[Federal Register Volume 59, Number 31 (Tuesday, February 15, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-3426]


[[Page Unknown]]

[Federal Register: February 15, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33067; File No. SR-NASD-94-2]

 

Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by National Association of Securities Dealers, Inc. Relating to 
Guidelines for Communications to the Public About Variable Life and 
Annuity Products

February 9, 1994.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on January 
6, 1994, the National Association of Securities Dealers, Inc. (``NASD'' 
or ``Association'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') and amended on February 8, 1994,\1\ the 
proposed rule change as described in Items I, II, and III below, which 
Items have been prepared by the NASD. The Commission is publishing this 
notice to solicit comments on the proposed rule change from interested 
persons.
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    \1\See letter from Suzanne E. Rothwell, Associate General 
Counsel, NASD, to Selwyn Notelovitz, Branch Chief, Over-the-Counter 
Regulation, Division of Market Regulation, SEC, dated February 8, 
1994. The NASD made technical changes to its proposed rule in 
response to comments raised by the staff of the Commission.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The NASD is proposing to adopt Guidelines Regarding Communications 
With the Public About Variable Life and Annuity Products. Below is the 
text of the proposed rule change. Proposed new language is italicized.

Guidelines for Communications With the Public About Variable Life 
Insurance and Variable Annuities

    The standards governing communications with the public are set 
forth in Article III, Section 35 of the NASD Rules of Fair Practice. In 
addition to those standards, these guidelines must be considered in 
preparing advertisements and sales literature about variable life 
insurance and variable annuities. The guidelines are applicable to 
advertisements and sales literature as defined in Section 35, as well 
as individualized communications such as personalized letters and 
computer generated illustrations, whether printed or made available on 
screen.

I. General Considerations

A. Product Identification

    In order to assure that investors understand exactly what security 
is being discussed, all communications must clearly describe the 
product as either a variable life insurance policy or a variable 
annuity, as applicable. Member firms may use proprietary names in 
addition to this description. In cases where the proprietary name 
includes a description of the type of security being offered, there is 
no requirement to include a generalized description. For example, if 
the material includes a name such as the ``XYZ Variable Life Insurance 
Policy,'' it is not necessary to include a statement indicating that 
the security is a variable life insurance policy.
    Considering the significant differences between mutual funds and 
variable products, the presentation must not represent or imply that 
the product being offered or its underlying account is a mutual fund.

B. Liquidity

    Considering that variable life insurance and variable annuities 
frequently involve substantial charges and/or tax penalties for early 
withdrawals, there must be no representation or implication that these 
are short-term, liquid investments. Presentations regarding liquidity 
or ease of access to investment values must be balanced by clear 
language describing the negative impact of early redemptions. Examples 
of this negative impact may be the payment of contingent deferred sales 
loads and tax penalties, and the fact that the investor may receive 
less than the original invested amount.
    With respect to variable life insurance, discussions of loans and 
withdrawals must explain their impact on cash values and death 
benefits.

C. Claims About Guarantees

    Insurance companies issuing variable life insurance and variable 
annuities provide a number of specific guarantees. For example, an 
insurance company may guarantee a minimum death benefit for a variable 
life insurance policy or the company may guarantee a schedule of 
payments to a variable annuity owner. Variable life insurance policies 
and variable annuities may also offer a fixed investment account which 
is guaranteed by the insurance company. The relative safety resulting 
from such a guarantee must not be overemphasized or exaggerated as it 
depends on the claims-paying ability of the issuing insurance company. 
There must be no representation or implication that a guarantee applies 
to the investment return or principal value of the separate account. 
Similarly, it must not be represented or implied that an insurance 
company's financial ratings apply to the separate account.

II. Specific Considerations

A. Fund Performance Predating Inclusion in the Variable Product

    In order to show how an existing fund would have performed had it 
been an investment option within a variable life insurance policy or 
variable annuity, communications may contain the fund's historical 
performance that predates its inclusion in the policy or annuity. Such 
performance may only be used provided that no significant changes 
occurred to the fund at the time or after it became part of the 
variable product. However, communications may not include the 
performance of an existing fund for the purposes of promoting 
investment in a similar, but new, investment option (i.e., clone fund 
or model fund) available in a variable contract.
    The presentation of historical performance must conform to 
applicable NASD and SEC standards. Particular attention must be given 
to including all elements of return and deducting applicable charges 
and expenses.

B. Product Comparisons

    A comparison of investment products may be used provided the 
comparison complies with applicable requirements set forth under 
Article III, Section 35 of the NASD Rules of Fair Practice. Particular 
attention must be paid to the specific standards regarding 
``comparisons'' set forth in subsection (d)(2)(M).

C. Use of Rankings

    A ranking which reflects the relative performance of the separate 
account or the underlying investment option may be included in 
advertisements and sales literature provided its use is consistent with 
the standards contained in the Guidelines for the Use of Rankings in 
Mutual Fund Advertisements and Sales Literature.

D. Discussions Regarding Insurance and Investment Features of Variable 
Life Insurance

    Communications on behalf of single premium variable life insurance 
may emphasize the investment features of the product provided an 
adequate explanation of the life insurance features is given. Sales 
material for other types of variable life insurance must provide a 
balanced discussion of these features.

E. Hypothetical Illustrations of Rates of Return in Variable Life 
Insurance Sales Literature and Personalized Illustrations

    (1) Hypothetical illustrations using assumed rates of return may be 
used to demonstrate the way a variable life insurance policy operates. 
The illustrations show how the performance of the underlying investment 
accounts could affect the policy cash value and death benefit. These 
illustrations may not be used to project or predict investment results 
as such forecasts are strictly prohibited by the Rules of Fair 
Practice. The methodology and format of hypothetical illustrations must 
be modeled after the required illustrations in the prospectus.
    An illustration may use any combination of assumed investment 
returns up to and including a gross rate of 12%, provided that one of 
the returns is a 0% gross rate. Although the maximum assumed rate of 
12% may be acceptable, members are urged to assure that the maximum 
rate illustrated is reasonable considering market conditions and the 
available investment options. The purpose of the required 0% rate of 
return is to demonstrate how a lack of growth in the underlying 
investment accounts may affect policy values and to reinforce the 
hypothetical nature of the illustration.
    The illustrations must reflect the maximum (guaranteed) mortality 
and expense charges associated with the policy for each assumed rate of 
return. Current charges may be illustrated in addition to the maximum 
charges.
    Preceding any illustration there must be a prominent explanation 
that the purpose of the illustration is to show how the performance of 
the underlying investment accounts could affect the policy cash value 
and death benefit. The explanation must also state that the 
illustration is hypothetical and may not be used to project or predict 
investment results.
    (2) In sales literature which includes hypothetical illustrations, 
member firms may provide a personalized illustration which reflects 
factors relating to the individual customer's circumstances. A 
personalized illustration may not contain a rate of return greater than 
12% and must follow all of the standards set forth in Section II, E, 1.
    (3) In general, it is inappropriate to compare a variable life 
insurance policy with another product based on hypothetical performance 
as this type of presentation goes beyond the singular purpose of 
illustrating how the performance of the underlying investment accounts 
could affect the policy cash value and death benefit. It is 
permissible, however, to use a hypothetical illustration in order to 
compare a variable life insurance policy to a term policy with the 
difference in cost invested in a side product. The sole purpose of this 
type of illustration would be to demonstrate the concept of tax-
deferred growth as a result of investing in the variable product. The 
following conditions must be met in order to make this type of 
comparison balanced and complete:
    (a) the comparative illustration must be accompanied by an 
illustration which reflects the standards outlined in Section II, E, 1;
    (b) the rate of return used in the comparative illustration must be 
no greater than 12%;
    (c) the rate of return assumed for the side product and the 
variable life policy must be the same;
    (d) the same fees deducted from the required prospectus 
illustration must be deducted from the comparative illustration;
    (e) the side product must be illustrated using gross values which 
do not reflect the deduction of any fees; and,
    (f) the side product must not be identified or characterized as any 
specific investment or investment type.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the NASD included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The NASD has prepared summaries, set forth in Sections 
(A), (B), and (C) below, of the most significant aspects of such 
statements.

(A) Self-regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    As the number of variable life insurance and annuity products has 
increased substantially in recent years, so has the variety of ways in 
which information about such products is communicated to the public. 
Because the use of such communications is proliferating, and because 
what is being described in such communications is, in some cases, a 
complicated hybrid product containing both insurance and securities 
elements, the NASD has determined to provide guidance by proposing a 
comprehensive set of guidelines (``Guidelines'') for the preparation 
and use of communications with the public regarding variable life 
insurance and variable annuities. The Guidelines incorporate past 
positions on variable products communications taken by the NASD, as 
well as certain positions taken by the staff of the SEC.
    The Guidelines govern the preparation of, and communication with 
the public through, advertising and sales literature of variable 
products. The Guidelines are intended to provide a level of disclosure 
sufficient to assist investors in making fair and informed investment 
decisions.

Guidelines for Communications With the Public About Variable 
Products

    The Guidelines of the proposed rule change set forth standards that 
must be considered, along with the standards set forth in Article III, 
Section 35 to the Rules of Fair Practice,\2\ in the preparation of 
advertising and sales literature about variable life insurance and 
annuities. For the purposes of these Guidelines, the terms 
``advertisements and sales literature'' include not only the 
definitions of those terms as found in section 35, but also 
individualized communications such as personalized letters and printed 
or on-screen computer illustrations.
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    \2\NASD Manual, Rules of Fair Practice, Article III, Section 35, 
(CCH) 2195.
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General Considerations

    Communications concerning variable products must clearly identify 
the product as either a variable life insurance policy or a variable 
annuity. Where product type is identified in a proprietary name, it is 
not necessary to include a generalized statement identifying product 
type. Since variable products are not mutual funds, no such statement 
or presentation may indicate or imply that the product offered or its 
underlying account is a mutual fund (See Part I, A).
    As products with potentially substantial tax penalties and charges 
for early withdrawal, variable products must not be presented by 
members as short-term, liquid investments. Any discussions or 
presentations concerning liquidity or accessibility to investment 
values must be balanced by the impact of early withdrawal, such as 
sales loads, tax penalties and potential loss of principal. 
Additionally, regarding variable life insurance products, a balanced 
presentation requires a discussion of the impact of loans and 
withdrawals on cash values and death benefits (See Part I, B).
    Guarantees by insurance companies, such as a minimum death benefit, 
a schedule of annuity payments, or a fixed return on the investment 
account, all depend on the claims-paying ability of the issuing 
insurance company, and thus must not be exaggerated. Members are 
prohibited from representing or implying that the investment return or 
principal value of the separate investment account is guaranteed, or 
that an insurance company's financial ratings apply to the separate 
account (See Part I, C).

Specific Considerations

Prior Fund Performance
    The proposed rule allows for variable product communications to the 
public to contain the historic performance of an existing fund that 
pre-dates the fund's inclusion in the variable policy or annuity, 
provided no significant changes occurred to the fund at the time of, or 
after, the inclusion. Communications to the public are prohibited for a 
variable product which contains a new, or ``clone'' fund as the 
underlying investment vehicle, but which promotes the performance 
history of an existing fund after which the new fund was modeled. All 
historic performance in communications to the public must conform to 
applicable NASD and SEC standards, including, in particular, elements 
of return and deduction of applicable charges and expenses (See Part 
II, A).
Product and Performance Comparisons
    Product comparisons which are fair allow investors to make informed 
investment decisions. Article III, Section 35 (d) (2) (M) of the NASD 
Rules of Fair Practice sets forth the specific standard in 
communications with the public which requires a member who makes 
investment comparisons, directly or indirectly, to ensure that the 
purpose of the communication is clear and that the comparison is fair 
and balanced, including any material differences between the subjects 
of the comparisons. A comparison using variable products is permissible 
so long as the comparison meets the standards set forth under 
Subsection (d) (2) (M) (See Part II, B).
Use of Rankings
    The use of variable products rankings prepared by ranking entities, 
variable products issuers and variable products issuer affiliates to 
demonstrate variable product performance also qualifies as a comparison 
under Subsection (d) (2) (M). A ranking which reflects the performance 
of the separate account or the underlying investment option is 
permissible in variable products advertising and sales literature so 
long as the use of such ranking meets the standards contained in the 
Guidelines for the Use of Rankings in Mutual Fund Advertisements and 
Sales Literature\3\ (See Part II, C).
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    \3\See Securities Exchange Act Release No. 33606 (February 9, 
1994), noticing for comment File No. SR-NASD-93-69 (proposing 
Guidelines for the Use of Rankings in Mutual Fund Advertisements and 
Sales Literature).
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Hybrid Variable Products
    Variable life insurance allows purchasers to combine life insurance 
coverage and tax-deferred accumulation of excess premium payments in 
one contract. Because such products are designed to equally serve both 
insurance and investing needs, communications to the public on behalf 
of variable life insurance products must provide a balanced discussion 
of these features. However, since single premium variable life 
insurance is predominantly designed to meet investment needs, 
communications to the public regarding single premium variable life 
insurance may emphasize the investment features of the product so long 
as an adequate explanation of the life insurance features is given (See 
Part II, D).
Hypothetical and Personalized Illustrations of Variable Life Products
    Hypothetical illustrations of variable life insurance products 
using assumed rates of return are permissible to show how the 
underlying investment accounts could affect the policy cash value and 
death benefit, but may not be used to predict or project investment 
results. Such illustrations must follow the methodology and form 
requirements for such illustrations in the prospectus.
    All illustrations must show a hypothetical 0% gross rate of return, 
and may show any additional combinations of rates of return up to and 
including a gross rate of 12%, though members are cautioned to choose a 
rate that is reasonable given current market conditions. The gross rate 
is the chosen, hypothetical rate of return applied to all excess 
premiums invested after deduction for maximum guaranteed mortality and 
expense charges. All illustrations of rates of return must reflect such 
maximum charges, though illustrations may reflect current charges in 
addition to maximum charges.
    Sales literature which contains hypothetical illustrations may also 
provide a personalized illustration reflecting factors relating to the 
circumstances of an individual customer.
    It is generally inappropriate and potentially misleading to compare 
a variable life insurance policy with another product, including a 
variable annunity, since the purpose of such a comparison would exceed 
the purpose of illustrating how underlying investment account 
performance affects the policy cash value and death benefit. However, 
it is permissible to use a hypothetical illustration comparing a 
variable life policy to a term policy with the difference in premium 
invested in a side fund, where the sole purpose of such a comparison 
would be to demonstrate the concept of tax-deferred growth as a result 
of investing in the variable product. In order for such a comparison to 
be balanced and complete, the comparative illustration must: reflect 
the standards in Section II, E, 1 of the proposed rule; use a rate of 
return no greater than 12% use the same rate of return for the variable 
product and the side fund; deduct the same fees from the required 
prospectus illustration; illustrate the side fund product using gross 
values which do not reflect the deduction of any fees; and, not 
characterize the side product as any specific investment or investment 
type (See Part II, E).
    The NASD believes that the proposed rule change is consistent with 
the provisions of Section 15A(b)(6) of the Act\4\ in that the 
Guidelines will work to protect investors and the public interest by 
establishing a baseline of standards to guide the use of communications 
with the public concerning variable life insurance and variable 
annuities in promoting the sale of variable products and by preventing 
the misleading use of such communications.
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    \4\15 U.S.C. 78o-3 (1988).
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(B) Self-Regulatory Organization's Statement on Burden on Competition

    The NASD does not believe that the proposed rule change will result 
in any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:

A. By order approve such proposed rule change, or
B. Institute proceedings to determine whether the proposed rule change 
should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission and all written communications relating to the proposed 
rule change between the commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to file number in the caption above 
and should be submitted by March 8, 1994.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority, 17 CFR 200.30-3(a)(12).
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-3426 Filed 2-14-94; 8:45 am]
BILLING CODE 8010-01-M