[Federal Register Volume 61, Number 105 (Thursday, May 30, 1996)]
[Notices]
[Pages 27110-27112]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-13544]



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SECURITIES AND EXCHANGE COMMISSION
[Rel. No. IC-21981; No. 812-9848]


Aetna Life Insurance and Annuity Company, et al.

May 23, 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'').

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APPLICANTS: Aetna Life Insurance and Annuity Company (``Aetna'') and 
Variable Life Account B of Aetna Life Insurance and Annuity Company 
(``Separate Account'').

RELEVANT 1940 ACT SECTIONS: Order requested under Section 6(c) 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 that will permit 
the Separate Account, any future separate accounts established by Aetna 
(``Future Accounts''), and all other persons, other than Aetna, that 
may, in the future serve as a principal underwriter (``Future Broker-
Dealers'') of certain flexible premium variable life insurance policies 
issued by Aetna, to deduct from premium payments an amount that is 
reasonably related to the Aetna's increased federal tax burden 
resulting from the receipt of those premium payments, pursuant to 
Section 848 of the Internal Revenue Code of 1986, as amended 
(``Code'').

FILING DATE: The application was filed on November 15, 1995 and was 
amended on May 17, 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 by writing to the Commission's Secretary 
and serving Applicants with a copy of the request, personally or by 
mail. Hearing requests should be received by the Commission by 5:30 
p.m. on June 18, 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 requestor'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, N.W., Washington, D.C. 20549. Applicants: Susan E. Bryant, 
Esq., Aetna Life Insurance and Annuity Company, 151 Farmington Avenue, 
Hartford, Connecticut 06156.

FOR FURTHER INFORMATION CONTACT: Pamela K. Ellis, Senior Counsel, or 
Wendy Finck 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 
Commission's Public Reference Branch.

Applicants' Representations

    1. Aetna is a stock life insurance company, organized in 
Connecticut, and is a wholly owned subsidiary of Aetna Life and 
Casualty Company.
    2. The Separate Account is a separate account established by Aetna 
and registered under the 1940 Act as a unit investment trust. 
Currently, the Separate Account has 17 subaccounts each of which 
invests in a corresponding investment portfolio of an open-end 
management investment company registered under the 1940 Act. The 
Separate Account funds flexible premium variable life insurance 
policies issued by Aetna (``Current Policies'') for which a 
registration statement has been filed with the Commission to register 
interests in the Current Policies under the Securities Act of 1933, and 
flexible premium variable life insurance policies developed by Aetna in 
the future (``Future Policies'') (Current Policies, together with 
Future Policies, ``Policies''). Aetna anticipates that any Future 
Accounts established to fund Current Policies or Future Policies would 
be registered under the 1940 Act as unit investment trusts.
    3. Aetna is the principal underwriter and distributor for the 
Policies. Aetna is a registered broker-dealer under the Securities 
Exchange Act of 1934 (``1934 Act''), and is a member of the National 
Association of Securities Dealers, Inc. (``NASD''). Any Future Broker-
Dealer will be registered as a broker-dealer under the 1934 Act, and 
will be a member of the NASD.
    4. Applicants propose to deduct from premium payments received 
under the Policies a 1.25% charge to reimburse Aetna for the increase 
in its federal income taxes resulting from Section 848 of the Code. The 
charge will be reasonably related to Aetna's increased federal tax 
burden.
    5. The Omnibus Budget Reconciliation Act of 1990 (``OBRA 1990''), 
amending Section 848 of the Code, requires life insurance companies to 
capitalize and amortize over ten years certain general expenses for the 
current year. Prior law allowed these expenses to be deducted in full 
from the current year's gross income. Section 848, as amended, 
effectively accelerates the realization of income from specified 
contracts and, consequently, the payment of taxes on that income. 
Taking into account the time value of money, Section 848 increases the 
insurance company's tax burden because the amount of general deductions 
that must be capitalized and amortized is measured by the premiums 
received under the policies.

[[Page 27111]]

    6. The amount of expenses subject to Section 848 equals a 
percentage of the current year's net premiums received (i.e., gross 
premiums minus return premiums and reinsurance premiums) under life 
insurance or other contracts categorized under this Section. The 
Policies will be categorized under Section 848 as life insurance 
contracts requiring 7.7% of the net premiums received to be capitalized 
and amortized under the schedule set forth in Section 848(c)(1).
    7. The increased tax burden on every $10,000 of net premiums 
received under the Policies is quantified by Applicants as follows. For 
each $10,000 of net premiums received in a given year, Aetna must 
capitalize $770 (i.e., 7.7% of $10,000), and $38.50 of this amount may 
be deducted in the current year. The remaining $731.50 ($770 less 
$38.50) is subject to taxation at the corporate tax rate of 35% and 
results in $256.03 (.35%  x  $731.50) more in taxes for the current 
year than Aetna would have owed prior to the enactment of OBRA 1990. 
However, the current tax increase will be offset partially by 
deductions allowed during the next ten years, which result from 
amortizing the remainder of the $770 ($77 in each of the following nine 
years and $38.50 in year ten).
    8. In Aetna's business judgement, it is appropriate to use a 
discount rate of at least 10% in evaluating the present value of its 
future tax deductions. Capital that Aetna must use to pay its increased 
federal tax burden under Section 848 will be unavailable for 
investment. The cost of capital used to satisfy this increased tax 
burden essentially will be Aetna's after-tax rate of return (i.e., the 
return sought on invested capital), which is at least 10%.\1\ 
Accordingly, Applicants submit that the targeted rate of return is 
appropriate for use in this present value calculation.
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    \1\ In determining the rate of return used in arriving at the 
discount rate, Aetna considered a number of factors. These factors 
included current market interest rates and expected interest rate 
trends, inflation, Aetna's anticipated long-term growth rate, the 
level of risk acceptable to Aetna, and available information about 
rates of return obtained by other life insurance companies.
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    9. Using a federal corporate tax rate of 35%, and assuming a 
discount rate of 10%, the present value of the tax effect of the 
increased deductions allowable in the following ten years, which 
partially offsets the increased tax burden, amounts to $160.40. The 
effect of Section 848 on the Policies is, therefore, an increased tax 
burden with a present value of $95.63 for each $10,000 of net premium 
payments received (i.e., $256.03 minus $160.40).
    10. Aetna does not incur incremental federal income tax when it 
passes on state premium taxes to Policy owners because state premium 
taxes are deductible in computing federal income taxes. In contrast, 
federal income taxes are not deductible in computing Aetna's federal 
income taxes. To compensate Aetna fully for the impact of Section 848, 
Aetna must impose an additional charge to make it whole for not only 
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 
determined by dividing $95.63 by the complement of 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%.
    11. Based on its prior experience, Aetna reasonably expects to take 
fully almost all future deductions. It is Aetna's judgement that a 
1.25% charge would reimburse it for the increased federal income tax 
liabilities, under Section 848. Applicants represent that the 1.25% 
charge will be reasonably related to Aetna's increased federal income 
tax burden under Section 848. This representation takes into account 
the benefit to Aetna of the amortization permitted by Section 848 and 
the use of a 10% discount rate (which is equivalent to Aetna's targeted 
rate of return) in computing the future deductions resulting from such 
amortization.

Applicants' Legal Analysis

    1. Applicants request an order under Section 6(c) of the 1940 Act 
exempting them and any Future Accounts 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 and any Future Accounts to deduct 
from premium payments made under the Policies, a charge in an amount 
that is reasonable in relation to Aetna's increased federal tax burden 
related to the receipt of such premium payments, without treating such 
charge as a sales load. Applicants assert that it is appropriate to 
deduct a charge for an insurer's increased tax burden attributable to 
premiums received, and to exclude the deduction of this charge from 
sales load, because it is a legitimate expense of the company and not 
for sales and distribution expenses. In addition, Applicants request 
that the order extend the same exemptions granted to Aetna, to any 
Future Broker-Dealer that may in the future serve as principal 
underwriter for the Current Policies or Future Policies.
    2. Section 6(c) authorizes the Commission, by order and upon 
application, to exempt any person, security, or transaction, or class 
of persons, securities, or transactions, from any provisions of the 
1940 Act. The Commission grants relief under Section 6(c) to the extent 
an 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.
    3. The Separate Account is, and the Future Accounts will be, 
regulated under the 1940 Act as issuers of periodic payment plan 
certificates. Accordingly, the Separate Account, the Future Accounts, 
and Aetna are subject to Section 27 of the 1940 Act.
    4. Section 27(c)(2) prohibits the sale of periodic payment plan 
certificates unless the following conditions are met. The proceeds of 
all payments (except amounts deducted for ``sales load'') must be held 
by a trustee or custodian having the qualifications established under 
Section 26(a)(1) for the trustees of unit investment trusts.
    5. ``Sales load'' is defined under Section 2(a)(35), in relevant 
part, as:

    The difference between the price of a security 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.

    Sales loads on periodic payment plan certificates are limited by 
Sections 27(a)(1) and 27(h)(1) to a maximum of 9% of total payments.
    6. Rule 6e-3(T) provides a range of exemptive relief to separate 
accounts issuing flexible premium variable life insurance contracts, as 
defined in subparagraph (c)(1) of that Rule.
    For example, paragraph (b)(13)(iii)(E) of Rule 6e-3(T) provides 
exemptive relief from Section 27(c)(2) by permitting an insurer to make 
certain deductions, other than sales load, including the insurer's tax 
liabilities from receipt of premium payments imposed by states or by 
other governmental entities. Applicants assert that the proposed tax 
burden charge arguably is covered by subparagraph (b)(13)(iii) or Rule 
6e-3(T). Applicants note, however, that the language of paragraph 
(c)(4) of the Rule appears to require that deductions for federal tax 
obligations resulting from receipt of

[[Page 27112]]

premium payments be treated as ``sales load.''
    7. Rule 6e-3(T)(c)(4) defines ``sales load'' during a period as the 
excess of any payments made during that period over certain specified 
charges and adjustments, including a deduction for state premium taxes. 
Under a literal reading of paragraph (c)(4) of the Rule, a deduction 
for an insurer's increased federal tax burden does not fall squarely 
into those itemized charges or deductions, arguably causing the 
proposed tax burden charge to be treated as part of ``sales load.''
    8. Applicants submit 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 probably is an historical accident related to that 
fact that when Rule 6e-3(T) was adopted in 1984, and when it was 
amended in 1987, the additional Code Section 848 tax burden 
attributable to the receipt of premiums did not exist. Applicants 
further submit that nothing in the administrative history of Rule 6e-
3(T) suggests that the exclusion from the definition of sales load of 
deductions for tax liabilities attributable to the amount of premium 
payments received was tied to the type of government entity imposing 
such taxes.
    9. Applicants also request exemptions for any Future Accounts that 
Aetna may establish to support the Current Policies or any Future 
Policies, as well as for each Future Broker-Dealer that may distribute 
the Current Policies or Future Policies.
    10. Applicants assert that the standards of Section 6(c) are 
satisfied because the requested relief is appropriate in the public 
interest and consistent with the purposes of the 1940 Act and the 
protection of investors. The exemptive relief would eliminate the need 
for Aetna to file additional exemptive applications for each Current 
Policy or Future Policy to be issued through a Future Account with 
respect to the same issues under the 1940 Act that have been addressed 
in this application, as well as for each Future Broker-Dealer that 
distributes the Current Policy or Future Policy, and thus would promote 
competitiveness in the variable life insurance market by avoiding 
delay, reducing administrative expenses, and maximizing efficient use 
of resources. Applicants further assert that the exemptive relief would 
enhance Aetna's ability to effectively take advantage of business 
opportunities as they arise. If Aetna were required to seek exemptive 
relief repeatedly with respect to the same 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.
    11. Applicants believe that a charge of 1.25% of premium payments 
would reimburse Aetna for the impact of Section 848 of the Code, as 
currently written on its federal income tax liabilities. Aetna 
believes, however, that it may have to increase this charge if any 
change in, or interpretation of, Section 848 or any successor provision 
results in a further increased federal income tax burden due to the 
receipt of premiums. Such an increase could result from a change in 
corporate federal income tax rate, a change in the 7.7% figure, or a 
change in the amortization period.

Conditions for Relief

    1. Aetna will monitor the reasonableness of the 1.25% charge.
    2. The registration statement for each Policy under which the 1.25% 
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 Aetna's increased federal tax burden under 
Section 848 of the Code.
    3. The registration statement for each Policy providing for the 
1.25% tax burden charge will contain as an exhibit an actuarial opinion 
as to: (a) the reasonableness of the charge in relation to Aetna's 
increased federal tax burden under Section 848 of the Code resulting 
from the receipt of premiums; (b) the reasonableness of the targeted 
rate of return that is used in calculating such charge; and (c) the 
appropriateness of the factors taken into account by Aetna in 
determining such 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, are 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. 96-13544 Field 5-29-96; 8:45 am]
BILLING CODE 8010-01-M