March 7, 1997
TO: All Admitted Life Insurers Qualified to Transact Variable Annuities and/or Variable Life Insurance in California, and Other Interested Parties.
- Revision of Bulletin 95-2 to provide:
- Adoption of an Expedited Process to Amend VA and VL Qualifications by Certification of Compliance;
- Definition of "Hazardous" and Examples of Situations That May Be Considered "Hazardous" Under California Insurance Code Sec. 10506(h)
This Bulletin replaces Bulletin 95-2, adopted on March 1, 1995. This Bulletin is promulgated under the authority set forth in Sections 10506, 12921.3 and 12921.5 of the California Insurance Code, and Articles 11 and 11.1 of Subchapter 3 of Chapter 5 of Title 10 of the California Code of Regulations (Separate Accounts-Variable Contracts-Variable Life Insurance), and Bulletin No. 87-3 of this Department (Variable Life Insurance). It is being issued in response to numerous inquiries by regulated parties as to the means by which the filing of amendments to insurers' variable contract authority may be expedited, and also in response to inquiries as to the meaning of the term "hazardous" as that term is used in the above referenced Section 10506 and in Section 2526.3 of the above referenced Article 11. It responds to and deals with many comments received regarding Bulletin 95-2.
The purpose of this Bulletin is two-fold:
(1) To establish an expedited procedure to amend Variable Annuity and Variable Life Qualifications of admitted life insurers by the filing of a Certification of Compliance with applicable California law, including this Bulletin, along with other documentation and filing fee as set forth herein; and,
(2) To clarify (and provide examples) and to set forth guidelines to enable a working definition to be formulated of the meaning of the phrase: "...no domestic or foreign life insurance company shall undertake the issuance of any contract providing for variable benefits until the company has satisfied the commissioner that its condition or method of operation in connection with the issuance of such contracts will not be such as would render its operation hazardous to the public or its policyholders in this state..." as that language appears and is used in Sec. 10506(h). Since it may not be possible to encompass in the guidelines contained herein all situations, circumstances, or conditions which may be construed as "hazardous", these guidelines shall not be considered as rigid, inflexible, and all inclusive. The Commissioner shall use his lawful discretion to apply additional reasonable guidelines to situations which merit the need.
(3) The definitions and guidelines listed here are, in part, in response to comments received regarding Bulletin 95-2, which is the predecessor of this Bulletin. The definitions and guidelines are illustrative of conditions that may under some, but not all, circumstances be considered "hazardous"; however, the definitions and guidelines are not intended to set forth a list of unequivocally hazardous conditions. Rather, the definitions and guidelines have been developed to help create an expedited procedure to amend variable annuity and variable life qualifications of life insurance companies. Companies seeking to utilize these expedited procedures may explain why certain conditions are not hazardous under circumstances particular to their company's operation or because conditions are consistent with or required by other regulatory requirements, such as state and federal securities laws and regulations.
III. CERTIFICATION OF COMPLIANCE.
Those life insurers already qualified to sell variable contracts in California may utilize an expedited filing procedure to amend their qualification by the completion and filing with the Department of a CERTIFICATION OF COMPLIANCE, the form of which is set forth in the Appendix attached to this Bulletin. The Appendix also contains Instructions for the use of such Certification and the format of certain Forms required to be filed with the Certification. If an insurer does not use a Certification of Compliance, in connection with the filing of an amendment to a qualification, it will be necessary for the insurer to obtain the prior approval of the Department before implementing the subject of the amendment in California.
IV. DEFINITIONS OF "HAZARDOUS," AND ADOPTION OF A REASONABLY PRUDENT INVESTOR STANDARD.
When a variable annuity is utilized for retirement purposes, it shall be deemed that the prospective purchaser or contract holder holds the viewpoints and expectations of a reasonably prudent investor. The reasonably prudent investor generally does not participate in highly speculative investments, but does have expectations of a reasonable rate of return on his or her investment. Over a long term, such an investor expects to see moderate growth in his or her investment, over a time frame consistent with his or her retirement plans and taking into account his or her ability to make appropriate investment strategy changes as conditions and expectations change over time.
However, the types of investments and degrees of investment risks appropriate for a reasonably prudent investor should be determined in light of the specific situation and characteristics of a given individual, considering such factors as the individual's age, wealth, other investments, dependents and financial obligations, long term financial prospects, life style preferences, and tolerance of risk.
In addition, under securities regulation, the NASD Conduct Rule 2310, as well as California Insurance Department Bulletin 87-3 (dealing with variable life insurance), require that brokers and agents selling variable contracts comply with "suitability standards" that obligate the broker or agent to make certain that there are reasonable grounds for believing that a variable contract recommended to a customer is suitable for that customer. It is expected that due diligence will be given to that consideration by brokers and agents licensed to sell variable contracts in California.
A variable annuity shall be considered hazardous to policyholders of it, and to the public, when the variable annuity contract, viewed as a whole, and from the viewpoint of a reasonably prudent investor, is so risky an investment that it seriously jeopardizes the retirement expectations of the investor. If the investor's reasonable retirement expectations are in jeopardy of remaining substantially unfulfilled, the presumption could arise that the contract is hazardous.
A variable life insurance contract shall be considered hazardous to policyholders of it, and to the public, when the variable life insurance contract, viewed as a whole, and from the viewpoint of a reasonably prudent investor, contains an inordinate number of risky investment options such that the realization of a fair investment return, over a long period of time, is jeopardized. Where the insurer informs the investor of a significant number of risks and uses an unusually large number of caveats in its explanation of the policy and its investment options, a presumption could arise that the policy is hazardous.
To the extent that an insurer's financial condition, or methods of operation, places the reasonably prudent investor in jeopardy of having his investment expectations remain substantially unfulfilled, that financial condition or business operation could be presumed to be hazardous.
In addition, a number of other factual situations, enumerated below, could cause a presumption to arise that a hazardous condition exists. When, and if, that occurs, a Company will be notified by the Department, and it may present evidence and argument to refute the presumption.
V. HAZARDOUS OPERATIONS.
The following situations or conditions may be considered "hazardous" by the Commissioner, though the following list shall not limit the Commissioner's authority to declare other activities or conditions to be hazardous.
A. Situations where a life insurance company, either issuing or proposing to issue variable contracts, delegates to a third party (including, but not limited to a "third party administrator"), who is not a lawfully licensed agent of the company, acting within the proper scope of such agent's authority, substantially any of the following activities: marketing of the contracts; underwriting of the contracts; issuance of the contracts; or, payment of benefits under the contracts;
B. Situations where a life insurance company's assets in its General Account are disproportionately small in relation to the amount of assets held in its Separate Account or Accounts explicitly for the purpose of guaranteeing reserves in connection with variable contracts. Reserves in a Separate Account, held to guarantee portions of a variable contract, may shrink in value due to market fluctuations, and thereby require a company to draw upon its General Account in order to support the Separate Account guarantee. Such a drainage from the General Account may, under adverse conditions, be large enough to cause a financial hazard for the company.
C. Situations where an underlying investment portfolio in a life insurance company's Separate Account (or Accounts) meets any of the following criteria:
(1) The name of the portfolio is deceptive in that it
implies circumstances which are, in whole or part, untrue.
(Examples: a "Growth Stock Fund" does or may invest a significant portion of its assets in high yielding, less than investment grade ["junk"] bonds. A "North American Fund" invests assets in securities of companies located outside of North America.) A company shall be considered responsible for providing adequate disclosure to prospective purchasers of its variable contracts of the potential risk nature of material investments held, or contemplated to be held, by portfolios the company chooses to make available to its variable contract holders. Thus, while federal securities regulation may prevent a mutual fund from calling itself a "high yield" fund, a substantial investment in "junk" bonds should be adequately disclosed to any prospective variable contract purchaser if that fund is utilized by a company as an investment portfolio for variable contracts. If the size and nature of the risk is large, then the disclosure should be such that it is readily recognizable in a reading of a prospectus describing such investment.
(2) The investment restrictions of the portfolio, or
Fund, permit it to invest more than 20% of its assets in bonds rated less than investment grade ["junk bonds"], unless the Fund specifically discloses the nature of the investment and the attendant risks associated with it, in a manner as described in (1) above.
(3) The portfolio is, in fact, leveraging its assets by borrowing amounts equivalent to more than 33 and 1/3% of its total assets. Entering into a reverse repurchase agreement shall be considered "borrowing" as that term is used herein.
(4) The investment restrictions of the portfolio, or
Fund, permit it to hedge by purchasing put and call options, futures contracts, or derivative instruments on securities, in an aggregate amount equivalent to more than 10% of its total assets.
(5) The number of investment portfolios available for the variable contract holder to choose from is excessive, in the reasonable judgement of the Commissioner, or is so complex, or duplicative, as to make the process of choosing unreasonably complicated for a reasonably prudent person.
(6)The investment advisor, or sub-advisor, to the portfolio, or Fund, does not, in the reasonable opinion of the
Commissioner, possess sufficient investment experience in order to be able to render reliable investment advice. Individuals providing investment advice shall be of good professional character and in good standing with the securities licensing authorities having jurisdiction over them.
(7) The portfolio turnover rate of the Fund is excessive in relation to the investment goals of the Fund. A fund's portfolio turnover rate shall not be considered excessive if it (i) is consistent with the investment objectives and policies as clearly set forth in its registration statement, and (ii) fulfills Guide 5 accompanying Form N-1A, the registration form for open-end investment companies.
(8) Regarding International and Global Funds:
(a) An International Fund or a Global Fund is not sufficiently diversified if it is not invested in a minimum of three different countries at all times, or has invested more than 50% of portfolio assets in any one second tier country or more than 25% of portfolio assets in any one third tier country. First tier countries are: Germany, the United Kingdom, Japan, the United States, France, Canada, and Australia. Second tier countries are all countries not in the first or third tier. Third tier countries are countries identified as "emerging" or "developing" by the International Bank for Reconstruction and Development ("World Bank") or International Finance Corporation.
(b) A Regional Fund is not sufficiently diversified if it is not invested in a minimum of three countries. The name of the fund must accurately describe the fund.
(c) The name of a single country fund must ccurately describe the fund.
(d) An Index Fund must substantially mirror the index.
(9) The insurance company utilizes its A.M. Best rating, or other similar rating, in advertising for its variable contracts, without sufficiently explaining the nature and purpose of the rating and indicating clearly that the rating does not apply to its Separate Account, or Accounts.
(10) The entire assets of the Separate Account are composed wholly, or in very large part, of investments in other Separate Accounts, not under the direct control of the insurer, such that the liquidity of the Separate Account is impaired.
(11) Investments directly in gold and/or silver bullion which, when combined, exceed 10% of the assets of the underlying Fund or portfolio.
(12) Investments in non-income producing real estate. (They will be presumed to be purely speculative.)
VI. NON-HAZARDOUS OPERATIONS.
For purposes of this Bulletin, a hazardous condition shall not exist if the variable contract issued, or issued for delivery, in this state:
(1) has underlying investment portfolio(s) that are registered under the Investment Company Act of 1940, regardless of whether such underlying portfolio(s) meet the criteria set forth in Paragraph C of Section V of this Bulletin;
(2) is issued in connection with a plan that is subject to the fiduciary standards of the Employee Retirement Income Security Act of 1974:
(3) is a variable life insurance contract issued under California Insurance Code Section 10506.3 and Insurance Department Bulletin 87-3 (as revised);
(4) is issued under California Insurance Code Section 10541 to entities such as a trust or foundation;
(5) is issued in connection with a welfare benefit, deferred compensation, pension, profit sharing, or retirement plan established or maintained by or for a plan sponsor; or
(6) is issued only to "accredited investors" as that term is defined in Section 501(a) of Regulation D, promulgated under the Securities Act of 1933, as amended.
Notwithstanding the above, the Commissioner reserves the right to review for possible hazardous conditions any variable contract falling into any of the above categories where he deems there is good cause to believe that the issuance of such contract may pose a hazard to California policyholders or the public, or where he finds that any material risk is not adequately disclosed.
VII. DELIVERY OF STATEMENT OF ADDITIONAL INFORMATION.
The Department requirement that a Statement of Additional Information be delivered with each prospectus that is delivered to a prospective variable contract purchaser in this State may be deemed to be complied with if such prospective purchaser may obtain such a Statement by phoning an 800 telephone number (or its equivalent),such number clearly appearing in the prospectus; provided that the company receiving such a request promptly responds to it by mailing, or otherwise delivering, such a Statement to the prospective purchaser.
VIII. SEPARABILITY PROVISION.
If any provision of this Bulletin or the application thereof to any person or circumstance is for any reason held to be invalid, the remainder of the Bulletin and the application of such provision to other persons or circumstances shall not be affected thereby.
Questions regarding this Bulletin should be addressed to the following:
State of California Department of Insurance
Legal Division - Corporate Affairs Bureau
45 Fremont Street
San Francisco, CA 94105