Legal Alert: SEC proposes new variable contract disclosure regime

Transcription

1 Legal Alert: SEC proposes new variable contract disclosure regime November 6, 2018 The US Securities and Exchange Commission (SEC or Commission) recently proposed a new disclosure framework for SEC-registered variable annuity contracts and variable life insurance policies (together, variable contracts) that reflects almost a decade of major insurance industry (and SEC staff) effort to develop a more modern and effective regime for variable contract prospectus disclosure. Among other things, proposed Rule 498A would permit (but not require) the use of summary prospectuses for variable contracts, with additional information available to investors online. To help investors make informed investment decisions, the proposal (the SEC proposing release) uses a layered disclosure approach similar to what has been in place for mutual funds. It is designed to provide investors with key information relating to the contract s terms, benefits and risks in a concise and more reader-friendly presentation, with access to more detailed information available online, or delivered in paper or electronic format on request. The proposing release notes that variable contracts are complex products, whose operation and terminology can be difficult for investors to understand, and the contract prospectuses are often quite lengthy. Moreover, currently the contract prospectuses are typically bundled with, or accompanied by, prospectuses for all of the available underlying funds (averaging 59 for variable annuities, 64 for variable life insurance, and some offering more than 250) and that all of these prospectuses are delivered to investors not only at the time of purchase but also annually thereafter. The Commission expressed its concern that the volume, format and content of these current disclosures may make it difficult for investors to find and understand key information that they need in order to make an informed investment decision. The summary prospectus and related proposals address these concerns. In addition to the optional summary prospectus, the SEC, to its credit, has taken this opportunity to review and examine many, if not most, of its various disclosure requirements and 1940 Act rules and regulations applicable to variable contracts. The SEC is proposing numerous updates and revisions (including required statutory prospectus revisions) and is inviting comment on a wide range of these matters. Overall, the proposals are the most significant advancement in variable contract disclosure since the adoption of registration statement forms specifically designed for variable contracts. The proposals (and accompanying requests for comment) are also an opportunity to further modernize a disclosure regime that has clearly become outmoded, costly, and, perhaps most importantly, ineffective. At the same time, in some ways the proposals may present some challenges for the industry to implement cost-effectively from a resource perspective. I. Executive Summary Because variable contracts typically include a number of optional benefits and numerous underlying investment options, a summary prospectus could not, by its very nature, include all relevant aspects and details regarding each of these contract features. The variable contract summary prospectus is designed to be a succinct summary of the contract s key benefits, terms and expenses, and most significant risks. This summary prospectus would serve as the cornerstone of a new layered disclosure framework that would alert investors to the availability of more detailed information in the statutory prospectus and in other locations. 1

2 The proposed new disclosure framework would include the following elements (each discussed in more detail below): Option to use summary prospectuses. Proposed new Rule 498A would permit the use of two distinct types of variable contract summary prospectuses: (1) an initial summary prospectus for new sales; and (2) an updating summary prospectus for in-force business (i.e., for annual updates to existing contract owners). Both would include certain specified (required) information in plain English in a prescribed order with standardized headings. The updating summary prospectus would include a brief description of certain changes to the contract that occurred during the previous year, as well as a subset of the information required to be in the initial summary prospectus. Availability of variable contract statutory prospectus and other materials. The proposed rule would require the variable contract statutory (i.e., section 10(a)) prospectus, as well as the contract s statement of additional information (SAI) (and summary prospectus), to be publicly accessible, free of charge, at a website address specified on, or hyperlinked in, the cover of the summary prospectus. An investor who receives a contract summary prospectus would be able to request the contract statutory prospectus and SAI in paper or electronically, at no cost to the investor. Optional access equals delivery method to satisfy portfolio company prospectus delivery requirements. The Commission is proposing a groundbreaking optional method for satisfying underlying mutual fund prospectus delivery obligations. This optional delivery method would make portfolio company summary and statutory prospectuses available online at the website address specified on or hyperlinked in the variable contract summary prospectus, which itself would contain certain key information about the portfolio companies in tabular format. Investors would also be able to request and receive those portfolio company prospectuses on paper or electronically at no cost. This new option for satisfying portfolio company prospectus delivery requirements would only be available for variable contracts that use contract summary prospectuses pursuant to Rule 498A. Great-Wested contracts. The Commission intends to grandfather discontinued contracts that are currently relying (as of the effective date of the final summary prospectus rules) on the Great-West line of no-action letters (permitting them to continue the practice of not filing annual updates to their registration statements), but not allow new reliance for contracts that are not Great-Wested as of the effective date. It also is soliciting comment on alternative approaches to providing disclosure for discontinued contracts. Statutory prospectus and registration statement form amendments. The Commission is also proposing amendments to variable contract registration statement forms (Forms N-3, N-4 and N-6), including substantial statutory prospectus revisions. The proposed statutory prospectus and form amendments would reflect the summary prospectus disclosure requirements (but would apply even if the summary prospectus is not used) as well as other revisions and updates, and are intended to consolidate certain summary information in a condensed presentation, reflect industry developments (e.g., the prevalence of optional benefits in today s variable contracts), and otherwise improve disclosures provided to variable contract investors. Registrants would be required to use the Inline XBRL format for the submission of certain variable contract information. Other rule amendments. As noted above, the SEC is proposing certain rule revisions, rescissions, and technical and conforming amendments to reflect the proposed new variable contract disclosure regime, as well as to reflect statutory revisions and other developments that have occurred over the past 20-plus years. Comments on the proposal are due by February 15, The proposal also includes an 18-month transition period, during which companies would be permitted, but not required, to comply with (rely on) the new disclosure provisions. II. Summary Prospectus Proposals The SEC s proposed new disclosure framework reflects the Commission s consideration of multiple inputs, including the operational complexity and unfamiliar terminology often associated with variable contracts; the length of contract prospectuses; the number of contract iterations covered by a single prospectus; the general availability of a wide range of investment options; the proliferation of guaranteed contract benefits; and the practice of bundling the underlying fund prospectuses with the variable contract prospectus. The sheer volume and complexity of disclosures investors now must wade through demonstrate that the current variable contract disclosure regime is clearly ineffective in enabling investors to find and understand the key information they need to make an informed investment decision. Through the proposal, the SEC seeks to improve this disclosure framework, as well as modernize the manner in which variable contract investors receive and review prospectuses. With this backdrop in mind, the proposal introduces two types of permissive variable contract summary prospectuses, together the Summary Prospectuses : An Initial Summary Prospectus for new investors An Updating Summary Prospectus for existing contract owners 2

3 Permitting the use of summary prospectuses for variable contracts reflects the SEC s commitment to ensuring that investors have access to a well-crafted package of information that facilitates informed decision making and to building on its successful experience with Rule 498, the mutual fund summary prospectus rule, which served as a catalyst for the insurance industry s long-standing advocacy for a parallel disclosure regime for variable contracts. Like the mutual fund summary prospectus, proposed Rule 498A would rely on a layered disclosure approach, which is designed to provide investors with key information relating to the variable contract s terms, benefits and risks in both a concise and more reader-friendly presentation, with Summary Prospectuses serving as the cornerstone of this layered disclosure framework. Like the mutual fund layered disclosure regime, the Summary Prospectuses would alert investors to the availability of more detailed information in the statutory prospectus and would incorporate that prospectus and SAI by reference. Such statutory prospectuses would be delivered upon demand, either electronically or in paper format, free of charge. A. Initial Summary Prospectus First and foremost, an Initial Summary Prospectus would be a point of sale document that is used solely with new purchasers. In addition, while the general industry practice has been to combine multiple and/or iterative contract offerings reflecting product design updates into a single registration statement and/or prospectus, the Initial Summary Prospectus would only be permitted to describe the features of a single, currently available contract (commonly referred to as a new business contract). The Initial Summary Prospectus can, however, encompass multiple classes of that single contract. A hypothetical Initial Summary Prospectus is included with the SEC release. In an Initial Summary Prospectus, proposed Rule 498A would require the following disclosure sections in this prescribed order: (i) a cover page; (ii) contract overview; (iii) important considerations; (iv) standard death benefit; (v) other benefits; (vi) buying the contracts; (vii) lapse information (for variable life); (viii) surrenders and withdrawals; (ix) additional information about fees; and (x) an appendix containing specified underlying mutual fund information. In addition, the meaning of any special terms are required to be clearly conveyed, either in a glossary or on an as used basis. Each section has a specified list of disclosure items that must be included. Several sections are required to be presented in a tabular format. There are various required legends in each section, presented either as lead-ins to certain information or as a simple stand-alone disclosure. In the same or varying format, all required sections are also required to be repeated in the statutory prospectus. A version of the important considerations section, which is comprised of a Key Information Table, and the fund appendix are also required in the Updating Summary Prospectus. Initial Observations: The proposal addresses the explosive growth of guaranteed benefits by requiring extensive tailored disclosure regarding such benefits. There are two fee presentations in the Initial Summary, one of which would be replicated in its entirety in the statutory prospectus All fund expenses, as well as performance, would be required in all prospectuses initial, updating and statutory. B. Updating Summary Prospectus Proposed Rule 498A would permit insurers to satisfy contract prospectus delivery obligations for existing contract owners by sending an annual Updating Summary Prospectus in lieu of the corresponding statutory prospectus. The Updating Summary Prospectus is built off of the Initial Summary Prospectus, and would include the same Key Information Table and mutual fund appendix. A hypothetical Updating Summary Prospectus is included with the SEC release. Unlike the Initial Summary Prospectus, the Updating Summary Prospectus can cover multiple contracts. The audience is not new investors, but rather existing contract owners (investors who have already made an initial purchase decision). In effect, rather than sending variable contract owners a 100-plus page variable contract prospectus each year, which typically contains very few year-over-year changes, but nevertheless obscures even important changes, Rule 498A would allow insurers to send the short Updating Summary Prospectus highlighting important changes and other information. As proposed, the Updating Summary is designed to focus contract owners attention on new or updated information, as well as remind them of the key features of their variable contracts. The SEC premised this disclosure approach, in part, on its belief that highlighting important changes - certain types of changes that would be prescribed - will provide the key information investors need in considering whether to continue making additional purchase payments and/or to reallocate contract value (or even whether to continue or surrender their contracts). 3

4 Specifically, Rule 498A would require the following content items be presented in this order in an Updating Summary Prospectus: (i) a cover page; (ii) updated information about the contract (see below); (iii) important information to consider; and (iv) an appendix containing specified underlying fund information. Updated information relating to the following changes would be required in the Summary Updating Prospectus: (i) the availability of portfolio companies; (ii) the statutory prospectus disclosure relating to the Fee Table; (iii) the standard death benefit; and (iv) the other benefits available under the contract. The Updating Summary Prospectus could also include a concise description of any other changes to the contract that the registrant wishes to disclose, provided they occurred within the same time period. The proposing release indicates that the description of each change should be such that it provides enough detail to allow contract owners to understand the change and how it will affect them. The proposing release provides the following examples: (i) stating that a fee has changed from 1.5% to 1.7%, rather than only stating that the fee has changed or increased; or (ii) specifically identifying each optional benefit that has changed (with a brief explanation of how), rather than generically stating that certain optional benefits are new or no longer available. Like the Initial Summary Prospectus, there are various required legends, either as lead-ins to information or simple stand-alone disclosures. Initial Observation: A Key Information Table would have to be created for contracts that are no longer sold in both the Updating Summary Prospectus, as well as the statutory prospectus. This will need to be done even if insurers do not use Updating Summary Prospectuses. C. Key Information Table The so-called Important Considerations section required in both the Initial and Updating Prospectus Summaries, which is comprised of a Key Information Table, may well be the lynchpin of Rule 498A. The Key Information Table would cover the following information: (1) fees and expenses; (2) risks; (3) restrictions; (4) taxes; and (5) conflicts of interest. It would summarize the variable contract s key elements, and it is by far the most comprehensive content requirement of each summary (going beyond what the industry recommended). The Key Information Table would include a two-column tabular presentation for each of five specified headings. The left column would list the specified disclosure items to be included under each heading, and the right column would provide a brief description for each corresponding item, per respective instructions for each. The Fees and Expenses portion of the table would include the following disclosure items: (i) surrender charges; (ii) transaction charges; and (iii) ongoing fees and expenses. The Risks portion of the table would include succinct descriptions of risks: (i) risk of loss; (ii) risks that could occur if an investor believes a variable annuity is a short-term investment; (iii) risks associated with the contract s investment options; and (iv) insurance company risks. The Restrictions section of the table would require registrants to briefly disclose the existence of restrictions and/or limitations related to two specified features: (i) investment options; and (ii) optional benefits. The Taxes portion of the table would require several (familiar) disclosure statements relative to the tax consequences and implications of investing in a variable contract. The Conflicts of Interest section would require two disclosure items: (i) investment professional compensation; and (ii) possible incentives to offer replacement contracts. D. Benefit Table The proposal includes a benefit table, to be included in the Initial Summary Prospectus that summarizes all available benefits presented in tabular format that includes the benefit name, purpose, whether it is standard or optional, and if it requires an additional fee. In the Initial Summary Prospectus, the table would cover the benefits available under the contract with no additional narrative disclosure. A benefit table along with additional narrative disclosure would be required in the statutory prospectus (see below). E. The Appendix: Portfolio Company (Underlying Fund) Information The other particularly notable feature of both contract Summary Prospectuses is the required appendix setting forth underlying fund information. The Portfolio Company appendix, required in both the Initial and Updating Summary Prospectuses, must be a table summarizing portfolio companies available under the contract, as follows: in a separate column for each portfolio company, the portfolio s type (e.g., money market fund, bond fund, balanced fund, etc.) or investment objective; the name of the portfolio company and its adviser or sub-adviser (as applicable); the portfolio company s expense ratio; and its average annual total returns over the past one-year, five-year and 10-year periods. 4

5 The table may only include portfolio companies that are currently offered under the contract. If the availability of one or more portfolio companies varies by benefit offered under the contract, insurers would be required to include another appendix with a separate table indicating which portfolio companies are available under each such benefit. This same summary table(s) of portfolio companies would be required in the statutory prospectus, irrespective of whether a Summary Prospectus is used. The Commission s proposal to include this appendix reflects the option to satisfy portfolio company prospectus delivery requirements through website access (discussed below). Compiling and updating this detailed information each year for dozens of portfolio companies could be a formidable undertaking for insurers. F. Summary Prospectus Use Conditions and Requirements There would be several conditions and requirements applicable to the use of Initial and Updating Summary Prospectuses. Proposed Rule 498A would require that: The Summary Prospectus must be sent or given to an investor no later than the time of the carrying or delivery of the contract security. The Summary Prospectus could not be bound together with any other materials, except that portfolio company summary and statutory prospectuses could be bound together with the contract Summary Prospectus, subject to certain conditions. The Summary Prospectus also would be required to meet the proposed rule s content requirements. The Initial Summary Prospectus, Updating Summary Prospectus, contract statutory prospectus and contract SAI must be publicly accessible, free of charge, on a website in the manner that the proposed rule specifies. Failure to comply with any of these requirements would prevent a person from relying upon the proposed rule to meet its section 5(b)(2) prospectus delivery obligations. Absent satisfaction of the section 5(b)(2) obligation by other available means, a section 5(b)(2) violation would result. Proposed Rule 498A contains a number of additional requirements, including: A registrant (or financial intermediary distributing the contract) must send a paper or electronic copy of the required online contract documents to any person requesting such a copy, within three business days after receiving the request. A contract Summary Prospectus must be given greater prominence than any other materials that accompany the Summary Prospectus. The greater prominence requirement would be satisfied if the placement of the contract Summary Prospectus makes it more conspicuous than any accompanying materials (e.g., the summary prospectus is on top of a group of papers that are provided together, or listed first if presented on a website together with other materials related to the contract). Any website address or cross-reference that is included in an electronic version of the Summary Prospectus (i.e., electronic versions sent to investors or available online) must be an active hyperlink. This is intended to ensure that investors viewing electronic versions of the prospectus are able to easily access website addresses and cross-referenced materials that are referenced in the prospectus. III. New Online Option to Satisfy Underlying Fund Prospectus Delivery Requirements Rule 498A would permit an optional method for satisfying mutual underlying fund ( portfolio company ) prospectus delivery obligations by making fund summary and statutory prospectuses available online. As proposed, online delivery of fund prospectuses would be available, if: (1) an Initial Summary Prospectus is used for each currently offered variable contract under a registration statement; (2) the fund uses a Summary Prospectus (only if the fund is registered on Form N-1A); and (3) the fund s current Summary Prospectus, statutory prospectus, SAI and most recent shareholder reports are posted online in accordance with certain specified conditions. The online delivery option would be available for variable annuity contracts and variable life insurance policies registered on Form N-4 and N-6 registration statements, respectively. It generally would not be available for contracts no longer being offered, including Great-Wested contracts. The additional specified conditions that must be met to use the online delivery option include that: (1) the variable contract summary prospectus must disclose a website address where investors can access the fund documents; (2) the fund documents must be publicly accessible, free of charge, on the website in a manner specified in proposed Rule 498A; and (3) copies of requested fund documents must be sent on paper or electronically within three business days after receipt of an investor s request. Under proposed Rule 498A, any communication related to an underlying fund, other than a prospectus permitted or required under section 10 of the Securities Act, would not be deemed a prospectus if the above conditions are satisfied. 5

6 In proposing the online delivery option for satisfying underlying fund prospectus delivery obligations, the SEC appears to have been motivated, in large part, by a concern that investors receiving the variable contract Summary Prospectus along with hundreds of pages of underlying fund prospectuses would not read or understand the information in the Summary Prospectus. The SEC also appears to view the proposed appendix to the variable contract Summary Prospectus (that would provide key summary information about underlying funds available under the contract), the availability of fund prospectuses and other fund documents online, and the ability of investors to obtain paper or electronic copies of the documents upon request, as safeguards that would ensure investors can obtain more detailed information about funds. It is noteworthy that in the proposing release the SEC also acknowledges the significant role agents have played in providing information about underlying funds to investors and anticipates that agents would play a significant role in assisting investors in understanding key factors about funds, obtaining fund prospectuses and understanding the proposed fund prospectus delivery framework. The proposed online delivery option for satisfying underlying fund prospectus delivery obligations represents the furthest step to date by the SEC in adopting an access equals delivery model for prospectus delivery and a significant opportunity for insurers and underlying funds to embrace a disclosure regime that on its face appears more rational and tailored for individual investors. If the conditions for use of the proposed online delivery option are met, insurers would no longer have to bind fund prospectuses to variable contract prospectuses and/or provide them upon initial allocation to an underlying fund and/or send them on an annual basis and/or upon fund supplement or amendment. IV. Proposed Amendments to Variable Contract Statutory Prospectuses and Registration Forms A. Overview Along with its historic summary prospectus proposal, the SEC is proposing major changes to the statutory prospectuses and SAIs for variable annuity contracts and variable life insurance policies. If adopted, the proposed amendments to SEC registration Forms N-3, N-4 and N-6 would significantly alter the format and content of statutory prospectus disclosure that insurers must provide for variable contracts regardless of whether the insurer chooses to utilize the option to offer variable contracts via an Initial Summary Prospectus. Some of the proposed statutory prospectus and form amendments are intended to complement the proposed summary prospectus framework while others are intended to update and enhance current disclosure requirements as well as require new disclosure to further assist investors in making informed investment decisions regarding variable contracts. A number of the proposed amendments are aimed at providing greater consistency among the registration forms for variable contracts with the SEC relying on Form N-6, its newest variable contract form, as a model for many of the proposed amendments to Forms N-3 and N-4. B. Variable Annuity Registration Statements (Forms N-3 and N-4) Several of the key proposed amendments to Forms N-3 and N-4 are presented below, focusing primarily on the amendments to the Form N-4 statutory prospectus. Migration of Information from the Prospectus to the SAI Accumulation Unit Value Disclosure. For Forms N-3 and N-4, the proposed amendments would relocate the Accumulation Unit Value (AUV) tables from the prospectus to the SAI. To further reduce burdens on insurers, the SEC is proposing to decrease the time periods for which the required information must be presented from 10 years to five years. Notably, the SEC also proposes to include an instruction that would permit insurers to omit AUV tables altogether if they provide each contract owner with an annual account statement that discloses, with respect to each class of accumulation units the contract owner holds, the actual performance of the subaccount during the prior fiscal year. Separate Account, Insurer Depositor and Fund Information. In an effort to more closely align Form N-3 and N-4 requirements with Form N-6, the SEC is proposing amendments to Item 5 of Forms N-3 and N-4 that would allow insurers to relocate information from the prospectus to the SAI about (1) the insurer depositor, including the description of its business, date and form of organization and state of organization, and information about control persons; and (2) the registrant separate account, such as date and form of organization and classification under the 1940 Act. To further consistency with Form N-6, Forms N-3 and N-4 would also be amended to relocate information regarding persons who provide significant administrative or business affairs management services, from the prospectus to the SAI. New Statutory Prospectus Disclosure Requirements Below are some of the new information requirements for variable annuity Form N-3 and Form N-4 statutory prospectuses that the SEC is proposing. As noted earlier, several of the proposed item requirements would also apply to Initial Summary Prospectuses, and in two cases to Updating Summary Prospectuses. 6

7 Overview of the Contract New Item 2. New Item 2 to Forms N-3 and N-4 (as well as Form N-6) would require insurers to include certain basic and introductory information about the variable contract and the benefits of the contract in the statutory prospectus. These disclosures would also be required in Initial Summary Prospectuses. Key Information Table New Item 3. Consistent with the Initial Summary Prospectus and the Updating Summary Prospectus, the SEC is proposing to require statutory prospectuses to include a Key Information Table which would provide a brief description of the key facts about the variable contract. Unlike the Key Information Table in the Initial Summary Prospectus, the Key Information Table in the statutory prospectus and the Updating Summary Prospectus could describe multiple contracts assuming the conditions of new proposed General Instruction C.3 are met. (See below.) Principal Risks of Investing in the Contract New Item 5. Proposed new Item 5 to Forms N-3 and N-4 would require a summary of the principal risks of purchasing a variable annuity contract. New Item 5 generally mirrors current Item 2(b) of Form N-6 and would follow the Key Information Table and Fee Table. Other Benefits Available Under the Contract New Item 12 of Form N-3 and New Item 11 of Form N-4 (and Form N-6). Recognizing that optional benefits and standard living benefits have become significant features of most variable contracts, but that prospectus disclosure about the features has varied in content and presentation because there has been no specific registration form disclosure requirement relating to these benefits, the SEC is proposing these new items. It would require discussion of any standard living benefits, as well as all optional benefits (e.g., death benefit, accumulation benefit, withdrawal benefit, long-term care benefit, etc.) available under the variable contract. The new items require a tabular summary overview of each benefit available under the variable contract, other than the standard death benefit. Although the tabular summary would be required in both the Initial Summary Prospectus and the statutory prospectus, the statutory prospectus would also be required to include narrative disclosures providing more detailed information about each benefit than would appear in the tabular summary. Appendix: Portfolio Companies/Investment Options Available Under the Contract New Item 19 to Form N-3 and New Item 18 to Form N-4 (and Form N-6). These proposed new items require adding an appendix to the statutory prospectus (as well as the Initial Summary and Updating Summary Prospectuses) that includes a table summarizing information about the funds available under the variable contract. The table would identify the investment adviser for the fund and any sub-advisers and the fund s expense ratio as well as provide average annual total return information. If the availability of funds vary based on the guaranteed benefit offered under the variable contract, a separate appendix with a table that identifies the funds available under the guaranteed benefit would be required. Updates to Fee Table and Examples Fee Table. Proposed amendments to the Fee Table would create new line items that are intended to simplify and update current fee and expense disclosure requirements. Examples. Proposed changes to the examples and related instructions are meant to ensure that the most expensive combination of variable contract features will be shown in an example which appears before any other examples that reflect less expensive combinations of variable contract features. Other changes include a revised legend to reflect revised Fee Table headings, a reference noting optional benefits are included in the Example s assumptions, an increase in the value of the assumed investment to $100,000, and revised instructions to the Examples to clarify that an example for each class of variable contract must be provided. Multiple Contracts New General Instruction C.3 would impose requirements for the preparation of registration statements, including instructions relating to their organization and presentation. It also provides new guidance addressing when an insurer may describe multiple contracts or contract iterations in a single prospectus. In determining whether multiple contracts can be included in a single prospectus, the proposed guidance directs insurers to consider whether the variable contracts at issue are essentially identical using a facts and circumstances analysis. The proposed guidance provides examples bearing on the question, but as the SEC notes in the proposing release, the proposed guidance is intended to be consistent with established industry practices. C. Inline XBRL When the requirement to use XBRL (extensible Business Reporting Language) was first proposed and implemented for financial statements in registration statements almost 10 years ago, variable contract registration statements were exempted. Now, however, the Commission is proposing to require the use of the Inline XBRL format for the submission of certain required disclosures in the variable contract statutory prospectus, in order to allow investors (directly and through their investment professionals), data aggregators, financial analysts, Commission staff and other data users to efficiently analyze and compare the available information about variable contracts. Information structured using the Inline XBRL format is both human-readable and machine-readable for purposes of validation, aggregation and analysis. Inline XBRL is a specification of the XBRL format 7

8 that allows filers to embed XBRL data directly into an HTML document, eliminating any need to submit a copy of the tagged information in a machine-readable document separate from the human-readable document. (In June 2018, the Commission amended its rules to require operating companies, mutual funds and exchange-traded funds (ETFs) to submit the required information in Inline XBRL). Filings to be tagged. Like mutual funds and ETFs, variable contract registrants would be required to submit to the Commission in Inline XBRL certain information in registration statements or post-effective amendments, and definitive forms of prospectuses filed pursuant to Rule 497(c) or Rule 497(e) under the Securities Act that include information that varies from the registration statement. Information to be tagged. The proposal would require that in the statutory prospectus, registrants tag the following prospectus disclosure items using Inline XBRL: (a) the Key Information Table, (b) Fee Table, (c) Principal Risks of Investing in the Contract, (d) Other Benefits Available Under the Contract, and (e) Investment Options Available Under the Contract. The proposing release explains that these items - which provide important information about a variable contract s key features, costs and risks - would be most suited to being tagged in a structured format and be of greatest utility for investors and other data users that seek structured data to analyze and compare variable contracts. Submission of Interactive Data File. In a framework similar to that for mutual funds and ETFs under the recently adopted Inline XBRL regime, the proposal would require variable contract registrants to submit Interactive Data Files (Regulation S-T defines the term Interactive Data File to mean the machine-readable computer code that presents information in XBRL electronic format pursuant to Rule 405 of Regulation S-T and as specified by the EDGAR Filer Manual). Consequence of failure to submit required Interactive Data File. Similar to the framework for mutual funds and ETFs, the Commission is proposing to amend Rule 485 under the Securities Act to provide that if a registrant does not submit a required Interactive Data File, the registrant s ability to file post-effective amendments to its registration statement under subparagraph (b) of the rule will be automatically suspended until the required Interactive Data File is submitted. V. Variable Life Insurance Disclosure Proposals The same proposed framework and SEC rule requirements that would govern the use of Initial Summary Prospectuses and Updating Summary Prospectuses for variable annuity contracts would also govern the use of Initial Summary Prospectuses and Updating Summary Prospectuses for variable life insurance policies registered on Form N-6. The proposed disclosure requirements for Initial Summary Prospectuses for variable life insurance closely track the proposed requirements for variable annuity contracts with only variations that reflect the fundamental differences in how the contracts function and the risks they present. For example, in the Overview section of the Initial Summary Prospectus for variable annuity contracts, insurers would disclose information about the accumulation and annuitization phases of the contract; for variable life insurance contracts, insurers would disclose information about whether premiums may vary in timing and amount, and any restrictions imposed on payments, and provide a statement that non-payment or insufficient payment of premiums may result in lapse. Under a section applicable only to variable life insurance entitled How Your Contract Can Lapse, insurers would be required to briefly address when and under what circumstances a variable life policy may lapse, any lapse options, the effect of lapse and the circumstances under which a policy could be reinstated. Because Form N-6 served as a model for many of the proposed amendments to Forms N-3 and N-4, the proposed amendments include fewer changes to Form N-6 than the other registration forms. Like Forms N-3 and N-4, however, new disclosure requirements have been proposed for Form N-6 to complement the summary prospectus framework, such as new Overview of the Contract, Key Information, and Other Benefits Available Under the Contract sections. Other proposed changes to Form N-6 include consolidating disclosure related to loans in the prospectus, and relocating disclosure on commissions paid to dealers from the SAI to the prospectus. VI. Treatment of Great-Wested Variable Contracts Based on the Great-West line of no-action letters, which date back to 1977, many insurance companies have stopped maintaining registration statements and delivering updated prospectuses for variable contracts that are no longer for sale and have relatively few contract owners (typically fewer than 5,000 contract owners, with certain no-action letters permitting substantially more). The proposing release notes that more than half of variable contract Securities Act registration statements rely on Great-West out of 1,576, based on the SEC s study of EDGAR filings combined annuity and life. In order for an insurance company to Great-West a variable contract, which the SEC refers to as an Alternative Disclosure Contract, the Great-West no-action letters require an insurance company to comply with various conditions, such as continued delivery of fund prospectuses, shareholder reports and proxies; continued delivery of confirmations; annual delivery of certain financial statements; and the continued filing of separate account annual reports with the SEC. In addition, an 8

9 insurance company may rely on the Great-West no-action letters only for as long as there are no material changes to the variable contract, although insurance companies have re-great-wested variable contracts immediately after filing posteffective amendments or new registration statements to make material changes. A. SEC Proposal As part of the proposing release, the SEC proposes to adopt a formal position going forward that no insurance company will be permitted to operate in accordance with the Great-West no-action letters, with a grandfather exception that an insurance company may continue to do so with respect to any variable contract that is Great-Wested as of the effective date of the final summary prospectus rules. As a result of the (limited) grandfathering, the SEC s proposed position would significantly limit the applicability of the Great-West no-action letters, and would also change their legal status from informal SEC staff enforcement positions to SEC agency statements. Based on certain statements made by the SEC in the proposing release, the SEC s proposed position may generally mean that if an insurance company files a post-effective amendment to the registration statement for a grandfathered Great-Wested variable contract or a new registration statement (such as in the context of an insurance company merger or a reinsurance transaction), the variable contract could not be re-great-wested by the insurance company responsible for maintaining the registration statement, and such insurance company would instead be required to file post-effective amendments, deliver updated prospectuses, and otherwise comply with the regulatory framework applicable to non-great-wested variable contracts, despite the fact that the variable contract will still no longer be for sale and will have presumably even fewer contract owners than when it was originally Great-Wested. B. Alternative Approaches In the proposing release, the SEC stated that it is considering two alternative approaches in lieu of the proposed position outlined above, referred to as Approach 1 and Approach 2. Both approaches would provide substantially similar relief as the Great-West no-action letters with respect to annually updating registration statements and delivering updated prospectuses, although the conditions of the relief would be similar and different in several ways. The parameters of Approach 1 and Approach 2 are summarized below. As contemplated by the SEC, under either approach, a variable contract would qualify to be treated as an Alternative Disclosure Contract if (i) it is no longer offered to new purchasers; (ii) there are fewer than 5,000 contract owners; and (iii) there have been no material changes to the contract since the last updated registration statement. While these requirements generally resemble the corresponding requirements of the Great-West no-action letters, the codification of the 5,000 contract owner threshold would represent a departure from the no-action letters with higher thresholds upon which several insurance companies currently rely. As reflected below, the other parameters of Approach 1 and Approach 2 are based largely on the framework established by the Great-West no-action letters, infuse certain aspects of the SEC s proposed summary prospectus rules, and introduce certain novel changes. It appears that either alternative approach could simultaneously facilitate and potentially complicate the administration of Great-Wested variable contracts by insurance companies. Approach 1 Under Approach 1, as being considered by the SEC, the Alternative Disclosure Contract rules would: 1. Require an annual notice including information comparable to an Updating Summary Prospectus, such as (i) the Key Information Table; (ii) a brief description of any material changes to the offering relating to fees, the standard death benefits, other benefits available under the contract, and [funds] available under the contract ; (iii) a table including information about the funds under the contract; and (iv) various legends to be delivered to contract owners and posted on the insurance company s website; 2. Require the financial statements required by the Great-West no-action letters to be filed with the SEC, posted on the insurance company s website, and delivered to contract owners upon request; 3. Require fund shareholder reports and proxy materials to be delivered to contract owners as required by applicable law; and 4. Permit insurance companies to rely on proposed Rule 498A for the purpose of satisfying their delivery obligations with respect to fund prospectuses. The hallmark of Approach 1 is that it follows the general framework of the Great-West no-action letters, except that it (i) eases an insurance company s physical delivery requirements related to financial statements and fund prospectuses and (ii) burdens an insurance company with the obligation to prepare and deliver the annual notice, which is akin to the Updating Summary Prospectus. In addition, the disclosure liabilities to which insurance companies are exposed under the federal securities laws are generally the same under Approach 1 as under the Great-West no-action letters. 9

10 Approach 2 Under Approach 2, as being considered by the SEC, the Alternative Disclosure Contract rules would follow Approach 1 with the following exceptions: 1. Approach 2 would require that the statutory prospectus and SAI be made available online and be delivered to contract owners upon request, similar to proposed Rule 498A. 2. Approach 2 would require the filing of the insurance company s and the separate account s financial statements with the SEC, permitting the registration statement to incorporate the financial statements by reference on a forward-looking basis. Like Approach 1, the financial statements would also have to be posted on the insurance company s website and be delivered to contract owners upon request. The hallmark of Approach 2 is that it generally follows Approach 1, except that Approach 2 also burdens an insurance company with the obligation to post the statutory prospectus and SAI on its website. In addition, due to the forward incorporation by reference of the financial statements into the registration statement, Approach 2 technically involves the maintenance of a current registration statement. While this should not impose any additional operational burdens on an insurance company, Approach 2 is intended to expose disclosures related to Alternative Disclosure Contracts to the same liabilities under the federal securities laws as disclosures related to non-alternative Disclosure Contracts. Approach 1 would not have that effect. Even though the SEC has not proposed rules related to Approach 1 and Approach 2, it has extensively requested comments on the approaches, as well as virtually every other portion of the proposing release related to Great-Wested variable contracts. We expect that interested parties will be actively engaged in this piece of the rulemaking process. VII. Other Proposed Rule Amendments and Rescissions In addition to proposed Rule 498A and the registration statement form amendments discussed above, the Commission proposes to amend 19 other rules and to rescind an additional nine (these are listed in a chart on pages 3 and 4 of the Proposing Release). These amendments and rescissions (referred to in the SEC release as Technical, Conforming and Updating Amendments to Other Aspects of the Regulatory Framework for Variable Contracts ) fall into two categories. First, there are conforming amendments to cross-references in various rules to reflect proposed Rule 498A, and the proposed amendments to Forms N-3, N-4 and N-6. Second, numerous rule (and form) amendments and rescissions are proposed to reflect the 1996 amendments to the Investment Company Act made by the National Securities Markets Improvement Act of 1996 (NSMIA). Prior to NSMIA, certain provisions of sections 26 and 27 of the Investment Company Act applied specific limits on the amount, type and timing of sales and other charges applicable to variable contracts. NSMIA exempted variable contracts from those limits and instead requires that fees and charges be reasonable when considered in the aggregate (see sections 26(f) and 27(i) of the Investment Company Act). Nevertheless, a number of SEC rules still on the books contain pre-nsmia fee and expense charge limits. In particular, Rules 6e-2 (for scheduled premium variable life insurance) and Rule 6e-3(T) (for flexible premium variable life insurance) currently still impose strict limits and detailed restrictions on fees and charges on variable life insurance products. Also, Rule 6c-8, which provides exemptive relief for variable annuity issuers to impose contingent deferred sales charges, imposes a 9% limit on such charges. The Commission has proposed amendments to these and other rules to reflect NSMIA s change to the SEC regulation of variable contract fees and charges, by eliminating the limits in those rules. Specifically, proposed amendments to Rules 6e-2 and 6e-3(T) would rescind significant portions of those rules that regulate variable life insurance fees and charges, and the 9% limit in Rule 6c-8 (and in Rule 11a-2) would be removed. The Commission also proposes to rescind various rules that were rendered moot by NSMIA. VIII. Conclusion The SEC s proposed new layered prospectus disclosure regime for variable contracts represents a major step forward in modernizing the disclosure requirements imposed by the federal securities laws on the variable insurance products industry, and recognizes the pervasive use of electronic media by the investing public. The sheer breadth of the proposal represents a substantial effort by the Division of Investment Management to implement the overarching investor protection and disclosure effectiveness goals set by Chairman Jay Clayton. The proposing release raises a number of issues on which the Commission is soliciting comment. Interested parties will be well served to study carefully the details of what the Commission has proposed and to comment on those aspects that can be refined or improved. 10