[Federal Register Volume 59, Number 242 (Monday, December 19, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-31041]


[[Page Unknown]]

[Federal Register: December 19, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Rel. No. IC-20764; File No. 812-9116]

 

Federal Kemper Life Assurance Company, et al.

December 12, 1994.
AGENCY: Securities and Exchange Commission (the ``SEC'' or the 
``Commission'').

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

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APPLICANTS: Federal Kemper Life Assurance Company (``FKLA''), FKLA 
Variable Separate Account (the ``Separate Account''), any other 
separate account established in the future (``Future Accounts'') by 
FKLA or an affiliated life insurance company to support certain 
scheduled premium, single premium, or flexible premium variable life 
insurance contracts issued by FKLA or an affiliated life insurance 
company (the ``Contracts''), and Kemper Financial Services, Inc. 
(``KFS'').

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

SUMMARY OF APPLICATION: Applications seek an order to permit them to 
deduct from premiums received under the Contracts an amount that is 
reasonable in relation to the increased federal income tax burden 
resulting from the receipt of such premiums in connection with the 
Contracts.

FILING DATE: The application was filed on July 19, 1994.

HEARING OR NOTIFICATION OF HEARING: An order granting the application 
will be issued unless the Commission orders a hearing. Interested 
persons may request a hearing on this application by writing to the 
Secretary of the SEC and serving Applicants with a copy of the request, 
personally or my mail. Hearing requests must be received by the 
Commission by 5:30 p.m. on January 6, 1995 and should 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 interest, the reason for the request, and the issues 
contested. Persons may request notification of a hearing by writing to 
the Secretary of the SEC.

ADDRESSES: Secretary, Securities and Exchange Commission, 450 Fifth 
Street NW., Washington, D.C. 20549. Applicants, 1 Kemper Drive, Long 
Grove, Illinois 60049.

FOR FURTHER INFORMATION CONTACT: Wendy Finck Friedlander, Senior 
Attorney, at (202) 942-0670, Office of Insurance Products, Division of 
Investment Management.

SUPPLEMENTARY INFORMATION: 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. FKLA, a stock life insurance company organized under the laws of 
Illinois, is the depositor of the Separate Account. FKLA offers life 
insurance and annuity products and is admitted to do business in the 
District of Columbia and in all states except New York.
    2. The Separate Account was established under Illinois law as a 
separate account of FKLA. The Separate Account, registered under the 
1940 Act as a unit investment trust, will fund the Contracts issued by 
FKLA. The Contracts will be registered under the Securities Act of 
1933. The Kemper Investors Fund (the ``Fund''), a registered open-end 
management investment company, will serve as the underlying investment 
medium for the Separate Account.
    3. KFS, a registered broker-dealer under the Securities Exchange 
Act of 1934, is the principal underwriter for the Contracts, and will 
be the principal underwriter of any other variable life insurance 
policies funded through the Separate Account or any Future Account 
(``Future Contracts'').
    4. The Contracts are flexible premium individual variable life 
insurance policies. Applicants represent that the Contracts will be 
issued in reliance on Rule 6e-3(T)(b)(13)(i)(B) under the 1940 Act.
    5. FLKA will deduct a charge of 1.00% of each premium payment under 
the Contracts to cover a portion of FKLA's estimated cost for higher 
federal corporate income tax liability resulting from changes made to 
the Internal Revenue Code of 1986 (``Code'') by the Omnibus Budget 
Reconciliation Act of 1990 (``OBRA''), affecting the treatment of 
deferred acquisition costs. The requested order also would permit the 
deduction of up to 1.25% of each premium payment under Future 
Contracts.
    6. OBRA amended the Code by, among other things, enacting Section 
848 thereof. Section 848 changed how a life insurance company must 
compute its itemized deductions from gross income for federal income 
tax purposes. Section 848 requires an insurance company to capitalize 
and amortize, over a period of ten years, part of the company's general 
expenses for the current year. Under prior law, these general expenses 
were deductible in full from the current year's gross income.
    7. The amount of deductions that must be capitalized and amortized 
over ten years, rather than deducted in the year incurred, is based on 
``net premiums'' received in connection with certain types of insurance 
contracts. Section 848 of the Code defines ``net premium'' for a type 
of contract as gross premiums received by the insurance company on the 
contracts minus return premiums and premiums paid by the insurance 
company for reinsurance of its obligations under such contracts. 
Applicants state that the effect of Section 848 is to accelerate the 
realization of income from insurance contracts covered by that Section, 
and, accordingly, the payment of taxes on the income generated by those 
contracts.
    8. The amount of general deductions that must be capitalized 
depends upon the type of contract to which the premiums received relate 
and varies according to a schedule set forth in Section 848. Applicants 
represent that the Contracts are ``specified insurance contracts'' that 
fall into the category of life insurance contracts, and, under Section 
848, 7.7% of the year's net premiums received must be capitalized and 
amortized.
    9. Applicants represent that the increased tax burden resulting 
from Section 848 may be quantified as follows. For each $10,000 of net 
premiums received under the Contracts in a given year, Section 848 
requires FKLA to capitalize $770 (7.7% of $10,000) and $38.50 of this 
$770 may be deducted in the current year. This leaves $731.50 ($770 
minus $38.50) subject to taxation at the corporate tax rate of 35% 
which results in FKLA owing $256.03 (.35  x  $731.50) more in taxes for 
the current year than would have been owed prior to OBRA. This current 
increase in federal income 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 ($77 in each of the following nine 
years and $38.50 in the tenth year).
    10. In FKLA's business judgment, a discount rate of 8% is 
appropriate for use in calculating the present value of the increased 
future tax deductions resulting from the amortization described above. 
Applicants state that FKLA seeks an after tax rate of return on the 
investment of its capital in excess of 15%. To the extent that capital 
must be used by FKLA to meets its increased federal tax burden under 
Section 848 resulting from the receipt of premiums, such capital is not 
available to FKLA for investment. Thus, Applicants argue, the cost of 
capital used to satisfy FKLA's increased federal income tax burden 
under Section 848 is, in essence, FKLA's after tax rate of return on 
capital; and, accordingly, the rate of return on capital is appropriate 
for use in this present value calculation. To the extent that the 8% 
discount rate is lower than FKLA's actual targeted rate of return, 
Applicants submit that a measure of comfort is provided that the 
calculation of FKLA's increased tax burden attributable to the receipt 
of premiums will continue to be reasonable over time, even if the 
corporate tax rate applicable to FKLA is reduced, or its targeted rate 
of return is lowered.
    11. In determining the after tax rate of return used in arriving at 
this discount rate, Applicants state that a number of factors were 
considered, including: market interest rates; FKLA's anticipated long 
term growth rate; the risk level for this type of business; inflation; 
and available information about the rates of return obtained by other 
life insurance companies. FKLA represents that such factors are 
appropriate factors to consider in determining FKLA's cost of capital. 
Applicants state that FKLA first projects its future growth rate based 
on the anticipated sales, the current interest rates, the inflation 
rate, acceptable risk levels, the amount of capital that FKLA can 
provide to support such growth, and industry practice. FKLA then uses 
the anticipated growth rate and the other factors enumerated above to 
set a rate of return on capital that equals or exceeds this rate of 
growth. Of these other factors, market interest rates, the acceptable 
risk levels and the inflation rate receive significantly more weight 
than information about the rates of return obtained by other companies.
    12. Applicants state that FKLA 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. 
Applicants state that maintaining the ratio of capital to assets is 
critical to offering competitively priced products and, as to FKLA, to 
maintaining a competitive rating from various rating agencies. 
Consequently, Applicants state that FKLA's capital should grow at least 
at the same rate as do its assets.
    13. Using a corporate federal income tax rate of 35% and assuming a 
discount rate of 8%, the present value of the federal income tax effect 
of the increased deductions allowable in the following 10 years, which 
partially offsets the increased federal income tax burden, comes to 
$174.60. The effect of Section 848 on the Contracts is, therefore, an 
increased federal income tax burden with a present value of $81.43 for 
each $10,000 of net premiums, i.e., $256.03 minus $174.60.
    14. State premium taxes are deductible in computing federal income 
taxes. Thus, FKLA does not incur incremental federal income tax when it 
passes on state premium taxes to owners of the Contracts. Conversely, 
federal income taxes are not deductible in computing FKLA's federal 
income taxes. To compensate FKLA fully for the impact of Section 848, 
therefore, it would be necessary to allow FKLA to impose an additional 
charge that would make it whole not only for the $81.43 additional 
federal income tax burden attributable to Section 848 but also for the 
federal income tax on the additional $81.43 itself. This federal income 
tax can be determined by dividing $81.43 by the complement of the 35% 
federal corporate income tax rate, i.e., 65%, resulting in an 
additional charge of $125.28 for each $10,000 of net premiums, or 
1.25%. However, FKLA currently intends to deduct 1.00% of each premium 
payment under the Contracts, which is less than its increased federal 
corporate income tax burden. FKLA reserves the rights to increase the 
charge and to deduct up to 1.25% of each premium payment of Future 
Contracts.
    15. Based on prior experience, FKLA expects that all of its current 
and future deductions will be fully taken. Applicants represent that 
the maximum 1.25% charge, and the current 1.00% charge, to be deducted 
pursuant to the relief requested, are reasonably related to their 
increased federal income tax burden under Section 848, taking into 
account the capitalization and amortization permitted by Section 848, 
and the use by FKLA of a discount rate of 8% in computing the future 
deductions resulting from such capitalization and amortization, such 
rate being lower than, but assumed for these purposes to be the 
equivalent of, FKLA's cost of capital.
    16. While the application states that FKLA believes that a charge 
of 1.00% of premium payments would reimburse it for the impact of 
Section 848 (as currently written) on FKLA's federal income tax 
liabilities, the application also states, however, that FKLA believes 
that it will have to increase this charge if any future change in, or 
interpretation of Section 848, or any successor provision, results in 
an increased federal income tax burden due to the receipt of premiums. 
Such an increase could result from a change in the corporate federal 
income tax rate, a change in the 7.7% figure, a change in the 
categorization of specified insurance contracts, or a change in the 
amortization period.

 Applicants' Legal Analysis

    1. Applicants request an order to the Commission pursuant to 
Section 6(c) exempting them from the provisions of Section 27(c)(2) of 
the 1940 Act, and Rules 6e-2(c)(4)(v) and 6e-3(T)(c)(4)(v) thereunder, 
to the extent necessary to permit deductions to be made from premium 
payments received in connection with the Contracts. The deductions 
would be in an amount that is reasonable in relation to the increased 
federal income tax burden related to the receipt of such premiums. 
Applicants further request an exemption from Rules 6e-2(c)(4) and 6e-
3(T)(c)(4) under the 1940 Act to premit the proposed deductions to be 
treated as other than ``sales load'' for the purposes of Section 27 of 
the 1940 and the exemptions from various provisions of that Section 
found in Rules 6e-2 and 6e-3(T).
    2. Section 6(c) of the 1940 Act provides, in pertinent part, that 
the Commission may by order upon application, conditionally or 
unconditionally exempt any person, security or transaction from any 
provision of the 1940 Act if and to the extent that such exemption is 
necessary or appropriate in the public interest and consistent with the 
protection of investors and the purposes fairly intended by the policy 
and the provisions of the 1940 Act.
    3. Section 27(c)(2) of the 1940 Act prohibits the sale of periodic 
payment plan certificates unless the proceeds of all payments (except 
such amounts as are deducted for sales load) are held under an 
indenture or agreement containing in substance the provisions required 
by Sections 26(a)(2) and 26(a)(3) of the 1940 Act. Certain provisions 
of Rules 6e-2 and 6e-3(T) provide a range of exemptive relief for the 
offering of variable life insurance policies such as the Contracts.
    4. Rule 6e-2(c)(4)(v) defines ``sales load'' charged on any payment 
as the excess of the payment over certain specified charges and 
adjustments, including ``a deduction approximately equal to state 
premium taxes''. Rule 6e-3(T)(c)(4)(v) 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, 
including ``a deduction for and approximately equal to state premium 
taxes.''
    5. Applicants submit that the deduction for federal income tax 
charges, proposed to be deducted in connection with the Contracts, 
should be treated as other than sales load, as is a state premium tax 
charge, for purposes of the 1940 Act.
    6. Applicants argue that the requested exemptions from Rules 6e-
2(c)(4) and 6e-3(c)(4) are necessary in connection with Applicant's 
reliance on certain provisions of Rules 6e-2(b)(13) and 6e-3(T)(b)(13), 
which provide exemptions from Sections 27(a)(1) and 27(h)(1) of the 
1940 Act. Issuers and their affiliates may only rely on Rules 6e-
2(b)(13)(i) or 6e-3(T)(b)(13)(i) if they meet the respective Rule's 
alternative limitations on sales load as defined in Rule 6e-2(c)(4) or 
Rule 6e-3(T)(c)(4). Applicants state that, depending upon the load 
structure of a particular Contract, these alternative limitations may 
not be met if the deduction for the increase in an issuer's federal tax 
burden is included in sales load. Although a deduction for an insurance 
company's increased federal tax burden does not fall squarely within 
any of the specified charges or adjustments which are excluded from the 
definition of ``sales load'' in Rules 6e-2(c)(4) and 6e-3(T)(c)(4), 
Applicants state that they have found no public policy reason for 
including them in ``sales load.''
    7. The public policy that underlies Rules 6e-2(b)(13)(i) and 6e-
3(T)(b)(13)(i), like that which underlies Sections 27(a)(1) and 
27(h)(1) of the 1940 Act, is to prevent excessive sales loads from 
being charged in connection with the sale of periodic payment plan 
certificates. Applicants submit that the treatment of a federal income 
tax 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. Applicants state that the Commission has concurred with this 
conclusion by excluding deductions for state premium taxes from the 
definition of ``sales load'' in Rules 6e-2(c)(4) and 6e-3(T)(c)(4).
    8. Applicants assert that the source for the definition of ``sales 
load'' found in the Rules supports this analysis. Applicants state that 
the Commission's intent in adopting such provisions was to tailor the 
general terms of Section 2(a)(35) of the 1940 Act to 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 Rules 6e-
2(b)(13)(i) and 6e-3(T)(b)(13)(i) depend on Rules 6e-2(c)(4) and 6e-
3(T)(c)(4), respectively, which do not depart, in principle, from 
Section 2(a)(35).
    9. Section 2(a)(35) excludes deductions from premiums for ``issue 
taxes'' from the definition of ``sales load'' under the 1940 Act. 
Applicants submit that this suggests that it is consistent with the 
policies of the 1940 Act to exclude from the definition of ``sales 
load'' in Rules 6e-2 and 6e-3(T) deductions made to pay an insurance 
company's costs attributable to its tax obligations. Section 2(a)(35) 
also excludes administrative expenses or fees that are ``not properly 
chargeable to sales or promotional activities.'' Applicants argue that 
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 FKLA for its increased federal income tax burden 
attributable to the receipt of premiums, 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.
    10. Applicants assert that the terms of the relief requested with 
respect to Contracts to be issued through the Separate Account or 
through Future Accounts 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 for each Future 
Contract. Applicants state that such additional requests for exemptive 
relief would present no issues under the 1940 Act not already addressed 
in this request for exemptive relief.
    11. Applicants assert 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 Applicants 
to file redundant exemptive applications, thereby reducing 
administrative expenses and maximizing efficient use of resources. The 
delay and expense involved in having to seek repeated exemptive relief 
would impair the ability of Applicants to take advantage fully of 
business opportunities as those opportunities arise. Additionally, 
Applicants state that the requested relief is consistent with the 
purposes of the 1940 Act and the protection of investors for the same 
reasons. If Applicants were required to seek exemptive relief 
repeatedly with respect to the same issues addressed in this 
application, investors would not receive any benefit or additional 
protection thereby and might be disadvantaged as a result of increased 
overhead expenses for Applicants.

Conditions for Relief

    1. Applicants represent that FKLA will monitor the reasonableness 
of the charge to be deducted pursuant to the requested exemptive 
relief.
    2. Applicants represent that the registration statement for each 
Contract under which the charge referenced in paragraph one of this 
section is deducted will : (i) Disclose the charge; (ii) explain the 
purpose of the charge; and (iii) state that the charge is reasonable in 
relation to the increased federal income tax burden under Section 848 
of the Code resulting from the receipt of premiums.
    3. Applicants represent that the registration statement for each 
Contract under which the charge referenced in paragraph one of this 
section is deducted will contain as an exhibit an actuarial opinion as 
to: (i) The reasonableness of the charge in relation to the increased 
federal income tax burden under Section 848 resulting from the receipt 
of premiums; (ii) the reasonableness of the after tax rate of return 
that is used in calculating such charge; and (iii) the appropriateness 
of the factors taken into account in determining the after tax rate of 
return.

Conclusion

    Applicants submit that, for the reasons and upon the facts set 
forth above, the requested exemptions from Section 27(c)(2) of the 1940 
Act, and Rules 6e-2(c)(4)(v) and 6e-3(T)(c)(4)(v) thereunder, to permit 
the deduction of up to 1.25% of premium payments under the Contracts 
meet the standards in Section 6(c) of the 1940 Act. In this regard, 
Applicants assert that granting the relief requested in the application 
would be 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.

    For the Commission, by the Division of Investment Management, 
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-31041 Filed 12-16-94; 8:45 am]
BILLING CODE 8010-01-M