[Federal Register Volume 59, Number 120 (Thursday, June 23, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-15292]


[[Page Unknown]]

[Federal Register: June 23, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. IC-20362; 812-8778]

 

Security Life of Denver Insurance Company, et al., Notice

June 17, 1994.
AGENCY: Securities and Exchange Commission (the ``SEC'' or 
``Commission'').

ACTION: Notice of Application for Exemptions under the Investment 
Company Act of 1940 (the ``1940 Act'').

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APPLICANTS: Security Life of Denver Insurance Company (``Security 
Life''), Security Life Separate Account L1 (the ``Account''), any other 
separate account established by Security Life in the future (the 
``Other Accounts'' and together with the Account, the ``Separate 
Accounts'') to support flexible premium variable life insurance 
policies and/or scheduled premium variable life insurance policies 
issued by Security Life, and SLD Equities, Inc. (``SLD Equities'').

RELEVANT 1940 ACT SECTIONS: Order requested under Section 6(c) for 
exemptions from Sections 27(c)(2) of the 1940 Act and Rules 6e-
3(T)(c)(4)(v), 6e-2(c)(4)(v), 6e-2(a)(2), and 6e-2(b)(15) under the 
1940 Act.

SUMMARY OF APPLICATION: Applicants seek an order to permit the 
deduction from premium payments of a charge that is reasonable in 
relation to the increased federal tax burden of Security Life under 
Section 848 of the Internal Revenue Code of 1986, as amended (the 
``Code'') in connection with the offering of flexible premium and 
scheduled premium variable life insurance policies issued by Security 
Life through the Separate Accounts (the ``Policies''). The order also 
would permit any Separate Account to derive its assets from both 
flexible premium and scheduled premium variable life insurance 
policies.

FILING DATES: The application was filed on January 14, 1994, and 
amended on April 15, 1994, and June 17, 1994.

HEARING OR NOTIFICATION OF HEARING: An order granting the applicantion 
will be issued unless the Commission orders a hearing. Interested 
persons may request a hearing by writing to the SEC's Secretary and 
serving Applicants with a copy of the request, personally or by mail. 
Hearing requests must be received by the SEC by 5:30 p.m. on July 12, 
1994, and must be accompanied by proof of service on Applicants in the 
form of an affidavit or, for lawyers, a certificate of service. Hearing 
requests should state the nature of the writer's interest, the reason 
for the request, and the issues contested. Persons may request 
notification of a hearing by writing to the SEC's Secretary.

ADDRESSES: Secretary, SEC, 450 5th Street, NW., Washington, DC 20549. 
Applicants, Security Life Center, 1290 Broadway, Denver, Colorado 
80203-5699.

FOR FURTHER INFORMATION CONTACT:
C. Christopher Sprague, Senior Staff Attorney, at (202) 942-0670, or 
Michael V. Wible, Special Councel, at (202) 942-0670, Office of 
Insurance Products, Division of Investment Management.

SUPPLEMENTARY INFORMATION: The following is a summary of the 
application. The complete application is available for a fee from the 
Commission's Public Reference Branch.

Applicants' Representations

    1. Security Life was organized under Colorado law as a stock life 
insurance company, and is the depositor of the Account. Security Life 
is an indirect, wholly-owned subsidiary of Internationale Nederlanden 
Groep, N.V. (``ING''). ING is headquartered in The Hague, Netherlands. 
Security Life is subject to the oversight of Internationale Nederlanden 
America Life Corporation, another indirect, wholly-owned subsidiary of 
ING that is located in Georgia. The Account was organized under 
Colorado law as an insurance company separate account, and it is 
registered under the 1940 Act as a unit investment trust. Neuberger & 
Berman Advisers Management Trust, Van Eck Investment Trust, Fidelity 
Variable Insurance Products Fund, Fidelity Variable Insurance Products 
Fund II, Alger American Fund, and INVESCO Variable Investment Funds 
(each a ``Fund'') will be the underlying investment media for the 
Account. Each Fund is registered under the 1940 Act as a diversified, 
open-end management investment company. SLD Equities will be the 
principal underwriter of Account Policies funded through the Account, 
and may act as principal underwriter for Other Policies issued by 
Security Life in the future.
    2. The Policies issued initially by the Account will be flexible 
premium variable life insurance policies issued in reliance on Rule 6e-
3(T) under the 1940 Act, although the requested order would allow the 
Account also to issue scheduled premium variable life insurance 
policies under Rule 6e-2 under the 1940 Act. The Other Accounts may 
issue flexible premium variable life insurance policies, scheduled 
premium variable life insurance policies, or both. Applicants seek an 
order so that they may make certain deductions from premium payments 
received in an amount that is reasonable in relation to the increased 
federal tax burden related to the receipt of premium payments under the 
Policies.
    3. Applicants state that Section 848 of the Code changed the 
federal income taxation of life insurance companies by requiring them 
to capitalize and amortize, over a period of ten years, part of their 
general expenses for the current year. Under prior law, these expenses 
were deductible in full from the current year's gross income. The 
amount of expenses that must be capitalized and amortized under Section 
848 is generally determined with reference to premium payments for 
specified categories of life insurance and other contracts which 
include the Policies. For each such specified contract, an amount of 
expenses must be capitalized and amortized equal to a percentage of the 
current year's net premium payments for that contract. The percentage 
varies depending on the type of insurance contract in question, 
according to a schedule set forth in Section 848(c)(1).
    4. The net effect of Section 848 is to accelerate the realization 
of income from insurance contracts covered by that Section and, 
accordingly, the payment of taxes generated by those contracts. Taking 
into account the time value of money, the tax burden of an insurance 
company related to those insurance contracts is increased. This 
increased tax burden has been referred to as a deferred acquisition 
cost or ``DAC tax.'' Because the amount of general deductions that must 
be capitalized and amortized is measured by premium payments paid, an 
increased federal income tax burden results from the receipt of those 
premium payments. In this respect, the impact of Section 848 can be 
compared to that of a state premium tax.
    5. The Policies fall under the category of ``specified insurance 
contracts'' under Section 848, which means that 7.7% of the net premium 
payments received must be capitalized and amortized. The increased tax 
burden on Security Life resulting from this requirement can be 
quantified as follows. For every $10,000 of net premium payments 
received by Security Life under the Policies in a given year, its 
general deductions are reduced by $731.50 or (a) $770.00 (7.7% of 
$10,000) minus (b) $38.50 (one-half year's portion of the ten-year 
amortization). Using a 35% corporate tax rate, this results in an 
increase in tax for the current year of $256.03. This current increase 
in tax will be partially offset by deductions that will be allowed 
during the next ten years as a result of amortizing the remainder of 
the $770.00 ($77.00 in each of the following nine years and $38.50 in 
the tenth year).
    6. In calculating the present value of these increased future 
deductions, Security Life determined, in its business judgment, to 
apply a 12% discount rate. Security Life seeks an after-tax return on 
the investment of its capital of 12%. To the extent that Security Life 
must use capital to satisfy its increased federal income tax burden 
under Section 848, such capital is not available for investment. Thus, 
the cost of capital used to satisfy the increased federal income tax 
burden under Section 848 is, in essence, Security Life's after-tax rate 
of return on capital. Accordingly, the rate of return on capital is 
appropriate for use in this present value calculation.
    7. Applying this 12% discount rate, and assuming a corporate tax 
rate of 35%, the present value of the tax effect of the increased 
deductions allowable in the following ten years amounts to a tax 
savings of $147.93. Thus, the present value of the increased tax burden 
resulting from the effect of Section 848 on each $10,000 of net premium 
payments received under the Policies is $108.09 ($256.03 minus 
$147.93).
    8. State premium taxes are deductible in computing federal income 
taxes. Thus, Security Life does not incur incremental income tax when 
it passes on state premium taxes to Owners. In contrast, federal income 
taxes are not deductible in computing Security Life's federal income 
taxes. In order to compensate fully for the impact of Section 848, 
Security Life, therefore, must impose an additional charge that would 
make it whole not only for the $108.09 additional tax burden 
attributable to Section 848, but also for the tax on the additional 
$108.09 itself. This total charge necessary to make Security Life whole 
can be determined by dividing $108.09 by the complement of the 35% 
federal corporate income tax rate, i.e., 65%, resulting in an 
additional charge of $166.29 for each $10,000 of net premium payments, 
or 1.66%.
    9. Security Life's cost of capital is the after-tax rate of return 
required by ING America Life, Security Life's oversight affiliate. ING 
America Life requires an after-tax return on equity of 12% from 
Security Life and from the other three companies that ING America Life 
oversees, based on a number of factors, including market interest 
rates, each company's anticipated long-term growth rate, each company's 
acceptable risk level for this type of business, inflation, and 
available information about the rates of return obtained by other life 
insurance companies and the return targeted by ING, the ultimate parent 
of Security Life and ING America Life. Security Life represents that 
these factors are appropriate factors to consider in determining its 
cost of capital.
    10. ING America Life first projects its future growth rate, 
including the future growth rate of Security Life, based on sales 
projections, current interest rates, the inflation rate, and the amount 
of capital that ING America Life and Security Life can provide to 
support such growth. ING America Life then uses the anticipated growth 
rate and the other factors set out above to set a rate of return on 
capital that equals or exceeds this rate of growth, as well as the rate 
ING can earn in other parts of the world. Of these other factors, 
market interest rates, the acceptable risk level, the surplus level 
required by rating agencies for their top ratings, and the inflation 
rate receive significantly more weight than information about the rates 
of return obtained by other companies.
    11. ING America Life (including Security Life) seeks to maintain a 
ratio of capital to assets that is established based on its judgment of 
the risks represented by various components of its assets and 
liabilities. Maintaining the ratio of capital to assets is critical to 
offering competitively priced products and to maintaining a competitive 
rating from various rating agencies. Consequently, ING America Life's 
capital should grow at least at the same rate as its assets.
    12. ING America Life has set, as one of its major objectives, an 
after-tax return on equity of at least 12%. In order to meet this 
objective, profitability criteria for new products being developed by 
any United States life insurance company in the ING complex, including 
Security Life, must include a minimum of 12% after-tax rate of return 
for life insurance (``12% targeted rate''). ING America Life's strategy 
is to motivate the companies it oversees to realize the 12% targeted 
rate by directing excess capital to the companies with the highest 
potential for growth and return on investment.
    13. Applicants' use of a cost of capital rate of 12% is consistent 
with: (a) the targeted rates of return of ING, ING America Life and 
Security Life, (b) the current pricing practice and recent experience 
of Security Life, and (c) recent industry practice. Accordingly, 
Applicants believe that use of a cost of capital rate of 12% is 
reasonable and justified for purposes of Security Life's computation of 
its increased federal tax burden.
    14. Based on the calculations set out above, Applicants have 
determined that the total charge necessary to enable Security Life to 
cover its increased federal tax burden approaches 1.66%. Applicants, 
under the circumstances noted below, have determined to impose a charge 
of 1.50% on premium payments made. Security Life represents that the 
1.50% charge is reasonably related to its increased federal tax burden 
under Section 848 of the Code. This representation takes into account 
the amortization permitted by Section 848 and the use by Security Life 
of a 12% discount rate in computing the future deductions resulting 
from such amortization, such rate being the equivalent of Security 
Life's cost of capital.
    15. Security Life recognizes that a charge of 1.50% (or, indeed, a 
charge at any level) could conceivably exceed the tax burden if, in the 
future, Security Life's corporate tax rate or targeted after-tax rate 
of return were reduced. Security Life submits that it is difficult to 
anticipate, with any degree of reasonable certainty, whether, or to 
what extent, any such rate would be reduced. However, to the extent 
that Security Life's charge of 1.50% is less than its increased tax 
burden of approximately 1.66%, Applicants submit that a measure of 
comfort is provided that the calculation of Security Life's increased 
tax burden attributable to the receipt of premiums will continue to be 
reasonable over time, even if the corporate tax or the targeted after-
tax rate of return applicable to Security Life is reduced. Furthermore, 
Security Life provides, in effect, in the Policies that it can decrease 
the charge under such circumstances. Security Life undertakes to 
monitor the tax burden imposed on it and reduce the charge to the 
extent of any significant decrease in the tax burden. At the same time, 
Security Life believes that it would have to increase its charge if any 
future change in, or interpretation of, Section 848 or any successor 
provision results in a further increased tax burden due to the receipt 
of premium payments. Such an increase could result from a change in the 
corporate tax rate, a change in the 7.7% figure, or a change in the 
amortization period. Accordingly, Security Life provides, in effect, in 
the Policies that it can increase the charge under such circumstances 
as a change in tax law.

Applicants' Legal Analysis

    1. Section 6(c) of the 1940 Act provides that the Commission may 
issue an order exempting any person, security or transaction, or any 
class or classes of persons, securities or transactions from any 
provision or provisions of the 1940 Act, or any Rule thereunder, as may 
be necessary or appropriate in the public interest and consistent with 
the protection of investors and the purposes fairly intended by the 
policy and provisions of the 1940 Act.

A. Request for Exemptive Relief From Section 27(c)(2) of the 1940 Act 
and Rules 6e-2(c)(4)(v) and 6e-3(T)(c)(4)(v) Thereunder

    1. Section 27(c)(2) of the 1940 Act, in effect, prohibits a 
registered investment company issuing periodic payment plan 
certificates (such as the Policies), or a depositor or underwriter for 
such company, from making any deduction from payments other than a 
deduction for ``sales load.'' Rule 6e-3(T)(c)(4) defines ``sales load'' 
charged during a contract period as the excess of any payments made 
during the period over the sum of certain specified charges and 
adjustments. Rule 6e-2(c)(4) contains a similar definition of sales 
load. Neither of those definitions specifically identifies a DAC tax 
charge as an item that is not deemed to be sales load. However, Rule 
6e-3(T)(c)(4)(v) and Rule 6e-2(c)(4)(v) each indicate that the life 
insurer may treat a deduction of an amount approximately equal to state 
premium taxes as other than sales load. Applicants request an order 
under Section 6(c) of the 1940 Act so that their proposed DAC tax 
charge would, like state premium taxes, be regarded as other than sales 
load under Rule 6e-3(T)(c)(4)(v) and Rule 6e-2(c)(4)(v). Applicants 
submit that the proposed DAC tax charge is akin to a state premium tax 
charge, in that it is an appropriate charge related to the tax burden 
attributable to premium payments received.
    2. Rule 6e-3(T)(b)(13)(iii)(E) provides an exemption from Section 
27(c)(2) to allow the life insurer to deduct ``premium or other taxes 
imposed by any state or other governmental entity.'' Applicants state 
that Rule 6e-2 contains a similar exemption. Applicants state that 
arguably, they could rely on Rule 6e-3(T)(b)(13)(iii)(E) to deduct 
their DAC tax charge. However, to remove any doubt about their ability 
to treat the DAC tax charge as other than sales load and to deduct the 
charge, Applicants seek the requested order.
    3. The exemptions requested by Applicants are necessary in order 
for them to rely on certain provisions of Rule 6e-3(T)(b)(13) and 
particularly on Rule 6e-3(T)(b)(13)(i), which provides exemptions from 
Sections 27(a)(1) and 27(h)(1). Issuers and their affiliates may only 
rely on Rule 6e-3(T)(b)(13)(i) if they meet the Rule's alternative 
limitations on ``sales load,'' as defined in Rule 6e-3(T)(c)(4). 
Depending upon the load structure of any of the Policies, these 
alternative limitations may not be met if the deduction for the 
increase in an insurance company's federal tax burden is included in 
``sales load.'' For similar reasons, Applicants also wish to be able to 
rely on the alternative sales load formula set out in Rule 6e-
2(b)(13)(i).
    4. The public policy that underlies Rule 6e-3(T)(b)(13)(i) and Rule 
6e-2(b)(13)(i), like that which underlies Sections 27(a)(1) and 
27(h)(1), is to prevent excessive sales loads from being charged in 
connection with the sale of periodic payment plan certificates. The 
treatment of a tax burden charge attributable to premium payments as 
sales load would not in any way further this legislative purpose, 
because such a deduction has no relation to the payment of sales 
commissions or other distribution expenses. The Commission has 
concurred with this conclusion by excluding deductions for state 
premium taxes from the definition of sales load in Rule 6e-
3(T)(c)(4)(v) and Rule 6e-2(c)(4)(v).
    5. The source for the definition of ``sales load'' found in Rule 
6e-3(T)(c)(4) supports this analysis. The Commission's intent in 
adopting Rule 6e-3(T)(c)(4) was to tailor the general terms of Section 
2(a)(35) to flexible premium variable life insurance contracts. Just as 
the percentage limits of Sections 27(a)(1) and 27(h)(1) depend on the 
definition of ``sales load'' in Section 2(a)(35) for their efficacy, 
the percentage limits in Rule 6e-3(T)(b)(13)(i) depend on Rule 6e-
3(T)(c)(4), which does not depart, in principle, from Section 2(a)(35).
    6. Section 2(a)(35) excludes from ``sales load'' under the 1940 Act 
deductions from premium payments for ``issue taxes.'' This suggests 
that it is consistent with the 1940 Act's policies to exclude from the 
definition of ``sales load'' in Rule 6e-3(T) deductions made to pay an 
insurance company's costs attributable to its tax obligations.
    7. Section 2(a)(35) also excludes administrative expenses or fees 
that are ``not properly chargeable to sales or promotional 
activities.'' This suggests that the only deductions intended to fall 
within the definition of ``sales load'' are those that are properly 
chargeable to such activities. Because the proposed deductions will be 
used to compensate Security Life for its increased federal tax burden 
attributable to the receipt of premium payments, and are not properly 
chargeable to sales or promotional activities, this language in Section 
2(a)(35) is another indication that not treating such deductions as 
``sales load'' is consistent with the policies of the 1940 Act.
    8. Applicants respectfully request that the Commission, pursuant to 
Section 6(c) of the 1940 Act, grant the exemptions from Section 
27(c)(2) and Rules 6e-3(T)(c)(4)(v) and 6e-2(c)(4)(v) of the 1940 Act 
in connection with Applicants' deduction from premium payments received 
under the Policies of an amount that is reasonable in relation to 
Security Life's increased federal tax burden related to the receipt of 
such premium payments. Applicants believe that the requested exemptions 
meet the standards of Section 6(c) of the 1940 Act.

B. Request for Exemptive Relief from Rules 6e-2(a)(2) and 6e-2(b)(15) 
Under the 1940 Act

    1. Applicants also request an order of the Commission under Section 
6(c) of the 1940 Act exempting the Separate Accounts from the 
provisions of Rule 6e-2(a)(2) and Rule 6e-2(b)(15) to the extent 
necessary to permit them to issue flexible premium variable life 
insurance policies under Rule 6e-3(T) without losing their ability to 
rely on Rule 6e-2 with regard to scheduled premium variable life 
insurance policies issued by the Separate Accounts. Rule 6e-2(a)(2), in 
effect, requires that a separate account relying on Rule 6e-2 derive 
its assets (other than advances by the life insurance company) ``solely 
from the sale of variable life insurance contracts as defined in 
paragraph (c)(1) of this Rule 6e-2 * * *.'' Paragraph (c)(1) of Rule 
6e-2, in turn, defines a variable life insurance contract somewhat 
differently than the definition of flexible premium life insurance 
contract in paragraph (c)(1) of Rule 6e-3(T). Thus, a separate account 
that funds both scheduled premium variable life insurance contracts and 
flexible premium variable life insurance contracts would not be 
regarded as having its assets derived solely from the sale of 
``variable life insurance contracts.'' In addition, the exemptions 
afforded by Rule 6e-2(b)(15) are available only with respect to the 
``variable life insurance separate accounts'' contemplated by Rule 6e-2 
(i.e., separate accounts that fund only scheduled premium variable life 
insurance contracts).
    2. Applicants submit that no policy reason would justify 
prohibiting the use of the same separate account as a funding vehicle 
for policies relying on Rule 6e-2 and Rule 6e-3(T). Applicants 
represent that the interests of flexible life policyholders and 
scheduled life policyholders, and the regulatory frameworks of Rules 
6e-2 and 6e-3(T) are sufficiently parallel that the use of the same 
separate account to fund both types of policies should not prejudice 
the owners of any of the Policies. Furthermore, the increased pooling, 
diversification, and economies of scale realized from the use of the 
same separate account should benefit owners of the Policies, according 
to the Applicants.
    3. As to each of the two requested exemptions discussed above, 
Applicants believe that the terms of the relief with respect to any 
Other Policies funded by the Account or any Other Account are 
consistent with the standards enumerated in Section 6(c) of the 1940 
Act. Without the requested relief, Applicants would have to request and 
obtain exemptive relief in connection with any other Policies to the 
extent required. Any such additional request for exemption would 
present no issues under the 1940 Act that have not already been 
addressed in this Application.
    4. Applicants submit that the requested relief is appropriate in 
the public interest, because it would promote competitiveness in the 
variable life insurance market by eliminating the need for Security 
Life to file redundant exemptive applications, thereby reducing its 
administrative expenses and maximizing the efficient use of its 
resources. The delay and expense involved in having to repeatedly seek 
exemptive relief would impair Security Life's ability to effectively 
take advantage of business opportunities as they arise.
    5. Applicants further submit that the requested relief is 
consistent with the purpose of the 1940 Act and the protection of 
investors for the same reasons. If Security Life were required to 
repeatedly seek exemptive relief with respect to the same issues 
addressed in this Application, investors would not receive any benefit 
or additional protection thereby. Indeed, they might be disadvantaged 
as a result of Security Life's increased overhead expenses. Thus, 
Applicants believe that the requested exemptions are appropriate in the 
public interest and consistent with the protection of investors and the 
purposes fairly intended by the policy and provisions of the 1940 Act.

Conditions for Relief

    1. Applicants represent that Security Life will monitor the 
reasonableness of the charge to be deducted pursuant to the requested 
exemptive relief.
    2. Applicants represent that the registration statement for the 
Policies under which the above-referenced charge is deducted will (a) 
disclose the charge, (b) explain the purpose of the charge, and (c) 
state that the charge is reasonable in relation to Security Life's 
increased federal tax burden under Section 848 resulting from the 
receipt of premium payments.
    3. Applicants represent that the registration statement for the 
Policies under which the above-referenced charge is deducted will 
contain, as an exhibit, an actuarial opinion as to (a) the 
reasonableness of the charge in relation to Security Life's increased 
federal tax burden under Section 848 resulting from the receipt of 
premium payments; (b) the reasonableness of the after-tax rate of 
return that is used in calculating such charge; and (c) the 
appropriateness of the factors taken into account by Security Life in 
determining the after-tax rate of return.

Applicants' Conclusion

    Security Life requests exemptions, pursuant to section 6(c) of the 
1940 Act, from the provisions of Section 27(c)(2) of the 1940 Act, and 
the specified provisions of Rules 6e-3(T) and 6e-2 under the 1940 Act, 
to the extent necessary to permit the deduction of a DAC tax charge 
from premium payments under the Policies, and the issuance by the 
Account or any Other Account of both flexible life and scheduled life 
Policies. Applicants submit, based on the grounds stated herein, that 
their exemptive request meets the standards set out in Section 6(c) of 
the 1940 Act, namely that the exemptions requested are necessary or 
appropriate in the public interest and consistent with the protection 
of investors and the purposes fairly intended by the policy and 
provisions of the 1940 Act, and that the Commission, therefore, should 
grant the requested order.

    For the Commission, by the Division of Investment Management, 
under delegated authority.
Margaret McFarland,
Deputy Secretary.
[FR Doc. 94-15292 Filed 6-22-94; 8:45 am]
BILLING CODE 8010-01-M