[Federal Register Volume 61, Number 148 (Wednesday, July 31, 1996)]
[Notices]
[Pages 40035-40040]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-19373]


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SECURITIES AND EXCHANGE COMMISSION

[Rel. No. IC-22097; File No. 812-9992]


Continental Assurance Company, et al.

July 25, 1996.
AGENCY: Securities and Exchange Commission (``SEC'' or ``Commission'').

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

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APPLICANTS: Continental Assurance Company (``CAC''), Valley Forge Life 
Insurance Company (``VFL,'' together with CAC, the ``Companies''), 
Continental Assurance Company Variable Life Separate Account (``CAC 
Account''), Valley Forge Life Insurance Company Variable Life Separate 
Account (``VFL Account''), and CNA Investor Services, Inc.

Relevant 1940 Act Sections: Sections 6(c), 27(a)(3), 27(c)(2), and 
27(e), and Rules 6e-3(T)(b)(13)(ii), 6e-3(T)(b)(13)(vii), 6e-
3(T)(c)(4)(v), and 27e-1 thereunder.

SUMMARY OF APPLICATION: Applicants seek an order to the extent 
necessary to permit them or any other variable life insurance separate 
account established in the future by the Companies (``Future 
Accounts,'' collectively with the CAC Account and the VFL Account, the 
``Accounts'') to support certain flexible premium variable life 
insurance policies offered currently or in the future through the 
Accounts (collectively, ``Policies'') to: (1) deduct from premium 
payments received under the Policies a charge that is reasonable in 
relation to each Company's increased federal tax burden related to the 
receipt of such premium payments that results from the application of 
Section 848 of the Internal Revenue Code of 1986, as amended, 
(``Code''); (2) deduct sales charges from premium payments received in 
connection with Policies in a manner that results, in some instances, 
in sales charges on subsequent premium payments exceeding sales charges 
on prior premium payments; (3) compute sales surrender charges on such 
premium payments in a manner that results, in some instances, in sales 
surrender charges on subsequent premium payments exceeding sales 
surrender charges on prior premium payments; and (4) refrain from 
sending owners of Policies a written notice of certain refund and 
withdrawal rights.

Filing Date: The application was filed on February 14, 1996.

Hearing or Notification of Hearing: An order granting the application 
will be issued unless the SEC orders a hearing. Interested persons may 
request a hearing by writing to the Secretary of the SEC and serving 
Applicants with a copy of the request, personally or by mail. Hearing 
requests should be received by the SEC by 5:30 p.m. on August 16, 1996 
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 writer's interest, the reason 
for the request, and the issues contested.

[[Page 40036]]

Persons who wish to be notified of a hearing may request notification 
by writing to the Secretary of the SEC.

ADDRESSES: Secretary, SEC, 450 Fifth Street, N.W., Washington, D.C. 
20549: Applicants. Donald M. Lowry, Esq., Senior Vice President and 
General Counsel, CNA Insurance Companies, CNA Plaza, 43 South, Chicago, 
Illinois 60685.

FOR FURTHER INFORMATION CONTACT:
Edward P. Macdonald, Staff Attorney, or Wendy F. Friedlander, Deputy 
Chief, Division of Investment Management (Office of Insurance 
Products), 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 SEC.

Applicants' Representations

    1. CAC, a stock life insurance company organized under the laws of 
Illinois in 1911, has been a registered investment adviser since 1966. 
CAC is authorized to transact business in all 50 states, the District 
of Columbia, all provinces of Canada, Guam, Puerto Rico, and the U.S. 
Virgin Islands. CAC is a wholly-owned subsidiary of Continental 
Casualty Company, all of the voting securities of which are owned by 
CNA Financial Corporation, a Delaware corporation. Loews Corporation, a 
publicly traded Delaware corporation, owns a majority of the 
outstanding voting securities of CNA Financial Corporation.
    2. VFL, a stock life insurance company organized under the laws of 
Pennsylvania in 1956, is authorized to transact business in the 
District of Columbia, Puerto Rico, Guam and all states except New York. 
Valley Forge is a wholly-owned subsidiary of CAC.
    3. The CAC Account was established by CAC as a separate account 
pursuant to Illinois insurance law on January 30, 1996, to be a funding 
medium for variable life insurance contracts. The CAC Account is 
registered as a unit investment trust with 18 subaccounts, each of 
which invests exclusively in the shares of a designated investment 
portfolio.
    4. The VFL Account was established by VFL as a separate account 
under Pennsylvania insurance law on October 18, 1995, to be a funding 
medium for variable life insurance contracts. It is registered as a 
unit investment trust with 18 subaccounts each of which invest 
exclusively in the shares of a designated investment portfolio.
    5. CNA Investor Services, Inc., an affiliate of the Companies, is 
the principal underwriter of the Policies. It is registered under the 
Securities Exchange Act of 1934 as a broker-dealer and is a member of 
the National Association of Securities Dealers, Inc.
    6. The Policies are flexible premium variable life insurance 
contracts. The Companies will deduct 1.25% from each premium payment of 
the Policies to cover each Company's federal income tax costs 
attributable to the amount of premium received.
    7. The Companies will deduct a sales charge from each premium 
payment. For Policy years 1 through 10 the sales charge is 4% of 
premium payments made in that Policy year, up to the target premium 
payment\1\ for the initial specified amount. For Policy years 11 and 
later, the sales charge is 2% of premium payments made in that Policy 
year, up to the target premium payment for the initial specified 
amount. The target premium payment is an amount of premium payments, 
computed separately for each increment of specified amount under a 
Policy, used to compute sales charges and surrender charges. Any 
premium payments received in excess of the target premium payment for 
the specified amount in any year are not subject to a sales charge.
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    \1\ A target premium payment is an amount of premium shown in 
the Policy that is based on the insured's age sex, rate class, the 
specified amount under the Policy, and certain assumptions made by 
the Companies. It is never larger than the corresponding guideline 
annual premium payment under a Policy.
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    8. If the Policy owner increases the specified amount, a target 
premium payment is established for the increase. Therefore, there is a 
target premium payment for each increment of specified amount and the 
Companies deduct the sales charge from premium payments attributable to 
an increase. For purposes of computing and deducting sales charges, all 
premium payments made after an increase in specified amount are 
apportioned to each increment of specified amount on the basis of the 
relative guideline annual premium payments, as defined in Rule 6e-
3(T)(c)(8), for each such increment. For the first ten 12-month periods 
following an increase in specified amount, the charge is 4% of premium 
payments made in that 12-month period attributable to the increase, up 
to the target premium for the increase. For subsequent 12 Policy month 
periods, the sales charge is 2% of premium payments made during the 12 
month period attributable to the increase up to the target premium for 
the increase.
    9. If an owner surrenders the Policy, makes a withdrawal, decreases 
the specified amount, or if the Policy lapses, each Company may deduct 
a surrender charge from any Policy value. The surrender charge has two 
components: an administrative surrender charge and a contingent 
deferred sales charge (``CDSC'').
    10. The CDSC in connection with the initial specified amount is 
calculated in Policy years 1 through 6 based on premium payments up to 
the target premium. Specifically, the CDSC is 34% of premium payments 
made in the first Policy year up to the target premium payment for the 
initial specified amount, and 33% of premium payments made in each of 
Policy years 2 through 6 up to the target premium payment for the 
initial specified amount in each such year until the total CDSC equals 
100% of a single target premium payment of the initial specified 
amount.
    11. The CDSC in connection with the initial specified amount during 
the first two Policy years will not exceed the sum of: (1) 26% of the 
first guideline annual premium payment for the initial specified 
amount, (2) 6% of the second guideline annual premium payment for the 
initial specific amount, and (3) 5% of all additional premium payments 
attributable to the initial specified amount.
    12. After the first six Policy years, the total surrender charge in 
connection with the initial specified amount to which a Policy may be 
subject is reduced on a Policy year basis. The total surrender charge 
decrease 10% per year from 80% of total surrender charges in Policy 
year 7 to no charge in Policy years 15 and later.
    13. If the initial specified amount is decreased during the first 
fourteen Policy years, the surrender charge imposed will equal the 
portion of the total surrender charge that corresponds to the 
percentage by which the initial specified amount is decreased. In the 
event of a decrease in the initial specified amount, the pro-rated 
surrender charge will be allocated to each subaccount and to the fixed 
account based on the proportion of Policy value in each subaccount and 
in the fixed account. A surrender charge imposed in connection with a 
reduction in the initial specified amount reduces the remaining 
surrender charge that may be imposed in connection with a surrender of 
a Policy.
    14. The surrender charge is computed and assessed separately for 
the initial specified amount and for each increase in specified amount. 
Only the CDSC component of the surrender charge, however, is assessed 
in connection with an increase in specified amount. For purposes of 
computing and assessing the CDSC attributable to an increase in

[[Page 40037]]

specified amount, all premiums made after an increase in specified 
amount are apportioned to each increment of specified amount on the 
basis of the relative guideline annual premium payments of each such 
increment. Likewise, Policy value is apportioned to each increment of 
specified amount on the basis of the relative guideline annual premium 
payments for each such increment.
    15. The CDSC for an increase in specified amount is as follows: in 
the first 12 Policy months following the increase, the CDSC is 34% of 
premium payments received up to the first target premium payment for 
the increase in specified amount, and, in each of the five subsequent 
12 Policy month periods following the increase, the charge is 33% of 
premium payments received up to the first target premium payment for 
the increase in specified amount in each such 12 month period until the 
total CDSC for the increase equals 100% of a single target premium 
payment for the increase in specified amount. Notwithstanding the 
foregoing, the CDSC during the first 24 Policy months following an 
increase in specified amount is never more than the sum of: (1) 26% of 
the first guideline annual premium payment for the increase in 
specified amount, (2) 6% of the second guideline annual premium payment 
for the increase in specified amount, and (3) 5% of all additional 
premium payments attributable to the increase in specified amount. 
Beginning with the 73rd Policy month following an increase in specified 
amount, the CDSC computed in connection with the increase grades off 
during the subsequent 96 Policy months in the same manner as does the 
surrender charge associated with the initial specified amount.

Deferred Acquisition Cost

    16. In the Omnibus Budget Reconciliation Act of 1990, Congress 
amended the Code by, among other things, enacting Section 848 thereof 
which requires that life insurance companies capitalize and amortize 
over a period of ten years part of their general expenses for the 
current year. Upon prior law, these expenses were deductible in full 
from the current year's gross income. Section 848, in effect, 
accelerates the realization of income from specified insurance 
contracts for federal income tax purposes and, therefore, 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 
borne by the insurance company because the amount of general deductions 
that must be capitalized and amortized is measured by premium payments 
received under specified contracts, such as the Policies (the ``DAC tax 
charge''). In this respect, the impact of Section 848 can be compared 
with that of a state premium tax.
    17. The Policies to which the tax burden charge will apply fall 
into the category of life insurance contracts identified under Section 
484 as those for which the percentage of net premiums that determines 
the amount of otherwise currently deductible general expenses to be 
capitalized and amortized is 7.7 percent.
    18. The increased tax burden resulting from the applicability of 
Section 848 to every $10,000 of net premiums received may be qualified 
as follows. In the year when the premiums are received, each Company's 
general deductions are reduced by $731.50--i.e., an amount equal to (a) 
7.7 percent of $10,000 ($770) minus (b) one-half year's portion of the 
ten-year amortization ($38.50). Using a 35 percent corporate tax rate, 
this computes to an increase in tax for the current year of $256.03 
(i.e., $731.50 multiplied by .35). This increase in tax 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.
    19. Capital which must be used by each Company to satisfy its 
increased federal tax burden under Section 848 (resulting from the 
receipt of premiums) is not available to the Companies for investment. 
Because they seek an after tax rate of return of at least 10 percent on 
their invested capital,\2\ each Company submits that a discount rate of 
at least 10 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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    \2\ Both Companies have computed their cost of capital as the 
after tax rate of return that each seeks to earn on its surplus. The 
Companies took into account a number of factors in computing this 
rate. First, they identified the level of investment return that can 
be expected to be earned risk-free over the long term. This rate is 
based upon the expected yield on 30-year Treasury bonds. Then, this 
rate was increased by market risk premium that is demanded by equity 
investors to compensate such investors for the risks associated with 
equity investment. This premium is based on the average excess 
return earned by investing in equities as compared to that earned by 
investing in risk-free instruments (i.e., long-term Treasury bonds). 
Finally, the resulting rate was modified to reflect the relative 
volatility of portfolio investments. Both Companies represent that 
these are appropriate factors to consider in determining their cost 
of capital.
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    20. Using a corporate tax rate of 35 percent, and assuming a 
discount rate of 10 percent, the present value of the tax effect of the 
increased deductions allowable in the following ten years comes to 
$160.40. Because this amount partially offsets the increased tax 
burden, applying Section 848 to the specified contracts imposes an 
increased tax burden on each Company equal to a present value of $95.63 
(i.e., $256.03 minus $160.40) for each $10,000 of net premiums.
    21. Each Company does not incur incremental income tax when it 
passes on state premium taxes to Policy owners, because state premium 
taxes are deductible when computing federal income taxes. In contract, 
federal income taxes are not tax-deductible when computing each 
Company's federal income taxes. Therefore, to offset fully the impact 
of Section 848, each Company 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 the tax on the additional $95.63 
itself. This additional charge can be computed by dividing $95.63 by 
the complement of the 35 percent federal corporate income tax rate 
(i.e. 65 percent), resulting in an additional charge of $147.12 for 
each $10,000 of net premiums, or 1.47 percent.
    22. Tax deductions are of value to the Companies only to the extent 
that it has sufficient gross income to fully utilize the deductions. 
Based upon its prior experience, both Companies submit that it is 
reasonable to expect that virtually all future deductions will be fully 
taken.
    23. Each Company submits that a DAC tax charge of 1.25 percent of 
premium payments would reimburse it for the impact of Section 848 on 
its federal tax liabilities. Each Company represents that a 1.25 
percent charge is reasonably related to its increased tax burden under 
Section 848, taking into account the benefit to each Company of the 
amortization permitted by Section 848, and the use by each Company of a 
10 percent discount rate in computing the future deductions resulting 
from such amortization, such rate being the equivalent of each 
Company's cost of capital.

Applicants' Legal Analysis

    1. Section 6(c) of the 1940 Act authorizes the SEC by order upon 
application, conditionally or unconditionally to exempt any person, 
security, or transaction, or any class or classes of persons, 
securities or transactions, from any provision(s) of the 1940 Act or 
from any rule or regulation thereunder, if and to the extent that such 
exemption is necessary or appropriate in the public interest and 
consistent with the protection of

[[Page 40038]]

investors and the purposes fairly intended by the policy and provisions 
of the 1940 Act.

Exemption From Section 27(c)(2) of the 1940 Act and From Rule 6e-
3(T)(c)(4)(v)

    2. 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 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.
    3. 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.
    4. Rule 6e-3(T)(b)(13)(iii), among other things, 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 represent that the requested 
exemption is necessary if they are to rely on certain provisions of 
Rule 6e-3(T)(b)(13).
    5. 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 submit 
that the proposed DAC tax charge is akin to a state premium tax charge 
and, therefore, should be treated as other than sales load for purposes 
of the 1940 Act and the rules thereunder.
    6. Applicants acknowledge that the proposed DAC tax charge does not 
fall squarely into any of the itemized categories of charges or 
adjustments set forth in Rule 6e-3(T)(c)(4); a literal reading of that 
rule arguably does not exclude such a ``tax burden 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. Applicant also assert that 
nothing in the administrative history of Rule 6e-3(T) suggests that the 
SEC intended to treat tax charges as sales load.
    7. Applicants assert that the public policy that underlies Rule 6e-
3(T)(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 charge has no 
relation to the payment of sales commissions or other distribution 
expenses. Applicants further submit that the Commission has concurred 
with this conclusion by excluding deductions for state premium taxes 
from the definition of sales load in Rule 6e-3(T)(c)(4).
    8. applicants assert that the genesis of Rule 6e-3(T)(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 intent of the SEC in adopting Rule 6e-
3(T)(c)(4) was to tailor the general terms of Section 2(a)(35) to 
flexible premium variable life insurance contracts in order, among 
other things, to facilitate verification by the SEC of compliance with 
the sales load limits set forth in Rule 6e-3(T)(b)(13)(i). Applicants 
submit that Rule 6e-3(T)(c)(4) does not depart, in principal, from 
Section 2(a)(35).
    9. Applicants further assert that Section 2(a)(35) excludes from 
the definition of sales load under the 1940 Act deductions from 
premiums for ``issue taxes.'' Applicants submit that, by extension, the 
exclusion from ``sales load'' (as defined in Rule 6e-3(T) of charges to 
cover an insurer's expenses attributable to its federal tax obligations 
is consistent with the protection of investors and the purposes 
intended by the policies and provisions of the 1940 Act.
    10. Applicants also 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 deductions 
intended to fall within the definition of sales load are those that are 
properly chargeable to such activities. Because the proposed DAC tax 
charge will be used to compensate each Company for its increased 
federal tax burden attributable to the receipt of premiums, and such 
deductions 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 such deductions as sales load is 
consistent with the purposes intended by the policies of the 1940 Act.
    11. Applicants agree to comply with the following conditions for 
relief: (a) Each Company will monitor the reasonableness of the 1.25 
percent proposed DAC tax charge; (b) the registration statement for the 
Policies under which the 1.25 percent charge is deducted will: (i) 
Disclose the charge; (ii) explain the purposes of the charge; and (iii) 
state that the charge is reasonable in relation to each Company's 
increased federal tax burden resulting from the application of Section 
848 of the Code; and (c) the registration statement for the Policies 
under which the 1.25 percent charge is deducted will contain as an 
exhibit an actuarial opinion as to: (a) The reasonableness of the 
charge in relation to each Company's increased federal tax burden 
resulting from the application of Section 848 of the Code; (ii) the 
reasonableness of the targeted rate of return that is used in 
calculating such charge; and (iii) the appropriateness of the factors 
taken into account by each Company in determining such targeted rate of 
return.
    12. Applicants also request exemptions for any Future Account that 
either 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 in this 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 this application. Nevertheless, unless such relief were 
granted, the Companies would have to obtain exemptions for each Future 
Account that either establishes unless that relief is granted in 
response to this application.
    13. 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 Companies to file 
redundant exemptive applications, thereby reducing its administrative 
expenses and maximizing the efficient use of its resources. The delay 
and expense involved in having to repeatedly seek the same exemptions 
would impair both Companies' 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

[[Page 40039]]

reasons. Investors would receive no benefit or additional protection if 
each Company were required to repeatedly seek Commission orders with 
respect to the same issues. In fact they might be disadvantaged as a 
result of the Companies' increased overhead expenses.

Exemption From Section 27(a)(3) of the 1940 Act and From Rule 6e-
3(T)(b)(13)(ii)

    14. Section 27(a)(3) provides that the amount of sales charge 
deducted from any of the first twelve monthly purchase payments on a 
periodic payment plan certificate by any registered investment company 
issuing such certificates or any depositor or underwriter for such 
company may not exceed proportionately the amount deducted from any 
other such payment, and that the amount deducted from any subsequent 
payment may not exceed proportionately the amount deducted from any 
other subsequent payment.
    15. Rule 6e-3(T)(b)(13)(ii) provides an exemption from Section 
27(a)(3) in connection with flexible premium variable life insurance 
contracts, provided that the proportionate amount of sales charge 
deducted from any premium payment for such a contract does not exceed 
the proportionate amount deducted from any prior premium payment, 
unless an increase is caused by reductions in the annual cost of 
insurance or reductions in sales load for amounts transferred to a 
variable life insurance contract from another plan of insurance.
    16. The Policies have both a sales charge deducted from certain 
premium payments and a CDSC that is computed as a percentage of certain 
premium payments. For any increment of specified amount, the sales 
charge deducted from any premium payments is a percentage of the 
payments made in a Policy year up to the target premium for that 
increment in that Policy year. No sales charge is deducted from premium 
payments made in a Policy year in excess of that target premium. Thus, 
where an owner of a Policy makes premium payments in any Policy year in 
excess of the target premium and makes any premium payment during the 
next Policy year, the sales charge on the first dollar paid in the next 
Policy year will always exceed that paid on the last dollar paid in the 
prior Policy year.
    17. Likewise for any increment of specified amount, the CDSC is 
computed as a percentage of premium payments made in a Policy year up 
to the target premium for that increment and no CDSC is associated with 
premium payments made in a policy year in excess of that target 
premium. Thus, where an owner of a Policy makes premium payments in 
excess of the target premium during any of the first five Policy years 
and makes any premium payment during the next Policy year, the CDSC 
associated with the first dollar paid in the next Policy year will 
always exceed that associated with the last dollar paid in the prior 
Policy year. Applicants state that this sales charge structure appears 
to violate the ``stair-step'' provisions in Section 27(a)(3) of the 
Act. Moreover, the exemption provided by Rule 6e-3(T)(b)(13)(ii) does 
not appear to cover this type of charge structure.
    18. Because Section 27(a)(3) and Rule 6e-3(T)(b)(13)(ii) appear to 
prohibit this structure, Applicants apply for an order under Section 
6(c) of the Act exempting them and any Future Accounts from these 
provisions to the extent necessary to: (1) Permit the deduction of 
sales charges from premium payments up to one target premium paid 
during any Policy year (or, in connection with an increase in specified 
amount, any 12 month period) to exceed the sales charge deducted on 
premium payments made in excess of one target premium in any prior 
Policy year (or 12 month period), and (2) to permit the deduction of 
the CDSC computed on the same basis with a similar result.
    19. Applicants state that the Policies could continue to comply 
with all of the other sales charge limitations and requirements in Rule 
6e-3(T), if the sales charges were deducted from, and the CDSC were 
computed on the basis of, all premium payments. Applicants assert that 
such charges, however, would be less favorable to Policy owners than 
that provided under the Policies. Under such a sales charge structure 
Applicants argue, sales charges would be recovered by the companies 
earlier than is the case under the Policies' sales charge structure. 
Under such a surrender charge structure, CDSCs could be greater than 
under the Policies' CDSC. Applicants submit that the sales charge 
structure under the Policies benefits Policy owners by spreading the 
sales charges over a longer period of time, thereby permitting a 
greater portion of a Policy owner's premium payments in excess of a 
target premium to be invested in the Policy.
    20. Applicants assert that the imposition of a sales charge only on 
premiums paid up to the target premium in any Policy year in part 
reflects the fact that the Companies will usually incur lower overall 
distribution costs in connection with premium payments in excess of the 
targets over the life of the Policies. Applicants argue that to impose 
the sales charge on such ``excess'' premium payments could generate 
more revenue than the Companies believe is necessary to cover such 
costs. Thus, the sales charge design provides a significant benefit to 
Policy owners by passing through to them a portion of the Companies' 
lower distribution costs with respect to ``excess'' premiums. The same 
can generally be said of the CDSC. Applicants submit that it would not 
be in the best interest of Policy owners to require the imposition of a 
sales charge on ``excess'' premiums that is higher than Applicants 
consider necessary.
    21. Applicants further argue that Section 27(a)(3) was designed to 
address the perceived abuse of periodic payment certificates that 
deducted large amounts of front-end sales charges so early in the life 
of the plan that an investor redeeming in the early period would recoup 
little of his or her investment. Applicants assert that, by imposing no 
sales charge on ``excess'' premium payments made in any Policy year, 
the Company will cause a greater proportion of total sales charges to 
be deducted later than otherwise would be the case under the Policies. 
Likewise, by assessing no CDSC in connection with ``excess'' premium 
payments, the CDSC would, in certain circumstances, be less than 
otherwise would be the case under the Policies.
    22. Applicants argue that one purpose behind Section 27(h)(3) of 
the 1940 Act, as provision similar to Section 27(a)(3), is to 
discourage unduly complicated sales charges. This purpose also may be 
deemed to be a purpose of Section 27(a)(3) and Rule 6e-3(T)(b)(13)(ii). 
Therefore, Applicants submit that the sales charge structure under the 
Policies is straightforward, easily understood, and less complicated 
than that of any many variable life insurance products that currently 
are being offered and sold.
    23. Applicants submit that, under the Policies, premium payments up 
to the target premium have higher levels of actual sales expenses 
associated with them than premium payments made in excess of such a 
target premium. Because the ``excess'' premium payments have a lower 
level of sales expenses, Applicants argue that it is entirely 
appropriate that the sales charge structures for the two types of 
payments be analyzed separately, the sales charge or CDSC related to 
premium payments up to the target premium each year will comply with 
Rule 6e-3(T)(b)(13)(ii), and the sales charge or CDSC related to 
``excess'' premium payments will remain level at

[[Page 40040]]

zero and therefore never increase from one excess premium payment to 
the next.
    24. Moreover, Applicants concede that the Companies could avoid the 
potential ``stair-step'' issue simply by imposing the higher sales 
charges equally on premium payments in any Policy year, subject to the 
overall sales charge limits under the 1940 Act; Applicants argue, 
however, that Policy owners benefit from the lower sales charge imposed 
in connection with ``excess'' premium payments under the sales charge 
structure of the Policy.

Exemption From Section 27(e) of the 1940 Act and Rule 27e-1 Thereunder, 
and From Rule 6e-3(T)(b)(13)(vii)

    25. Section 27(e) requires, with respect to any periodic payment 
plan certificate sold subject to Section 27(d), written notification of 
the right to surrender and receive a refund of the excess sales load. 
Rule 27e-1 establishes the requirements for the notice mandated by 
Section 27(e) and prescribes from N-27E-1 for that purpose. Rule 6e-
3(T)(b)(13) in essence modifies the requirements of Section 27 of the 
1940 Act and the rules thereunder. Rule 6e-3(T)(b)(13)(vii) adopts Form 
N-27I-1 and requires it to be sent to a Policy owner upon issuance of 
the Policy and again during any lapse period in the first two Policy 
years. The Form requires statements of: (a) the Policy owner's right to 
receive back the excess sales load for a surrender during the first two 
Policy years, (b) the date that the right expires, and (c) the 
circumstances in which the right may not apply upon lapse. Thus Section 
27(e) of the 1940 Act, and Rules 27e-1 and 6e-3(T)(b)(13)(vii) 
thereunder, require a notice of right of withdrawal, and refund on Form 
N-27I-1 to be provided to owners of the Policies entitled to a refund 
of sales load in excess of the limits stated in paragraph (b)(13)(v)(A) 
of Rule 6e-3(T).
    26. The Policies have a sales charge and a CDSC that does not, 
during the first two Policy years (or, as to an increase in specified 
amount, during the first twenty-four months after the increase), exceed 
the limits described by paragraph (b)(13)(v)(A) of Rule 6e-3(T) beyond 
which sales charges are characterized as ``excess sales charge'' is 
ever paid by an owner surrendering, withdrawing, reducing his or her 
specified amount, or lapsing in the first two Policy years (or, as to 
an increase in specified amount, during the first twenty-four months 
after the increase).
    27. Applicants represent that the sales charge and the CDSC on 
premium payments (and with respect to the CDSC applicable to an 
increase in specified amount, after the first twenty-four months 
following that increase) may exceed the limits described by paragraph 
(b)(13)(v)(A) of Rule 6e-3(T). Therefore, Applicants are requesting the 
relief sought in this application.
    28. Rule 27e-1, pursuant to which Form N-27I-1 was first 
prescribed, specifies in paragraph (e) that no notice need be mailed 
when there is otherwise no entitlement to receive any refund of sales 
charges. Applicants stat that Rules 27e-1 and 6e-2 (from which Rule 6e-
3(T) was derived) were adopted in the context of front-end loaded 
products only and in the broader context of the companion requirements 
in Section 27 for the depositor or underwriter to maintain segregated 
funds as security to assure the refund of any excess sales charges.
    29. Applicants assert that requiring delivery of a Form N-27I-1 
could confuse Policy owners at best, and, at worst, encourage them to 
surrender during the first two Policy years (or surrender or decrease 
to specified amount of their Policies during the first twenty-four 
Policy months following a specified amount increase) when it may not be 
in their best interests to do so. Applicants submit that an owner of a 
Policy with a declining CDSC, unlike a policy with a front-end sales 
charge, does not foreclose his or her opportunity, at the end of the 
first two Policy years (or twenty-four Policy months following a 
specified amount increase), to receive a refund of most monies spent. 
Not only has such an owner not paid any excess sales charges, but 
because the deferred charge declines over the life of the policy, the 
owner may never have to pay the deferred charge. Applicants thus assert 
that encouraging a surrender during the first two Policy years could, 
in the end, cost such an owner more in total sales charges (relative to 
total premium payments) than he or she would otherwise pay if the 
Policy, which is designed as a long-term investment vehicle, were held 
for the period originally intended.
    30. Applicants submit that the absence of ``excess sales charges,'' 
and, therefore, the absence of an obligation to assure repayment of 
that amount, do not create a right in an owner which Form N-27I-1 was 
designed to highlight. In the absence of this right, Applicant's argue 
that the notification contemplated by Form N-27I-1 is an unnecessary 
and counter-productive administrative burden the cost of which appears 
unjustified, and any other purpose potentially served by the Form N-
27I-1 would already be addressed by the required Form N-27I-2 Notice of 
Withdrawal Right, generally describing the charges associated with the 
Policy, and prospectus disclosure detailing the sales charge design. 
Applicant's submit that neither Congress, in enacting Section 27, nor 
the Commission, in adopting Rule 27e-1, could have contemplated the 
applicability of Form N-27I-1 in the context of an insurance policy 
with a declining contingent deferred sales charge.

Conclusion

    For the reasons summarized above, the Applicants represent that the 
requested relief from Sections 27(a)(3), 27(c)(2), and 27(e) of the 
1940 Act, paragraphs (b)(13)(ii), (b)(13)(vii), and (c)(4)(v) of Rule 
6e-3(T) thereunder, and 27e-1 thereunder, is necessary or appropriate 
in the public interest and otherwise meets the standards of Section 
6(c) of the 1940 Act.

    For the Commission, by the Division of Investment Management, 
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-19373 Filed 7-30-96; 8:45 am]
BILLING CODE 8010-01-M