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July 21, 2004 at 08:00 PM
New SEC Requirements Should Prompt Variable Insurer Talks With Underlying Funds
The Securities and Exchange Commission has adopted new requirements for prospectus disclosure of policies and procedures pertaining to frequent transfers of variable product account values. The new requirements make it advisable for variable product issuers to begin discussing this subject promptly with their underlying funds.
As originally proposed, and as ultimately adopted, essentially identical disclosure requirements will apply to each SEC-registered separate account and to each underlying fund. Under the new requirements, the prospectus must disclose whether the separate account or the fund has policies and procedures with respect to frequent transfer activity. If so, considerable detail about those policies and procedures must also be disclosed. The new requirements do not mandate that a separate account or a fund have any such policies and procedures. However, the absence of such policies and procedures must be disclosed, as well as the reasons why none have been adopted.
Commenters on the proposals pointed out certain potential problems. For example, a single underlying fund frequently has many different participating insurers. In such a case, the participating insurers can be expected to differ considerably in the extent to which the terms of their variable contracts and their computer systems permit them to implement whatever frequent transfer policies and procedures an underlying fund might adopt.
For example, if an underlying fund seeks to discourage frequent transfers by imposing a withdrawal charge on redemptions made within a specified number of days following a purchase, it would be necessary for an insurer participating in the fund to administer this restriction and impose the fee at the contract owner level. In many cases, however, the terms of the insurers variable contracts will not permit the insurer to impose such fees on its customers. Similarly, an underlying fund could adopt other types of transfer restrictions that are more severe than permitted under the terms of at least some of the affected variable contracts or that would require costly systems modifications for the insurer to implement.
In theory, such problems could be addressed if a fund adopted different policies and procedures for different insurers, to the extent necessary to accommodate each insurers circumstances. Such an arrangement, however, would result in awkward and voluminous fund disclosure, because the SECs new requirements effectively would require the specifics of the procedures applicable to each insurer to be set forth in the funds prospectus.
Furthermore, an insurer may, for any one variable product, use multiple (often unrelated) underlying funds that might adopt different policies and procedures to address the problem of frequent transfers. The more underlying funds involved, the greater the likelihood that the insurer would be unable to implement at least some of such procedures at the contract owner level. At a minimum, the insurer could be exposed to the cost and “prospectus clutter” associated with administering several different sets of procedures.
An insurer that merely implements at the contract owner level the policies and procedures that the relevant underlying funds have imposed could argue it has not itself adopted any policies and procedures for its separate account. Rather, such an insurer arguably is merely cooperating in the implementation of the policies and procedures of the underlying funds.
The SECs new requirements contemplate that an insurer will refrain from adopting frequent transfer policies and procedures for its separate account only if the insurer, as the separate accounts “depositor,” has concluded that this is appropriate. Deference by an insurer to underlying fund policies and procedures may be appropriate on the grounds that each underlying fund is in the best position to judge what type of transfer activity is or is not in the interest of all the participants in that fund.
Also, an insurer may have reason to believe that most other insurers that participate in a particular fund will simply be implementing that funds policies and procedures. If so, the insurer may consider it contrary to its own contract owners best interest to subject them to any stricter procedures.
If the insurer in these circumstances successfully argues that it has not adopted any policies or procedures concerning frequent transfers, the variable contract prospectus could perhaps simply refer to the relevant fund prospectuses for the details of the frequent transfer policies and procedures that would apply. This would at least result in somewhat manageable and non-duplicative prospectus disclosure.
