[Federal Register Volume 68, Number 70 (Friday, April 11, 2003)]
[Notices]
[Pages 17842-17845]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-8921]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. IC-25994; File No. 812-12815]


Principal Life Insurance Company, et al., Notice of Application

April 7, 2003.
AGENCY: Securities and Exchange Commission (``SEC'' or ``Commission'').

ACTION: Notice of application for an order pursuant to section 26(c) of 
the Investment Company Act of 1940 (the ``Act'') approving the 
substitution of securities and an order of exemption pursuant to 
section 17(b) of the Act.

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Applicants: Principal Life Insurance Company (``Principal Life''), 
Principal Life Insurance Company Variable Life Separate Account (the 
``Separate Account'').

Summary of Application: Applicants seek an order to permit, under the 
specific circumstances identified in the application, the substitution 
of shares of the Bond Account of Principal Variable Contracts Fund, 
Inc. (``Bond Account'') for shares of the High Yield Account of 
Principal Variable Contracts Fund, Inc. (``High Yield Account''). The 
shares are currently held by the Separate Account which is a unit 
investment trust under the Act. Applicants also request an order 
exempting the proposed substitution from the provisions of section 
17(a) of the Act.

Filing Date: The Application was filed on May 8, 2002, and amended on 
December 19, 2002, and March 24, 2003.

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 SEC's Secretary and serving 
Applicants with a copy of the request, personally or by mail. Hearing 
requests should be received by the SEC by 5:30 on April 29, 2003 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. Persons who wish to be 
notified of a hearing may request notification by writing to the SEC's 
Secretary.

ADDRESSES: Secretary, SEC, 450 5th Street, NW, Washington, DC 20549. 
Applicants, c/o John W. Blouch, Esq., Jones & Blouch L.L.P., 1025 
Thomas Jefferson Street, NW., Washington, DC 20007-0805; copy to 
Michael D. Roughton, Esq., Principal Financial Group, Inc., 711 High 
Street, Des Moines, Iowa 50392-0200.

FOR FURTHER INFORMATION CONTACT: Rebecca A. Marquigny, Senior Counsel, 
or Zandra Bailes, Branch Chief, 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 SEC's Public 
Reference Branch, 450 Fifth Street, NW., Washington, DC 20549-0102 
(telephone (202) 942-8090).

Applicants' Representations

    1. Principal Life is a stock life insurance company organized under 
the laws of Iowa in 1879. It is authorized to transact life insurance 
and annuity business in all of the United States and the District of 
Columbia.
    2. The Separate Account was established in 1987 by Principal Life 
as a separate account under Iowa law for the purpose of funding 
variable life contracts issued by Principal Life. The only contract 
affected by this application is a flexible premium variable life 
insurance policy called ``Flex Variable Life'' (File No. 33-13481) (the 
``Contract''). The Separate Account is registered as a unit investment 
trust under the Act.
    3. Purchase payments for the Contract are allocated to one or more 
subaccounts (``Divisions'') of the Separate Account. The Contracts 
permit allocations of accumulation value to the available Divisions. 
Each Division invests in shares of an underlying mutual fund 
(``Underlying Fund''). There currently are 40 Divisions available under 
the Contract, 23 of which invest in Principal Variable Contracts Fund, 
Inc. (``Principal Fund''), an open-end management investment company 
registered under the Act (File Nos. 811-01944 and 002-35570). The only 
Divisions affected by this application are the High Yield Division 
which invests solely in the High Yield Account and the Bond Division 
which invests solely in the Bond Account. The High Yield Account and 
the Bond Account are referred to collectively as the ``Funds.''
    4. The Contract permits transfers of accumulation value from one 
Division to another. No sales charge applies to a transfer of 
accumulation value among the Divisions. Under the Contract, four free 
transfers are permitted each year, and $25 is charged for each 
subsequent transfer.
    5. Applicants propose a substitution of shares of the Bond Account 
for shares of the High Yield Account held by the High Yield Division.
    6. The High Yield Account is managed by Principal Management 
Corporation (``PMC''), an indirect, wholly-owned subsidiary of 
Principal Financial Group, Inc. The High Yield Account's investment 
objective is to seek high current income primarily by purchasing high 
yielding, lower or non-rated, fixed income securities which are 
believed not to involve undue risk to income or principal. Capital 
growth is a secondary objective when consistent with the objective of 
high current income. The expense ratio of the High Yield Account for 
2002 was 0.66%. The High Yield Account has no 12b-1 plan. The total 
return of the High Yield Account was 1.90% for the year ended December 
31, 2002. The average annual

[[Page 17843]]

total return for the five-year period ended December 31, 2002, was -
0.12% and for the ten-year period ended December 31, 2002 was 6.51%.
    7. The Bond Account is managed by PMC. The Bond Account's 
investment objective is to seek as high a level of income as is 
consistent with the preservation of capital and prudent investment risk 
by investing primarily in intermediate maturity fixed-income or debt 
securities rated BBB or higher by Standard & Poor's Rating Service or 
Baa or higher by Moody's Investor's Service, Inc. The expense ratio of 
the Bond Account for 2002 was 0.49%. The Bond Account has no 12b-1 
plan. The total return of the Bond Account for the year ended December 
31, 2002, was 9.26%. The average annual total return for the five-year 
period ended December 31, 2002, was 6.04%, and for the ten-year period 
ended December 31, 2002 was 7.23%. There are no fee waiver or expense 
reimbursement provisions with respect to either Fund.
    8. Applicants believe that the substitution will better serve the 
interests of contractowners because it will eliminate an investment 
option under the Contract that has never been able to attract 
significant contractowner interest, will provide contractowners with an 
investment in an account that has similar, although not identical, 
investment objectives and policies, a lower expense ratio and superior 
historical performance, and should benefit contractowners by providing 
economies of scale that result from investing in a much larger account. 
Applicants represent that the substitution will take place at the 
relative net asset values determined on the date of the substitution in 
accordance with Section 22 of the Act and Rule 22c-1 thereunder. 
Applicants represent that there will be no financial impact to any 
contractowner.
    9. Applicants agree that, to the extent that the annualized 
expenses of the Bond Account exceed, for each fiscal quarter during the 
two-year period following the Substitution, the 2002 net expense level 
of the High Yield Account, Principal Life will, for each Contract 
outstanding on the date of the Substitution, make a reduction in (or 
reimbursement of) the Bond Division expenses on the last day of each 
such fiscal period, such that the sum of the net expenses of the Bond 
Account and the net expenses of the Bond Division will, on an 
annualized basis, be no greater than the sum of the net expenses of the 
High Yield Account and the net expenses of the High Yield Division for 
the 2002 fiscal year. In addition, for the two-year period following 
the Substitution, Principal Life will not increase asset-based fees or 
charges under the Contract.
    10. The substitution will be effected by having the High Yield 
Division redeem its shares of the High Yield Account for cash at the 
net asset value calculated on the date of the substitution and purchase 
shares of the Bond Account for cash at net asset value on the same 
date. In the alternative, the substitution may be effected by having a 
partial ``in-kind'' redemption with the High Yield Division receiving 
from the High Yield Account securities that are eligible investments 
for the Bond Account and that have a value equal to the net asset value 
of the shares of the High Yield Account being redeemed and then 
contributing these securities to the Bond Account in exchange for 
shares of the Bond Account having a net asset value equal to the value 
of the securities contributed (the ``In-Kind Transaction''). In 
connection with the completion of the substitution, Principal Life will 
withdraw its seed money from the High Yield Account and terminate the 
High Yield Account. In addition, Principal Life will combine the High 
Yield Division with the Bond Division.
    11. Applicants represent that the proposed substitution was 
described in a supplement to the prospectus for the Contract 
(``Sticker'') filed with the Commission on August 16, 2002, and mailed 
to contractowners. The Sticker gave contractowners notice of the 
substitution, described the reasons for engaging in the substitution 
and informed the contractowners that no amounts may be transferred to 
the High Yield Division on or after May 31, 2003. In addition, the 
Sticker informed affected contractowners that they will have an 
opportunity to reallocate accumulation value, prior to the 
substitution, from the High Yield Division, or for 60 days after the 
substitution, from the Bond Division to another Division available 
under the Contract, without the imposition of any transfer-charge or 
limitation and without counting the transfer as one of the four annual 
free transfers (the ``Free Transfer Right''). Contractowners may elect 
to reallocate accumulation value to the Fidelity VIP High Yield 
Division (``Fidelity High Income Division'') that invests solely in an 
Underlying Fund that, like the High Yield Account, emphasizes 
investment in lower-quality debt securities.
    12. Each contractowner has been provided a prospectus for the Bond 
Account. Within five days after the substitution, Principal Life will 
send to contractowners written confirmation that the substitution has 
occurred.
    13. Applicants represent that Principal Life will pay all expenses 
and transaction costs of the substitution. Affected contractowners will 
not incur any fees or charges as a result of the substitution, nor will 
their rights or the obligations of Principal Life under the Contract be 
altered in any way. The proposed substitution will not cause the fees 
and charges under the Contract currently being paid by contractowners 
to be greater after the substitution than before the substitution. The 
proposed substitution will not have a tax impact on contractowners.

Applicants' Legal Analysis

    1. Applicants request an order pursuant to section 26(c) of the Act 
approving the substitution. Section 26(c) of the Act makes it unlawful 
for any depositor or trustee of a registered unit investment trust 
holding the security of a single issuer to substitute another security 
for such security unless the Commission approves the substitution. The 
Commission will approve such a substitution if the evidence establishes 
that it is consistent with the protection of investors and the purposes 
fairly intended by the policy and provisions of the Act.
    2. Applicants assert that the purposes, terms and conditions of the 
substitution are consistent with the principles and purposes of section 
26(c) and do not entail any of the abuses that section 26(c) is 
designed to prevent. Substitution is an appropriate solution to the 
small size and higher relative expense of the High Yield Account. 
Applicants believe that the Bond Account will better serve 
contractowner interests because of its larger size, lower expenses and 
better historical performance. Moreover, Principal Life has reserved 
the right to effect substitutions in the Contract and disclosed this 
reserved right in the prospectus for the Contract.
    3. Applicants represent that the substitution will not result in 
the type of costly, forced redemption that section 26(c) was intended 
to guard against and, for the following reasons, is consistent with the 
protection of investors and the purposes fairly intended by the Act:
    (a) The proposed substitution permits contractowners continuity of 
investment objectives and expectations. Both the Bond Account and the 
High Yield Account seek a high level of income through investing in 
fixed-income securities. Although the Bond Account and the High Yield 
Account differ significantly in the credit quality of the securities in 
which each principally invests, there is substantial overlap in the 
range of the credit qualities of the

[[Page 17844]]

securities in which each may invest, and the Bond Account, with its 
emphasis on investment grade securities, will afford shareholders of 
the High Yield Account an opportunity for continued, if reduced, 
investment exposure to high yield securities.
    (b) The contract owners will have ample opportunity to consider 
their investment options because they will be given notice prior to the 
substitution and will have an opportunity to reallocate accumulation 
value among other available Divisions without the imposition of any 
transfer charge or limitation as a result of the Free Transfer Right. 
Contractowners who wish to maintain a higher investment exposure to 
high yield securities than is possible through the Bond Division may 
elect to reallocate accumulation value to the Fidelity High Income 
Division available under the Contract.
    (c) The costs of the substitution will be borne by Principal Life 
and will not be borne by the Funds or the contractowners.
    (d) The substitution will be at net asset values of the respective 
shares, without the imposition of any transfer or similar charge and 
with no change in the amount of any contractowner's accumulation value 
under the Contract.
    (e) The substitution will not cause the fees and charges under the 
Contract currently being paid by contractowners to be greater after the 
substitution than before the substitution.
    (f) Within five days after the substitution, Principal Life will 
send to contractowners written confirmation that the substitution has 
occurred.
    (g) The substitution will in no way alter the insurance benefits to 
contractowners or the contractual obligations of Principal Life.
    (h) The substitution will in no way alter the tax benefits to 
contractowners.
    (i) To the extent that the annualized expenses of the Bond Account 
exceed, for each fiscal quarter during the two-year period following 
the substitution, the 2002 net expense level of the High Yield Account, 
Principal Life will, for each Contract outstanding on the date of the 
substitution, make a reduction in (or reimbursement of) the Bond 
Division expenses on the last day of each such fiscal period, such that 
the sum of the net expenses of the Bond Account and the net expenses of 
the Bond Division will, on an annualized basis, be no greater than the 
sum of the net expenses of the High Yield Account and the net expenses 
of the High Yield Division for the 2002 fiscal year. In addition, for 
the two-year period following the substitution, Principal Life will not 
increase asset-based fees or charges under the Contract.
    4. Section 17(a) of the Act provides, in pertinent part, that it is 
unlawful for any affiliated person of a registered investment company, 
or any affiliated person of such an affiliated person, acting as 
principal, knowingly to sell any security or other property to such 
registered company or to purchase from such registered company any 
security or other property. Section 2(a)(3) of the Act defines the term 
``affiliated person'' of another person to include in pertinent part 
``(A) any person directly or indirectly owning, controlling, or holding 
with power to vote, 5 per centum or more of the outstanding voting 
securities of such other person; (B) any person 5 per centum or more of 
whose outstanding voting securities are directly or indirectly owned, 
controlled, or held with power to vote, by such other person; (C) any 
person directly or indirectly controlling, controlled by, or under 
common control with such other person; * * * (E) if such other person 
is an investment company, any investment adviser thereof or any member 
of an advisory board thereof.''
    5. Each of the Funds was sponsored by Principal Life. Principal 
Life may be deemed an affiliated person of an affiliated person of each 
of the Funds because it is under common control with PMC, which serves 
as the investment adviser to the Funds. Moreover, Principal Life is the 
owner of all the outstanding shares of the Bond Account and all of the 
outstanding shares of the High Yield Account. As a result of these 
relationships, the Funds might be deemed to be under common control 
and, therefore, affiliated persons of each other for purposes of the 
prohibitions set forth in section 17(a) of the Act. Thus, absent 
exemptive relief, consummation of the substitution using the In-Kind 
Transaction could result in a violation of section 17(a) because the 
transaction would involve the purchase from and sale of securities to 
an investment company by an affiliated person, or an affiliated person 
of an affiliated person, of that investment company.
    6. Section 17(b) of the Act provides that the Commission may exempt 
any transaction from the prohibitions of section 17(a) if the evidence 
establishes that:
    (a) The terms of the proposed transaction, including the 
consideration to be paid or received, are fair and reasonable and do 
not involve overreaching on the part of any person concerned;
    (b) The proposed transaction is consistent with the policy of each 
registered investment company concerned, as recited in the registration 
statements and reports filed under the Act; and
    (c) The proposed transaction is consistent with the general 
purposes of the Act.
    7. Applicants assert that the terms of the proposed In-Kind 
Transaction are reasonable and fair and do not involve any overreaching 
on the part of any person concerned. The substitution will be 
accomplished on the basis of the relative net asset values of each of 
the Funds and, therefore, will have no economic impact on the interest 
of any contractowner.
    8. Applicants assert that the substitution is consistent with the 
investment objective of each of the Funds in that both Funds seek a 
high level of income through investing if fixed-income securities. 
Although the funds differ significantly in the credit quality of the 
securities in which each principally invests, there is substantial 
overlap in the range of the credit qualities of the securities in which 
each may invest, and the Bond Account, with its emphasis on investment 
grade securities, will nonetheless afford contractowners with an 
interest in the High Yield Division an opportunity for continued, if 
reduced, investment exposure to high yield securities. In addition, 
contractowners with an opportunity to transfer their interest, without 
charge, to any other Division, including the Fidelity High Income 
Division.
    9. Applicants assert that the substitution is consistent with the 
general purposes of the Act. Section 1(b)(2) of the Act declares that 
the public interest and interest of investors are adversely affected 
when investment companies are organized and managed in the interest of 
affiliated persons, rather than in the interest of the company's 
security holders. The substitution does not result in any of the self-
dealing abuses that the Act was designed to prevent. Principal Life 
will pay all expenses incurred in connection with the substitution. The 
substitution will be effected by Principal Life in accordance with the 
terms of the Contract. The substitution will eliminate a small fund 
that has never been able to attract significant investor interest, will 
provide contractowners with an interest in that fund with an interest 
in a fund that has similar, although not identical, investment 
objectives and policies as well as a lower expense ratio and superior 
historical performance, and should benefit the shareholders of both 
Funds by providing economies of scale that

[[Page 17845]]

result from combining the assets and operations of the two Funds.
    10. Applicants request an order of the Commission pursuant to 
Section 26(c) of the Act approving the substitution and an order of 
exemption pursuant to section 17(b) of the Act in connection with 
aspects of the substitution that may be deemed to be prohibited by 
section 17(a), as described above. Section 26(c), in pertinent part, 
provides that the Commission shall issue an order approving a 
substitution of securities if the evidence establishes that it is 
consistent with the protection of investors and the purposes fairly 
intended by the policy and provisions of the Act. For the reasons and 
upon the facts set forth above, Applicants believe that the requested 
order meets the standards set forth in section 26(c) and should, 
therefore, be granted. Section 17(b) of the Act provides that the 
Commission may grant an order exempting transactions prohibited by 
section 17(a) of the Act upon application subject to certain 
conditions. Applicants represent that the proposed In-Kind Transaction 
meets all of the requirements of section 17(b) of the Act and that an 
exemption should be granted, to the extent necessary, from the 
provisions of section 17(a).

Conclusion

    Section 6(c) of the Act, in pertinent part, provides that the 
Commission, by order upon application, may conditionally or 
unconditionally exempt any persons, security or transaction, or any 
class or classes of persons, securities or transactions, from any 
provision or provisions of the Act, or any rule or regulation 
thereunder, to the extent that such exemption is necessary or 
appropriate in the public interest and consistent with the protection 
of investors and the purposes fairly intended by the policy and 
provisions of the Act. Applicants submit that, for the reasons stated 
in the Application, their exemptive requests meet the standards set out 
in section 6(c) and that an order should, therefore, be granted.

    For the Commission, by the Division of Investment Management, 
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-8921 Filed 4-10-03; 8:45 am]
BILLING CODE 8010-01-P