[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: 94-31102]


[[Page Unknown]]

[Federal Register: December 19, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Rel. No. IC-20765; File No. 812-9110]

 

Providentmutual Life and Annuity Company of America

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

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

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APPLICANTS: Providentmutual Life and Annuity Company of America 
(``Providentmutual''), Providentmutual Variable Life Separate Account 
(the ``Account''), and PML Securities Company (``PML''). 
(Providentmutual, the Account, and PML shall be referred to herein 
collectively as ``Applicants.'')

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 Rule 
6e-3(T)(c)(4)(v) thereunder.

SUMMARY OF APPLICATION: Applicants seek an order permitting them and 
other separate accounts that Providentmutual may establish in the 
future to support flexible premium variable life insurance contracts 
(the ``future accounts'') to deduct from premium payments received an 
amount that is reasonable in relation to Providentmutual's increased 
federal tax burden resulting from the application of Section 848 of the 
Internal Revenue Code of 1986, as amended.

FILING DATE: July 14, 1994.

HEARING OR NOTIFICATION OF HEARING: An order granting the application 
will be issued unless the Commission order 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 by mail. Hearing requests must be received by the SEC 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, by 
certificate. 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, SEC, 450 Fifth Street, N.W., Washington, D.C. 
20549. Applicants, Providentmutual Life and Annuity Company of America, 
1600 Market Street, Philadelphia, Pennsylvania 19103.

FOR FURTHER INFORMATION CONTACT:
Patrice M. Pitts, 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 Public 
Reference Branch of the Commission.

Applicants' Representations

    1. Providentmutual, a stock life insurance company incorporated 
under the name of Washington Square Life Insurance Company in the 
Commonwealth of Pennsylvania in 1958 and redomiciled as a Delaware 
insurance company in December 1992, is a wholly-owned subsidiary of 
Provident Mutual Life Insurance Company of Philadelphia (``Provident 
Mutual Life''), a mutual insurance company chartered by the 
Commonwealth of Pennsylvania in 1865. Providentmutual currently is 
licensed to transact life insurance business in 48 states and the 
District of Columbia.
    2. For purposes of the 1940 Act, Providentmutual is depositor and 
sponsor of the Account (and would be the depositor and sponsor of any 
future accounts) as those terms have been interpreted by the Commission 
with respect to variable life insurance company separate accounts.
    3. Providentmutual currently is developing a new flexible premium 
adjustable variable life insurance contract (the ``Contract'') which 
includes the ``tax burden charge'' identified above and as explained 
more fully below. Providentmutual also anticipates that it would 
include such a charge in future flexible premium variable life 
insurance contracts (``future contracts'') that it may develop.
    4. The Contract and any future contracts issued by Providentmutual 
may be supported by the Account or any future accounts.
    5. The Account was established by Providentmutual as a separate 
investment account under Delaware law on June 30, 1994, as a funding 
vehicle for variable life insurance contracts. The Account will be 
registered under the 1940 Act as a unit investment trust. The Account 
will be divided into subaccounts, each of which will invest exclusively 
in the shares of a designated investment portfolio of a specified open-
end management investment company registered under the 1940 Act.
    6. Under Delaware law, amounts allocated to the Account are owned 
by Providentmutual. To the extent provided under the Contract, however, 
that portion of the assets of the Account equal to the reserves and 
other Contract liabilities pertaining to the Account shall not be 
chargeable with liabilities arising out of any other business 
Providentmutual may conduct. The income, gains and losses, realized and 
unrealized, from the assets allocated to the Account are credited to or 
charged against the Account without regard to other income, gains or 
losses of Providentmutual. The Account is, and any future account will 
be, a ``separate account,'' as defined by Rule 0-1(e) under the 1940 
Act.
    7. PML is an indirect wholly-owned subsidiary of Provident Mutual 
Life Insurance Company of Philadelphia. PML acts as principal 
underwriter, as defined in the 1940 Act, of the variable life insurance 
contracts supported by the Account. PML is registered as a broker-
dealer under the Securities Exchange Act of 1934, and is a member of 
the National Association of Securities Dealers, Inc. Applications for 
the Contracts and future contracts will be solicited by registered 
representatives of PML, or other broker-dealers having selling 
agreements will PML, who are licensed by applicable state insurance 
authorities to sell flexible premium variable life insurance contracts.
    8. In the Omnibus Budget Reconciliation Act of 1990, Congress 
amended the Internal Revenue Code of 1986 (the ``Code'') by, among 
other things, enacting Section 848 thereof. Section 848 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.
    9. The amount of expenses that must be capitalized and amortized 
under Section 848 is generally determined with reference to premiums 
for certain categories of life insurance and other contracts 
(``specified contracts''). Thus, for each specified contract, an amount 
of expenses must be capitalized and amortized equal to a percentage of 
the current year's net premiums (i.e., gross premiums minus return 
premiums and reinsurance premiums) for that contract. The percentage 
varies, depending on the type of specified contract in question, 
according to a schedule set forth in Section 848(c)(1).
    10. Although framed in terms of requiring a portion of a life 
insurance company's general expenses to be capitalized and amortized, 
Section 848 in effect accelerates the realization of income from 
specified contracts for federal income tax purposes and, therefore, the 
payment of taxes on the income generated by those contracts. When the 
time value of money is taken into account, this has the economic 
consequence of increasing the tax burden borne by the insurance company 
that is attributable to such contracts. Because the amount of general 
deductions that must be capitalized and amortized is measured by 
premiums paid for specified contracts, an increased tax burden results 
from the receipt of those premiums. In this respect, the impact of 
Section 848 can be compared with that of a state premium tax.
    11. The Contract and any future contracts to which the ``tax burden 
charge'' will be applied are among the specified contracts. They fall 
into the category of life insurance contracts for which the percentage 
of net premiums that determines the amount of otherwise currently 
deductible general expenses to be capitalized and amortized with 
respect to such contracts is 7.7 percent.
    12. The increased tax burden resulting from the applicability of 
Section 848 to every $10,000 of net premiums received may be quantified 
as follows. In the year when the premiums are received, 
Providentmutual's general deductions are reduced by $731.50--i.e., an 
amount equal to (a) 7.7 percent of $10,000, or $770, minus (b) one-half 
year's portion of the ten-year amortization, or $38.50. Using a 35 
percent corporate tax rate, this works out to an increase in tax for 
the current year of $256.03. This reduction will be partially offset by 
increased 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.
    13. To the extent and capital must be used by Providentmutual to 
satisfy its increased federal tax burden under Section 848 resulting 
from the receipt of premiums, such profits are not available to 
Providentmutual for investment. Accordingly Providentmutual submits 
that its targeted rate of return is appropriate for use in this present 
value calculation. Because it seeks an after tax rate of return of 9.3 
percent on its invested capital\1\ Providentmutual submits that a 
discount rate of at least 9.3 percent is appropriate for use in 
calculating the present value of its future tax deductions resulting 
from the amortization described above.
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    \1\In determining its cost of capital, Providentmutual 
considered a number of factors. Providentmutual first projected its 
future growth rate based on sales projects, current interest rates, 
the inflation rate, and the amount of capital that it can provide to 
support such growth. Providentmutual then used the anticipated 
growth rate and other factors (such as market interest rates, 
Providentmutual's anticipated long-term growth rate, the risk level 
for this type of business that is acceptable to Providentmutual, 
inflation and available information about the rates of return 
obtained by other insurance companies) 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 level and the 
inflation rate receive significantly more weight than information 
about the rates of return obtained by other insurance companies.) 
Providentmutual represents that these are appropriate factors for 
Providentmutual to consider in determining its cost of capital.
    Providentmutual also took into account the ratio of surplus to 
assets that it seeks to maintain. Providentmutual represents that 
maintaining the ratio of surplus to assets is critical to 
maintaining a competitive rating from various rating agencies and to 
offering competitively priced products (i.e., sufficient dividends 
on outstanding contracts and competitive pricing on newly offered 
contracts). Consequently, Providentmutual asserts that its surplus 
must grow at least at the same rate as its assets.
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    14. Using a corporate tax rate of 35 percent, and assuming a 
discount rate of 9.3 percent, the present value of the tax effect of 
the increased deductions allowable in the following ten years comes to 
$165.16. Because this amount partially offsets the increased tax 
burden, applying Section 848 to the specified contracts imposes an 
increased tax burden on Providentmutual equal to a present value of 
$90.87 (i.e., $256.03 minus $165.16) for each $10,000 of net premiums.
    15. Because state premium taxes are deductible when computing 
federal income taxes, Providentmutual does not incur incremental income 
tax when it passes on state premium taxes to contract owners. In 
contrast, federal income taxes are not tax-deductible when computing 
Providentmutual's federal income taxes. Therefore, to offset fully the 
impact of Section 848, Providentmutual must impose an additional charge 
that would make it whole not only for the $90.87 additional tax burden 
attributable to Section 848, but also for the tax on the additional 
$90.87 itself. This additional charge can be computed by dividing 
$90.87 by the complement of the 35 percent federal corporate income 
taxe rate (i.e., 65 percent), resulting in an additional charge of 
$139.80 for each $10,000 of net premiums, or 1.40 percent of net 
premiums.
    16. Tax deductions are of value to Providentmutual only to the 
extent that it has sufficient gross income to fully utilize the 
deductions. Based on its prior experience, Providentmutual submits that 
it can reasonably expect to have sufficient taxable income in future 
years to utilize all deferred acquisition cost deductions.
    17. Providentmutual submits that a charge of 1.25 percent of 
premium payments would reimburse it for the impact of Section 848 (as 
currently written) on its federal tax liabilities. Providentmutual 
represents that a 1.25 percent charge is reasonably related to its 
increased tax burden under Section 848, taking into account the benefit 
to Providentmutual of the amortization permitted by Section 848, and 
the use by Providentmutual of a 9.3 percent discount rate in computing 
the future deductions resulting from such amortization, such rate being 
the equivalent of Providentmutual's cost of capital.
    18. Providentmutual asserts that it would have to increase the 1.25 
percent charge if future changes in, or interpretations of, Section 848 
or any successor provision result in a further increased tax burden 
resulting from the receipt of premiums. Such an increase could result 
from a change in the corporate tax rate, a change in the 7.7 percent 
figure, or a change in the amortization period. The Contract and any 
future contracts issued by Providentmutual will reserve the right to 
increase or decrease the 1.25 percent charge in response to future 
changes in, or interpretations of, Section 848 or any successor 
provision that increase or decrease Providentmutual's tax burden.

Applicant's Legal Analysis

    1. Section 6(c) of the 1940 Act provides, in relevant part, that 
the Commission, by order upon application, may exempt any person, 
security or transaction (or any class or classes of persons, securities 
or transactions) from provisions of the 1940 Act or any rules 
thereunder, if and to the extent that the 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 
provisions of the 1940 Act.
    2. Applicants request an order of the Commission pursuant to 
Section 6(c) of the 1940 Act, exempting them from the provisions of 
Section 27(c)(2) of the 1940 Act and Rule 6e-3(T)(c)(4)(v) thereunder 
to the extent necessary to permit Applicants to deduct from premium 
payments received in connection with the Contracts and any future 
contracts an amount that is reasonable in relation to Providentmutual's 
increased federal tax burden created by its receipt of such premium 
payments. The deduction would not be treated as sales load.

A. Relief From Provisions of Section 27(c)(2) and Rule 6e-3(T)(c)(4)(v)

    1. Section 2(a)(35) of the 1940 Act defines ``sales load'' as the 
difference between the price of a security offered to the public and 
that portion of the proceeds from its sale which is received and 
invested or held for investment by the issuer (or in the case of a unit 
investment trust, by the depositor or trustee), less any portion of 
such difference deducted for trustees's or custodian's fees, insurance 
premiums, issue taxes, or administrative expenses or fees which are not 
properly chargeable to sales or promotional activities.
    2. Section 27(c)(2) of the 1940 Act prohibits a registered 
investment company or a depositor or underwriter for such company from 
making any deduction from purchase payments made under periodic payment 
plan certificates other than a deduction for sales load. Sections 27(a) 
(1) and 27(h)(1) of the 1940 Act, in effect, limit sales loads on 
periodic payment plan certificates to 9 percent of total payments.
    3. Paragraph (a) of Rule 6e-3(T) requires that a separate account 
(such as the Account or any future accounts) that issues flexible 
premium variable life insurance contracts, its principal underwriter 
and its depositor, comply with all provisions of the 1940 Act and rules 
thereunder applicable to a registered investment company issuing 
periodic payment plan certificates.
    4. Paragraph (b) of Rule 6e-3(T) provides numerous limited 
conditional exemptions from most such provisions and rules in 
connection with the offer, sale and administration of flexible premium 
variable life insurance contracts. For example, among other things, 
Rule 6e-3(T)(b)(13)(iii)(E) provides relief from Section 27(c)(2) of 
the 1940 Act to the extent necessary to permit the deduction of certain 
charges other than sales load, including ``[t]he deduction of premium 
or other taxes imposed by any state or other governmental entity.'' 
Applicants request the relief from Section 27(c)(2) sought in this 
application only to preclude the possibility that a charge related to 
the increased burden resulting from Section 848 of the Code is not 
covered by the exemption provided by Rule 6e-3(T)(b)(13)(iii)(E). 
Applicants submit that the public policy reasons underlying Rule 6e-
3(T)(b)(13)(iii)(E) provide support for the exemption from Section 
27(c)(2) requested herein. In this regard, Applicants note that the 
Commission previously has issued orders granting substantially similar 
relief to that requested by Applicants, including an order to 
Providentmutual's corporate parent under nearly identical 
circumstances.\2\
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    \2\Provident Mutual Life Insurance Company, Investment Company 
Act Release Nos. 19552 (July 1, 1993) and 19519 (June 4, 1993).
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    5. Applicants represent that the requested exemption is necessary 
if they are to rely on Rule 6e-3(T)(b)(13)(i) under the 1940 Act, which 
provides critical exemptions from Sections 27(a)(1) and 27(h)(1) 
thereof. Applicants note that issuers and their affiliates may rely on 
Rule 6e-3(T)(b)(13)(i) only if they meet its alternative limits that 
apply to ``sales load,'' as defined in rule 6e-3(T)(c)(4). Rule 6e-
3(T)(c)(4) defines ``sales load'' during a contract period as the 
excess of any payments made during that period over certain specified 
charges and adjustments, including a deduction for and approximately 
equal to state premium taxes. Applicants represent that a ``tax burden 
charge'' such as the one Providentmutual proposes to deduct does not 
fall squarely into any of the itemized categories of charges or 
adjustments. Applicants note that a literal reading of Rule 6e-
3(T)(c)(4) arguably does not exclude such a ``tax burden charge'' from 
sales load.
    6. Applicants maintain, however, that there is no public policy 
reason why a ``tax burden charge'' designed to cover the expense of 
federal taxes should be treated as sales load or otherwise be subject 
to the sales load limits of Rule 6e-3(T). Applicants also assert that 
nothing in the administrative history of Rule 6e-3(T) (or, for that 
matter, in the administrative history of Rule 6e-2, its predecessor 
rule) suggests that the Commission intended to treat tax charges as 
sales load.
    7. Applicants assert that the public policy that underlies Rule 6e-
3T(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. Applicants submit 
that the treatment of a ``tax burden charge'' attributable to the 
receipt of purchase payments as sales load would in no way further this 
legislative purpose because such a deduction has no relation to the 
payment of sales commissions or other distribution expenses.
    8. Applicants assert that the genesis of Rule 6e-3T(c)(4) supports 
this analysis. in this regard, Applicants note that Section 2(a)(35) of 
the 1940 Act provides a scale against which the percent limits of 
Sections 27(a)(1) and 27(h)(1) thereof may be measured. Applicants 
submit that the Commission's intent in adopting Rule 6e-3T(c)(4) was to 
tailor the general terms of Section 2(a)(35) to flexible premium 
variable life insurance contracts in order, among other things, to 
facilitate verification by the Commission of compliance with the sales 
load limits set forth in Rule 6e-3T(b)(13)(i). Applicants submit that 
Rule 6e-3T(c)(4) does not depart, in principal, from Section 2(a)(35), 
and that both Section 2(a)(35) and Rule 6e-3T(c)(4) define ``sales 
load'' derivatively.
    9. Applicants further assert that Section 2(a)(35) clearly excludes 
from the definition of ``sales load'' under the 1940 Act deductions 
from purchase payments for ``issue taxes.'' Applicants submit that the 
exclusion of charges for expenses attributable to federal taxes from 
sales load (as defined in Section 2(a)(35)) is consistent with the 
protection of investors and the purposes intended by the policies and 
provisions of the 1940 Act. By extension, Applicants submit, it is 
equally consistent to exclude such charges, including the ``tax burden 
charge'' described above, from the definition of ``sales load'' in Rule 
6e-3T(c)(4).
    10. Applicants submit that the reference in Section 2(a)(35) to 
administrative expenses or fees that are ``not properly chargeable to 
sales or promotional activities'' suggests that the only charges or 
deductions intended to fall within the definition of ``sales load'' are 
those that are properly chargeable to such activities. Because the 
proposed ``tax burden charge'' will be used to pay costs attributable 
to Providentmutual's federal tax liabilities, and such costs are not 
properly chargeable to sales or promotional activities, Applicants 
assert that the language of Section 2(a)(35) is another indication that 
not treating the proposed ``tax burden charge'' as sales load is 
consistent with the purposes intended by the policies and provisions of 
the 1940 Act.
    11. Applicants state that the specification of only state premium 
taxes in Rule 6e-3T(c)(4)(v) probably is an historical accident, 
related to the fact that the Section 848 tax burden attributable to the 
receipt of premiums did not exist when Rule 6e-3T was initially adopted 
in 1984 and amended in 1987. Applicants note that nothing in the 
administrative history of Rule 6e-3(T) suggests that the exclusion from 
the definition of ``sales load'' of deductions for tax liabilities 
attributable to the amount of premium payments received was tried to 
the type of government entity imposing such taxes.
    12. For these reasons, Applicants assert that deducting a charge 
from variable life insurance contract premium payments for an insurer's 
tax burdens attributable to its receipt of such payments and excluding 
that charge from sales load is 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. Applicants 
submit that this is because such a charge is for a legitimate expense 
of the insurer and is not designed to cover sales and distribution 
expenses. Applicants note that, in adopting Rule 6e-3(T) and its 
analog, Rule 63-2, which applies to schedule premium variable life 
insurance contracts, the Commission considered similar deductions for 
tax burdens in respect of premium taxes. In each case, the Commission 
permitted deductions for such taxes to be made and to be treated as 
other than sales load. Applicants submit that the propriety of a charge 
for an insurer's tax burden attributable to premium payments received 
is the same whether such burden arises under state or federal law.

B. Request for ``Class Relief''

    1. Applicants note that the relief sought herein applies to 
existing Accounts as well as to future accounts that Providentmutual 
may establish to support flexible premium variable life insurance 
contracts. Such future accounts may be established as additional 
investment options under previously issued contracts. Such future 
accounts may be established as additional investment options under 
previously issued contracts that have a ``tax burden charge'' or as 
investment options for new contracts that may have a ``tax burden 
charge.''
    2. Applicants submit that because the terms of any exemption sought 
for the future accounts to permit the deduction of a ``tax burden 
charge'' would be substantially identical to those in this application, 
any additional requests for exemptive relief for the future accounts 
would present no issues under the 1940 Act that have not already been 
addressed in this application. Applicants note, however, that unless 
the ``class relief'' requested herein is granted, Providentmutual would 
have to request and obtain exemptive relief for each future account to 
the extent required. For the reasons set forth below, Applicants assert 
that the requested exemptions are appropriate in the public interest 
and are consistent with the protection of investors and the purposes 
intended by the policy and provisions of the 1940 Act.
    3. Applicants submit that the requested ``class relief'' would 
promote competitiveness in the variable life insurance market by 
eliminating the need for Providentmutual to file redundant exemptive 
applications, thereby reducing its administrative expenses and 
maximizing the efficient use of its resources. Applicants submit that 
the delay and expense involved in having repeatedly to seek the same 
exemptions would impair Providentmutual's ability to effectively take 
advantage of business opportunities as they arise.
    4. Applicants further submit that owners of Contracts and future 
contracts would receive no benefit or additional protection if 
Providentmutual were required repeatedly to seek Commission orders with 
respect to the same issues addressed in this application; indeed, they 
might be disadvantaged as a result of Providentmutual's increased 
overhead expenses.

Conditions for Relief

    1. Applicants agree to comply with the following conditions for 
relief:
    a. Providentmutual will monitor the reasonableness of the 1.25 
percent charge.
    b. The registration statement for the Contract and for any future 
contracts under which the 1.25 percent charge is deducted will include: 
(i) disclosure of the charge; (ii) disclosure explaining the purpose of 
the charge; and (iii) a statement that the charge is reasonable in 
relation to Providentmutual's increased tax burden as a result of 
applying Section 848 of the Code.
    c. Providentmutual also will include an exhibit to the registration 
statement for the Contract and for any other variable life insurance 
contract under which the 1.25 percent charge is deducted an actuarial 
opinion as to: (i) the reasonableness of the charge in relation to 
Providentmutual's increased tax burden as a result of Section 848 of 
the Code; (ii) the reasonableness of the after tax rate of return used 
in calculating the charge; and (iii) the appropriateness of the factors 
taken into account by Providentmutual 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 Rule 6e-3(T)(c)(4)(v) thereunder to permit the deduction of 1.25 
percent of premium payments under the Contracts and any future 
contracts meet the standards of Section 6(c) of the 1940 Act. In this 
regard, Applicants assert that granting the requested relief 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, 
under delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-31102 Filed 12-16-94; 8:45 am]
BILLING CODE 8010-01-M