SEC Breaks Ground In Adopting New VL Registration Form N-6

The Securities and Exchange Commission has adopted Form N-6, the long-awaited registration form designed specifically for variable life insurance policies.

VL insurers may generally convert to the new form after June 1, 2002.

As you will see, adoption of N-6 has important implications for VL insurers, producers and consumers.

The new form uses the two-part disclosure format currently enjoyed by mutual funds and variable annuity contracts.

This format will allow insurers to shorten their prospectuses significantly–by moving financial statements and other detailed legal and financial information from the prospectus to a Statement of Additional Information. The SAI is delivered only to investors requesting it.

The shorter prospectuses should significantly reduce insurers printing and mailing costs. In addition, by permitting more concise prospectuses, Form N-6 should help producers and investors increase their overall level of understanding of VL insurance.

Furthermore, lower development and administration costs, together with potentially higher sales, may ultimately increase insurers return on investment in the VL market, and spur increased product development, too.

Even though it will facilitate use of shorter prospectuses, Form N-6 does expand the amount of disclosure required in VL prospectuses about policy fees and charges. For instance, every prospectus will now be required to include a “fee table” specifying the maximum amount of every policy charge, including charges for every available rider.

For any charge that varies depending on individual policyowner characteristics (such as age or risk rating classification), the fee table must show the minimum and maximum charge as well as the actual amount that would be paid by a “representative policyowner.”

The requirement to show charges that a hypothetical policyowner would pay represents, to some degree, an uneasy compromise between competing disclosure theories.

The SEC has historically struggled with whether to permit hypothetical information in prospectuses. Apparently, however, it has concluded that for VL, the benefit of providing investors with a way to compare fees and charges of different policies outweighs the risk that prospectus-disclosed charges may differ significantly from the actual charges a purchaser will pay.

The SECs concern about this risk was evident, however, from oral debate during the April 11, 2002 meeting at which Form N-6 was adopted. To address the concerns, the SEC voted to require the disclosure of minimum and maximum charges in addition to the specific charge a “representative policyowner” would pay, with the goal of alerting investors to the fact that actual policy charges may vary widely.

This “representative policyowner” charge disclosure requirement raises a number of interpretive questions.

For one, cost of insurance charges under some VL policies depend not only on policyowner characteristics such as age and rating classification, but also upon policy duration and face amount banding. There is limited guidance in the form on how to determine what “representative policyowner” to use in disclosing charges, and none on how to determine additional assumptions such as duration or banding.

New types of prospectus disclosure, expanded marketing materials, and additional producer training may be necessary to ensure consumers understand the limitations of the new fee tables.

Consider an investor comparing the COI charge shown in the fee table for a joint and survivor VL to the charge shown in the fee table for an individual VL. The COI for a joint and survivor VL will generally be significantly lower than that for an individual VL, but a joint and survivor VL is obviously unsuitable for the investordespite its lower cost–if the VLs purpose is to provide financial support to the investors family in event of his or her death.

The aspect of the fee table that will most significantly lengthen some prospectuses is the requirement to disclose charges for all optional riders available under the VL. This new requirement will pose challenges to companies in determining how to disclose specific charges, and the lengthy and detailed disclosure that in some cases will result may actually tend to obscure the charges of the base policy.

The SEC significantly revised existing industry disclosure practices in other areas, as well.

For example, Form N-6 appears generally to require the use of “gross” fund expenses before reimbursements in hypothetical illustrations appearing in the prospectus. This requirement may discourage the introduction of new insurance product funds, which typically rely on expense reimbursement arrangements to reduce what otherwise would be relatively high expenses during the first several years of their operation.

Without the ability to reflect the positive effect of fund expense reimbursement arrangements in hypothetical prospectus illustrations, insurers may choose to use only established funds to avoid what could be a significant negative effect on the illustrations.

The industry will need to begin an immediate and critical evaluation of Form N-6 to identify the interpretive issues it raises and to begin to formulate disclosure that will satisfy the forms new requirements.

As these issues are identified and companies begin the process of converting to the new disclosure format, a continuing dialogue with the SEC staff will, in all likelihood, be necessary to ensure that Form N-6s goal of providing user-friendly disclosure is in fact achieved.

Steven E. Roth and W. Thomas Conner are partners in the Washington, DC office of the Sutherland Asbill & Brennan LLP law firm. Their e-mail addresses are sroth@sablaw.com and tconner@sablaw.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, April 22, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.