure into general parity with that for variable annuities and mutual funds, and also would promote comparisons among different VLI Policies."19
Six commenters objected to the requirement to include a tabular presentation of fees and charges.20 The commenters asserted that the proposed fee table will not provide useful disclosure for a prospective investor seeking to evaluate a variable life insurance product or to compare several variable life insurance products primarily because fees and charges for such policies (1) differ from policy to policy, (2) are deducted at various levels within a policy, (3) may be deducted at different times during the life of a policy, (4) vary based on the individual characteristics of the insured; and (5) may vary over the life of the policy.
The commenters that objected to the fee table requirement recommended alternative approaches that would not prescribe any particular format for disclosure of fees and charges. Three commenters suggested that the fee table requirement be replaced by a requirement that the registrant provide a concise description of the fees and charges under the policy with a brief discussion of how and when such fees and charges are calculated and deducted.21 One of these commenters also stated that a registrant that does not include a fee table should be required to include a statement in its prospectus that personalized illustrations are available upon request.22 Another commenter recommended allowing the issuer to select the way to present fees and charges with a requirement that the presentation be clear.23
Another commenter, while acknowledging that the fee table is useful and would work for many products, noted that the fees and charges of other products do not lend themselves to a fee table format.24 This commenter recommended that the form instead require the transaction and annual charge sections of the fee table to disclose for each charge, either (1) the maximum of the charge (minimum and maximum amount for cost of insurance charges) on both current and guaranteed bases; or, when charges cannot adequately be described in this format, (2) a brief narrative description of the charge and the factors that determine the amount of the charge. This commenter also stated that, if a registrant discloses any charge in a narrative presentation, the registrant should be required to state prominently in the prospectus that a personalized illustration is available upon request.
One of the commenters that objected to the requirement to include a fee table also objected to the requirement to present disclosure of fees and charges at the beginning of the policy prospectus.25 This commenter stated that "it would be better to give the issuers the flexibility to determine how best to describe the material provisions of the policies" and suggested that a full explanation of the policy charges may be deferred to later in the prospectus when "the investor is ready and able to understand them."
b. Four Column Format
Commenters: 4 of 12; Favor Three Column Format: 2; Favor Two Column Format: 1; Other: 1
For each charge, the proposed table would use a four-column format to require a registrant to identify the charge, when the charge is deducted, the amount of the charge, and whether the charge is deducted from all policies or only certain policies. The three commenters that expressed views on the four column format recommended changes.26
One commenter recommended that the Commission delete the fourth column.27 This commenter asserted that the heading "Policies From Which Charge is Deducted" may be inaccurate since fees and charges are deducted not from policies but rather from premiums before those payments are invested, from the assets of a fund or account, or from payments out of a fund or account. Another commenter recommended that, if the fourth column is actually necessary in the Portfolio Company section of the fee table, the column heading be changed to "Policies Under Which Portfolio Company is Offered" or a similar phrase that indicates that these fees are deducted from fund assets and not from separate account assets or from the account value under the contract.28
One commenter favored a two column fee table where the first column would identify the charge, and the second column would disclose both the amount deducted and when the charge is assessed.29 This commenter stated that, if a charge does not apply to all policies, the form should require disclosure in a footnote that identifies which policies will be assessed the particular charge.
Another commenter suggested that, for the Portfolio Company section of the fee table, it would be better to follow the format of Form N-4, which borrows the expense presentation for Portfolio Companies from Form N-1A.30 The commenter argued that the headings for the Portfolio Company section of the fee table do not adequately distinguish Portfolio Company expenses from charges assessed under the terms of a variable life insurance policy.
c. Requirement to Disclose All Fees and Charges
Commenters: 5 of 12; Support: 1; Oppose: 4
The proposed fee table would require registrants to disclose all fees and charges, whether or not a specific caption is provided for a charge in the proposed fee table.
Five commenters expressed views on this requirement.31 One commenter specifically expressed support for the requirement.32 Four commenters objected to the requirement to disclose all fees and charges, particularly charges for riders, in the fee table.33 One commenter stated that "charges that are applicable to only a limited number of contractowners should not be required to be disclosed in the fee table."34 This commenter noted that revised Form N-1A requires disclosure of fees that may be charged to a typical investor in a fund and recommended that the Commission take a similar approach in Form N-6. Another commenter suggested that "summary charge disclosure (whether by fee table or otherwise) should be limited to the charges relevant to most policies, and companies should have discretion to defer disclosure of less relevant charges to a more detailed discussion of the policy in the body of the prospectus."35 Both of these commenters argued that the form should not require disclosure of charges for riders in the fee table because they generally apply to a limited number of policyholders or are not considered significant features of a contract. A third commenter argued that disclosure of rider charges could dominate a fee table and detract from the information about the base policy.36
The commenters that opposed fee table disclosure about riders differed on the appropriate location of such disclosure. One commenter suggested that disclosure about riders should appear in the body of the prospectus.37 Another commenter argued that riders are not typically considered essential information to a prospective investor's decision whether to purchase a particular policy and suggested that a brief description of each rider should be located in the SAI.38 This commenter suggested that the fee table identify the riders that are available to policyholders, but contain a cross-reference to an appropriate provision in the SAI for more information. A third commenter stated that its current practice is to disclose in the prospectus the availability of some riders and to advise investors to consult with their agents for more information about the riders.39
d. Requirement to Disclose Maximum Charges in the Fee Table
Commenters: 3 of 12; Favor Equally Prominent Current Charge Disclosure: 3
The proposed fee table would require disclosure of the maximum charge for each item, unless a specific instruction directs otherwise. Three commenters expressed views on this requirement.40 The three commenters recommended that the form permit registrants to disclose current charges with the guaranteed charges because: (1) placing current charge information in a footnote will not adequately disclose variations between current and guaranteed charges;
(2) disclosing the maximum guaranteed charge may significantly overstate the amount of a charge; and (3) policyholders will continue to see guaranteed charges in a contract and can return the contract during the free look period.
e. Requirement to Disclose Minimum and Maximum Cost of Insurance Charge
Commenters: 9 of 12; Oppose Disclosure of a Range: 9
The Proposed Form would require registrants to disclose in the fee table the minimum and maximum cost of insurance charges that may be imposed under a variable life insurance policy. The nine commenters that expressed views on this proposal objected to the proposed requirement to disclose a range of the cost of insurance charge.41 They argued that this approach would have little relevance to many investors. One commenter noted that the disclosure of a range of the cost of insurance charge is not useful to an investor, given that all policies are subject to the same maximum cost of insurance charge.42
Three commenters recommended that the form require separate tables that disclose a wider range of cost of insurance rates at various issue ages, rate classes, genders and policy years.43 They noted that cost of insurance charges are often the largest cost of a policy and that the added complexity of a more detailed presentation is outweighed by the benefit of more precise information.
One commenter recommended that the form require registrants to provide standardized textual disclosure of the factors that affect the cost of insurance charge ( e.g., issue and attained ages, sex, risk classification).44 The commenter also recommended that registrants be required to disclose how the cost of insurance charge increases over the life of the policy, expressed as a cost of insurance rate per $1000 of the amount at risk. The commenter stated that such disclosure could be in narrative or any other format. The commenter also stated its belief that showing cost of insurance charges at ten year intervals from issue ages 35, 45, 55, and 65 to attained age 85 provides useful information that is representative of the majority of product purchases.
One commenter recommended that issuers disclose the level of the charge for a policyholder with characteristics that are fairly representative of purchasers of a policy.45 This commenter also stated, however, that, if the Commission proceeds with the proposed approach, greater guidance is needed with respect to the parameters for the range of the cost of insurance charge ( e.g., whether a minimum should be for the youngest insured at the lowest permissible face amount; whether the maximum should be for the oldest insured or for insureds who present substandard underwriting risks).
Another commenter recommended that the form permit the registrant to include in the fee table under the "Amount Deducted" column a brief narrative description of the amount deducted for cost of insurance charges or the factors that affect the amount of the charge, and how the investor can obtain information about the rates that apply to his or her policy.46
f. Disclosure of Portfolio Company Charges
If a registrant invests in multiple Portfolio Companies, the proposed fee table would require disclosure of the range of expenses for all of the Portfolio Companies. The proposed fee table would require the Portfolio Company operating expenses to be disclosed before expense reimbursements and fee waiver arrangements. Expenses after reimbursement or waiver could be disclosed in a footnote.
In the Proposing Release, the Commission also stated that it would amend Form N-1A to require the prospectus of a mutual fund that offers its shares as investment options for variable life insurance policies to include a fee table if the Proposed Form, as adopted, did not require separate disclosure of the operating expenses of each Portfolio Company.
Nine commenters addressed the requirement to disclose only the range of expenses for all of the Portfolio Companies.47 One commenter supported the proposal, noting the significant number of funds that are available for investment under a typical policy.48
Four commenters recommended that the form require registrants to include the fees and expenses for each of the Portfolio Companies offered through the policy.49 One of these commenters argued that a range is not particularly helpful to investors who typically are more interested in the exact fees and expenses for the particular fund in which they intend to invest.50 Two of these commenters also argued that investors would not be well served if they were required to piece together the various cost components of the policy from multiple prospectuses.51
Two commenters recommended that the form permit registrants to determine how to disclose the fees and expenses for the Portfolio Companies.52 In particular, one of these commenters recommended that the form permit registrants to include in the fee table either the range of expenses for all of the Portfolio Companies or the fees and expenses for each of the Portfolio Companies.53 This commenter also recommended that registrants have the option of omitting from the fee table in the policy prospectus any information contained in a fee table in the Portfolio Company prospectus, except for total Portfolio Company operating expenses, so long as the prospectus refers the investor to the fund prospectus for more information. The other commenter suggested that a fee table may be appropriate where there are a limited number of Portfolio Companies and the fee structure is simple.54 Where there are more than a limited number of Portfolio Companies, or where the fees and charges are complex, the commenter stated that it may be appropriate to disclose that Portfolio Company fees will be charged and refer the purchaser to the detailed disclosure presented elsewhere.
One commenter objected to the proposal to require any disclosure in the fee table regarding Portfolio Company operating expenses.55 This commenter recommended that the fee table in the variable life insurance policy prospectus mention that such charges are imposed and provide a cross-reference that directs investors to the Portfolio Company prospectus for disclosure of the actual expenses.56
The remaining commenter did not express a preference regarding Portfolio Company operating expense disclosure in the fee table, but stated that the Commission should adopt a consistent approach for Form N-4 and Form N-6.57
Four commenters expressed views on the requirement to disclose Portfolio Company fees and expenses before waiver or reimbursement.58 All four commenters recommended that the form permit disclosure of net fees and expenses in the fee table. One of these commenters argued that the form should permit the presentation of net fees and expenses in the fee table, with gross expenses set forth in a footnote, provided that the fund's adviser has committed to continuing the waiver or reimbursement arrangement at least until the end of the current fiscal year.59 Another commenter argued that the form should permit registrants to disclose in the fee table underlying fund fees and expenses that reflect fee waivers or reimbursement arrangements when such arrangements are based upon contractual obligations, and are not simply voluntary waivers.60
g. Fee Table Example
Commenters 2 of 12; Support: 2
Item 3 would not require an example of the expenses that would be incurred by an investor over specified periods as is currently required by Forms N-1A and N-4. The two commenters that expressed views on the proposal not to require a fee table example supported the proposal.61 One of the commenters stated, "We agree with the Commission that the individualized nature of the fees and charges associated with variable life insurance makes it difficult to design a single example or small number of examples that would provide a useful comparison tool for investors."62
h. Captions in the Fee Table
Commenters: 3 of 12; Oppose: 3
Three commenters objected to the captions or headings contained in the proposed fee table.63 One of these commenters argued that the fee table requires disclosure of fees and charges using terminology that is no longer appropriate considering the enactment in 1996 of Section 26(e) of the Investment Company Act.64 This commenter argued that prior to enactment of Section 26(e), disclosure of variable life insurance fees and charges was "shoehorned" into arbitrary categories to meet perceived disclosure requirements of Section 26(a). This commenter asserted that Section 26(e) makes this unnecessary.
Another commenter cited specific concerns about the headings in the proposed fee table.65 The commenter stated that the heading "Transaction Fees" may be confusing to policyholders because it does not include all charges that are arguably transactional in nature, such as the monthly deduction from cash value, including the monthly cost of insurance charge. The commenter also stated that the heading "Annual Charges" may be confusing because it includes disclosure of charges that are deducted at intervals other than annually.
3. Item 4 General Description of Registrant, Depositor, and Portfolio Companies
Commenters: 4 of 12; Support with Recommendations: 2; Make Recommendations: 2
Item 4 would require a concise discussion of the organization and operation of the registrant, including the name and address of the depositor, a brief description of the registrant, a brief description of the Portfolio Companies, and a concise discussion of policy owner voting rights. Four commenters expressed views on the disclosure that would be required by this item.66 Two of these commenters specifically expressed support for Item 4 but recommended changes to the item.67 The remaining two commenters suggested changes to the requirement to provide a concise description of policyholder voting rights.68
a. Depositor Information Item 4(a)
Item 4(a) would require the registrant to provide the name and address of the depositor. One commenter suggested that the address of the depositor may be unnecessary information for a prospective investor to make an educated investment and insurance choice.69 The commenter recommended that the form permit the registrant to disclose the address for the depositor in the SAI, so long as the prospectus includes information on how to contact the issuer and administrator for the policy, if different than the issuer.
b. Registrant Information Item 4(b)
Item 4(b) would require a brief description of the registrant. One commenter suggested that Item 4 specifically require a brief statement that the separate account holds shares of the Portfolio Companies and buys and sells those shares each business day in response to transactions initiated by policyholders.70
c. Portfolio Companies Item 4(c)
Item 4(c) would require the registrant to describe briefly each Portfolio Company, including its name, its type or a brief statement concerning its investment objectives, and its investment adviser and any sub-adviser. One commenter suggested that this item only require disclosure of the names of the Portfolio Companies and a classification by investment type ( e.g., money market fund, equity fund, etc.).71 This commenter argued that the inclusion of information about the Portfolio Companies in the product prospectus is not only redundant, but also lessens the likelihood of an investor reading the Portfolio Company prospectus. This commenter expressed support for the requirement to state how investors may obtain a prospectus containing more complete information on each Portfolio Company.
d. Voting Rights Item 4(e)
Item 4(e) would require a concise discussion of a policyholder's voting rights. Two commenters addressed this requirement.72 One of the commenters recommended that the form permit a brief description of a policyholder's voting rights in the prospectus, with more technical disclosure about voting rights appearing in the SAI.73 The other commenter recommended that the Commission eliminate Item 4(e) and require disclosure regarding voting rights in the SAI.74 This commenter argued that voting rights information is not essential information that assists an investor in making an investment decision and that moving this information to the SAI would further simplify the prospectus, and be consistent with recent revisions to Form N-1A.
4. Item 5 Charges
Commenters: 5 of 12; Support with Recommendations: 5
Item 5 would require registrants to describe briefly all charges deducted from premiums, cash value, assets of the registrant, or any other source. Registrants also would be required to identify the recipient of any amount deducted and the consideration provided for any charge, and explain the extent to which the charge can be modified. If the organizational expenses of the registrant are to be paid out of its assets, the registrant would be required to disclose, if applicable, how the expenses will be amortized and the period of amortization.
Five commenters suggested changes to the proposed item.75 Two commenters stated that the Commission should not require registrants to explain what is provided in consideration for each charge.76 One of the commenters recommended that the form instead require registrants to explain briefly what is provided in consideration for the charges.77 This commenter noted that an insurer uses the revenue from all of the charges as a combined pool of resources from which it pays for the costs of administering the product. Another commenter argued that Item 5(a) and its accompanying instruction use language that is anachronistic as a result of the 1996 amendments to Section 26(e) of the Investment Company Act, and recommended that the language be updated.78
One commenter requested that the form permit shorter descriptions of the fees and charges under a policy than would be required by the proposed item.79 The commenter stated that technical disclosure about fees and charges could be set forth in the SAI.
Another commenter recommended that Items 3 and 5 be combined in one place in the prospectus to reduce repetition and duplication.80 The commenter argued that Item 5 differs from the information required in Item 3 only to the extent the same or similar information is requested but in a brief narrative description.
One commenter stated that registrants should not be required to "identify the factors upon which the cost of insurance charge will be based, including the insurer's amount at risk and the expected longevity of the insureds" and to "identify the factors reflected in the rate scale."81 The commenter stated that the form should instead require registrants to "identify the factors that determine the applicable cost of insurance rate" and to "disclose how the cost of insurance charge is calculated." The commenter argued that this formulation avoids confusing the concepts of cost of insurance rate and the cost of insurance charge, which is the rate times the net amount at risk.
This commenter also argued that the Commission should not require disclosure that simplified underwriting will cause healthy individuals to pay higher cost of insurance charges than they would pay under other underwriting methods unless the company offers the same, or a substantially similar, policy that is available on a different underwriting basis. The commenter argued that there is not a clear cut distinction between simplified underwriting and conventional underwriting, and the disclosure required by the Proposed Form would be speculative except in the circumstance identified by the commenter as appropriate for the disclosure.
Two commenters stated that the Commission should eliminate Item 5(d) which would require disclosure concerning organizational expenses for which the registrant is responsible and, if organizational expenses are to be paid by the registrant out of its assets, the amortization of those expenses.82 One of the commenters argued that operating expenses are disclosed in the fee table and that technical disclosure about these expenses would not be useful to investors.83 The other commenter asserted that organizational expenses for separate accounts, as opposed to mutual funds, are not liabilities of the registrant that are amortized and borne by the policyholders, although these expenses are taken into consideration when pricing the product.84
5. Item 7 Premiums
Commenters: 1 of 12; Supports with Changes: 1
Item 7 would require registrants to describe how to purchase a variable life insurance policy and the provisions of the policy relating to premiums. Registrants would be required to disclose the minimum initial and subsequent premiums required, any limits on the amount and frequency of premiums that will be accepted, how long investors must continue to pay premiums, and whether investors can prevent a policy from lapsing by paying a certain level of premiums. One commenter stated that the requirements of Item 7(a) are more appropriate for scheduled premium variable life insurance policies and recommended that the form designate Item 7(a) for scheduled premium policies and a new Item 7(b) for flexible premium policies to address more appropriately the differences between scheduled and flexible premium policies.85
6. Item 8 Death Benefits and Contract Values
Commenters: 1 of 12; Recommends Changes: 1
Item 8 would require a registrant to describe briefly the death benefits available under the variable life insurance policy, including how the death benefit is calculated and what forms of death benefit are available. One commenter stated that registrants also should be required to include disclosure regarding the differences between the fixed and variable death benefit options.86 This commenter recommended that this disclosure appear in the SAI and potentially consist of a graphic presentation based on a reasonable rate of return and current charges accompanied by narrative disclosure of the circumstances under which a change from one type of benefit to the other might be useful.
7. Item 9 Surrenders, Partial Surrenders, and Partial Withdrawals
Commenters: 1 of 12; Recommends Changes: 1
Item 9 would require registrants to describe briefly how a policyholder may surrender a policy. The item would require registrants to disclose any limits on the ability to surrender, how surrender proceeds are calculated, when proceeds are payable, and whether and under what circumstances partial surrenders and partial withdrawals are available under the policy. One commenter recommended that the form require a shorter description of the surrender provisions of the policy and a reference to the SAI for a more detailed description.87
8. Item 12 Taxes
Commenters: 2 of 12; Favor Moving Detailed Tax Disclosure to SAI: 2
Item 12 would require registrants to describe the material tax consequences to the policyholder and the beneficiary of buying, holding, exchanging, or exercising rights under the policy. Registrants would be required to discuss the taxation of death benefit proceeds, periodic and non-periodic withdrawals, loans, and any other distribution that may be received under the policy, as well as tax benefits accorded the policy.
Two commenters recommended that the form should emphasize brevity of tax disclosure in the prospectus with more detailed tax disclosure in the SAI.88 These commenters generally argued that technical tax disclosure reduces the usefulness of the policy prospectus. One commenter recommended that the form specifically instruct registrants to locate more extensive disclosure concerning tax issues in the SAI.89 The other commenter listed a number of points that should be succinctly stated in the prospectus tax deferral, the tax free nature of the death benefit, no taxes upon withdrawals of basis or upon loans, and the risk of significant taxes if substantial withdrawals and loans are followed by lapse with detail left to the SAI.90 This commenter also stated that a simple statement that excessively high premiums during the first seven years could lead to the loss of some of the tax advantages of the policy should suffice for the prospectus.
9. Item 14 Financial Statements
The Proposed Form would not require financial statements of the registrant and the depositor to be included in the prospectus. Item 14, however, would require the registrant to state in the prospectus where the financial statements may be found and explain how any financial statements not in the SAI may be obtained. The Proposed Form also would not require a registrant to include summary financial information in its prospectus.
a. Location of Financial Statements of Registrant and Depositor
Commenters: 4 of 12; Support Proposal: 4
The Commission requested comment on the appropriate location for registrant and depositor financial statements. All four commenters that addressed this request supported the Commission's proposal not to require in the prospectus the financial statements of the registrant and the depositor.91 The commenters agreed that the SAI is the appropriate location for the financial statements.
The Proposed Form would permit issuers of variable life insurance policies to incorporate by reference into the SAI the financial statements of the registrant and the depositor subject to the rules of the Commission on incorporation by reference. One commenter recommended that the Commission amend General Instruction D.1.(c) to provide that if a registrant incorporates by reference financial statements in the SAI, then the registrant should be required to provide those financial statements to any investor that requests an SAI, along with any other documents incorporated by reference in the SAI.92
b. Summary Financial Information for the Registrant
Commenters: 4 of 12; Support Proposal: 4
The Commission requested comment on whether variable life insurance registrants should be required to include summary financial information for the registrant in their prospectuses. All four commenters that addressed this request supported the Commission's proposal not to require summary financial information for the registrant.93 One commenter stated that the inclusion of summary financial information for the registrant would provide little, if any, meaningful information to investors.94 Another commenter stated that, because of the individual nature of variable life insurance charges, there is no measure of performance comparable to that required by Form N-4 for variable annuity registrants that would be applicable to all policyholders.95
c. Summary Financial Information for the Portfolio Companies
Commenters: 4 of 12; Support Proposal: 4
The Commission also requested comment on whether variable life insurance registrants should be required to include in their prospectuses summary financial information for the Portfolio Companies. All four commenters that addressed this issue supported the Commission's proposal not to require such information since the information already is available in the prospectuses for the Portfolio Companies.96
1. Item 15 Cover Page and Table of Contents
Commenters: 1 of 12; Makes Recommendation: 1
Item 15 requires that the cover page of the SAI contain, among other things, a table of contents for the SAI. One commenter who recommended moving detailed disclosure about loans, lapse and reinstatement, withdrawals, and changes in death benefits to the SAI, with only a brief mention of these policy provisions in the prospectus, also recommended that the form require a table of contents for the SAI that has a brief narrative under each heading describing what information is provided in the SAI.97 The commenter stated that policyowners would ask for the SAI more often, but only when they need it.
2. Item 20 Underwriters
Commenters: 1 of 12; Makes Recommendation: 1
The Proposed Form would require registrants to disclose the identity of each principal underwriter, and for each such underwriter include a statement whether the offering is continuous and disclosure of the commissions paid to such underwriter. In addition, registrants must disclose payments made to any underwriter of or dealer in its contracts. One commenter suggested that the item be revised to reflect the fact that, with some significant exceptions, most variable life insurance policies are sold by the life insurance company through one of several different distribution systems.98
3. Item 24 Financial Statements
The Proposed Form would require the full financial statements of the registrant to be in the SAI. The only financial information for the depositor required to be in the SAI would be comparative balance sheets for the last two fiscal years and, in certain cases, a more current interim balance sheet. The other financial statements of the depositor would be required to be included in the registration statement, but could be included in Part C rather than the SAI.
a. GAAP vs. Statutory Accounting
Commenters: 5 of 12; Support Proposal: 1; Oppose: 4
Instruction 1 to Item 24 would provide that a depositor's financial statements may be prepared in accordance with statutory requirements if the depositor would not have to prepare financial statements in accordance with generally accepted accounting principles ("GAAP") except for use in a registration statement filed on Forms N-3, N-4, or N-6. The Commission requested comment on the requirements concerning the use of financial statements prepared in accordance with GAAP and financial statements prepared in accordance with statutory requirements.
One commenter supported the proposed instruction to Item 24.99 This commenter noted that Regulation S-X currently permits financial statements for mutual life insurance companies to be prepared in accordance with statutory requirements and that there was no reason to reconsider the current requirements.
Four commenters objected to Instruction 1 to Item 24.100 One of these commenters recommended that the Proposed Form either mandate that all depositors include financial statements prepared in accordance with GAAP, or permit all depositors that do not otherwise prepare GAAP financial statements to file statutory financial statements.101 Another commenter recommended that depositors be permitted to include financial statements that are prepared in accordance with either statutory requirements or GAAP.102 A third commenter stated its belief that the proper standard for determining whether GAAP financial statements must be used should depend upon whether the GAAP financial statements are in the public domain and investors have relied upon them in making investment decisions.103
The remaining commenter objected to the requirement that the depositor's financial statements must be prepared in accordance with GAAP if the depositor prepares financial information in accordance with GAAP for use by the depositor's parent.104 The commenter stated that it is organizing a subsidiary in New York that, under New York insurance law, must prepare financial statements that meet statutory requirements. The commenter stated that the proposed instruction would require the subsidiary to prepare additional financial statements in accordance with GAAP. The commenter noted that this requirement does not appear in Form N-4 and requested that the instruction be revised to be consistent with Form N-4 so that issuers are not subject to different requirements for financial statements depending on the applicable form and also will not incur the cost of preparing additional financial statements in accordance with GAAP.
b. Depositor Financial Statements
Commenters: 1 of 12; Permit Complete Depositor Financials in Part C: 1
Instruction 2 to Item 24 would permit the registrant to include all statements and schedules of the depositor, other than comparative balance sheets for the last two fiscal years and, in certain cases, a more current interim balance sheet, in Part C of the registration statement. One commenter recommended that the form permit registrants to include the depositor's complete financial statements in Part C upon the condition that the complete financial statements be delivered to anyone who requests the SAI.105 The commenter pointed out that some states require insurers to deliver the SAI to investors. Placement of the insurer's full financial statements in Part C would permit insurers to have a single document that can be used for all separate account registrants, and save printing costs and audit expenses. The commenter stated that the proposed instruction will not result in significant cost savings since the bulk of the depositor's financial statements consists of accompanying notes, and under accounting standards, many of the notes to the full set of financial statements would be required to accompany the balance sheet.
c. Age of the Financial Statements
Commenters: 4 of 12; Support Proposal: 4
Instruction 3 to Item 24 would provide that the financial statements of the depositor need not be more current than as of the end of the most recent fiscal year of the depositor. In addition, Instruction 3 would provide that if the anticipated effective date of a registration statement is within 90 days of the end of the depositor's fiscal year and audited financial statements for the fiscal year are unavailable, the financial statements of the depositor need not be more current than the close of the third quarter of the previous fiscal year.
Four commenters supported this approach.106 Two commenters recommended that Instruction 3 also apply to the financial statements of the registrant.107 One of these commenters argued that interim financial statements of the registrant also do not provide useful information to a prospective investor.108
4. Item 25 Performance Data
Commenters: 7 of 12; Support Proposal Not to Require the Presentation of Performance Information in Prospectus: 5; Commission Should Prohibit the Presentation of Some Forms of Performance Information: 3; Commission Should Provide More Guidance: 1; Other: 1
Item 25 would require the registrant to include in the SAI an explanation of how it calculates performance data used in advertising, including how charges are reflected in the data. Registrants also would be required to provide a quotation of performance for each sub-account for which performance data is advertised. The Proposed Form would neither require nor preclude disclosure of any historical performance information, including Portfolio Company performance information, in the prospectus.
Five commenters supported the Commission's proposal not to require any historical performance information in the prospectus.109 Two commenters agreed with the Commission that, for the reasons cited in the Proposing Release, no method for standardizing the presentation of historical performance information has been devised that is useful enough that its disclosure should be required.110 Two commenters stated that performance information is best addressed in personalized illustrations.111
The commenters differed, however, on whether all of the various forms of performance information discussed in the Proposing Release should be permitted to be shown to prospective investors. Three commenters stated that all of the categories of performance information discussed in the Proposing Release may have informational value to investors and that registrants should be permitted to include performance information using any of the three methodologies, provided that the limitations of the method chosen are disclosed.112 One of these commenters stated its belief that performance information is essential to an informed investment decision, but noted that since no method exists for standardizing the presentation of variable life insurance performance data, each company must decide on a case-by-case basis which, if any, of the three categories of performance information discussed in the Proposing Release is appropriate under the circumstances.113 Another commenter, in stating its support for the proposal not to prohibit the inclusion of any particular form of performance information in the prospectus, stated that historic performance information is the most accurate barometer for investors to evaluate the capacity of portfolio managers to achieve the rate of return depicted in personalized illustrations.114
Two commenters expressed concern about the presentation of Portfolio Company returns.115 One of these commenters recommended that the Commission prohibit the presentation of Portfolio Company returns unless the returns are accompanied by the returns of the Portfolio Companies adjusted for separate account charges.116 This commenter argued that Portfolio Company performance adjusted for separate account level charges is more useful than Portfolio Company performance because it more accurately reflects the return someone might receive. The other commenter stated that Portfolio Company performance is misleading because it is not a measure of how a policyholder's accumulation unit values will grow.117
In contrast, another commenter argued that the Commission should prohibit the presentation of Portfolio Company performance adjusted for separate account fees and charges because the number has no useful meaning but can mislead and cause misunderstanding.118 This commenter stated that "[t]he average annual total return of the Portfolio [C]ompanies is something that investors are familiar and comfortable with, and they can be made to understand that they are only part of the story." The commenter stated that this information should be made available, at the option of the issuer, in the prospectus, the SAI, or by cross-reference to the attached fund prospectus or profile, and should be accompanied by a prominent narrative that explains that significant policy-related expenses reduce the account value and that only the personalized illustrations show what the values are after the aggregate of all charges and expenses have been deducted.
The final commenter recommended that the Commission provide more guidance in the area of performance advertising.119 The commenter stated that it had developed its own advertising guidelines for variable life insurance policies that reflect the principles that the Commission articulated for advertising variable annuities that it would be misleading in most circumstances to advertise Portfolio Company performance without presenting performance information that reflects charges at the separate account level. In particular, the commenter developed a "prototype insured" approach under which performance is presented for an insured who is representative of a class of outstanding policies. For the prototype insured, the advertisements showed changes in death benefit, cash value, and cash surrender value over periods of 1, 5, and 10 years based on an assumed pattern of premium payments. The commenter stated its belief that, because this approach requires the issuer to reflect all charges under the policy, this approach addresses the Commission's concerns about advertising Portfolio Company performance without presenting performance information that reflects charges at the separate account level. The commenter also stated that, although this approach is not perfect since the expenses that are reflected will not apply to all investors, it is a means for reflecting all charges under a policy and is preferable to presenting only performance information for the Portfolio Companies. The commenter expressed concern, however, that, in the absence of Commission guidance in this area, some issuers will present only the performance of the Portfolio Companies, which would then become an industry standard.
5. Item 26 Illustrations
Item 26 would permit, but not require, registrants to include hypothetical illustrations of a variable life insurance policy in either the prospectus or the SAI. These are tabular presentations of numbers that demonstrate how the cash value, cash surrender values, and death benefit under a policy change over time based on (i) assumed gross rates of return of the Portfolio Companies; and (ii) deduction of fees and charges for a hypothetical policyholder with a specified policy face amount and premium payment pattern.
a. Optional Use of Hypothetical Illustrations
Commenters: 6 of 12; Support Optional Use: 6
Six commenters supported the Commission's proposal to permit, but not require, hypothetical illustrations in the prospectus or the SAI.120 No commenters opposed this proposal.
b. Requirements for Hypothetical Illustrations
Item 26 would impose requirements for any hypothetical illustrations included in the prospectus or SAI.
Item 26 would require registrants to use gross rates of return of 0% and one other rate not exceeding 10%. Additional gross rates of return not greater than 10% would be permitted. The Commission expressed concern that rates above 10% may have a significant tendency to invite unrealistic investor expectations because long-term stock market returns have averaged approximately 10-11% per year and long-term returns on other asset classes have been lower. The Commission also expressed concern that investors may give undue weight to a 12% illustration because they may discount a 0% illustration as unrealistically low.
10% Rate Cap (Commenters: 7 of 12; Support: 1; Oppose: 6). One commenter supported the Commission's proposal not to permit illustrations showing rates greater than 10%.121 The commenter expressed concern that use of a 12% rate may cause investors to underestimate the level of premiums they need to pay to support a particular death benefit and to avoid policy lapse.
Six commenters argued that the Commission should permit illustrations with rates as high as 12%.122 The commenters argued that 12% fairly depicts stock market performance. One commenter also argued that there is no substantiated reason to believe that rates of return greater than 10% may have a significant tendency to invite unrealistic investor expectations.123 Another commenter argued that limiting hypotheticals to a 10% return would increase the possibility that, in a high interest rate environment, non-variable universal life insurance illustrations will be based on higher assumed rates of return than variable life illustrations.124 Two commenters argued that 12% is preferable to 10% because a 12 percentage point range gives investors a better understanding of how a contract might fare under different market conditions.125
Number of Rates of Return Required (Commenters: 5 of 12; Recommend Three Rate Requirement: 4; Other: 1). Four commenters recommended that the form require registrants to illustrate three rates of return instead of two.126 The commenters generally argued that the use of three rates of return in an illustration more effectively demonstrates how variable life insurance policies operate and the effect that underlying fund returns have on cash values and death benefits.
One commenter recommended that illustrations should contain an 8% intermediate rate to demonstrate the dramatic results that a two percentage point difference can have on policy performance.127 Two commenters recommended that illustrations contain three rates of return with a maximum rate of 12%.128 One of these commenters stated that the illustrations should contain rates of 0% as the lowest rate, a reasonable intermediate rate selected by the registrant, and a third rate also selected by the registrant no greater than 12%.129 The other commenter recommended that illustrations contain rates of 0% as the lowest rate, an intermediate rate selected by the registrant no greater than 6%, and a third rate also selected by the registrant no greater than 12%.130
Another commenter favored the current practice of presenting three hypothetical rates of 0%, 6%, and 12%.131 The commenter argued that, under the proposed approach, an investor may discount the 0% illustration as unrealistically low and focus on the 10% illustration; whereas, under current practice, the investor could look to results at both 6% and 12% which better communicate the hypothetical nature of the returns and a hypothetical range of results.
One commenter suggested that, if the Commission is concerned that investors may discount the 0% return as unrealistically low and that non-equity asset class returns are typically lower than long-term equity returns, Form N-6 could require the inclusion of three rates of return of 0%, 12%, and one other rate not greater than 10%.132
Item 26 would require that Portfolio Company management fees and other Portfolio Company charges and expenses be reflected using the arithmetic average of those charges and expenses for all available Portfolio Companies. Seven commenters opposed the required use of an arithmetic average.133
Five of these commenters argued that a weighted average would better reflect the proportionate allocations that investors actually make in a particular product, and would therefore serve as a better proxy of what a prospective investor might pay in actual Portfolio Company expenses.134 One commenter argued that the use of an arithmetic average creates the opportunity for abuse in that an insurer could deliberately add low cost Portfolio Companies to a variable life policy to reduce the average expenses.135 Another commenter argued that a simple average is problematic because it can magnify the effect of a single Portfolio Company that has high costs.136 Likewise, one commenter argued that requiring an arithmetic average could deter registrants from adding good but expensive funds such as international funds or aggressive growth or small-cap funds.137
Two commenters recommended that the form require the use of a weighted average of Portfolio Company expenses.138 Four commenters recommended that the form should permit the use of either a weighted or an arithmetic average.139
Five commenters stated that issuers should determine the weighted average based on the actual allocations among Portfolio Companies.140 One commenter recommended that new registrants estimate proportionate allocations for purposes of determining a weighted average.141 One commenter recommended that registrants be required to use an arithmetic average for new policies that have no money invested in the Portfolio Companies and a weighted average in subsequent years.142 Two commenters recommended that, during the first year of operation of a new Portfolio Company, the registrant should estimate the weighting for that Portfolio Company.143
Two commenters argued that the use of a weighted average would be consistent with the standard contained in the Proposed Form for determining the other assumptions within the illustration ( e.g., Item 26(c) states that premium amounts should be representative of actual or expected contract size, and that the insured's age should be representative of actual or expected contract sales).144
Item 26 also would require that hypothetical prospectus illustrations reflect Portfolio Company charges and expenses without taking into account any fee waiver or expense reimbursement arrangements.
Two commenters recommended that the form permit insurers to take into account fee waiver and expense reimbursement arrangements where the arrangements are binding either (1) for at least one year or until the next prospectus update,145 or (2) until the end of the current fiscal year.146 One of these commenters argued that as long as the arrangements are binding commitments for the period of time suggested by the commenter, they would reflect the actual fees and expenses that policyholders would experience as investors in the Portfolio Companies.147 This commenter also stated that, in some cases, investment advisers limit the duration of a fee waiver or expense reimbursement arrangement by a predetermined size to be reached by the Portfolio Company rather than, or as an alternative to, a time limitation.148 The commenter stated that these advisers would expect to be able to do likewise in the future and asked that Form N-6 or the adopting release acknowledge this practice and permit it to continue.
Item 26 would require that illustrations reflect both current and guaranteed maximum charges for charges not attributable to the Portfolio Companies. Three commenters supported this approach.149 \
Item 26(c) would require that premium amounts used in illustrations should not be unduly larger or smaller than the actual or expected average policy size, and ages used should be representative of actual or expected policy sales. One commenter asked the Commission to
clarify whether the term "policy size" refers to policy premium amount or face amount.150
The commenter also stated that averaging of premium amount can result in a premium amount that can be significantly different from the premium amount that is representative of the actual policies sold, especially in the early years after a new policy becomes available or if the policy is a modified single premium policy. The commenter recommended that either an average or a median premium amount (or policy size, if the Commission was referring to a policy's face amount or death benefit) be permitted so that insurers have the flexibility needed to determine a more meaningful representative amount than the exclusive use of an averaging method permits.
Item 26(d) would require that illustrations be shown for the rating classification with the greatest number of outstanding policies. One commenter argued that this requirement may result in a rating classification being used that is not meaningful for the representative policy being illustrated.151 This commenter recommended that the requirement be changed to state that the rating classification used in the illustrations should be a representative risk classification for the age and policy premium amount (or policy size) illustrated.
c. Hypothetical Illustrations Based on Historical Rates of Return
Commenters: 4 of 12; Support Optional Use: 2; Limit Performance Information to Sales Material: 1; Other: 1
The Commission requested comment on the use of hypothetical illustrations constructed using historical rates of return for the Portfolio Companies"hypothetical historical illustrations") rather than assumed rates of return e.g., 0% and 10%). The Proposed Form did not specifically address hypothetical historical illustrations.
Four commenters expressed views in response to the request for comment.152 One commenter stated that it was concerned about the use of actual past performance to illustrate future values.153 The commenter argued that, to the extent actual results are used, illustrations lose much of their hypothetical nature, despite any disclaimer to the contrary. The commenter suggested that the presentation of historical performance results should be limited to performance advertisements and the like.
Two commenters stated that the Commission should permit, but not require, the use of hypothetical historical illustrations.154 One of these commenters agreed that such illustrations have limits but argued that insurers should be permitted to weigh these limits against the potential benefits.155 The commenter also argued that these illustrations demonstrate the mechanics of a contract by showing the effect that varying rates of returns have on a policy. The commenter also stated that hypothetical historical illustrations should be prepared in accordance with the requirements applicable to hypothetical prospectus illustrations (except for requirements as to the rates of return that may be illustrated).
Another commenter argued that hypothetical historical illustrations can add to a prospective investor's understanding of the policy by showing the relative performance of one Portfolio Company to another.156 The commenter stated that, although this also may be done by disclosing the historical rates of return for each Portfolio Company, an illustration can translate those returns into actual dollar amounts and may make the information more tangible for some investors. The commenter also argued that hypothetical historical illustrations are the variable life insurance equivalent of the required line graph illustration for mutual funds that shows the growth of a $10,000 investment in the fund.
One commenter stated that it would oppose a requirement to include hypothetical historical illustrations in the prospectus, but stated that it would not object if such illustrations are permitted in the SAI.157 The commenter argued that such illustrations can add unnecessary length and complexity to the prospectus. The commenter also stated its preference to use historical rates of return in personalized illustrations.
d. Inclusion of Additional Information in Illustrations
Commenters: 1 of 12; Recommends that Registrants be Permitted to Include in Illustrations Information that is not Required: 1
One commenter recommended that issuers be permitted to include in prospectus and personalized illustrations any other information that the registrant considers helpful, including, for example, historical returns and internal rates of return on net cash value and death benefit, provided that the information is not misleading.158 The commenter stated that some companies also may wish to present net cash values and death benefits based on historic returns in either the prospectus, in personalized illustrations, or both. The commenter recommended that, in these cases, the registrant should include in the illustration, or in an introduction to the illustration, a brief explanation of any features, benefits or characteristics specific to the product that are not elsewhere disclosed in the prospectus or the SAI.
e. Personalized Illustrations
Personalized illustrations are frequently provided by insurers to prospective variable life insurance investors at the point of sale. These illustrations reflect the investor's particular circumstances, including age, sex, risk classification, proposed face amount, and expected premium payment pattern. The Proposed Form does not address personalized illustrations because these are customized for individual investors, delivered at the point of sale, and not susceptible to inclusion in a prospectus.
The Commission requested comment on whether insurers should be required to disclose in the prospectus whether or not personalized illustrations are available. Four commenters stated that the Commission should require insurers to disclose in the prospectus that personalized illustrations are available upon request, if applicable.159 One of these commenters stated that no disclosure should be required if personalized illustrations are not available.160
The Commission also requested comment on whether variable life insurance registrants should be required to deliver personalized illustrations to prospective investors. One commenter stated that personalized illustrations should be required, except in the context of corporate-owned life insurance.161 Another commenter stated that personalized illustrations should be available to policyholders upon request.162 Two commenters stated that the depositor should be required to provide personalized illustrations upon request if it elects to disclose charges in a narrative format rather than by means of a fee table.163 Two commenters stated that personalized illustrations should be optional.164 One of these commenters argued that personalized illustrations are a form of sales literature and issuers should be able to choose what forms of sales literature to use.165
The Commission also solicited comment concerning: (i) whether it should prescribe any requirements for registrants using personalized illustrations; and (ii) if so, what those requirements should be. Nine commenters stated that the Commission should prescribe requirements for personalized illustrations either in Form N-6 or in another rulemaking or interpretive proceeding.166 The commenters argued that: (1) personalized illustrations would be most accurate and most useful if they are prepared by all issuers in accordance with the same set of standards;167 (2) mandating some degree of uniformity of content would offer a number of benefits to investors, such as facilitating comparisons among different policies;168 and (3) establishing standards for personalized illustrations would create efficiencies within the variable life insurance market and contribute to overall fairness.169
One commenter also argued that Commission guidelines would facilitate the ability of NASD Regulation, Inc. ("NASDR") to review personalized illustrations.170 The commenter stated that Commission guidelines would establish a uniform standard for review, whereas the NASDR currently takes inconsistent positions.171 Another commenter requested that the Commission set aside NASDR's requirement that personalized illustrations be prepared using the same methodology and format as prospectus illustrations because the two types of illustrations have different roles.172
One commenter specifically stated that the Commission should not prescribe requirements for personalized illustrations in Form N-6, but rather in a separate rulemaking proceeding.173 The commenter stated its belief that a separate rulemaking, and not a registration form, is the appropriate forum for substantive requirements regarding sales literature, including personalized illustrations. The commenter also stated that NASDR currently requires that personalized illustrations be prepared on the same basis as the insurer's hypothetical prospectus illustrations. In addition, the commenter stated that there is already a regulatory mechanism for the prospectus illustration requirements of Form N-6 to be imposed on personalized illustrations. This commenter expressed its concern that if the Commission were to decide to regulate the format and use of personalized illustrations through Form N-6, then the disclosure benefits of the form would be delayed in part because any such effort could require the reproposal of Form N-6.
One commenter urged the Commission to take an active role in the area of personalized illustrations, but argued that the Commission needed more experience in this area before establishing uniform standards for the industry.174 This commenter suggested that, in order to gain more experience, the Commission should require issuers to include, as an exhibit to the registration statement, a representative example of the personalized illustrations currently being used by the issuer. The commenter also urged the Commission to encourage the use of plain English in the narratives that typically accompany personalized illustrations.
The commenters that recommended that the Commission prescribe requirements for personalized illustrations also submitted views on what those requirements should be. Two commenters stated that the standards should conform, to the extent practicable, with the National Association of Insurance Commissioners ("NAIC") standards for fixed life insurance policy illustrations.175 One of these commenters argued that the requirements for personalized illustrations should not be the same as those for hypothetical prospectus illustrations, because personalized illustrations are based on the unique characteristics of an individual investor and the particular insurance policy.176 The commenter stated, for example, that although the use of historical rates of return in prospectus illustrations may be complex and costly, the use of historical rates of return of specific Portfolio Companies is essential to preparing an accurate and useful personalized illustration.
Two commenters suggested that the standards for personalized illustrations should be similar to the proposed requirements for hypothetical prospectus illustrations.177 One commenter stated that the Commission should articulate the primary objectives of personalized illustrations, and permit the states to draft detailed regulations governing personalized illustrations.178 The commenter also specifically recommended that the Commission should not prohibit illustrations that reflect returns and expenses of a single portfolio company because many policyholders will allocate all or most of their premiums to just one or two Portfolio Companies.
Two commenters stated that an insurer providing personalized illustrations should be required to provide a standardized "compliance ledger."179 One commenter suggested that issuers should be required to include in the compliance ledger illustrations based on two hypothetical rates of 0% and one other rate not greater than 12%; historical rates would not be permitted.180 Portfolio Company fees and expenses would be reflected in the illustration based on a weighted, rather than arithmetic, average, and net, not gross, expenses. Issuers would be permitted to provide other personalized illustrations along with the compliance ledger, including personalized illustrations based on historical rates of return, but no standards would apply to these optional illustrations. The commenter recommended that when personalized illustrations are provided, a sample calculation should be required to be filed as an exhibit to the registration statement.
The other commenter recommended a similar approach and submitted proposed guidelines for the use of personalized illustrations that it suggested could be incorporated into Form N-6 or a separate rulemaking or interpretive release.181 The proposed guidelines would require an insurer to provide a "basic illustration" that reflects maximum fees and charges at a hypothetical rate of 0%, and both current and maximum fees and charges at one other rate of return not greater than 12%. Portfolio Company fees and expenses could be reflected in the basic illustration based on either a weighted or arithmetic average of all available Portfolio Companies or only those selected by the investor. Issuers would be permitted to provide other personalized illustrations along with the basic illustration. The issuer also would be required to include in the registration statement an undertaking that the methodology used in deriving the personalized illustration will be consistent with the methodology used in deriving the prospectus illustration. The issuer would be required to make the same certification to the NASDR.
Five commenters recommended that the Commission permit personalized illustrations that reflect the weighted average of Portfolio Company fees and expenses based on the funds actually selected by a prospective investor.182 One commenter recommended that the Commission permit personalized illustrations that reflect either the weighted or arithmetic average of Portfolio Company fees and expenses based on the funds actually selected by the investor.183 Another commenter recommended that the Commission permit personalized illustrations that reflect either the weighted or arithmetic average of Portfolio Company fees and expenses based on either
(1) the funds actually selected by the investor, or (2) all of the available Portfolio Companies.184
One commenter requested that, even if the Commission does not opt to establish standards for personalized illustrations, it should indicate in the adopting release that customization of Portfolio Company expenses is not per se misleading and does not make the illustration into a projection.185 This commenter argued that customized Portfolio Company fees and expenses make personalized illustrations more accurate and more useful as comparison shopping tools. Another commenter argued that use of an arithmetic average in personalized illustrations creates an opportunity for abuse.186
One commenter recommended that the rates of return used in the illustrations should be "net" rates, that is, rates that reflect the fees and expenses of the Portfolio Companies and therefore represent assumed average annual total returns for the Portfolio Companies.187 The commenter argued that the term "gross rate" ( i.e., the rate of return before deduction of Portfolio Company fees and expenses) is not a concept with which investors are familiar. This commenter also argued that the concept of net returns causes confusion because insurers define the term differently. The commenter noted, for example, that some insurers use the term "net return" to refer to the rate of return net of all fees and expenses of the Portfolio Companies and all asset-based charges at the separate account level, while others use the term to refer only to the return of a Portfolio Company net of its fees and expenses.
The Commission solicited comment concerning the use of personalized illustrations that reflect the fees and charges of a single available Portfolio Company. All eight commenters that expressed views on this issue stated that there are circumstances in which it is appropriate for insurers to use personalized illustrations that reflect the fees and charges of only one or a limited number of available Portfolio Companies.188 Two commenters argued that fund fees and expenses are another feature of an illustration that can be personalized in an effort to provide the consumer with a better understanding of how personal characteristics and preferences, including fund selection, will affect policy benefits under different return assumptions.189 Two commenters argued that personalized illustrations that reflect the fees and expenses of one or a limited number of Portfolio Companies are particularly beneficial when illustrating in force policies.190 Another commenter argued that any potential for abuse should not result in a per se prohibition on the use of expenses of a single Portfolio Company in illustrations, since this would restrain the flow of information to investors who request it.191 This commenter expressed disappointment that the Proposing Release contained a broad statement that this practice may be misleading and urged the Commission to correct this matter.
1. Item 27 Exhibits
a. Item 27(l) Actuarial Certification
Commenters: 3 of 12; Recommend Changes to Certification: 3
An opinion of an actuarial officer of the depositor would be required by Item 27(l) if illustrations are included in the registration statement as permitted by Item 26. Three commenters addressed this requirement, and none objected to the requirement.192 All three commenters, however, recommended that the Commission modify the certification that would be required.
One commenter argued that the proposed certification is not appropriate because there are no established accounting, actuarial, or securities law standards upon which an actuary may rely in preparing the proposed certification.193 Rather, the actuary should represent that (i) the illustrations are consistent with the policies, based on the stated assumptions that accompany the illustrations; (ii) the stated assumptions, including any elements that are illustrated at rates that are not guaranteed, are reasonable; (iii) the policies have not been designed to make the relationship between premiums and benefits, as shown in the illustrations, appear disproportionately more favorable than it would for illustrations based on any other assumptions; and (iv) the stated assumptions used for the illustrations have not been chosen for the purpose of making the relationship between premiums and benefits appear more favorable than it would appear under other assumptions.
Two commenters argued that the requirement to certify that the relationship between premiums and benefits illustrated is not materially more favorable than for a substantial majority of other prospective policyholders is in conflict with the requirements of Items 26(c) and 26(d) regarding preparation of hypothetical prospectus illustrations.194 One of the commenters recommended that the actuary certify that the rate class selected for the assumptions is not materially more favorable than for the rate class with the greatest number of existing contracts (or expected contracts in the case of a new contract), as opposed to the substantial majority of existing contracts.195 This commenter stated that a contract's most prevalent rating classification also could be the most favorable of the insurer's rating classifications, however, a majority of outstanding contracts may not receive that classification. The commenter noted that, under these circumstances, illustrating the most prevalent classification as required by Item 26(d) could result in the relationship between premiums and benefits being more favorable than for a majority of other contracts. The commenter also recommended that the certification be based on existing contract owners rather than prospective contract owners.
The other commenter recommended that the actuary certify that the rate structure of the policy and the assumptions selected for the illustrations do not result in a relationship between premiums and benefits, as shown in the illustrations, that is materially more favorable than the representative policies being illustrated relative to the actual or expected illustrations to be shown to prospective policyholders.196
b. Item 27(q) Redeemability Exemption
Commenters: 1 of 12; Requests Clarification: 1
One commenter requested that the Commission clarify that, for purposes of claiming exemptions under Rules 6e-2(b)(12)(ii) or 6e-3(T)(b)(12)(iii), the form designated by the Commission under paragraph (b)(3)(ii) of those rules is Form N-6.197 The commenter asked that the Commission amend Item 27(q) to include a statement that "[t]he filing of this exhibit shall be considered to be satisfactory compliance with the filing requirement of these two rules."
1. General Instruction B Filing and Use of Form N-6
Commenters: 2 of 12; Recommend Addition of Instruction on Use of Form to Register under Securities Act but not under Investment Company Act: 2
The Commission did not include an instruction that would permit Form N-6 to be used for registration under the Securities Act of variable life insurance policies funded by separate accounts that would be required to be registered under the Investment Company Act as unit investment trusts except for the exclusion in Section 3(c)(11) of the Act, unlike Form N-4, which contains such an instruction. The Commission stated that it was not aware of any variable life insurance policies that are funded by separate accounts that are not registered under the Investment Company Act. Two commenters requested that the form include such an instruction.198 One of the commenters stated that it was considering developing a variable life insurance policy that would be funded by a separate account that is not registered under the Investment Company Act.199
The Commission stated that all new registration statements and post-effective amendments that are annual updates to effective registration statements filed six months after the effective date of Form N-6 would be required to comply with its requirements. The final compliance date for filing amendments to effective registration statements to conform with the Form N-6 requirements would be 18 months after the effective date of the form. At its option, a registrant could comply with the requirements of Form N-6 at any time after the effective date of the form.
One commenter specifically supported the proposed transition period.200 This commenter also requested that the Commission permit existing registrants to make financial statements available upon request while using Forms N-8B-2 and S-6 during the 18 month transition period, instead of requiring their continued presentation. Another commenter recommended that the Commission treat any post-effective amendment filed for the purpose of complying with Form N-6 as a filing under Rule 485(b) rather than a filing under paragraph (a) of Rule 485, because the information presented is basically the same as that required in Forms S-6 and N-8B-2, but presented in a three-part format.201
The Commission requested comment on whether Form N-1 should be rescinded as obsolete and whether there is any continuing need for the form. Currently, Form N-1 would be used only by an open-end management investment company that is a separate account of an insurance company offering variable life insurance policies.
One commenter responded to the request stating that Form N-1 should not be rescinded because there are still registrants relying upon the form.202 The commenter stated that some older variable insurance contracts that were registered on Form N-1 are still in existence, but not actively marketed. The commenter argued that it would be unnecessarily expensive and unproductive to delete the form and require compliance with a new format for these contracts.
The Commission requested that any interested persons submit comments on the Proposed Form, suggest changes, or submit comments on other matters that might affect the Proposed Form.
One commenter requested that the Commission incorporate into Form N-6 instructions for the use of multiple prospectuses within a single registration statement.203 This commenter argued that having such an ability would contain the number of registration statements filed, thereby alleviating additional burdens on both the registrant and the Commission.
One commenter requested that the Commission use a term less technical than "depositor," and instead refer to the "insurance company" in the release and Form N-6.204 Another commenter also suggested that the Commission refer to a purchaser of a variable life insurance policy as something other than an "investor."205 The commenter argued that, although variable life insurance has an investment component, it is primarily an insurance product.
Another commenter recommended that the Commission consider proposing a series of new or revised rules to incorporate recent changes and improvements with regard to investment company filings and disclosures and to address changes in the variable contract industry that have occurred over the last five to ten years.206 These rules and forms relate to the following:
|1||Release Nos. 33-7514 and IC-23006 (Mar. 13, 1998) [63 FR 13988 (March 23, 1998)].|
|2||For purposes of this summary, ReliaStar I and ReliaStar II were counted as one commenter.|
|3||ACLI; L. Latto; MassMutual; NAVA; Prudential; ReliaStar I.|
|4||ACLI; MassMutual; Prudential.|
|5||L. Latto; NAVA; ReliaStar I.|
|14||Prudential; ReliaStar I.|
|17||Equitable; MassMutual; New York Life; Prudential.|
|20||ACLI; Hancock; L. Latto; L. Latto II; Lincoln; NAVA; Pacific Life.|
|21||ACLI; Hancock; Pacific Life. The instruction to Item 3 proposed by the ACLI states that disclosure of fees and charges could employ a tabular presentation, flow chart, narrative presentation, or a combination of disclosure presentations.|
|24||NAVA and NAVA II.|
|26||ACLI; MassMutual; NAVA.|
|31||ACLI; MassMutual; NAVA; New York Life; Pacific Life.|
|32||New York Life.|
|33||ACLI; MassMutual; NAVA; Pacific Life.|
|36||Pacific Life. The commenter also suggested that most riders are not securities, that the offer and sale of a rider should be considered a separate sale from that of the base policy, and questioned whether the Commission may require disclosure of charges for riders that are not securities.|
|40||Equitable; NAVA; ReliaStar I.|
|41||ACLI; Equitable; L. Latto II; Lincoln; NAVA; NAVA II; New York Life; Pacific Life; Prudential; ReliaStar I.|
|43||Equitable; Prudential; ReliaStar I.|
|45||Pacific Life. This commenter also noted that the mortality and expense risk charge under several of its policies is, in part, based on the policy's face amount, and varies with the age of the insured. Thus, like the cost of insurance charge on many policies, the mortality and expense risk charge varies with the individual insured, and would be difficult to disclose under the proposed fee table.|
|46||New York Life. This commenter stated, however, that if numeric disclosure is required, it prefers to base the numbers on the hypothetical insured and other policy factors that are used in the prospectus illustrations (or could be used if such illustrations were included).|
|47||ACLI; Equitable; Lincoln; MassMutual; Nationwide; NAVA; Pacific Life; Prudential; ReliaStar I.|
|48||Pacific Life. The commenter also noted that fund expenses are not specified under the terms of a variable contract and such disclosure would clarify the differences between contractual charges and fund expenses.|
|49||Equitable; Lincoln; Prudential; ReliaStar I.|
|56||This commenter agreed with the proposal to amend Form N-1A to require the prospectus of a mutual fund that offers its shares as investment options for variable life insurance policies to include a fee table if the Form N-6, as adopted, does not require separate disclosure of the operating expenses of each Portfolio Company. This commenter, however, also stated that if the form, as adopted, requires disclosure of Portfolio Company operating expenses in the fee table, the form should require separate disclosure of the expenses associated with each Portfolio Company.|
|58||Equitable; Nationwide; NAVA; Prudential.|
|63||ACLI; L. Latto; Pacific Life.|
|66||ACLI; MassMutual; NAVA; Prudential.|
|72||ACLI; NAVA. The ACLI commented on the voting rights disclosure requirements in the context of Item 6(a) which would require registrants to identify all persons who have material rights under the policy and the nature of those rights. For purposes of this summary, the ACLI's comments on the voting rights disclosure requirements are discussed along with NAVA's comments on Item 4(e).|
|75||ACLI; L. Latto; NAVA; Prudential; ReliaStar I.|
|76||L. Latto; NAVA.|
|82||L. Latto; Prudential.|
|88||ACLI; L. Latto.|
|91||ACLI; Hancock; Prudential; ReliaStar II.|
|93||ACLI; Hancock; MassMutual; Prudential.|
|96||ACLI; Hancock; MassMutual; Prudential.|
|100||Lincoln; MassMutual; Pacific Life; ReliaStar II.|
|106||ACLI; Lincoln; MassMutual; ReliaStar II.|
|109||ACLI; L. Latto; MassMutual; NAVA; Prudential.|
|110||L. Latto; NAVA.|
|111||L. Latto; MassMutual.|
|112||ACLI; NAVA; Prudential.|
|120||ACLI; Equitable; Hancock; NAVA; Pacific Life; Prudential.|
|122||ACLI; Equitable; Hancock; Lincoln; NAVA; Pacific Life.|
|123||ACLI. At the request of the staff, one commenter provided sample hypothetical illustrations that show the cash values that result from assuming a constant rate of return of 12% each year and an annual rate of return that averages 12% but varies from year to year. See NAVA II. NAVA II argued that the sample illustrations show that using a constant average rate of return does not necessarily result in accumulated values higher than those that would result from using a series of varying rates that average out to the constant rate of return.|
|126||Equitable; NAVA; Pacific Life; Prudential.|
|133||ACLI; Equitable; Hancock; Lincoln; NAVA; NAVA II; Pacific Life; Prudential.|
|134||ACLI; Equitable; Hancock; NAVA; NAVA II; Pacific Life.|
|139||ACLI; Hancock; Lincoln; Pacific Life.|
|140||ACLI; Equitable; Hancock; NAVA; Prudential. Prudential also stated that issuers should be obligated to update the illustrations in response to changed fund asset values no more frequently than every sixteen months.|
|149||ACLI; Hancock; NAVA.|
|150||ACLI. This commenter stated that it assumed that the Commission meant "policy premium amount" and recommended that "premium amount" be substituted for "size" as "size" usually refers to a policy's face amount or death benefit. Alternatively, if the Commission intended that the premium amount illustrated be representative of the premium for the actual or expected average policy size, the commenter recommended that the italicized phrase be added after "than" in Item 26(c) for clarity.|
|152||Equitable; Hancock; NAVA; Prudential.|
|159||ACLI; Equitable; Hancock; Nationwide.|
|166||ACLI; Equitable; Hancock; Lincoln; MassMutual; Nationwide; NAVA; New York Life; Prudential.|
|167||ACLI; New York Life.|
|170||New York Life.|
|171||The commenter stated, for example, that NASDR currently prohibits personalized illustrations that reflect expenses for the specific underlying portfolios chosen by an investor, although many insurers use these illustrations apparently with prior NASDR approval.|
|178||MassMutual. This commenter suggested, for example, that the Commission could require within the illustration: (a) the use of clear and concise language; (b) the use of no more than three rates of return with no rate greater than 10%; (c) the prospective insured's particular characteristics, such as age, sex, underwriting class, face amount, premium amount, and payment mode; (d) all policy and separate account expenses applicable to the insured, as well as Portfolio Company expenses if actual performance is being used; (e) appropriate cautionary disclosure regarding rates of return and the purpose of the illustrations; and (f) reflection of both current and guaranteed rates and expenses. This commenter also suggested that the Commission could require an actuarial opinion to be filed as an exhibit to the registration statement.|
|182||Lincoln; Nationwide; NAVA; New York Life; Prudential.|
|185||New York Life.|
|188||ACLI; Equitable; Hancock; MassMutual; NAVA; New York Life; Pacific Life; Prudential.|
|189||Equitable; New York Life.|
|192||ACLI; NAVA; New York Life.|
|193||New York Life.|
|195||NAVA and NAVA II.|
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