[Federal Register Volume 61, Number 117 (Monday, June 17, 1996)] [Notices] [Pages 30647-30650] From the Federal Register Online via the Government Publishing Office [www.gpo.gov] [FR Doc No: 96-15275] ======================================================================= ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION [Rel. No. IC-22012; File No. 812-9954-01] ITT Hartford Life and Annuity Insurance Company, et al. June 11, 1996. AGENCY: Securities and Exchange Commission (``SEC'' or ``Commission''). ACTION: Notice of Application for an Order under the Investment Company Act of 1940 (``1940 Act''). ----------------------------------------------------------------------- APPLICANTS: ITT Hartford Life and Annuity Insurance Company (``ILA''), ICMG Registered Variable Life Separate Account One (``Separate Account''), and Hartford Equity Sales Company (``HESCO''). RELEVANT 1940 ACT SECTIONS: Order requested under Section 6(c) of the 1940 Act granting exemptions from Section 27(c)(2) of the 1940 Act and Rule 6e-3(T)(c)(4)(v) thereunder. SUMMARY OF APPLICATION: Applicants request an order permitting the Separate Account and other separate accounts established in the future by ILA to support certain group flexible premium variable life insurance policies to deduct from premium payments an amount that is reasonably related to the increased federal tax burden of ILA resulting from the application of Section 848 of the Internal Revenue Code of 1986, as amended. FILING DATE: The application was filed on October 30, 1995. An amended application was filed on May 29, 1996. 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 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 July 8, 1996, 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 Commission. ADDRESSES: Secretary, SEC, 450 Fifth Street, N.W., Washington, DC 20549. Applicants, c/o Scott K. Richardson, Esq., Assistant Counsel, ITT Hartford Life Insurance Companies, P.O. Box 2999, Hartford, CT 06104-2999. FOR FURTHER INFORMATION CONTACT: Patrice M. Pitts, Special Counsel, Office of Insurance Products (Division of Investment Management) at (202) 942-0670. 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. ILA is a stock life insurance company engaged in the business of writing both individual and group life insurance and annuity policies in the District of Columbia and in all states except New York. ILA was redomesticated from Wisconsin to Connecticut on May 1, 1996. ILA is a wholly-owned subsidiary of Hartford Life Insurance Company. 2. The Separate Account was established by ILA under the laws of the state of Connecticut, and is registered as a unit investment trust under the 1940 Act. The assets of the Separate Account are not chargeable with liabilities arising out of any other business which ILA may conduct. Income and realized and unrealized capital gains and losses of the Separate Account will be credited to the Separate Account without regard to any of ILA's other income or realized and unrealized capital gains and losses, or the income, gains and losses of other ILA separate investment accounts. [[Page 30648]] 3. The Separate Account presently consists of twelve investment divisions, each of which invests exclusively in the shares of investment options available through seven open-end management investment companies. 4. In the future, the board of directors of ILA may establish other separate accounts (``Future Accounts'') which may serve as funding vehicles for other variable life insurance policies issued by ILA. The Future Accounts will be organized as unit investment trusts, and will file registration statements under the 1940 Act and the Securities Act of 1933. 5. HESCO will serve as the principal underwriter for certain group flexible premium variable life insurance policies (``Policies'') and any other variable life insurance policies (``Future Policies'') issued in the future by ILA through the Separate Account or Future Accounts. HESCO is registered as a broker-dealer under the Securities Exchange Act of 1934, and is a member of the National Association of Securities Dealers. 6. In 1990, Congress amended the Internal Revenue Code of 1986 (``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, those expenses were deductible in full from the gross income of the current year. 7. The amount of expenses that must be capitalized and amortized under Section 848 generally is determined with reference to premiums for certain categories of life insurance contracts (``specified contracts''). More specifically, an amount of expenses equal to a percentage of the premiums for the current year (i.e., gross premiums minus return premiums and reinsurance premiums) must be capitalized and amortized for each specified contract. The percentage varies, depending upon the type of specified contract in question, in accordance with a schedule set forth in Section 848. 8. In effect, Section 848 accelerates the realization of income from certain insurance contracts and, accordingly, the payment of taxes on the income generated by those contracts. Taking into account the time value of money, Section 848 increases the tax burden of an insurance company because the amount of general expenses that must be capitalized and amortized is measured by the premiums received under certain insurance contracts. 9. The Policies and Future Policies to which a charge for the federal tax burden related to deferred acquisition costs (``tax burden charge'') will be applied are/will be among the specified contracts. They fall/will fall into the category of life insurance contracts under Section 848 for which 7.7% of net premiums received must be capitalized and amortized. 10. The increased tax burden resulting from the application of Section 848 may be quantified as follows. For each $10,000 of net premiums received by ILA under the Policies, ILA may capitalize $770.00 (i.e., 7.7% of $10,000). $38.50 of that amount may be deducted in the current year, leaving $731.50 (i.e., $770 minus $38.50) subject to taxation at the corporate tax rate of 35 percent. This works out to an increase in tax for the current year of $256.03 (i.e., 0.35 x $731.50). This increased federal income tax burden will be partially offset by deductions 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 year ten. 11. To the extent that capital must be used by ILA to satisfy its increased tax burden under Section 848, such profits are not available to ILA for investment. ILA submits that the cost of capital used to satisfy its increased federal income tax burden under Section 848 is, in essence, its targeted rate of return on invested capital. Because ILA seeks a targeted rate of return on its invested capital of 10 percent,\1\ ILA submits that a discount rate of 10% is appropriate for use in calculating the present value of its future tax deductions resulting from the amortization described above. --------------------------------------------------------------------------- \1\ In determining the targeted rate of return on invested capital used in arriving at this discount rate, ILA first identified a reasonable risk-free rate of return that can be expected to be earned over the long term. ILA then determined the premium it needs to earn over that risk-free rate of return because of the nature of the products it sells. Applicants represent that such factors are appropriate to consider in determining ILA's targeted rate of return on invested capital. --------------------------------------------------------------------------- 12. Using a corporate tax rate of 35 percent, and assuming a discount rate of 10 percent, the present value of the federal income tax effect of the increased deductions allowable in the following ten years is $160.40. Because this amount partially offsets the increased tax burden, Section 848 imposes an increased tax burden on ILA equal to a present value of $95.63 ($56.03 minus $160.40) for each $10,000 of net premiums received under the Policies. 13. ILA does not incur incremental federal income tax when it passes on state premium taxes to contract owners because premium taxes are deductible when computing federal income taxes. The same is not true for federal income taxes. Therefore, to offset fully the impact of Section 848, ILA must impose an additional charge that would make it whole not only for the $95.63 additional tax burden attributable to Section 848, but also for the tax on the additional $95.63 itself. This additional charge can be computed by dividing $95.63 by the complement of the 35% federal corporate income tax rate (i.e., 65%), resulting in an additional charge of $147.12 for each $10,000 of net premiums, or 1.47% of net premiums. 14. Based on its prior experience, ILA expects that all of its current and future deductions will be fully taken. ILA submits that a charge of 1.25% of net premium payments would reimburse it for the impact of Section 848, taking into account the benefit to ILA of the amortization permitted by Section 848 and the use by ILA of a discount rate of 10% (which is equivalent to its targeted rate of return) in computing the future deductions resulting from such amortization. Applicants' Legal Analysis 1. Section 6(c) of the 1940 Act provides, in pertinent 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) exempting them from the provisions of Section 27(c)(2) of the 1940 Act and Rule 6e-3(T)(c)(4)(v) thereunder to permit ILA to deduct from premium payments received in connection with Policies and Future Policies an amount that is reasonable in relation in ILA's increased federal income tax burden related to the receipt of such premiums. Applicants further request an exemption from Rule 6e- 3(T)(c)(4)(v) to permit the proposed deductions to be treated as other than ``sale load'' for the purposes of Section 27 of the 1940 Act and the exemptions from various provisions of that Section found in Rule 6e-3(T)(b)(13) under 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 (excepts 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 [[Page 30649]] 26(a)(3) of the 1940 Act. Sections 27(a)(1) and 27(h)(1), in effect, limit sales load on periodic payment plan certificates to 9% of total payments. 4. Certain provisions of Rule 6e-3(T) provide a range of exemptive relief for the offering of flexible premium variable life insurance policies such as the Policies and Future Policies. For example, subject to certain conditions, Rule 6e-3(T)(b)(13)(iii) provides exemptions from Section 27(c)(2) that include permitting the payment of certain administrative fees and expenses, the deduction of a charge for certain mortality and expense risks, and ``[t]he deduction of premium taxes imposed by any state or other governmental entity.'' 5. 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, including ``[a] deduction for and approximately equal to state premium taxes[.]'' Applicants submit that the proposed tax burden charge is akin to a state premium tax charge in that it is an appropriate charge related to ILA's tax burden attributable to premiums received under the Policies and Future Policies. 6. Applicants represent that the requested exemptions from Rule 6e- 3(T)(c)(4)(v) are necessary in connection with Applicants' reliance on certain provisions of Rule 6e-3(T)(b)(13), particularly on subparagraph (b)(13)(i), which provides exemptions from Sections 27(a)(1) and 27(h)(1) of the 1940 Act. Issuers and their affiliates may 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). Applicants acknowledge that 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 Rule 6e-3(T)(c)(4). Nevertheless, Applicants submit that there is no public policy reason for treating such increased federal tax burden as sales load. 7. Applicants assert that the public policy which 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 federal income tax charge attributable to premium payments as sales load would in no way further this legislative purpose because such a deduction bears no relation to the payment of sales commissions or other distribution expenses. Applicants assert that the Commission has concurred in this conclusion by excluding deductions for state premium taxes from the Rule 6e- 3(T)(c)(4) definition of ``sales load.'' 8. Applicants submit that Rule 6e-3(T)(c)(4) tailors the general terms of Section 2(a)(35) of the 1940 Act to variable life insurance contracts. Applicants further submit that, 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). Applicants submit that Rule 6e-3(T)(c)(4) does not depart, in principal, from Section 2(a)(35). 9. Applicants assert that Section 2(a)(35) excludes from ``sales load'' expenses or fees ``not properly chargeable to sales or promotional activities.'' Because the proposed tax burden charge will be used to compensate ILA for its increased federal tax burden attributable to the receipt of premiums, and such cost is not properly chargeable to sales or promotional activities, Applicants submit that not treating the proposed tax burden charge as sales load is consistent with the policies of the 1940 Act. 10. Applicants further assert that Section 2(a)(35) excludes from the definition of ``sales load'' deductions for premiums 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 policies of the 1940 Act. By extension, Applicants submit, it is equally consistent to exclude such charges, including the proposed tax burden charge, from the definition of ``sales load'' in Rule 6e-3(T)(c)(4). 11. For these reasons, Applicants submit 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 consistent with the policies of the 1940 Act. Applicants assert that this is because such a deduction is an appropriate charge related to the insurer's tax burden attributable to the premium payments received. 12. Applicants seek the relief requested herein with respect to the Policies and Future Policies. Without the requested relief, ILA would have to request and obtain exemptive relief for each Future Contract to be issued. Such additional requests for exemptive relief would present no issues under the 1940 Act not already addressed in this request for exemptive relief. 13. Applicants submit that the requested relief would promote competitiveness in the variable life insurance market by eliminating the need for them to file redundant exemptive applications, thereby reducing ILA's administrative expenses and maximizing efficient use of its resources. Applicants further submit that the delay and expense involved in having to seek exemptive relief repeatedly would impair ILA's ability to take advantage of business opportunities as they arise. Moreover, if Applicants were required to seek exemptive relief repeatedly with respect to the 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 ILA. For these reasons, Applicants assert that the requested relief is appropriate in the public interest and consistent with the protection of investors. Conditions for Relief Applicants agree to comply with the following conditions for relief. 1. ILA will monitor the reasonableness of the tax burden charge. 2. The registration statement for the Policies and Future Policies under which the tax burden 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 ILA's increased federal tax burden under Section 848 resulting from the receipt of premiums. 3. The registration statement for any Policies of Future Policies under which a tax burden charge is deducted will contain as an exhibit an actuarial opinion as to: (a) the reasonableness of the charge in relation to ILA's increased federal tax burden under Section 848 resulting from the receipt of premiums; (b) the reasonableness of the targeted rate of return used in calculating such charge; and (c) the appropriateness of the factors taken into account by ILA in determining the targeted rate of return. Conclusion For the reasons and upon the facts set forth above, Applicants submit that 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% of premium payments under the Policies and any Future Policies-- 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. [[Page 30650]] For the Commission, by the Division of Investment Management, by delegated authority. Margaret H. McFarland, Deputy Secretary. [FR Doc. 96-15275 Filed 6-14-96; 8:45 am] BILLING CODE 8010-01-M