[Federal Register Volume 60, Number 232 (Monday, December 4, 1995)]
[Notices]
[Pages 62126-62129]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-29383]
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SECURITIES AND EXCHANGE COMMISSION
[Rel. No. IC-21545; No. 812-9668]
National Life Insurance Company, et al.
November 27, 1995.
AGENCY: Securities and Exchange Commission (``Commission'').
ACTION: Notice of Application for an Exemption pursuant to the
Investment Company Act of 1940 (the ``1940 Act'').
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APPLICANTS: National Life Insurance Company (the ``Company''), National
Variable Life Insurance Account (the ``Account''), any other separate
account established in the future by the Company (the ``Future
Accounts'', collectively, with the Account, the ``Accounts'') to
support flexible premium variable life insurance policies (the ``Future
Contracts,'' collectively, with the Existing Contracts, the
``Contracts'') and Equity Securities, Inc. (the ``Underwriter'').
RELEVANT 1940 ACT SECTIONS: Order requested pursuant to Section 6(c) of
the 1940 Act seeking exemptions from the provisions of Section 27(c)(2)
thereof and from Rule 6e-3(T)(c)(4)(v) thereunder.
SUMMARY OF APPLICATION: Applicants seek an order permitting them to
deduct from premiums received under the Contracts issued by the Company
and the Accounts a charge in an amount that is reasonable in relation
to the Company's increased federal income tax burden related to the
receipt of such premium payments and that results from the application
of Section 848 of the Internal Revenue Code of 1986, as amended (the
``Code'').
FILING DATE: The application was filed on July 14, 1995.
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 by writing to the Secretary of the
Commission and serving Applicants with a copy of the request,
personally or by mail. Hearing requests must be received by the
Commission by 5:30 p.m. on December 22, 1995, 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 Secretary of the Commission.
ADDRESSES: Secretary, Securities and Exchange Commission, 450 5th
Street, NW., Washington, DC 20549. Applicants, c/o D. Russell Morgan,
Counsel, National Life Insurance Company, One National Life Drive,
Montpelier, Vermont 05604.
FOR FURTHER INFORMATION CONTACT:
Kevin M. Kirchoff, Senior Counsel, or Wendy Friedlander, Deputy Chief,
Office of Insurance Products (Division of Investment Management), at
(202) 942-0670.
SUPPLEMENTARY INFORMATION: The following is a summary of the
application; the complete application is available for a fee from the
Public Reference Branch of the Commission.
Applicant's Representations
1. The Company, a mutual life insurance company chartered pursuant
to the law of the State of Vermont in 1848, is authorized to transact
life insurance and annuity business in Vermont and in 50 other
jurisdictions. The Company is depositor and sponsor of the Account.
2. The Company established the Account pursuant to Vermont law to
support variable life insurance contracts. The Account is registered
with the Commission as a unit investment trust and is a ``separate
account'' as defined by Rule 0-1(e) under the 1940 Act. The Company
anticipates that any Future Account would be registered under the 1940
Act as a unit investment trust and would meet the definition of a
separate account in Rule 0-1(e) thereunder.
3. The Account currently has nine sub-accounts, each of which
invests in a corresponding portfolio of one of two series-type mutual
funds registered with the Commission as open-end, diversified
management investment companies: the Market Street Fund and Variable
Insurance Products Fund.
4. The Underwriter, an indirect, wholly-owned subsidiary of the
Company, is registered as a broker-dealer pursuant to the Securities
Exchange Act of 1934 and is a member of the National Association of
Securities Dealers, Inc.
5. The Existing Contracts are flexible premium variable life
insurance contracts.
6. In the Omnibus Budget Reconciliation Act of 1990, Congress
amended 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.
7. The amount of expenses that must be capitalized and amortized
under Section 848 is generally determined with reference to premium
payments 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
[[Page 62127]]
the current year's net premium payments (i.e., gross premium payments
minus return premium payments and reinsurance premium payments) 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).
8. Although framed in terms of requiring a portion of a life
insurance company's general expenses to be capitalized an 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 Company that is
attributable to such contracts. Because the amount of general
deductions that must be capitalized and amortized is measured by
premium payments paid for Specified Contracts, an increased tax burden
results from the receipt of those premium payments.
9. The Contracts to which Applicants wish to apply the tax burden
charge are among the Specified Contracts. They fall into the category
of life insurance contracts for which the percentage of net premium
payments that determines the amount of otherwise currently deductible
general expenses to be capitalized and amortized with respect to such
contracts is 7.7%.
10. The increased tax burden resulting from the applicability of
Section 848 to every $10,000 of net premium payments received may be
quantified as follows. In the year when the premium payments are
received, the Company's general deductions are reduced by $731.50--
i.e., an amount equal to (a) 7.7% of $10,000, or $770, minus (b) one-
half year's portion of the ten-year amortization, or $38.50. Using a
35% corporate tax rate, this results in 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.
11. In the Company's business judgment, a discount rate of at least
8% is appropriate for use in calculating the present value of its
future tax deductions resulting from the amortization described above.
For business relating to participating insurance policies, the Company
seeks an after tax rate of return on the investment of its surplus of
at least 8%. To the extent that surplus must be used by the Company to
satisfy its increased federal tax burden under Section 848 resulting
from the receipt of premium payments, such surplus is not available to
the Company for investment. Thus, the cost to the Company of
``capital'' used to satisfy its increased federal tax burden under
Section 848 is, in essence, the Company's after tax rate of return on
surplus, and accordingly, the rate of return on surplus is appropriate
for use in this present value calculation.\1\
\1\ In determining the cost of capital, the Company considered a
number of factors. First, the Company considered its anticipated
long-term growth rate. The Company seeks an after-tax rate of return
earned on investments that is at least equal to its long-term growth
rate. The cost of capital should also represent a fair after-tax
rate of return to the Company for investing surplus. This rate can
be thought of as consisting of a ``risk-free'' rate of return plus a
``risk premium'' for engaging in this type of business. Other
factors taken into consideration were market interest rates and
information about the rates of return obtained by other insurance
companies. The Company represents that these are appropriate factors
to consider in determining its cost of capital.
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12. Again using a corporate tax rate of 35% and assuming a discount
rate of 8%, the present value of the tax effect of the increased
deductions allowable in the following ten years, which (as noted above)
partially offsets the increased tax burden, comes to $174.59. The
effect of Section 848 on the Company in connection with the Existing
Contracts is therefore an increased tax burden with a present value of
$81.44 for each $10,000 of net premium payments received, (i.e.,
$256.03 minus $174.59).
13. State premium taxes are deductible in computing federal income
taxes. Thus, the Company 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 in computing the Company's federal
income taxes. Therefore, in order to compensate fully for the impact of
Section 848, the Company must impose an additional charge that would
make it whole not only for the $81.44 additional tax burden
attributable to Section 848, but for the tax on the additional $81.44
itself. This additional charge can be determined by dividing $81.44 by
the complement of the 35% federal corporate income tax rate (i.e.,
65%), resulting in an additional charge of $125.29 for each $10,000 of
net premium payments, or approximately 1.25% of net premium payments.
14. Tax deductions are of value to the Company only to the extent
that it has sufficient gross income to fully use the deductions.
However, based on its prior experience, the Company believes that it
can reasonably expect to use virtually all future deductions available.
That is, the Company believes that it can reasonably expect to have
sufficient taxable income in future years to use all deferred
acquisition cost deduction.
15. The Company also represents that the 1.25% charge is reasonably
related to the Company's increased tax burden under Section 848 of the
Code, taking into account the benefit to the Company of the
amortization permitted by Section 848, and the use by the Company of a
8% discount rate in computing the future deductions resulting from such
amortization, such rate being the equivalent of the Company's cost of
capital.
16. The Company believes that a charge of 1.25% of premium payments
would reimburse it for the impact of Section 848 (as currently written)
on its federal tax liabilities. The Company believes, however, that it
would have to increase this charge if future changes in, or
interpretations of, Section 848 or any successor provision result 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.
The Contracts will or may reserve the right to increase or decrease the
1.25% charge in response to future changes in, or interpretations of,
Section 848 or any successor provision that increase or decrease the
Company's tax burden. The Company understands, however, that it would
need additional exemptions before increasing the charge above 1.25%.
Applicants' 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 an amount that is
reasonable in relation to the Company's increased federal tax burden
related to the receipt of such premium payments and that results from
the application of Section 848 of
[[Page 62128]]
the Code. The deduction would not be treated as sales load.
Relief From Provisions of Section 27(c)(2) and Rule 6e-3(T)(c)(4)(v)
3. 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 trustee's or custodian's fees, insurance
premiums, issue taxes, or administrative expenses or fees which are not
properly chargeable to sales or promotional activities.
4. 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.
5. Paragraph (a) of Rule 6e-3(T) requires that a separate account
(such as the 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.
6. 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, 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.
7. Paragraph (c)(4) of Rule 63-3(T) defines ``sales load'' (for
purposes of the rule) as the excess of any purchase payments over
certain itemized charges and adjustments. A tax burden charge, such as
the one the Company proposes to deduct, may not fall squarely into any
of the itemized categories of charges or adjustments. Consequently, a
literal reading of paragraph (c)(4) arguably does not exclude such a
charge from sales load. 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
subject to the sales load limits of Rule 6e-3(T). Applicants assert
that nothing in the administrative history of the Rule (or in the
administrative history of Rule 6e-2, its predecessor) suggests that the
Commission intended to treat tax charges as sales load.
8. The exemption requested by Applicants is necessary in order for
them and any Future Account to rely on certain provision of Rule 6e-
3(T)(b)(13), including sub-paragraph (b)(13)(i) thereof, which provides
critical exemptions from Sections 27(a)(1) and 27(h)(1) of the 1940
Act. Issuers and their affiliates only may rely, however, on sub-
paragraph (b)(13)(i) if they meet its alternate limits that apply to
sales load as defined in paragraph (c)(4). Applicants and Future
Accounts generally could not meet these limits if the tax burden charge
is included in sales load.
9. The public policy that underlies sub-paragraph (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 assert that the
treatment of a tax burden charge attributable to the receipt of
purchase 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.
10. Applicants assert that the genesis of Rule 6e-3(T)(c)(4)
supports this analysis, and suggest that Section 2(a)(35) provides a
scale against which the percentage limits of Sections 27(a) (1) and
27(h)(1) may be measured. Applicants submit that Rule 6e-3(T)(c)(4), is
simply a more specific articulation of the requirements of Section
2(a)(35) as applied to flexible premium variable life insurance
policies. Section 2(a)(35), like Rule 6e-3(T)(c)(4), defines sales load
derivatively, treating as sales load the:
difference between the price of a security to the public and that
portion of the proceeds from its sale which is invested or held for
investment . . . less any portion of such difference deducted for
trustee's or custodian's fees, insurance premiums, issue taxes, or
administrative expenses or fees which are not properly chargeable to
sales or promotional activities. (Emphases added.)
Applicants maintain that the Commission's intent in adopting paragraph
(c)(4) of Rule 6e-3(T) was to tailor the general terms of Section
2(a)(35) to flexible premium variable life insurance policies in order,
among other things, to facilitate verification by the Commission of
compliance with the sales load limits set forth in sub-paragraph
(b)(13)(i). According to their analysis, paragraph (c)(4) does not
depart, in principal, from Section 2(a)(35).
11. Section 2(a)(35) excludes deductions from purchases payments
for ``issue taxes'' from the definition of sales load under the 1940
Act. Applicants suggest that this indicates that it is consistent with
the protection of investors and the purposes intended by the policies
and provisions of the 1940 Act to exclude charges for expenses
attributable to federal taxes from sales load. Applicants argue that,
by extension, it is equally consistent to exclude such charges,
including the tax burden charge described above, from the Rule 6e-
3(T)(c)(4) definition of sales load.
12. Applicants argue that the Section 2(a)(35) reference to
administrative expenses or fees that are ``not properly chargeable to
sales or promotional activities'' (quoted and emphasized above)
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 the Company's federal tax liabilities, which
are not properly chargeable to sales or promotional activities,
Applicants assert that language is another indication that not treating
such deductions as sales load is consistent with the purposes intended
by the policies and provisions of the 1940 Act.
13. Applicants note that the Rule 6e-3(T)(c)(4)(v) limitation of
the premium tax exclusion from the definition of ``sales load'' to
state premium taxes is probably a historical accident, related to the
fact that, when Rule 6e-3(T) was initially adopted in 1984 and when it
was amended in 1987, the additional Section 848 tax burden attributable
to the receipt of premiums did not exist.
14. Applicants represent that, for the reasons summarized above,
deducting a
[[Page 62129]]
charge from variable life insurance policy premium payments for an
insurer's tax burdens attributable to its receipt of such payments, and
excluding the 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.
This is because such a charge is, Applicants represent, for a
legitimate expense of the insurer and is not designed to cover sales
and distribution expenses. Applicants assert that, in adopting Rule 6e-
3(T), the Commission considered similar deductions for tax burdens in
respect of premium taxes and permitted deductions for such taxes to be
made and to be treated as other than sales load. Applicants assert 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.
Request for ``Class Relief''
15. Applicants also request exemptions for any Future Account that
the Company may establish to support flexible premium variable life
insurance contracts as defined in Rule 6e-3(T)(c)(1). Applicants
believe that the terms of any exemption sought for Future Accounts to
permit the deduction of a tax burden charge would be substantially
identical to those they describe in the application. Applicants assert
that any additional requests for exemptive relief for such Future
Accounts would present no issues under the 1940 Act that have not
already been addressed in the application. Nevertheless, the Company
would have to obtain exemptions for each Future Account it establishes
unless class relief is granted in response to the application.
16. The requested exemptions are appropriate in the public interest
because they would promote competitiveness in the variable life
insurance market by eliminating the need for the Company 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 repeatedly to seek the same exemptions
would impair the Company's ability to effectively take advantage of
business opportunities as they arise. Likewise, the requested
exemptions are consistent with the protection of investors and the
purposes intended by the policy and provisions of the 1940 Act for the
same reasons. Investors would receive no benefit or additional
protection if the Company were required repeatedly to seek Commission
orders with respect to the same issues addressed in the application.
Indeed, they might be disadvantaged as a result of the Company's
increased expenses.
Applicants' Conditions
1. The Company will monitor the reasonableness of the 1.25% charge.
2. The registration statement for the Existing Contracts and any
Future Contracts under which the 1.25% charge is deducted will include:
(a) disclosure of the charge;
(b) disclosure explaining the purpose of the charge; and
(c) a statement that the charge is reasonable in relation to the
Company's increased tax burden as a result of Section 848 of the Code.
3. The Company also will include as an exhibit to the registration
statement for the Existing Contracts and any Future Contracts under
which the 1.25% charge is deducted an actuarial opinion as to:
(a) the reasonableness of the charge in relation to the Company's
increased tax burden as a result of Section 848 of the Code;
(b) the reasonableness of the after tax rate of return used in
calculating the charge; and
(c) the appropriateness of the factors taken into account by the
Company in determining the after tax rate of return.
Conclusion
For the reasons summarized above, Applicants represent that the
exemptions requested are necessary and 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. 95-29383 Filed 12-1-95; 8:45 am]
BILLING CODE 8010-01-M