variable annuities and other insurance investment products · investment adviser regulation: a...

Variable Annuitiesand Other InsuranceInvestment Products

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ART LAWArt Law: The Guide for Collectors, Investors, Dealers & Artists

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EMPLOYMENT LAWEmployment Law YearbookERISA Benefits Litigation Answer BookLabor Management Law Answer Book

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IMMIGRATION LAWFragomen on Immigration Fundamentals: A Guide to Law and Practice

INSURANCE LAWBusiness Liability Insurance Answer BookInsurance Regulation Answer BookReinsurance Law

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LITIGATIONArbitrating Commercial Disputes in the United StatesClass Actions and Mass Torts Answer BookDepositions Answer BookElectronic Discovery DeskbookEssential Trial Evidence: Brought to Life by Famous Trials, Films, and FictionExpert Witness Answer BookEvidence in Negligence CasesFederal Bail and Detention HandbookHow to Handle an AppealMedical Malpractice: Discovery and TrialProduct Liability Litigation: Current Law, Strategies and Best PracticesSinclair on Federal Civil PracticeTrial Handbook

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Variable Annuitiesand Other InsuranceInvestment Products

Third Edition

VOLUME 1

Edited byClifford E. Kirsch

Practising Law InstituteNew York City

#240085

This work is designed to provide practical and usefulinformation on the subject matter covered. However, it issold with the understanding that neither the publishernor the author is engaged in rendering legal, accounting,or other professional services. If legal advice or otherexpert assistance is required, the services of a competentprofessional should be sought.

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For general information about Practising Law Institute,please visit www.pli.edu.

Legal Editor: Carol Benedicto

Copyright © 2005–2018 by Practising Law Institute.

First edition 2005, originally published as Variable Annuities and Variable LifeInsurance Regulation (compression binder with cumulative supplements).

Second edition 2012 (and cumulative supplements).

Third edition 2018, published as Variable Annuities and Other InsuranceInvestment Products.

All rights reserved. Printed in the United States of America. No part of thispublication may be reproduced, stored in a retrieval system, or transmitted inany form by any means, electronic, mechanical, photocopying, recording, orotherwise, without the prior written consent of Practising Law Institute.

LCCN: 2018938494

ISBN: 978-1-4024-3044-2

For My Family, With Love

About the Editor

Clifford E. Kirsch (editor; author of chapters 14, 16, 19, 20, 22, and23; and co-author of chapters 1, 9, 13, 17, and 29) is a partner atEversheds Sutherland (US) LLP. A seasoned securities lawyer withmore than twenty-five years of regulatory, corporate counsel, and pri-vate practice experience, Mr. Kirsch focuses his practice on investmentmanagement, where he regularly counsels clients on the comprehen-sive regulations governing advisers and broker-dealers, bank fiducia-ries, pooled investment vehicles (including mutual funds, managedadvisory accounts, bank collective investment funds, and retirementand insurance investment products), and the retirement marketplace.

Mr. Kirsch advises many of the most prominent U.S. dual-registrants (entities that are registered as both advisers and broker-dealers) with respect to the sale and distribution of investmentproducts, compliance and supervisory procedures, and sales practiceissues. A former chief legal officer for one of the country ’s largestdually registered broker-dealer/advisers, he routinely guides clientsthrough U.S. Securities and Exchange Commission (SEC), FinancialIndustry Regulatory Authority, and state securities departments inconnection with regulatory and examination matters. Mr. Kirsch alsoworks regularly with the preeminent securities, retirement and insur-ance industry trade associations, and serves as policy counsel to theFinancial Services Institute, which is the industry trade association forindependent broker-dealers.

Mr. Kirsch began his career at the SEC, rising to the position ofAssistant Director at the agency ’s Division of Investment Manage-ment. His extensive experience and in-depth knowledge allows him toeffectively advise clients, and he is a sought-after speaker and thoughtleader with respect to current regulatory issues. He is the author andeditor of two of the leading treatises in the broker-dealer and adviserarena, Broker-Dealer Regulation and Investment Adviser Regulation(also published by the Practising Law Institute), and also serves aseditor of the Practising Law Institute’s blog, BD/IA: Regulation inFocus, which provides legal perspectives on current regulatory de-velopments for broker-dealers and investment advisers. Mr. Kirsch isa member of the faculty of FINRA Compliance Institute at TheWharton School of the University of Pennsylvania. He has beenrecognized by The Legal 500 United States in the area of financial

(Ins. Inv. Prods., 3rd ed., 11/18) ix

services: regulatory (2015–2018) and is the recipient of the SEC ’sManual F. Cohen award for outstanding legal ability.

In addition to his work at Eversheds Sutherland, Mr. Kirsch isheavily involved in the community. In 2012, he co-founded the JuliaAnne Kirsch Foundation, which seeks to serve the needs of disabledindividuals and their families.

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VARIABLE ANNUITIES & INSURANCE INVESTMENT PRODUCTS

About the Contributors

John T. Adney (Chapter 5) is a partner at Davis & Harman LLP,practicing primarily in the areas of taxation and insurance law. Since1977, he has engaged in an insurance product taxation advisory,ruling, and audit practice, covering universal life insurance, variablelife insurance, group-term life insurance, COLI, fixed and variableannuities, and long-term care insurance. During the same period, hehas engaged in extensive advisory, ruling, and audit work relating toinsurance company taxation. In addition, since 1981, Mr. Adney hasbeen involved in legislative representation of insurance companies ontax matters relating to those companies and their products, includingthe enactment or revision of Internal Revenue Code sections 72, 101(f),101(g), 801–08, 846, 1035, 7702, 7702A, and 7702B. In 1985, hehelped organize Davis & Harman, serving as the firm’s first managingpartner.

Mr. Adney received his B.A., summa cum laude, from MillikinUniversity in 1972 and his J.D. from Yale Law School in 1975. Heserved as a law clerk for the Trial Division of the U.S. Court of Claimsin 1975 and 1976, and then clerked for Judge Marion T. Bennett of theU.S. Court of Claims in 1976 and 1977.

Cynthia J. Borrelli (Chapter 10) is a partner at Bressler, Amery &Ross, PC and directs the firm’s Insurance Law practice group. Herpractice also includes participation in the firm’s Executive Compensa-tion & Employee Benefits and Labor and Employment practice groups.Her insurance practice is dedicated primarily to matters affectingcorporate regulatory and enforcement aspects of insurance law. Thescope of her practice comprises a broad range of client engagementsrelating to property-casualty and life, annuity and health, managedcare, disability insurance, and reinsurance matters. She works closelywith attorneys in the firm’s Taxation, Executive Compensation &Employee Benefits, and Workers’ Compensation practice groups onissues relating to employee benefits and executive compensation,ERISA welfare benefit plans (including insurance funding mechan-isms for health and pension plans and plan design), agent disputes,workers’ compensation benefits, and related issues. She also chairsthe firm’s Diversity Committee.

Ms. Borrelli has published and lectured on insurance-related topicsfrequently before national organizations. She is an active participant inNational Association of Insurance Commissioners matters. She has

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served as Chair of the Public Regulation of Insurance Law Committeeof the Tort and Insurance Practice Section of the American BarAssociation, and as a Vice-Chair of the Life Insurance Law Committee.Ms. Borrelli remains active on both Committees.

Ms. Borrelli serves on the Board of Directors of the Federationof Regulatory Counsel. She is a former Legal Committee memberof the National Organization of Life and Health Insurance GuarantyAssociations, a current member of the Legal Committee of theNational Conference of Insurance Guaranty Funds, a member ofthe Federation of Defense and Corporate Counsel, the New JerseyState Bar Association Diversity Committee, the Association ofProfessional Insurance Women and the New Jersey Chapter of RiskInsurance Management Society.

David N. Brown (Chapter 24) is a retired partner in the Washington,D.C. office of Covington & Burling LLP, where his practice involvesvarious aspects of corporate and securities law. He has advised lifeinsurance companies, general agencies, and producer groups regardingthe federal securities laws as they relate to variable products.Mr. Brown has also advised private equity fund sponsors regardingthe formation of funds and the application of federal securities laws totheir operations. He has focused recently on privately placed variablelife insurance. Mr. Brown received his bachelor ’s degree from CornellUniversity and his J.D. from the University of Chicago. He is amember of the Bar of the District of Columbia and the American BarAssociation.

Gary M. Brown (Chapter 30) is a partner with Nelson Mullins Riley &Scarborough LLP, where he concentrates his practice in securities,representation of public companies, and corporate governance.Previously, he was the Chief Executive Officer of CMG Life Services,Inc., a financial services firm that concentrated on the life settlementmarket that, during his tenure, acquired and managed life settlementportfolios with over $4 billion in face amount.

In his thirty-one prior years of private law practice, Mr. Brown wasrecognized in both Best Lawyers in America and Chambers—America’s Leading Business Lawyers. In addition, from 1994 untiljoining CMG in 2011, he taught corporate and securities law at theVanderbilt University Law School. He also served as general counsel tothe Ethics and Compliance Officer Association (now known as theEthics and Compliance Initiative), then the world’s largest group ofethics and compliance professionals. Mr. Brown is a frequentinstructor at securities programs for the Practising Law Institute(PLI), co-chairing one of PLI’s national securities programs, Under-standing the Securities Laws, and instructing at the SEC Reporting and


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Practice Skills Workshop for Lawyers, a program started in 2015 byThe SEC Institute, a division of PLI. He is also the author of PLI’sSecurities Law and Practice Deskbook and Master the 8-K.

In 2002, Mr. Brown served as Special Counsel (Minority) to the U.S.Senate’s Governmental Affairs Committee in its investigation of thecollapse of Enron Corp. In that role, he worked with the Committee’sPermanent Subcommittee on Investigations (PSI) and provided adviceon aspects of the Sarbanes-Oxley Act while the legislation was beingdebated in the Senate. As part of the investigation, he providedtestimony before the Subcommittee on the activities of major U.S.investment banks that assisted Enron in the manipulation of itsfinancial statements. In an August 2006 Senate investigation ofabusive tax shelters, he provided testimony before PSI on how variousstructures employed in offshore and other tax devices are employed tocircumvent compliance with U.S. federal securities laws. In 2010, hewas retained by PSI to assist in its investigation of Goldman Sachsduring PSI’s overall investigation, “Wall Street and the FinancialCrisis,” and related televised hearings. While in that role, he alsoprovided advice on aspects of the Dodd-Frank Wall Street Reform andConsumer Protection Act while the legislation was being debated inthe Senate.

Mr. Brown received both his undergraduate and law degrees fromVanderbilt University, where he graduated Order of the Coif.

Kerry Shannon Burke (Chapter 24) is a partner in the Washington,D.C. office of Covington & Burling LLP in the corporate andsecurities practice areas. The focus of Ms. Burke’s practice is oncapital markets and securities transactions. She has a broad rangeof experience representing companies, underwriters, and otherinstitutional investors in private and public debt and equity financings.Ms. Burke also regularly advises on general corporate and federalsecurities law matters. Specifically, Ms. Burke has provided assistanceon issues related to registered and unregistered investment advisersand registered broker-dealers, including on various status questionsand ongoing compliance matters.

Paul G. Cellupica (Chapter 25) is the Chief Counsel of the Divisionof Investment Management of the Securities and Exchange Commis-sion, and will continue serving as the Division’s Deputy Director.Mr. Cellupica served in a number of capacities in the Division ofInvestment Management and the Division of Enforcement from 1996to 2004, during which time he received the Martha Platt Award for hiswork in the Division of Investment Management, and the Law andPolicy Award as part of the Proxy Review Task Force. Mr. Cellupica

(Ins. Inv. Prods., 3rd ed., 11/18) xiii


rejoined the Commission as Deputy Director of the Division ofInvestment Management in November 2017. As Deputy Director,Mr. Cellupica has overseen a number of the Division’s strategic,rulemaking, and industry engagement initiatives. In his role leadingthe Division’s Chief Counsel’s Office, Mr. Cellupica and his staff areresponsible for, among other things, responding to requests for legaland policy guidance, evaluating applications for exemptive relief, andoverseeing the Division’s enforcement liaison program.

Prior to rejoining the Commission, Mr. Cellupica was theManaging Director and General Counsel, Securities Law, of TIAA.Previous to that, he was Chief Counsel for Securities Products andRegulation in the Law Department of MetLife, Inc., where he wasresponsible for legal issues involving MetLife’s registered variableinsurance products, broker-dealers, mutual funds, and SEC and NASDregulatory inquiries. Mr. Cellupica is a frequent speaker on issuesinvolving mutual funds and variable insurance products. He has a B.A.from Harvard College and a J.D. from Harvard Law School, and was alaw clerk for Judge David Nelson of the U.S. Court of Appeals for theSixth Circuit.

Richard T. Choi (Chapter 21) is a shareholder at Carlton Fields JordenBurt, P.A. As a member of the firm’s variable insurance products/investment company group, he advises life insurance companies,mutual funds, broker-dealers, and investment advisers regardingvarious aspects of federal securities and income tax law matters, aswell as state insurance and securities law matters. Mr. Choi haspublished articles and is a frequent speaker on federal securities andNASD issues relating to the use of electronic media to market variableinsurance products. He earned his bachelor ’s degree at the Universityof Chicago and his law degree at the University of Virginia School ofLaw. Mr. Choi is a member of the Virginia Bar, the Bar of the District ofColumbia, and the American Bar Association. He serves on theRegulatory Affairs Committee of the National Association for VariableAnnuities.

Elizabeth A. Diffley (Chapter 18) is a partner in the Corporate &Securities Practice Group of Drinker Biddle & Reath LLP. Ms. Diffleyconcentrates her practice in securities law compliance, mergers andacquisitions, banking and corporate finance transactions, and corpo-rate governance. She joined Drinker Biddle from Sullivan & Cromwellin Paris, where her practice primarily involved cross-border securitiesofferings and compliance with U.S. securities laws and reportingobligations. Ms. Diffley earned her J.D., magna cum laude, from theUniversity of Pennsylvania, where she was an articles editor ofthe Law Review. She received her bachelor ’s degree, summa cum

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laude, in economics from the Wharton School of the University ofPennsylvania.

Jack Ewing (Chapter 13) is Vice President and Corporate Counsel withthe Prudential Insurance Company of America, where he concentrateson product development, compliance, and distribution issues fortraditional and variable life insurance and annuity products. Prior tojoining Prudential, Mr. Ewing was an associate in the Philadelphiaoffice of the Dechert law firm, where he specialized in ERISA, tax, andsecurities law issues of employee benefit plans and executivecompensation. He received his B.S. from Rutgers University and hisJ.D., with highest honors, from Rutgers School of Law–Newark.

Wendell M. Faria (Chapter 3) is Of Counsel to Paul Hastings LLP. Heconcentrates his practice in the area of investment management,particularly on matters involving the regulation of investmentcompanies and investment advisers under the federal securities laws,and in the offering of equity-oriented insurance contracts. Mr. Fariawas formerly with the U.S. Securities and Exchange Commission inWashington, D.C., in the SEC ’s Division of Investment Management.He served as the Deputy Chief and as the Acting Chief of theDivision’s Office of Insurance Products, responsible for the regulationof certain equity-oriented insurance contracts (such as variableannuities, variable life policies, modified guaranteed annuities, andguaranteed investment contracts). He frequently speaks at conferencesdealing with investment management issues, and is an AdjunctProfessor of Law at Georgetown University Law Center, where heteaches securities law.

Evan Giller (Chapter 26) is Of Counsel to Boutwell Fay, LLP, a law firmspecializing in employee benefits and ERISA. Mr. Giller ’s practicefocuses on issues relating to the employee benefit plans of tax-exemptorganizations and governments, including 403(b) plans, 457 plans,qualified plans, and fiduciary issues. His practice also includes advisingon the design and regulation of investment products for retirementplans. Prior to his current position, Mr. Giller was a founding mem-ber of the firm of Giller & Calhoun, LLC. He also spent over twentyyears at TIAA-CREF, where he served as Vice President and GeneralCounsel, Institutional Client Services, and managed the Pension LawUnit. Mr. Giller is a member of the New York City Bar Association,where he is currently serving on the Committee on Employee Benefitsand Executive Compensation. He received his J.D. from the StateUniversity of New York at Buffalo Law School.

(Ins. Inv. Prods., 3rd ed., 11/18) xv


Issa J. Hanna (Chapter 17) is counsel in Eversheds Sutherland’s NewYork office, where he advises investment advisers, broker-dealers andinvestment funds on compliance with federal and state securities lawsand regulations, and self-regulatory organization rules. Mr. Hanna alsoadvises life and annuity insurers on securities issues associated withthe management and distribution of variable products and on otherregulatory issues under state insurance laws.

Before joining the firm as an associate, Mr. Hanna participated inEversheds Sutherland (US)’s Summer Associate Program in 2008,where he assisted primarily with matters relating to investmentadvisers, broker-dealers, and investment funds. During law school, heserved as a law clerk in the Civil Division of the Office of the U.S.Attorney for the Middle District of Florida, and as an extern in theCounty Attorney ’s office in Alachua County, Florida. Mr. Hannareceived his B.A. from Duke University, where he served as SeniorEditor and Staff Writer of The Duke Chronicle. He received his J.D.,cum laude, from the University of Florida Levin College of Law, wherehe was a Board Member of the Florida Law Review.

Gary E. Jenkins (Chapter 4) is currently Deputy General Counsel forthe Insurance Solutions business of Voya Financial, which includes itsindividual life and group insurance business lines. Mr. Jenkins has hada long career in the financial services industry, providing legal adviceregarding the development, sale, and administration of institutionaland retail products/services across investment management, banking,and insurance industries, with a focus on managing regulatory, legis-lative, and compliance risks. Prior to joining Voya Financial, he servedas General Counsel of CitiStreet LLC, a joint venture of State StreetBank and Trust Company and Citigroup, providing recordkeeping ser-vices for defined contribution, defined benefit, and health and welfareplans. Before CitiStreet, he held the position of Division Counsel forState Street Bank and Trust Company ’s 401(k) recordkeeping business.Mr. Jenkins has a broad background and knowledge of ERISA, federalsecurities laws, and state insurance laws. During his career, he hasworked closely with various federal and state regulators on mattersrelevant to the banking, investment management, retirement, andinsurance industries. Mr. Jenkins is a graduate of Columbia College,earned his law degree from Washington University School of Law, andholds a Master ’s in Taxation from the University of Miami.

Weiyen “Ann” Jonas (Chapter 26) is a Vice President and AssociateGeneral Counsel at Fidelity Investments. Ms. Jonas advises on legalmatters affecting the retirement plans of tax-exempt and governmentalemployers, including 401(k), 403(b), and 457 plans, under the Inter-nal Revenue Code, ERISA, and other federal and state laws. Ms. Jonas

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graduated cum laude from Harvard Law School and received her B.S.in business administration from Georgetown University, graduatingmagna cum laude. Ms. Jonas previously practiced employee benefitslaw at Goodwin Procter LLC, and was employed as a tax accountantand CPA for Price Waterhouse, prior to law school. She frequentlypresents at conferences, and has taught ERISA and Employee BenefitsLaw at Suffolk University Law School in Boston. Ms. Jonas is amember of the Texas and Massachusetts bars.

Dodie Kent (Chapters 1 and 29) is a partner at Eversheds Sutherland.With more than 20 years of experience as corporate counsel in thefinancial services industry, Ms. Kent advises on product design,marketing, and administrative issues as they relate to variable and fixedlife insurance and annuity products. She also has particular experiencecounseling on related regulatory compliance and enforcement issues.Ms. Kent focuses on many novel and complex insurer initiatives,including the de-risking of legacy product offerings; the design andregulation of index-linked investments; issues related to the use ofvolatility management; and the simplification of variable annuitydisclosure. Ms. Kent’s in-depth knowledge of these topics—particularlyvariable life and annuity insurance regulations and issues—makes her asought-after speaker at industry conferences. Her years as corporatecounsel provide her with a practical, results-oriented understanding ofinsurance companies’ internal processes and competing business inputsrelated to product development, distribution and administration.Ms. Kent joined Eversheds Sutherland (US) from one of the world’sleading insurance and asset management groups, where she served asVice President, Lead Director and Associate General Counsel in theInsurance Practice Group of its U.S. holdings. There, she served as thecompany’s principal legal securities advisor regarding its variable andfixed life and annuity product lines. Ms. Kent was recognized by TheLegal 500 United States in the area of insurance: non-contentious(2016). She received her B.A. from Gettysburg College and her J.D. fromNew York Law School.

Daniel W. Krane (Chapter 18) is a partner in the Corporate andSecurities Group of Drinker Biddle & Reath LLP. Mr. Krane advisesinsurance and financial services clients on corporate, transactional andregulatory matters, business formations, mergers and acquisitions,holding company transactions, reinsurance, product design anddistribution, regulatory examinations, compliance, internal investiga-tions, and delinquency proceedings. He has particular experienceadvising insurance companies and their affiliates, including broker-dealers, agencies, advisors and mutual funds, in connection withstructuring compliance programs and related investigations. Mr. Krane

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graduated from the Pennsylvania State University in 1981 and fromDickinson School of Law in 1985, where he was elected to the Order ofthe Barristers and served as an editor of the Dickinson Journal ofInternational Law. He is a member of numerous bar associations andtrade groups, and has presented before NAIC working groups onvarious topics. Recently, Mr. Krane has served as an Adjunct FacultyMember at the Rutgers School of Law–Newark for an advancedinsurance course. He has been active on committees and task forcesinvolved with drafting insurance, financial services, and healthcarelaws, and frequently writes and lectures on these topics.

Susan S. Krawczyk (Chapter 15) is a partner in the Washington, D.C.office of Eversheds Sutherland, where her practice focuses on federaland state regulation of insurance, financial, and investment products.She counsels insurers, mutual fund sponsors, banks, and financialproduct distributors in developing products, establishing distributionand marketing arrangements, and implementing appropriate compli-ance systems and procedures. She works closely with insurers as wellas distributors in structuring and negotiating joint venture andmarketing arrangements for insurance products and insurance productfunds. She also advises clients on wrap fee programs, financialplanning programs, and networking arrangements for banks andinsurance agencies. Ms. Krawczyk represents clients before theSecurities and Exchange Commission and the National Associationof Securities Dealers, Inc. She is a member of and serves on severalindustry committees focusing on sales and marketing practices.Ms. Krawczyk is a member of the District of Columbia Bar and theVirginia State Bar. She received a J.D. degree from George WashingtonUniversity National Law Center in 1984.

Michael J. Mazza (Chapter 9), Assistant General Counsel in the LawDepartment of The Northwestern Mutual Life Insurance Company, isresponsible for legal issues involving Northwestern Mutual’s variableinsurance products. His responsibilities include filing registrationstatements with the SEC and advising on issues related to variableannuity and variable life insurance product development, administra-tion, distribution, and compliance. Prior to joining NorthwesternMutual in 2003, Mr. Mazza clerked for the Honorable John L. Coffey ofthe United States Court of Appeals for the Seventh Circuit and workedin private practice in the areas of estate planning and employeebenefits. Mr. Mazza graduated summa cum laude in 1999 from theMarquette University Law School, where he served as Editor-in-Chiefof the Marquette Law Review, and where he now teaches a class oninvestment company and investment adviser regulation as an AdjunctAssociate Professor of Law.


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Joseph F. McKeever, III (Chapter 5) is a partner at Davis & HarmanLLP, practicing primarily in the areas of taxation and insurance law.Mr. McKeever represents life insurance companies throughout NorthAmerica, advising these companies on a wide variety of federal incometax issues, including issues associated with the design, developmentand marketing of annuities and life insurance contracts. He alsorepresents companies on tax controversies in both Internal RevenueService administrative proceedings and in the federal courts.Mr. McKeever has an extensive practice in the IRS National Officewith respect to requests for private letter rulings, requests for technicaladvice, and other miscellaneous proceedings. In addition, he repre-sents many life insurance companies in legislative matters.

Mr. McKeever graduated with a B.A. in history from GeorgeWashington University in 1972. He obtained his law degree (withhigh honors) from George Washington University in 1978, where hewas elected to the Order of the Coif. During 1978–79, he served aslaw clerk to Trial Judge Harry Wood at the United States Court ofClaims, and during 1979–80, he was law clerk to former Chief JudgeWilson Cowen of the United States Court of Appeals for the FederalCircuit.

Christopher E. Palmer (Chapters 7 and 12) is a partner in the law firm ofGoodwin Procter LLP. He is the leader of the Business Law Departmentin Goodwin Procter ’s Washington, D.C. office, and is a member of theFinancial Services Group. Mr. Palmer focuses his practice on securities,investment management and insurance matters. He represents mutualfunds, investment advisers, insurance companies, and broker-dealers onthe development, regulatory approval, sale, and administration of avariety of investment products, including mutual funds and variable andfixed life insurance and annuity contracts. He also represents mutualfund independent directors, and advises companies on securities lawmatters, including reporting and corporate governance matters. Inaddition, he also represents companies in financial services litigation, inSEC inspections and enforcement actions, and before state insurancedepartments. Mr. Palmer was a partner at Shea & Gardner prior to itscombination with Goodwin Procter in 2004. After graduating magnacum laude from the Georgetown University Law Center in 1986, heserved as a Court Law Clerk for the U.S. Court of Appeals for theDistrict of Columbia Circuit.

Christopher S. Petito (Chapter 2) is Of Counsel in the Washington,D.C. office of Willkie Farr & Gallagher LLP. Mr. Petito concentrates ininvestment company, investment adviser, and broker-dealer federaland state securities law matters. His practice includes all aspects of thedesign, organization, and registration of investment companies and


(Ins. Inv. Prods., 3rd ed., 11/18) xix

related insurance products, as well as providing regulatory counseling.Mr. Petito has also represented regulated entities before federal andstate securities regulators in connection with exemptive applications,no-action requests, and regulatory examinations, investigations, andenforcement proceedings.

Daniel A. Rabinowitz (Chapter 31) is a partner with Kramer LevinNaftalis & Frankel LLP. Mr. Rabinowitz advises clients in the insuranceand reinsurance industry on a comprehensive range of transactionaland regulatory matters, including mergers and acquisitions, capitalmarkets, reinsurance, restructurings, securitization and structuredfinance, reserve financing, reorganizations, insurance-linked securi-ties, capital standards, group solvency, insurance company invest-ments, and corporate governance. From 2011 to 2014, he served aschair of the Insurance Law Committee of the New York City BarAssociation.

In the area of insurance M&A, Mr. Rabinowitz was instrumental inobtaining New York and Tennessee insurance regulatory approvals, ascounsel to White Mountains Insurance Group in its $2.6 billion sale ofSirius International to Chinese investment fund China MinshengInvestment Corp. in 2016. His recent insurance M&A experience alsoincludes representing ACP Re Ltd. in its merger with Tower Group,National General Holdings in its acquisition of Direct GeneralInsurance, Stone Point Capital in its acquisition of Kestra Financialfrom National Financial Partners, and AmTrust Financial in itsacquisition of Warranty Solutions from Wells Fargo.

In the area of reinsurance, Mr. Rabinowitz has advised six largepolicyholders of Financial Guaranty Insurance Co. (FGIC) in aproposed $1.9 billion transaction, involving Assured Guaranty andFGIC, to reinsure and commute certain FGIC obligations. He has alsorepresented holders of surplus notes of MBIA Insurance Corp. in a$325 million senior credit facility for MBIA in connection with claimsarising out of MBIA’s exposure to the Zohar CDOs.

Mr. Rabinowitz has been recognized by Chambers USA as a leadingpractitioner in the insurance transactional and regulatory field.According to Chambers, he has “considerable experience handling abroad range of transactional and regulatory insurance matters” (2018)and “wins high praise from clients, who say he is ‘knowledgeable andrefreshingly practical and levelheaded.’ Another rave review describeshim as ‘a solution seeker and finder ’” (2016). Clients describe him as a“subject area expert in terms of both insurance and reinsurance,”noting that “he’s experienced, so he’s able to respond quickly to issuesthat are time-sensitive” (2017). He “has a touch with the regulatorwhile remaining affirmative” and is “very technical as well as beingpractical and very accessible” (2015).

xx


William A. Schmidt (Chapter 6) is a partner in the Washington, D.C.office of K&L Gates LLP. He works in the areas of institutionalinvesting and employee benefits, with particular emphasis on fiduciaryresponsibility matters under the Employee Retirement IncomeSecurity Act of 1974. Mr. Schmidt advises major financial institutions,including banks, insurance companies, registered investment advisersand large employee benefit plans about ERISA restrictions relating toplan investments and to fee arrangements for investment managementand plan administrative services. He was formerly Counsel forRegulation in the Plan Benefits Security Division of the Office of theSolicitor of the U.S. Department of Labor, where he was responsible forproviding legal advice with respect to the Department’s regulatory,interpretive, and legislative activities under ERISA. Mr. Schmidt servesas an Adjunct Professor of Law at Georgetown University Law Center.

C. Christopher Sprague (Chapters 8 and 11) was Vice President andCorporate Counsel with Prudential Financial from 1994 to 2017. AtPrudential, he specialized in product development, distribution, andcompliance issues for variable annuities, variable life, mutual funds,and stable value products. Mr. Sprague also dealt with investmentadviser and broker/dealer issues for Prudential’s broker-dealers. Priorto 1994, Mr. Sprague was Senior Counsel in the SEC ’s Division ofInvestment Management, where he worked on a variety of issuesunder the Investment Company Act and Investment Advisers Act.Mr. Sprague has spoken at a number of industry conferences concerningvariable insurance products, including ALI-CLE, the Securities IndustryAssociation, and the Insured Retirement Institute. He is a graduate ofYale University and New York University Law School.

Kristina M. Zanotti (Chapter 6) is a partner in the Washington, D.C.office of K&L Gates LLP in the investment management practicegroup, concentrating in the ERISA Fiduciary and Derivatives practiceareas. In the ERISA Fiduciary practice area, Ms. Zanotti has substan-tial experience advising clients regarding fiduciary responsibilitymatters under ERISA. Ms. Zanotti assists investment advisers, banksand trust companies, fund complexes, and other financial institutions,in navigating ERISA’s prohibited transaction restrictions and exemp-tions. Ms. Zanotti co-authors chapters on ERISA in two corporate andsecurities law treatises for the Practising Law Institute and also teachesa class on ERISA for the D.C. Bar. In the Derivatives area, Ms. Zanottirepresents financial services clients in connection with swap and otherderivatives transactions and in negotiating master agreements,including ISDAs, Master Repurchase Agreements, Master SecuritiesForward Transaction Agreements, futures agreements, cleared deriva-tives documentation, and related agreements.

(Ins. Inv. Prods., 3rd ed., 11/18) xxi


Table of Chapters

VOLUME 1

PART I:VARIABLE INSURANCE PRODUCTS

PART I-A:OVERVIEW OF THE REGULATORY FRAMEWORK

Chapter 1 An Introduction to Variable Insurance Products

Chapter 2 Status of Insurance Products Under theSecurities Act of 1933

Chapter 3 Status of Insurance Companies and InsuranceCompany Separate Accounts Under theInvestment Company Act

Chapter 4 Regulation of Variable Insurance ProductsUnder the Investment Company Act of 1940

Chapter 5 Tax Treatment of Variable Contracts

Chapter 6 ERISA Issues

PART I-B:PRODUCT DESIGN

Chapter 7 Variable Insurance Product Design

Chapter 8 The Funding Vehicle

Chapter 9 SEC Registration

Chapter 10 State Contract Issues

(Ins. Inv. Prods., 3rd ed., 11/18) xxiii

PART I-C:PRODUCT ADMINISTRATION

Chapter 11 Issues Related to Product Administration

Chapter 12 Redemption Fee Rule

Chapter 13 Insurer Exchange Programs

PART I-D:PRODUCT DISTRIBUTION

Chapter 14 SEC Regulation of Product Distribution

Chapter 15 FINRA Regulation of Product Distribution

VOLUME 2

Chapter 16 FINRA Suitability, Supervision, and SalesPractices

Chapter 17 State Insurance Regulation Applying to theDistribution of Variable Insurance Products

Chapter 18 Replacement of Insurance Products

Chapter 19 Advertising

Chapter 20 Variable Life Insurance Illustrations

Chapter 21 Marketing on the Internet

PART I-E:COMPLIANCE AND REGULATORY EXAMINATIONS

Chapter 22 Separate Account Compliance Programs

Chapter 23 SEC Insurance Product SeparateAccount Exams


xxiv

PART I-F:SPECIAL TOPICS

Chapter 24 Private Placement Variable Life Insurance

Chapter 25 Asset Allocation Programs and Funds of Fundsin Variable Insurance Products

Chapter 26 Variable Annuities in Retirement Plans

Chapter 27 [Reserved]


PART II:OTHER INSURANCE INVESTMENT PRODUCTS

Chapter 29 Registered Index-Linked Insurance Contracts

Chapter 30 Introduction to Life Settlements

Chapter 31 Insurance-Linked Securities

(Ins. Inv. Prods., 3rd ed., 11/18) xxv

Table of Chapters

Table of Contents

VOLUME 1

About the Editor ...............................................................................ix

About the Contributors ...................................................................xi

Table of Chapters.........................................................................xxiii

Introduction....................................................................................lxxi

PART I:VARIABLE INSURANCE PRODUCTS

PART I-A:OVERVIEW OF THE REGULATORY FRAMEWORK

Chapter 1 An Introduction to Variable Insurance ProductsClifford E. Kirsch & Dodie Kent

§ 1:1 Background—Variable Annuities and Variable LifeInsurance ........................................................................ 1-3

§ 1:2 Variable Annuities in Today ’s Marketplace..................... 1-3§ 1:2.1 Generally.................................................................. 1-3§ 1:2.2 Variable Annuities in the Retail Marketplace........... 1-4

[A] Generally.................................................................. 1-4[B] Insurance and Other Guarantee Features ................ 1-5

Table 1-1 Variable Annuity Riders............................................ 1-9[C] Current Product-Related Developments................... 1-9[C][1] Recent Regulatory-Driven Product

Developments .................................................... 1-10[D] Variable Annuity Share Classes.............................. 1-11[E] Unique Investment Features .................................. 1-13

§ 1:2.3 Annuities Sold in the Retirement Marketplace...... 1-14

(Ins. Inv. Prods., 3rd ed., 11/18) xxvii

§ 1:3 Variable Life Insurance in Today ’s Marketplace............ 1-14§ 1:3.1 Generally................................................................ 1-14§ 1:3.2 Variable Life Insurance in the Retail Marketplace ....1-15§ 1:3.3 Life Insurance Sold to Individuals Through

Employers and Associations .................................. 1-16§ 1:3.4 Life Insurance Sold to Businesses (Corporate

Owned Life Insurance) ........................................... 1-16§ 1:4 Legal Structure and Changes ........................................ 1-17Figure 1-1 Contributions and Premium Payments .................. 1-18§ 1:5 Regulatory Treatment of Variable Products................... 1-19

§ 1:5.1 Generally................................................................ 1-19§ 1:5.2 Product Design and Approval ................................ 1-20

[A] State Insurance Requirements Regarding ProductDesign and Approval.............................................. 1-20

[B] Federal Securities Laws Regarding ProductDesign and Approval.............................................. 1-21

[B][1] Background ........................................................ 1-21[B][2] Private Offering Exception ................................. 1-23[B][3] Retirement Plan Exemption............................... 1-23[C] State Securities Laws.............................................. 1-23

§ 1:5.3 Product Administration ......................................... 1-24§ 1:5.4 Product Distribution .............................................. 1-26

[A] Background ............................................................ 1-26[B] FINRA Regulation.................................................. 1-27[B][1] Generally ........................................................... 1-27[B][2] Requirements Governing the Suitability of

Variable Annuity Transactions........................... 1-28[B][2][a] NASD’s Suitability Rule Applying to

Recommended Transactions—FINRARule 2111........................................................ 1-28

[B][2][b] Guidance Concerning Variable AnnuityExchanges........................................................ 1-29

[B][3] Controls Over Marketing Material: Review,Content, and Filing Requirements..................... 1-30

[B][4] Requirement to Adopt and Implement aSupervisory System Over Sales Activity............. 1-31

[B][4][a] Written Supervisory Procedures....................... 1-31[B][4][b] Chain of Supervision....................................... 1-31[B][4][c] Approval of Transactions................................. 1-31[B][4][d] Approval of Correspondence ........................... 1-31[B][4][e] Annual Compliance Meetings with

Representatives................................................ 1-31[B][4][f] Office Designations......................................... 1-32[B][4][g] Inspections ...................................................... 1-32[B][4][h] “Outside” Activities of a Representative.......... 1-32[B][4][i] Continuing Education Requirements .............. 1-32


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(Ins. Inv. Prods., 3rd ed., 11/18)

[B][5] Requirement to Establish an EffectiveCompliance Program ......................................... 1-33

[B][6] Controls Over Compensation............................ 1-33[B][7] Examinations and Enforcement......................... 1-33[C] Group Variable Annuities—Regulation Under

FINRA Rules .......................................................... 1-35§ 1:5.5 Marketing............................................................... 1-35

[A] Generally................................................................ 1-35[B] SEC Rules............................................................... 1-36[C] FINRA Rules .......................................................... 1-37

Chapter 2 Status of Insurance Products Under theSecurities Act of 1933Christopher S. Petito

§ 2:1 Overview......................................................................... 2-2§ 2:2 Section 3(a)(8): Exclusion for “Non-Securities” .............. 2-4

§ 2:2.1 The Statute .............................................................. 2-4§ 2:2.2 Supreme Court Cases .............................................. 2-5

[A] SEC v. VALIC ........................................................... 2-5[B] SEC v. United Benefit .............................................. 2-7

§ 2:2.3 Rule 151 Safe Harbor............................................. 2-11§ 2:2.4 Lower Court Cases Interpreting Section 3(a)(8)

and Rule 151.......................................................... 2-13[A] Olpin v. Ideal National Insurance Co. ................... 2-13[B] Peoria Union Stockyards Co. v. Pennsylvania

Mutual Life Insurance Co. ..................................... 2-15[C] Otto v. VALIC ......................................................... 2-15[D] Associates in Adolescent Psychiatry, S.C. v.

Home Life Insurance Co. ....................................... 2-17[E] Berent v. Kemper Corp........................................... 2-18[F] Malone v. Addison Insurance Marketing, Inc. ........ 2-18

§ 2:2.5 Vacated Rule 151A Proposal................................... 2-19§ 2:2.6 Section 989J of the Dodd-Frank Act ...................... 2-22

§ 2:3 Section 3(a)(2): Exemption for Contracts FundingQualified Plans ............................................................. 2-24

§ 2:4 Section 4(2): Exemption for Private Offerings .............. 2-25§ 2:5 The Securities Act—Status of Annuity Contracts ........ 2-25

§ 2:5.1 Traditional Fixed Annuities ................................... 2-25§ 2:5.2 Excess Interest Annuity Contracts......................... 2-26

[A] Nature of the Issuer ............................................... 2-27[B] Investment Risks Retained .................................... 2-27[B][1] Link to Separate Account Performance.............. 2-27[B][2] Guarantee of Non-forfeiture Rates .................... 2-28[B][3] Market Value Adjustments ................................ 2-29[B][4] Frequency of Declaration of Excess Rates.......... 2-31

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[C] Marketing............................................................... 2-31[D] Mortality Risks Assumed....................................... 2-33

§ 2:5.3 Indexed Annuities.................................................. 2-34[A] Nature of the Issuer ............................................... 2-37[B] Investment Risks Retained .................................... 2-37[B][1] Link to Separate Account Performance.............. 2-38[B][2] Guarantee of Non-forfeiture Rates .................... 2-38[B][3] Market Value Adjustments ................................ 2-39[B][4] Frequency of Declaration of Index-Based

Credits ............................................................... 2-39[C] Marketing............................................................... 2-40[D] Mortality Risks Assumed....................................... 2-41[E] State Regulation ..................................................... 2-41

§ 2:5.4 Variable Annuities.................................................. 2-42§ 2:6 The Securities Act—Status of Life Insurance

Contracts ...................................................................... 2-43§ 2:6.1 Traditional Term Life Insurance Contracts ............ 2-43§ 2:6.2 Whole Life Insurance Contracts ............................ 2-43§ 2:6.3 Universal Life Insurance Contracts ....................... 2-44§ 2:6.4 Indexed Universal Life Insurance Contracts .......... 2-44§ 2:6.5 Variable Universal and Variable Whole Life

Insurance Contracts............................................... 2-45

Chapter 3 Status of Insurance Companies andInsurance Company Separate AccountsUnder the Investment Company ActWendell M. Faria

§ 3:1 Introduction.................................................................... 3-2§ 3:2 What Is an Investment Company?................................. 3-4

§ 3:2.1 Section 3(a)(1)(A): The Orthodox InvestmentCompany ................................................................. 3-4

[A] Meaning of “Issuer”................................................. 3-5[B] Meaning of “Engaged Primarily” ............................. 3-7

§ 3:2.2 Section 3(a)(1)(B): The Face-Amount CertificateCompany ................................................................. 3-7

§ 3:2.3 Section 3(a)(1)(C): The Inadvertent InvestmentCompany ................................................................. 3-8

§ 3:2.4 Exclusions for Certain Holding Companies............. 3-9[A] Sections 3(b)(1) and 3(b)(2) ...................................... 3-9[A][1] Meaning of “Engaged Primarily” for Purposes

of Section 3(b).................................................... 3-10[B] Section 3(c)(6) ........................................................ 3-12


xxx

§ 3:2.5 Section 3(b)(3) ........................................................ 3-12§ 3:2.6 Exclusions for Various Other Companies .............. 3-13

§ 3:3 Status on Insurance Companies—Definitions ............. 3-13§ 3:3.1 Insurance Company............................................... 3-13§ 3:3.2 Meaning of “Primary and Predominant

Business Activity” .................................................. 3-13[A] Foreign Insurance Companies................................ 3-15

§ 3:4 Status of Variable Annuity Separate Accounts.............. 3-16§ 3:4.1 History ................................................................... 3-16

[A] The Prudential Decision ........................................ 3-16[B] Difficulties with the Prudential Decision: The

Legal Identity of the Separate Account .................. 3-17[C] Difficulties with the Prudential Decision:

Regulation As Periodic Payment Plans Underthe Investment Company Act................................ 3-19

§ 3:4.2 Current Regulation of Variable AnnuitySeparate Accounts.................................................. 3-20

[A] Investment Company Classification...................... 3-21[A][1] Open-End Management Companies.................. 3-22[A][2] Unit Investment Trusts ..................................... 3-22[A][2][a] Registration of Variable Annuity Separate

Accounts Organized As Unit InvestmentTrusts .............................................................. 3-25

[B] Rules Applying to Regulation of VariableAnnuity Separate Accounts.................................... 3-25

[B][1] Rule 11a-2 ......................................................... 3-26[B][2] Rule 14a-2 ......................................................... 3-26[B][3] Rules 15a-3, 16a-1, 32a-2.................................. 3-27[B][4] Rule 22d-2 ......................................................... 3-27[B][5] Rule 22e-1.......................................................... 3-28[C] Exemptive Relief Applicable to Variable

Annuities ............................................................... 3-28[C][1] Section 26(b) Relief ............................................ 3-29

§ 3:5 Status of Variable Life Insurance Separate Accounts .... 3-29§ 3:5.1 History ................................................................... 3-29§ 3:5.2 Regulation of Variable Life Insurance Company

Separate Accounts.................................................. 3-31[A] Rule 6e-2 ................................................................ 3-31[B] Rule 6e-3(T) ........................................................... 3-34[C] Exemptive Relief—Mixed and Shared Funding

Relief ...................................................................... 3-34§ 3:6 Other Separate Accounts .............................................. 3-39


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Chapter 4 Regulation of Variable Insurance ProductsUnder the Investment Company Act of 1940Gary E. Jenkins

§ 4:1 Introduction.................................................................... 4-2§ 4:2 Conceptual Framework Under the Investment

Company Act.................................................................. 4-4§ 4:2.1 Generally.................................................................. 4-4§ 4:2.2 Separate Accounts Under State and Federal Law..... 4-5§ 4:2.3 Variable Contracts Separate Accounts As

Investment Companies and UITs .......................... 4-12§ 4:2.4 UITs Under Investment Company Act

Section 12(d)1(E)—Contract Holder Voting andUnderlying Funds .................................................. 4-14

§ 4:3 Variable Insurance Contracts and the InvestmentCompany Act................................................................ 4-16

§ 4:3.1 Classification of Investment Companies ............... 4-16[A] Open- and Closed-End Funds—Diversified and

Non-Diversified Funds ........................................... 4-16§ 4:3.2 Registration of the Variable Separate Account and

the Variable Contract Offering................................. 4-17[A] Overview ................................................................ 4-17[B] Underlying Funds—Form N-1A............................. 4-19[C] Variable Contracts—Forms N-4 and N-6............... 4-22[D] Prospectus Updates ................................................ 4-24

§ 4:3.3 Organizational and Governance Requirements...... 4-25[A] Overview ................................................................ 4-25[B] Initial Funding ....................................................... 4-25[C] Custody.................................................................. 4-26[D] Election and Requirements of Board of

Directors—Underlying Funds ................................ 4-27[E] Approval of Advisory Fees ...................................... 4-31[F] Capital Structure—Senior Securities and

Preferential Rights.................................................. 4-34§ 4:3.4 Affiliated Transactions/Fiduciary Responsibility..... 4-36

[A] Overview ................................................................ 4-36[B] Principal Transactions............................................ 4-38[C] Joint Transactions .................................................. 4-39[D] Agency Transactions .............................................. 4-39[E] Fiduciary Responsibility ......................................... 4-40[F] Reasonableness Standard ....................................... 4-42[G] Fund Selection and Substitution............................ 4-44[H] Insurer Disclosure Liability.................................... 4-44


xxxii


§ 4:3.5 Valuation, Redemptions, Exchanges, andDistribution ........................................................... 4-45

[A] Valuation and the Forward Pricing Rule................. 4-45[B] Redemptions .......................................................... 4-47[C] Exchanges............................................................... 4-48[D] Distribution ........................................................... 4-50

§ 4:3.6 Administrative Considerations .............................. 4-53[A] Reporting................................................................ 4-53[B] Recordkeeping ........................................................ 4-55[C] Independent Accountant........................................ 4-56[D] Compliance Programs............................................ 4-57

§ 4:3.7 Other Considerations for Variable InsuranceContracts ............................................................... 4-58

[A] Insurance Dedicated Funds—DiversificationRequirements of Section 817(h) ............................. 4-58

[B] Mixed and Shared Funding .................................... 4-60[C] Summary Prospectus.............................................. 4-62

§ 4:4 Conclusion ................................................................... 4-66

Chapter 5 Tax Treatment of Variable ContractsJohn T. Adney & Joseph F. McKeever, III

§ 5:1 Introduction.................................................................... 5-2§ 5:2 Tax Definition of “Variable Contract” ............................ 5-2§ 5:3 Contractholder Tax Treatment........................................ 5-4

§ 5:3.1 General Contractholder Tax Rules ........................... 5-4[A] Life Insurance Contracts.......................................... 5-4[B] Annuity Contracts ................................................. 5-11[C] Modified Endowment Contracts ............................ 5-25[D] Long-Term Care Insurance Combination Products....5-26

§ 5:3.2 Special Contractholder Tax Rules Applicable toVariable Contracts.................................................. 5-27

[A] Diversification Rules (I.R.C. § 817(h)) ................... 5-28[A][1] General Diversification Test .............................. 5-29[A][2] Safe Harbor Test ................................................ 5-29[A][3] Alternative Test for Variable Life Contracts ....... 5-30[A][4] Rules of Application........................................... 5-30

Figure 5-1 Unacceptable Structure........................................... 5-35Figure 5-2 Acceptable Structure ............................................... 5-36

[A][5] Consequences of Nondiversification.................. 5-36[B] Investor Control..................................................... 5-37

§ 5:4 Insurance Company Tax Treatment ............................. 5-41

Appendix 5A Selected Sections of the Internal RevenueCode and Treasury Regulations.................. App. 5A-1

Appendix 5B Treasury Regulation § 1.817-5 ................... App. 5B-1

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Chapter 6 ERISA IssuesWilliam A. Schmidt & Kristina M. Zanotti

§ 6:1 Introduction.................................................................... 6-2§ 6:2 ERISA ............................................................................. 6-2

§ 6:2.1 Which Programs Are Covered.................................. 6-3§ 6:2.2 Exclusions from Coverage: Governmental and

Church Plans ........................................................... 6-7§ 6:3 Implications of ERISA Coverage..................................... 6-8§ 6:4 Reporting and Disclosure.............................................. 6-10

§ 6:4.1 Overview and Schedule A ...................................... 6-10§ 6:4.2 Schedule C ............................................................. 6-12§ 6:4.3 Service Provider Disclosures Under ERISA

§ 408(b)(2).............................................................. 6-14§ 6:4.4 Participant-Level Disclosures ................................. 6-15

§ 6:5 Fiduciary Responsibilities ............................................. 6-16§ 6:5.1 Overview ................................................................ 6-16§ 6:5.2 Fiduciary Status and Plan Assets ........................... 6-16§ 6:5.3 The “Plan Assets” Issue......................................... 6-20

§ 6:6 Application of the Fiduciary Responsibility Rules toVariable Annuity Contracts .......................................... 6-23

§ 6:7 Prohibited Transaction Restrictions .............................. 6-24§ 6:8 The Best Interest Contract Exemption......................... 6-30§ 6:9 Statutory Exemption for Investment Advice................. 6-31

§ 6:9.1 General Requirements for Computer Models ........ 6-32§ 6:9.2 Authorization, Disclosure, and Other

Requirements ......................................................... 6-34§ 6:9.3 Relief for Plan Sponsors ......................................... 6-36

§ 6:10 Conclusion ................................................................... 6-36

PART I-B:PRODUCT DESIGN

Chapter 7 Variable Insurance Product DesignChristopher E. Palmer

§ 7:1 Overview......................................................................... 7-2§ 7:2 Federal Regulatory Framework........................................ 7-4

§ 7:2.1 Pre-1996 Federal Regulation .................................... 7-4§ 7:2.2 The Reasonableness Standard.................................. 7-5§ 7:2.3 Unused Rulemaking Authority ................................ 7-6


xxxiv

§ 7:2.4 Mechanics of the Reasonableness Representation..... 7-7[A] Location and Language of Reasonableness

Representation ......................................................... 7-7[B] Supporting Memorandum........................................ 7-7

§ 7:2.5 Legislative History ................................................... 7-8§ 7:2.6 SEC Staff Guidance.................................................. 7-9§ 7:2.7 Factors to Consider in Assessing Reasonableness ..... 7-9

[A] “Services Rendered”................................................ 7-10[B] “Expenses Expected to Be Incurred”....................... 7-10[C] “Risks Assumed”.................................................... 7-10[D] Aggregate Charges Within Range of Industry

Practice................................................................... 7-11[E] Reasonable Profit.................................................... 7-11[F] Innovation.............................................................. 7-12[G] General Economic Factors and Industry Trends .... 7-12[H] Other Regulatory Requirements ............................. 7-12[I] Pre-NSMIA Standards............................................ 7-13[J] Other Considerations............................................. 7-13

§ 7:2.8 Underlying Fund Fees and Charges ....................... 7-13§ 7:2.9 Litigation Involving the Reasonableness

Standard................................................................. 7-15§ 7:2.10 Specific Contracts Fees and Charges...................... 7-15

[A] Mortality and Expense Risk Charges ..................... 7-16[B] Administrative Charges.......................................... 7-16[C] Cost of Insurance Charges..................................... 7-16[D] Sales Charges ......................................................... 7-17[E] DAC Taxes ............................................................. 7-17

§ 7:2.11 Required Liquidity Determination ......................... 7-18§ 7:3 Variable Annuity Product Design.................................. 7-19

§ 7:3.1 Overview ................................................................ 7-19§ 7:3.2 Specific Design Features......................................... 7-20

[A] Death Benefits........................................................ 7-20[B] Payout Options ...................................................... 7-21[C] Living Benefits........................................................ 7-22[D] Long-Term Care Benefits........................................ 7-23[E] Sales Charges ......................................................... 7-23[F] Purchases and Redemptions................................... 7-23[G] Partial Withdrawals................................................ 7-24[H] Nonforfeiture Law.................................................. 7-24[I] Free Look Period..................................................... 7-25[J] Other State Law Features....................................... 7-25

§ 7:4 Variable Life Product Design......................................... 7-25§ 7:4.1 Overview ................................................................ 7-25


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§ 7:4.2 Specific Design Features......................................... 7-27[A] Minimum Death Benefits and Grace Periods ........ 7-27[B] Purchases and Redemptions................................... 7-28[C] Partial Withdrawals................................................ 7-29[D] Mandatory Policy Provisions.................................. 7-29[D][1] Mandatory Disclosure ....................................... 7-29[D][2] Contestability Provisions ................................... 7-30[D][3] Free Look Period ................................................ 7-30[D][4] Other Mandatory Provisions ............................. 7-30

Chapter 8 The Funding VehicleC. Christopher Sprague, Esq.

§ 8:1 Regulation Under the Investment Company Act ........... 8-2§ 8:2 Unique Federal Tax Status of Underlying Mutual

Funds ................................................................................. 8-3§ 8:3 Mixed and Shared Funding............................................. 8-4§ 8:4 Rule 12b-1 Plans........................................................... 8-10§ 8:5 Participation Agreements.............................................. 8-12

§ 8:5.1 Purchases and Redemptions .................................. 8-12§ 8:5.2 Prospectuses and Sales Literature .......................... 8-13§ 8:5.3 Mixed and Shared Funding Provisions................... 8-13§ 8:5.4 Other Typical Provisions ........................................ 8-14

§ 8:6 Substitution of Underlying Funds Held by UITAccounts ....................................................................... 8-14

§ 8:6.1 Section 26(c) Applications ..................................... 8-16§ 8:7 Mutual Fund Redemption Fees..................................... 8-20§ 8:8 Rule 22e-3: Exemption for Liquidation of Money

Market Funds ............................................................... 8-22§ 8:9 Investment Company Liquidity Risk Management

Programs....................................................................... 8-25§ 8:10 Special Exemptions for Underlying Funds.................... 8-26§ 8:11 Fund Summary Prospectus ........................................... 8-28§ 8:12 State Regulation of Underlying Funds .......................... 8-30

Chapter 9 SEC RegistrationClifford E. Kirsch & Michael J. Mazza

§ 9:1 Introduction.................................................................... 9-2§ 9:2 Drafting Considerations ................................................. 9-3

§ 9:2.1 Requirement That Prospectuses Be Written inPlain English ............................................................ 9-3

§ 9:2.2 SEC Staff Insurance Products IndustryComment Letters..................................................... 9-5


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§ 9:3 Mechanics of the Registration Process forNew Products ................................................................. 9-5

§ 9:3.1 Filing the Initial Registration Statement.................. 9-5§ 9:3.2 Staff Review Process................................................. 9-6§ 9:3.3 Going Effective......................................................... 9-6§ 9:3.4 Registration Fees ...................................................... 9-7

§ 9:4 Prospectus Delivery and Updating Requirements........... 9-7§ 9:4.1 Requirement to Keep Prospectus Current ................ 9-8§ 9:4.2 Delivery of Updated Prospectus ............................... 9-8§ 9:4.3 Discontinued Contracts ........................................... 9-9

[A] Generally.................................................................. 9-9[B] Group Contracts .................................................... 9-10

§ 9:4.4 Delivery of One Prospectus to Investors WhoShare an Address—Householding .......................... 9-10

§ 9:4.5 Electronic Delivery of Prospectuses........................ 9-12§ 9:5 Mechanics of Updating the Prospectus......................... 9-12

§ 9:5.1 Post-Effective Amendments ................................... 9-13[A] Generally................................................................ 9-13[B] Text of Rule 485..................................................... 9-15

§ 9:5.2 Stickers................................................................... 9-20[A] Generally................................................................ 9-20[B] Text of Rule 497..................................................... 9-21

§ 9:5.3 The Yearly Update Season ..................................... 9-22§ 9:6 Forms N-3 and N-4—Registration Forms for

Variable Annuities......................................................... 9-22§ 9:6.1 Form N-4 Requirements ........................................ 9-23

§ 9:7 The Variable Annuity Profile ........................................ 9-35§ 9:8 Form N-6—Registration Form for Variable Life

Insurance ...................................................................... 9-36§ 9:8.1 Form N-6 Requirements ........................................ 9-37

§ 9:9 Form N-1A—Registration Form for UnderlyingFunds ............................................................................ 9-48

§ 9:9.1 Delivery of Fund Prospectus .................................. 9-48§ 9:10 Registering a Marketing Value Adjustment

Contract........................................................................ 9-49§ 9:10.1 Generally................................................................ 9-49§ 9:10.2 MVA Contracts and Exchange Act Reporting ........ 9-49

§ 9:11 Special Topics ............................................................... 9-50§ 9:11.1 Marketing Prior to an Effective Registration

Statement............................................................... 9-50[A] Legal Framework .................................................... 9-50[A][1] Permissible Marketing Activity During the

Waiting Period.................................................... 9-51[A][1][a] Oral Offers ...................................................... 9-52[A][1][b] Written Offers ................................................. 9-52

§ 9:11.2 Rule 38a-1 and the Registration Process................ 9-54

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Appendix 9A Form N-4 ................................................... App. 9A-1

Appendix 9B Form N-6 ................................................... App. 9B-1

Appendix 9C Industry Comment Letters.........................App. 9C-1

Appendix 9D Form N-4 Registration Statement DueDiligence Grid ............................................App. 9D-1

Chapter 10 State Contract IssuesCynthia J. Borrelli

§ 10:1 Regulation of Variable Products .................................... 10-2§ 10:2 State Standards for Contracts on a Variable Basis ........ 10-2§ 10:3 Alternatives to 50-State Filing and Approval................ 10-4

§ 10:3.1 Certification Filings on a State-by-State Basis ....... 10-4[A] “Unique Product Features or Design” .................... 10-4[B] The “Certification Memo” ..................................... 10-5[C] Regulatory Acknowledgement ................................ 10-6

§ 10:3.2 Interstate Product Regulation Compact ................. 10-6[A] The Compact ......................................................... 10-6[B] Variable Compact Products .................................... 10-8[C] IIPRC Procedures ................................................. 10-11[D] Compact Benefits................................................. 10-11[E] Noted Compact Product Exceptions .................... 10-12[F] Compact Product Uniformity .............................. 10-12

§ 10:4 Unique Products ......................................................... 10-13§ 10:4.1 Innovative Variable Products Developed

Post-1996 Amendments to the InvestmentCompany Act of 1940.......................................... 10-13

[A] Regulatory Issues Associated with NewProduct Designs ................................................... 10-14

[B] Disclosure Requirements Under GLBs................. 10-15[C] Reserve Liabilities for Guaranteed Minimum

Death Benefit (GMDB) Riders ............................. 10-16§ 10:4.2 Synthetic Guaranteed Investment Contract

(GIC) Forms......................................................... 10-18§ 10:5 Practical Tips for Policy Form Filing .......................... 10-19§ 10:6 Conclusion ................................................................. 10-21

Appendix 10A Summary of Five-Year Review Commentsand PSC Recommendations For UniformStandards in Phases 2, 3, and 4 of theFive-Year Review ...................................... App. 10A-1


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PART I-C:PRODUCT ADMINISTRATION

Chapter 11 Issues Related to Product AdministrationC. Christopher Sprague, Esq.

§ 11:1 Introduction.................................................................. 11-1§ 11:2 Variable Annuity Processing Issues............................... 11-2

§ 11:2.1 Two-Day/Five-Day Rule.......................................... 11-2§ 11:3 Group Variable Annuities ............................................. 11-4

§ 11:3.1 Principal Mutual No-Action Letter ........................ 11-5§ 11:4 Variable Life Processing Issues ...................................... 11-6§ 11:5 Processing of Premium Payments by the Insurer ......... 11-8§ 11:6 Allocation of Premiums During the Free Look Period .....11-9§ 11:7 Impact of Underlying Fund Redemption Fees ............ 11-11

Chapter 12 Redemption Fee RuleChristopher E. Palmer

§ 12:1 Overview....................................................................... 12-1§ 12:2 Administrative History ................................................. 12-2

§ 12:2.1 Proposal ................................................................. 12-2§ 12:2.2 Adoption ................................................................ 12-2§ 12:2.3 Amendments.......................................................... 12-3§ 12:2.4 Compliance Date ................................................... 12-3§ 12:2.5 Funds Covered by the Rule .................................... 12-4

§ 12:3 Redemption Fee ............................................................ 12-5§ 12:3.1 Board Determination ............................................. 12-5§ 12:3.2 Features of Any Redemption Fee............................ 12-6§ 12:3.3 Factors for Board Consideration ............................ 12-9

§ 12:4 Shareholder Information Agreements......................... 12-10§ 12:5 Industry Standardization Efforts ................................. 12-14§ 12:6 Implementation of Shareholder Agreement

Requirement ............................................................... 12-15§ 12:7 Variable Insurance Products Funds ............................. 12-18§ 12:8 Conclusion ................................................................. 12-21

Chapter 13 Insurer Exchange ProgramsClifford E. Kirsch & Jack Ewing

§ 13:1 Introduction.................................................................. 13-3§ 13:2 Text of Relevant Provisions........................................... 13-3

§ 13:2.1 Section 11—Offers to Exchange Securities ............ 13-3


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§ 13:2.2 Rule 11a-2—Offers of Exchange by CertainRegistered Separate Accounts or Others theTerms of Which Do Not Require PriorCommission Approval ........................................... 13-4

§ 13:3 Section 11 of the Investment Company Act ................ 13-7§ 13:3.1 Overview ................................................................ 13-7§ 13:3.2 Coverage of Section 11 .......................................... 13-8

[A] Exchange of Investment Company Security forAnother Investment Company Security................. 13-8

[A][1] Reallocation of Sub-Account Assets................... 13-8[A][2] Section 11 Coverage Summary.......................... 13-9[B] Internal Versus External Exchange Offers .............. 13-9[C] Covered Parties: Separate Account; Principal

Underwriters ........................................................ 13-10[D] Timing of Exchanges............................................ 13-11

§ 13:3.3 Exceptions to Section 11...................................... 13-12[A] Treatment of Retail Transactions: “The Retail

Exception” ............................................................ 13-12[B] Rule 11a-2............................................................ 13-14[B][1] Conditions of Rule 11a-2—Variable Life

Insurance Contracts ........................................ 13-15[B][2] Conditions of Rule 11a-2—Variable Annuity

Contracts ......................................................... 13-15[B][3] Conditions of Rule 11a-2-Reallocation of

Sub-Account Assets ......................................... 13-17[C] Exemptive Orders................................................. 13-17[C][1] Hartford Life Insurance Company—New

Contingent Deferred Sales Charge................... 13-19§ 13:4 Insurance Law Considerations ................................... 13-20

§ 13:4.1 State Regulation of Policy Replacements.............. 13-21[A] NAIC Model Unfair Trade Practices Act ............. 13-21[B] NAIC Replacement of Life Insurance and

Annuities Model Regulation ................................ 13-22[B][1] Exceptions for Certain Exchange Offers .......... 13-23

§ 13:4.2 Relationship to Section 11 Exchange Offers ........ 13-23[A] Comparison of Section 11 with State

Insurance Rules.................................................... 13-23


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PART I-D:PRODUCT DISTRIBUTION

Chapter 14 SEC Regulation of Product DistributionClifford E. Kirsch

§ 14:1 Introduction.................................................................. 14-2§ 14:2 Broker-Dealer Registration............................................ 14-3

§ 14:2.1 Registration of an Insurance Company/InsuranceCompany Subsidiary—Exchange Act ReleaseNo. 8389 ................................................................. 14-3

§ 14:2.2 Registration of an Insurance Agency...................... 14-4§ 14:3 Registration As a Transfer Agent .................................. 14-6§ 14:4 Recordkeeping Requirements ........................................ 14-8

§ 14:4.1 Required Records.................................................... 14-8§ 14:4.2 Preservation of Records ........................................ 14-16

[A] Time Period.......................................................... 14-16[B] Location ............................................................... 14-16[C] Requirements to Maintain Records at

an Office .............................................................. 14-16§ 14:4.3 Recordkeeping—Insurance Company Subsidiary

Registered As a Broker-Dealer ............................... 14-18§ 14:5 Financial Reporting..................................................... 14-18

§ 14:5.1 Financial Statements............................................ 14-18§ 14:5.2 FOCUS Reports ................................................... 14-19§ 14:5.3 Form Custody ...................................................... 14-19

§ 14:6 Net Capital Requirements .......................................... 14-19§ 14:6.1 Required Level of Net Capital .............................. 14-19§ 14:6.2 Restrictions on Withdrawals of Equity Capital ..... 14-20

§ 14:7 Customer Protection Rule .......................................... 14-20§ 14:8 SIPC Membership....................................................... 14-21§ 14:9 Payment of Commissions........................................... 14-22

§ 14:9.1 Payment of Commissions to Captive Agents ...... 14-22§ 14:9.2 Payment of Commissions to an Insurance

Agency.................................................................. 14-22§ 14:10 Broker-Dealer Standard of Care—Proposed

Regulation Best Interest.............................................. 14-23§ 14:10.1 Background—Compensation Related Conflicts ..... 14-23§ 14:10.2 SEC Regulation Best Interests Proposal ............... 14-24

§ 14:11 Effecting Transactions................................................. 14-25§ 14:11.1 Insurance Company’s Role in Effecting Variable

Product Transactions............................................. 14-25§ 14:11.2 Settlement of Transactions .................................. 14-26


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§ 14:11.3 Confirmation Requirements ................................ 14-26[A] Immediate Confirmation Requirements:

Rule 10b-10(a)...................................................... 14-27[B] Quarterly Confirmation Requirements:

Rule 10b-10(b)...................................................... 14-28[C] SEC Exemptive Authority .................................... 14-29[D] Special Considerations Applicable to Variable

Products ............................................................... 14-29§ 14:12 Duty to Supervise ....................................................... 14-30§ 14:13 SEC Exam and Enforcement Authority ...................... 14-31

Chapter 15 FINRA Regulation of Product DistributionSusan S. Krawczyk

§ 15:1 Introduction.................................................................. 15-8§ 15:1.1 Origin of the NASD............................................... 15-9

[A] Industry Interest in a Self-RegulatoryOrganization .......................................................... 15-9

[B] Legislation Authorizing National SecuritiesAssociations ........................................................... 15-9

[C] NASD Registration As a National SecuritiesAssociation........................................................... 15-10

[D] Subsequent Amendments to the Maloney Act..... 15-10§ 15:1.2 Rules Governing FINRA As a National

Securities Association .......................................... 15-11[A] Powers and Duties ............................................... 15-11[B] SEC Oversight of Self-Regulatory Organizations.....15-11[B][1] SEC Approval of Rules and Rule Changes ....... 15-12[B][2] SEC Examinations of SROs............................. 15-13[B][3] SEC Review of Disciplinary Actions and

Other Determinations ..................................... 15-13§ 15:1.3 FINRA Operational Structure .............................. 15-14

[A] Original Structure ................................................ 15-14[B] Re-Examination of the NASD’s Structure ........... 15-15[B][1] Rudman Report................................................ 15-15[B][2] Justice Department Settlement........................ 15-16[B][3] SEC Consent Order and Section 21(a) Report.....15-16[C] Plan of Allocation—1996 to 2002 ....................... 15-17[D] Divisional Structure ............................................. 15-20[E] FINRA: Consolidation of the NASD and

Certain NYSE Operations .................................... 15-21§ 15:1.4 FINRA Rule Material and Guidance.................... 15-22

[A] FINRA By-Laws.................................................... 15-22[B] NASD Rules......................................................... 15-23[C] Interpretive Material ............................................ 15-24


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[D] Other Guidance ................................................... 15-24[D][1] Interpretive Letters and Exemptions................ 15-24[D][2] Notices to Members and Regulatory Notices .....15-25[D][3] NASD Regulatory & Compliance Alert ........... 15-25[D][4] Other FINRA Publications............................... 15-26[D][5] FINRA Website ................................................ 15-26

§ 15:1.5 Other Functions Performed by FINRA ................ 15-26[A] Central Registration Depository (CRD) System

and Investment Adviser RegistrationDepository............................................................ 15-27

[B] Review of Investment Company AdvertisingMaterial................................................................ 15-28

[C] Continuing Education Program ........................... 15-28[D] Investor Education ............................................... 15-29[E] Arbitration and Mediation ................................... 15-30

§ 15:2 Historical Overview of FINRA Regulation ofBroker-Dealers Selling Variable Contracts................... 15-30

§ 15:2.1 Early NASD Regulation of Members SellingVariable Contracts................................................ 15-30

[A] Voluntary Membership ........................................ 15-31[B] Establishment of the Variable Contracts

Committee ........................................................... 15-32[C] Variable Contracts Rule........................................ 15-32[D] Examination Requirements.................................. 15-34[E] Dealing with Non-Members ................................ 15-35

§ 15:2.2 Later Developments ............................................. 15-36[A] Mandatory Membership Requirement ................. 15-36[B] Regulation of Member Activity in Qualified

Contracts ............................................................. 15-37[C] Defined Variable Annuities Rule .......................... 15-38

§ 15:3 FINRA Membership ................................................... 15-39§ 15:3.1 Applying for Membership .................................... 15-40

[A] Membership Application...................................... 15-40[B] Designation of Executive Representative.............. 15-41[C] Designation of Offices.......................................... 15-41[D] Minimum Number of Principals ......................... 15-42[E] Limits on Member Names and

Organizational Forms .......................................... 15-43[F] Additional Registrations....................................... 15-44

§ 15:3.2 FINRA Membership Admission Process .............. 15-45[A] District Office Review .......................................... 15-45[B] Membership Interview ......................................... 15-45[C] Standards for Admission...................................... 15-46[D] Restrictions and Conditions ................................ 15-46


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[E] Membership Agreement....................................... 15-46[F] Appeal Process ..................................................... 15-47

§ 15:3.3 Impact of Other Business Activities..................... 15-48[A] Mutual Fund Sales ............................................... 15-49[B] Retail Brokerage Activities ................................... 15-49[C] Retail Investment Advisory Operations and

Financial Planning Services.................................. 15-50[D] Mutual Fund Investment Advisory Operations..... 15-51[E] Insurance Products............................................... 15-51[F] Certificates of Deposit and Other Bank

Products ............................................................... 15-52[G] Activities in Foreign Jurisdictions ........................ 15-53[H] 529 Plans ............................................................. 15-54

§ 15:3.4 Subsequent Filings and Changes Relating toMembership or Permissible Operations ............... 15-54

[A] Changes in Form BD ........................................... 15-55[B] Changes in Member Name or Executive

Representative ...................................................... 15-55[C] Changes in Office Locations or Supervisors......... 15-55[D] Changes in Restrictions ....................................... 15-55[E] Changes in Ownership, Control, or Operations .....15-56[F] Changes in Status Under the Customer

Protection Rule..................................................... 15-57[G] Business Continuity Plans ................................... 15-58

§ 15:3.5 Termination of Membership ................................ 15-58§ 15:4 Registration of Principals and Representatives ........... 15-59

§ 15:4.1 Registration Requirements ................................... 15-59[A] Definition of “Associated Person” ........................ 15-59[B] Definition of “Principal” ...................................... 15-60[C] Definition of “Representative” ............................. 15-60[D] Definition of “Engaged in the Investment

Banking or Securities Business” ........................... 15-61[E] Exemptions .......................................................... 15-62[E][1] Clerical Employees........................................... 15-62[E][2] Directors and Corporate Officers..................... 15-63[E][3] Home Office and Service Center Employees..... 15-64[E][4] Foreign Finders ................................................ 15-65

§ 15:4.2 Qualification and Registration Process ................ 15-65[A] FINRA Qualification Requirements ..................... 15-65[B] Examinations and Categories of Registration ...... 15-66[C] Application and Approval .................................... 15-68[D] Other Registration Issues..................................... 15-68[D][1] Minimum Number of Principals ..................... 15-68[D][2] Change in Principal Status .............................. 15-69[D][3] Registration Renewals...................................... 15-69


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§ 15:4.3 Background Investigation and Hiring Practices..... 15-69[A] Duty to Review Form U-4 and Form U-5

History ................................................................. 15-70[B] Best Hiring Practices ............................................ 15-70[C] Non-Registered Persons........................................ 15-71

§ 15:4.4 Employment Issues .............................................. 15-72[A] Employee Versus Independent Contractor ........... 15-72[B] Associated Person Agreements............................. 15-73[C] Dual Registration ................................................. 15-73[D] FINRA Arbitration Procedures ............................. 15-73

§ 15:4.5 Continuing Obligations and RequirementsApplicable to Registered Persons.......................... 15-74

[A] Duties and Obligations ........................................ 15-74[B] Reporting Obligations .......................................... 15-75[C] Continuing Education Requirements................... 15-75[C][1] Regulatory Element.......................................... 15-75[C][2] Firm Element................................................... 15-77[D] Disclosures to Associated Persons ....................... 15-79

§ 15:4.6 Termination of Registration ................................. 15-79§ 15:4.7 Transferring Registration from One Member

to Another............................................................ 15-80§ 15:5 Overview of Supervision Requirements ...................... 15-80

§ 15:5.1 The Supervision Rule........................................... 15-80[A] Written Supervisory Procedures ........................... 15-81[B] Chain of Supervision ........................................... 15-82[B][1] Qualified Supervisors....................................... 15-83[B][2] Principal/Representative Ratios........................ 15-84[B][3] Compliance Officers ........................................ 15-85[C] Approval of Transactions ..................................... 15-85[D] Approval of Correspondence ................................ 15-86[E] Internal Inspections ............................................. 15-88[F] Annual Compliance Meetings with

Representatives..................................................... 15-89§ 15:5.2 Office Designations.............................................. 15-91

[A] Office of Supervisory Jurisdiction......................... 15-92[B] Branch Office ....................................................... 15-93[C] Non-Branch Locations ......................................... 15-93[D] Proposed Amendments to Branch Office

Definition............................................................. 15-95§ 15:5.3 Use of Compliance Manuals and Other

Procedures............................................................ 15-95[A] Manuals ............................................................... 15-95[B] Exception and Activity Reports ............................ 15-96[C] Compliance Audits and Other Sampling

Techniques ........................................................... 15-97


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§ 15:5.4 Outside Activities................................................. 15-97[A] Dual Registration ................................................. 15-98[B] Accounts with Other Institutions ........................ 15-98[C] Other Activities.................................................... 15-99[C][1] Private Securities Transaction........................ 15-100[C][2] Outside Business Activities ........................... 15-101[C][3] Applicability to Investment Adviser

Activities........................................................ 15-101[C][4] Applicability to Viaticals and Life

Settlements .................................................... 15-102[C][5] Applicability to Promissory Notes and

Other Instruments......................................... 15-103§ 15:5.5 Special Supervisory Situations ........................... 15-103

[A] Guidance for Supervision of Remote Locations.....15-103[B] Guidance for Supervision of Certain

Registered Persons.............................................. 15-104[B][1] Identifying Problem Representatives.............. 15-105[B][2] Guidelines...................................................... 15-105[C] Guidance for Telemarketing Activities ............... 15-106

§ 15:5.6 Anti-Money Laundering CompliancePrograms ............................................................ 15-107

[A] Customer Identification Requirements .............. 15-109§ 15:5.7 Supervisory Controls.......................................... 15-109§ 15:5.8 CEO Certification and Designation of Chief

Compliance Officer ............................................ 15-110§ 15:5.9 Outsourcing ....................................................... 15-110

§ 15:6 Sales and Advertising Practices................................. 15-111§ 15:6.1 Variable Contracts Rule...................................... 15-111

[A] Distribution and Selling Agreements ................. 15-111[B] Compliance with Pricing Rule ........................... 15-111[C] Sales Charges ..................................................... 15-112[D] Sales Compensation........................................... 15-112[E] Comparison with the Investment Company

Rule .................................................................... 15-112[F] Proposed Amendments ...................................... 15-113

§ 15:6.2 The Deferred Variable Annuities Rule ............... 15-113§ 15:6.3 The Suitability Rule ........................................... 15-116

[A] Recommendation ............................................... 15-116[B] Customer Profile ................................................ 15-117[C] Institutional Investors........................................ 15-119[D] Guidance for Variable Contracts ........................ 15-120[E] Know-Your-Customer Rule ................................. 15-123

§ 15:6.4 Advertising and Customer Communications .... 15-124[A] Rules Governing Communications.................... 15-124


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[B] Review, Approval, and Record-KeepingRequirements ..................................................... 15-125

[B][1] Advertisements and Sales Literature.............. 15-125[B][1][a] Research Reports and Reprints.................... 15-125[B][1][b] Seminars and Radio Talk Shows ................. 15-126[B][1][c] Correspondence........................................... 15-126[B][1][d] Institutional Sales Materials ....................... 15-127[B][1][e] Electronic Communications........................ 15-127[B][2] Internal Review and Approval Procedures ..... 15-128[B][3] FINRA Filing and Approval Requirements

for Investment Company Material ................ 15-129[B][3][a] What Is Investment Company Material? ..... 15-130[B][3][b] Timing of Filing .......................................... 15-130[B][3][c] Record-Keeping Requirements..................... 15-131[C] Variable Contract Guidelines ............................. 15-131[C][1] Variable Annuity Tax Deferral Illustrations......15-132[C][2] Personalized Variable Life Hypothetical

Illustrations ................................................... 15-132[C][3] Fund Performance.......................................... 15-133[D] Other Content Standards for Communications ....15-133[D][1] General Fairness and Balance Standards ....... 15-134[D][2] Rankings Disclosure ...................................... 15-134[D][3] Dollar Cost Averaging and Other Periodic

Investment Plans ........................................... 15-135[D][4] Testimonials .................................................. 15-135[D][5] References to Tax-Advantaged Status............. 15-135[D][6] Comparisons.................................................. 15-136[D][7] Use of Index Returns..................................... 15-136[E] Specific Disclosures Required............................. 15-136[E][1] Member Name............................................... 15-136[E][1][a] Business Cards and Stationery.................... 15-137[E][1][b] Use of Logos................................................ 15-138[E][2] Date of First Use ........................................... 15-138[E][3] Bank Disclosure............................................. 15-138

§ 15:6.5 Other Business Conduct and Sales PracticeRules .................................................................. 15-139

[A] Sales Presentations............................................. 15-139[B] Cold Calling and Telemarketing Practices ......... 15-141[C] Bank Broker-Dealer Rule .................................... 15-142[D] General Standards of Business Conduct ............ 15-143

§ 15:7 Compensation .......................................................... 15-145§ 15:7.1 Rules Specifically Applicable to Variable

Contract Compensation Arrangements ............. 15-145


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[A] Current Rules..................................................... 15-145[A][1] Dealing Only with Members ......................... 15-145[A][2] Limits on Sales Charges ................................ 15-145[A][3] Refunds and Commission-Netting

Practices......................................................... 15-146[A][4] Regulation of Cash and Non-Cash

Compensation ............................................... 15-146[A][4][a] Associated Person Receipt of

Compensation............................................. 15-148[A][4][b] Prohibition on Non-Cash Compensation .... 15-149[A][4][c] Record-Keeping Requirements..................... 15-151[A][4][d] Applicability to Exempted Securities........... 15-152[B] Proposed Rule Changes...................................... 15-152

§ 15:7.2 General Rules Governing Compensation........... 15-152[A] Payments to Non-Members ............................... 15-152[B] Payments to Associated Persons ........................ 15-153[C] Payments to Another Member ’s Associated

Person ................................................................ 15-153[D] Payments to Former Registered Persons............. 15-155[E] Assignments by Associated Persons................... 15-155[F] Referral Fees and Transaction-Based

Compensation.................................................... 15-156[G] Payments to Customers ..................................... 15-157

§ 15:7.3 Sales Practices Issues Involving CompensationArrangements...................................................... 15-157

[A] Guidance Concerning Mutual Fund SalesPractices ............................................................. 15-158

[B] Tully Committee................................................ 15-158[C] FINRA Study on Compensation ........................ 15-159

§ 15:8 Customer Accounts and Complaints ....................... 15-160§ 15:8.1 Establishment and Maintenance of Customer

Accounts ............................................................ 15-160[A] Customer Accounts and Files ............................ 15-160[B] Customer Agreements ....................................... 15-162[C] Acceptance of Accounts ..................................... 15-162[D] Approval of Transactions and Correspondence.....15-163[E] Release of Confidential Information .................. 15-163[F] Customer Account Transfer ............................... 15-164

§ 15:8.2 Customer Complaints ....................................... 15-165[A] Resolution of Customer Complaints ................. 15-165[B] Settlement Agreements ...................................... 15-165[C] Reporting Requirements..................................... 15-165

§ 15:8.3 Handling Customer Funds, Applications,and Requests ...................................................... 15-166


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§ 15:8.4 Customer Disclosures and Provision ofInformation........................................................ 15-167

[A] Confirmations.................................................... 15-168[B] Control Relationship.......................................... 15-168[C] Notice of Public Disclosure Program ................. 15-168[D] Customer Account Statements .......................... 15-169[E] Other Information for Customers...................... 15-169

§ 15:9 FINRA Record-Making, Record-Keeping, andReporting Requirements ........................................... 15-170

§ 15:9.1 FINRA Record-Making and Record-KeepingRequirements ..................................................... 15-170

[A] SEC Records....................................................... 15-170[B] Customer Account Records................................ 15-171[C] Transaction Records ........................................... 15-171[D] Correspondence Files ......................................... 15-171[E] Advertising Files................................................. 15-172[F] Due Diligence Files ............................................ 15-172[G] Customer Complaint Files................................. 15-172[H] Do-Not-Call Lists .............................................. 15-172[I] Associated Person Files ...................................... 15-173[J] Training, Supervision, and Continuing

Education Files................................................... 15-173[K] Foreign Finders and Other Compensation

Payments............................................................ 15-174[L] Outside Activities Records ................................. 15-174[M] FINRA Manual .................................................. 15-174[N] Application Materials and Bad Acts................... 15-174[O] Reports and Filings ............................................ 15-174

§ 15:9.2 Reporting Requirements..................................... 15-174[A] Bad Act Reporting Requirements ....................... 15-175[B] Quarterly Complaints Reporting

Requirements ..................................................... 15-176[C] Changes in Form BD or Membership

Application Information .................................... 15-176[D] Annual Assessment Reports and Renewal Fees .....15-176[E] Form U-4 and Form U-5 Filings........................ 15-177[F] Registered Person Reporting Requirements ........ 15-177

§ 15:10 Citations for NASD Rules ........................................ 15-177


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VOLUME 2

Table of Chapters............................................................................vii

Chapter 16 FINRA Suitability, Supervision, andSales PracticesClifford E. Kirsch

§ 16:1 Background ................................................................... 16-2§ 16:2 FINRA Regulatory Framework...................................... 16-3

§ 16:2.1 General FINRA Rules Applying to All Securities .... 16-3[A] The Suitability Rule ............................................... 16-3[A][1] Text of New Suitability Rule—FINRA

Rule 2111 (Suitability) (Effective July 9,2012—Replaced NASD Rule 2310) ................... 16-3

[A][2] Discussion of FINRA’s General Suitability Rule... 16-6[A][2][a] Old NASD Conduct Rule 2310....................... 16-6[A][2][b] FINRA Rule 2111 (Suitability) ........................ 16-7[A][2][b][i] Recommendations to Customers................. 16-8[A][2][b][ii] What Are Investment Strategies?................. 16-9[A][2][b][iii] Reasonable-Basis; Customer-Specific;

Quantitative Suitability ............................. 16-10[A][2][b][iv] Customer ’s Investment Profile .................. 16-11[A][2][b][v] Institutional Investors ............................... 16-11[A][2][c] FINRA Rule 2090 (Know Your Customer)

(Effective July 9, 2012) .................................. 16-13[A][3] General Interpretative Questions Regarding

the Application of FINRA’s GeneralSuitability Rule to Variable Products................ 16-14

[A][3][a] Duty Runs to FINRA Members .................... 16-14[A][3][b] Duty Runs to Transactions Involving a

“Recommendation” ....................................... 16-14[A][3][c] Application of the Suitability Rule to

Third-Party Sales........................................... 16-15[B] Other Relevant FINRA General Rules.................. 16-16[B][1] Supervisory Systems ........................................ 16-16[B][2] Customer Account Requirements.................... 16-17

§ 16:2.2 FINRA Rulemaking and Related GuidanceSpecific to Variable Product Sales......................... 16-17

[A] Reminder That Sales of Variable ContractsAre Subject to FINRA SuitabilityRequirements: 1996 ............................................. 16-17

[B] Sale of Variable Annuities: 1999 .......................... 16-18[C] Sale of Variable Life Insurance: 2000 ................... 16-18


l

[D] Replacement of Annuities’ Impact on ContractValue and Death Benefit—Regulatory &Compliance Alert: 2002; Notice toMembers 05-50 ..................................................... 16-19

[E] Application of Suitability Rule to TransactionsWhere Registered Product Is Sold to PurchaseUnregistered Product—Regulatory & ComplianceAlert: 2002; Notice to Members 05-50 ....................16-20

[F] SEC/NASD Joint Report: 2004 ............................ 16-20[G] FINRA Rule 2330—Supervision and Suitability

of Annuity Transactions ........................................ 16-21[G][1] Text of FINRA Rule 2330 ................................ 16-21[G][2] Coverage .......................................................... 16-27[G][3] Recommendation Requirements ...................... 16-27[G][4] Principal Review and Approval ........................ 16-28[G][4][a] Prompt Transmittal Requirement ................. 16-29[G][5] Supervisory Procedures and Training............... 16-30

§ 16:2.3 FINRA Enforcement and Examinations............... 16-30[A] Background .......................................................... 16-30[B] “L” Shares............................................................. 16-32[C] Guarantees ........................................................... 16-32[D] Exchanges............................................................. 16-33[E] New York Regulation 60 ...................................... 16-33[F] Supervision of Redemption .................................. 16-34[G] Broker-Dealer Access to Variable Annuity

Transaction Data.................................................. 16-34

Chapter 17 State Insurance Regulation Applying to theDistribution of Variable Insurance ProductsClifford E. Kirsch & Issa Hanna

§ 17:1 Introduction.................................................................. 17-2§ 17:2 State Insurance Licensing Requirements for

Distributors of Variable Insurance Products ................. 17-2§ 17:2.1 State Regulatory Framework .................................. 17-2§ 17:2.2 New NAIC Model Licensing Act Approach ........... 17-3

§ 17:3 State Insurance Suitability............................................ 17-4§ 17:3.1 State Regulatory Framework .................................. 17-4§ 17:3.2 NAIC Model Variable Life Insurance Regulation .... 17-5§ 17:3.3 NAIC Suitability in Annuity Transactions

Model Regulation................................................... 17-5Table 17-1 Model Regulation Developments............................ 17-5

[A] Customer Information........................................... 17-6[B] Supervisory Program .............................................. 17-6[C] Records................................................................... 17-6


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§ 17:3.4 2010 Amendments ................................................ 17-6§ 17:3.5 Insurer Supervisory Programs ................................ 17-7§ 17:3.6 State Adoption of the Model Annuity

Suitability Regulation............................................. 17-8§ 17:3.7 NAIC Annuity Suitability (A) Working Group’s

Efforts to Revise the Model Annuity SuitabilityRegulation .............................................................. 17-8

§ 17:3.8 New York Insurance Regulation 187: Suitabilityand Best Interests in Life Insurance andAnnuity Transactions ............................................ 17-10

[A] Best Interest Duties and Obligations forInsurers ................................................................ 17-11

[B] Best Interest Duties and Obligations forProducers.............................................................. 17-12

Chapter 18 Replacement of Insurance ProductsDaniel W. Krane & Elizabeth A. Diffley

§ 18:1 Introduction.................................................................. 18-3§ 18:2 Background ................................................................... 18-5

§ 18:2.1 Definition of a Replacement .................................. 18-5§ 18:2.2 Early Regulation of Replacements .......................... 18-7

[A] State Regulation ..................................................... 18-7[B] Federal Regulation.................................................. 18-9

§ 18:2.3 Bonus Annuities .................................................. 18-11§ 18:2.4 Recent Developments .......................................... 18-12

§ 18:3 Federal Regulation of Replacements ........................... 18-17§ 18:3.1 Suitability............................................................. 18-17§ 18:3.2 Duty of Fair Dealing ............................................ 18-22§ 18:3.3 Disclosure ............................................................ 18-23§ 18:3.4 Supervision .......................................................... 18-25

§ 18:4 State Regulation.......................................................... 18-29§ 18:4.1 State Replacement Regulation.............................. 18-29

[A] NAIC Model Regulations..................................... 18-29[A][1] Life Insurance and Annuities Replacement

Model Regulation............................................. 18-30[A][1][a] Scope and Application................................... 18-32[A][1][b] Duties of Producers....................................... 18-33[A][1][c] Duties of Insurers That Use Producers......... 18-34[A][1][d] Duties of Replacing Insurers That Use

Producers....................................................... 18-36[A][1][e] Duties of the Existing Insurer ....................... 18-37[A][1][f] Duties of Insurers with Respect to Direct

Response Solicitations................................... 18-38[A][1][g] Violations and Penalties................................ 18-38


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[B] Suitability in Annuity Transactions ModelRegulation ............................................................ 18-40

[B][1] Scope and Application ..................................... 18-41[B][2] Suitability ........................................................ 18-42[B][3] Supervision ...................................................... 18-44[B][4] Insurance Producer Training............................ 18-45[B][5] Compliance; Mitigation; Penalties................... 18-46[B][6] State Reaction to the Suitability in Annuity

Transactions Model ......................................... 18-46[C] Model Unfair Trade Practices Act ........................ 18-47

§ 18:4.2 State Statutes and Regulations............................. 18-49[A] New York State Insurance Department

Regulation 60....................................................... 18-49[A][1] Scope and Application ..................................... 18-51[A][2] Duties of Producers ......................................... 18-53[A][3] Duties of All Insurers ...................................... 18-54[A][4] Duties of Replacing Insurers............................ 18-55[A][5] Existing Insurers .............................................. 18-56[A][6] Prohibited Acts ................................................ 18-57[A][7] Market Conduct Exams and Disciplinary

Action .............................................................. 18-58[B] California ............................................................. 18-61[C] Florida .................................................................. 18-65[D] Illinois.................................................................. 18-67[E] Pennsylvania ........................................................ 18-68

§ 18:4.3 State Securities Laws............................................ 18-69

Chapter 19 AdvertisingClifford E. Kirsch

§ 19:1 Overview....................................................................... 19-3§ 19:2 Content Requirements.................................................. 19-4

§ 19:2.1 SEC Content Requirements ................................... 19-4[A] Background ............................................................ 19-5[B] Permissible Types of Marketing Material ............... 19-5[B][1] Advertisements .................................................. 19-6[B][1][a] Omitting Prospectuses: Rule 482

Advertisements................................................ 19-6[B][1][b] Generic Advertisements .................................. 19-7[B][2] Supplemental Sales Literature ........................... 19-7[C] Standards ............................................................... 19-8

§ 19:2.2 FINRA Content Requirements............................... 19-8[A] FINRA Communication Categories ....................... 19-9[A][1] Retail Communications................................... 19-10


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[A][2] Institutional Communications ........................ 19-10[A][2][a] Internal Communications............................. 19-11[A][2][b] “Reason to Believe” Standard ........................ 19-11[A][3] Correspondence ............................................... 19-12[A][3][a] Prior Definition of Correspondence .............. 19-12[B] Requirements As to Content ............................... 19-13[B][1] General Content Standards Applicable to

All Communications with the Public.............. 19-13[B][2] Predictions and Projections.............................. 19-14[B][3] Bond Fund Volatility Ratings........................... 19-14[B][4] Testimonials .................................................... 19-15[B][5] Use and Disclosure of Member ’s Name.......... 19-15[B][6] Comparisons.................................................... 19-17[B][7] Performance Figures ........................................ 19-17[B][8] Tax ................................................................... 19-18[B][8][a] Tax-Deferral Illustrations .............................. 19-18[B][9] Specific Content Standards Applicable to

Variable Life and Variable Annuity Products ..... 19-19§ 19:2.3 State Content Requirements ................................ 19-21

[A] Applicability: Definition of Advertising ............... 19-21[B] Requirements As to Content ............................... 19-22[B][1] General Standards ........................................... 19-22[B][2] Specific Disclosure Requirements .................... 19-22[B][3] Identity of Insurer and Policies........................ 19-23

§ 19:3 Internal Review and Recordkeeping Procedures.......... 19-24§ 19:3.1 SEC Internal Review Requirements ..................... 19-24§ 19:3.2 FINRA Internal Review and Recordkeeping

Requirements ....................................................... 19-24[A] Institutional Sales Material.................................. 19-24[B] Correspondence.................................................... 19-25[C] Material Used by Intermediary Firms.................. 19-25[D] Other Exceptions: Market Letters, Online Posts,

and Administrative Communications................... 19-26§ 19:3.3 State Internal Review and Recordkeeping

Requirements ....................................................... 19-26§ 19:4 Filing Requirements.................................................... 19-27

§ 19:4.1 Requirements to File Sales Material withthe SEC................................................................ 19-27

§ 19:4.2 FINRA Filing Requirements................................. 19-27[A] FINRA Review Procedure ..................................... 19-27[B] Exceptions to the Filing Requirements ................ 19-28[B][1] Retail Communications................................... 19-28[B][1][a] Generic Fund Communications.................... 19-28[B][1][b] Backup Material for Investment Company

Performance Rankings and Comparisons ...... 19-28


liv

[B][1][c] Investment Analysis Tools ............................ 19-28[B][1][d] Bond Fund Volatility Ratings ........................ 19-29[B][2] Institutional Sales Material and

Correspondence ............................................... 19-29[B][2][a] For “Internal Use Only” ............................... 19-29[B][3] Prospectuses..................................................... 19-30[B][4] Updates of Previously Filed Material ............... 19-30[B][5] Unregistered Group Variable Annuities ........... 19-30[B][6] Advisory Services ............................................. 19-31[B][7] Listing of Available Securities .......................... 19-31[B][8] Traditional Products ........................................ 19-31[B][9] Extemporaneous Statements at Seminars........ 19-32[B][10] Independently Prepared Reprints ..................... 19-32[B][11] Online Communications................................. 19-32[B][12] Templates......................................................... 19-32

§ 19:4.3 State Filing Requirements .................................... 19-33§ 19:5 Specific Types of Variable Products Sales Literature ..... 19-33

§ 19:5.1 Performance Advertising ...................................... 19-33[A] Variable Annuity Performance Advertising........... 19-34[A][1] Fund Performance Pre-Dating the Fund’s

Inclusion in a Variable Product........................ 19-34[A][2] Related Performance ........................................ 19-35[A][2][a] Inclusion of Related Performance

Information in a Prospectus.......................... 19-36[A][2][b] Inclusion of Related Performance in

Advertising and Sales Literature.................... 19-37[A][2][b][i] Related Performance Distributed to

Institutional Investors ............................... 19-38[A][3] FINRA Guidance: Back-Tested Index

Performance/Institutional Communication...... 19-41[B] Variable Life Performance..................................... 19-41

§ 19:5.2 Variable Annuity Tax-Deferral Illustrations ......... 19-44§ 19:5.3 Investment Analysis Tools ................................... 19-45§ 19:5.4 Hypothetical Illustration of Mathematical

Principles ............................................................. 19-45§ 19:5.5 Customized Hypothetical Investment Planning

Illustrations ........................................................... 19-46§ 19:5.6 Interactive Computer Software Programs That

Compare Variable Annuities to Mutual Funds...... 19-46§ 19:5.7 Foreign Language Marketing Material ................. 19-47§ 19:5.8 Bonus Annuity Products ...................................... 19-48§ 19:5.9 Variable Annuity Illustrations .............................. 19-48

[A] Background .......................................................... 19-48[B] FINRA’s Current Position .................................... 19-51


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§ 19:5.10 Dollar Cost Averaging Programs.......................... 19-52§ 19:5.11 Rankings .............................................................. 19-52

§ 19:6 Recent Developments Related to FINRA’s VariableProduct Advertising Rules........................................... 19-54

§ 19:6.1 Variable Product Advertising Rule Filing .............. 19-54[A] Regulatory Notice 08-39 ...................................... 19-54[B] Current Status ..................................................... 19-55

§ 19:6.2 FINRA Retrospective Rule Review ....................... 19-55§ 19:6.3 Customized Hypothetical Investment Planning

Illustrations ........................................................... 19-55

Chapter 20 Variable Life Insurance IllustrationsClifford E. Kirsch

§ 20:1 Overview....................................................................... 20-2§ 20:1.1 The Different Types of Illustrations....................... 20-2

[A] Non-Personalized Illustrations............................... 20-2[B] Personalized Illustrations ....................................... 20-2[B][1] The Basic Illustration ........................................ 20-2[B][2] The Conceptual Illustration .............................. 20-3

§ 20:2 Overview of the Regulatory Structure ........................... 20-3§ 20:2.1 The SEC Framework.............................................. 20-3§ 20:2.2 The FINRA Framework ......................................... 20-3

[A] Filing Requirement................................................. 20-4§ 20:2.3 The State Framework............................................. 20-4

§ 20:3 Regulation of the Underlying Assumptions.................. 20-4§ 20:3.1 Cash Flow: Premium Payments, Loans, and

Withdrawals ........................................................... 20-5§ 20:3.2 Charges .................................................................. 20-5

[A] Contract Charges ................................................... 20-6[B] Fund Charges ......................................................... 20-6[B][1] Fund-Specific Illustrations ................................. 20-7

§ 20:3.3 Investment Returns ............................................... 20-7[A] Prospectus Illustrations.......................................... 20-7[A][1] Historical Illustrations....................................... 20-9[B] Personalized Illustrations ....................................... 20-9[B][1] Historical Illustrations..................................... 20-10

§ 20:4 Required Disclosures .................................................. 20-10§ 20:5 Requirement to Use an Illustration............................ 20-11§ 20:6 Special Topics ............................................................. 20-11

§ 20:6.1 Internal Rate of Returns ...................................... 20-11§ 20:6.2 Comparisons........................................................ 20-12


lvi


Chapter 21 Marketing on the InternetRichard T. Choi

§ 21:1 Introduction.................................................................. 21-4§ 21:2 SEC Pronouncements ................................................... 21-5

§ 21:2.1 SEC Analytical Framework .................................... 21-5[A] Basic Premise ......................................................... 21-5[B] Procedural Considerations ..................................... 21-6[B][1] Consent ............................................................. 21-6[B][1][a] SEC Requirements for Consents ..................... 21-7[B][1][a][i] E-SIGN Consent Requirements ................... 21-7[B][1][a][ii] Telephonic Consent ................................... 21-10[B][1][a][iii] Rule 160 .................................................... 21-10[B][1][b] Negative Consents ........................................ 21-11[B][1][c] Third-Party Reliance...................................... 21-13[B][2] Notice .............................................................. 21-13[B][3] Access .............................................................. 21-15[B][4] Evidence of Delivery ........................................ 21-16[C] Clarification of the “Envelope Theory”................ 21-16[D] Responsibility for Hyperlinked Information

on Websites .......................................................... 21-17[D][1] Entanglement and Adoption Theories............. 21-18[D][1][a] Context of Hyperlink .................................... 21-18[D][1][b] Risk of Confusion ......................................... 21-19[D][1][c] Presentation of Hyperlinked Information ..... 21-20[D][2] Anti-Fraud Liability for Hyperlinked

Information ..................................................... 21-20[E] Access to Historical Information ......................... 21-22[F] Summary Information ......................................... 21-23[G] Interactive Website Features................................. 21-23[H] Disclosure Controls and Procedures .................... 21-24[I] Access Equals Delivery Model.............................. 21-24[J] Notice and Access Model..................................... 21-25

§ 21:2.2 SEC Regulation .................................................... 21-26[A] Advertisements..................................................... 21-26[A][1] Types of Advertisements .................................. 21-26[A][2] Legends ............................................................ 21-27[B] Sales Literature..................................................... 21-27[B][1] Prospectus Delivery Requirement .................... 21-27[B][2] Mixed Media.................................................... 21-28[B][3] Unsolicited Materials ...................................... 21-29[B][4] Applications..................................................... 21-29[C] Prospectuses ......................................................... 21-30[C][1] General Requirements ..................................... 21-30[C][1][a] Format of Prospectus..................................... 21-30[C][1][b] Internet Legend ............................................. 21-30

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[C][2] Preliminary Prospectuses ................................. 21-31[C][3] Definitive Prospectuses.................................... 21-32[C][4] Summary Prospectuses .................................... 21-32[C][4][a] Layered Disclosure Approach ........................ 21-33[C][4][b] Industry Proposal .......................................... 21-33[C][5] Updates and Amendments .............................. 21-33[C][6] Information Incorporated by Reference into

Prospectus ......................................................... 21-34[D] Reports and Proxies.............................................. 21-34[E] Revised Materials ................................................. 21-34[F] Single Document Delivery or “Householding” ..... 21-34[G] Electronic “Road Shows”...................................... 21-36[H] Private Offerings .................................................. 21-37[H][1] Lamp Technologies, Inc. .................................. 21-39[H][1][a] Nature of Website.......................................... 21-39[H][1][b] Procedural Safeguards.................................... 21-39[H][2] IPONET........................................................... 21-40[H][2][a] Nature of Website.......................................... 21-40[H][2][b] Procedural Safeguards.................................... 21-40[I] Third-Party Service Providers ............................... 21-41[I][1] Broker/Dealer Status ........................................ 21-41[I][1][a] Charles Schwab & Co., Inc........................... 21-41[I][1][b] Angel Capital Electronic Network................. 21-42[I][1][c] Progressive Technology, Inc. .......................... 21-44[I][1][d] Oil-N-Gas ..................................................... 21-44[I][2] Responsibility for Third-Party Content ........... 21-45[J] Use of Electronic Means in Issuer ’s

Discretion ............................................................ 21-46[K] Plain English ........................................................ 21-47

§ 21:2.3 Use of Social Media ............................................. 21-47[A] 2012 SEC Actions................................................ 21-47[A][1] Investor Alert: Social Media and Investing—

Avoiding Fraud.................................................. 21-47[A][2] Investor Bulletin: Social Media and

Investing—Understanding Your Accounts ....... 21-48[A][3] National Examination Risk Alert: Investment

Adviser Use of Social Media.............................. 21-49[A][4] Order Instituting Proceedings: In the Matter

of Anthony Fields, CPA d/b/a Anthony Fields& Associates and d/b/a Platinum SecuritiesBrokers (“Fields”) ............................................. 21-53

[B] SEC Social Media Sweep...................................... 21-53§ 21:3 FINRA Pronouncements............................................. 21-56

§ 21:3.1 Overview .............................................................. 21-56


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§ 21:3.2 Suitability............................................................. 21-57[A] Possible Higher Duty Where Internet Involved..... 21-57[B] Special Care for Widely Disseminated

Communications ................................................. 21-58§ 21:3.3 Supervision .......................................................... 21-58

[A] Supervisory Procedures Must Cover OnlineActivities .............................................................. 21-58

[B] Supervisory Procedures for Incoming andOutgoing Correspondence.................................... 21-59

[B][1] Specific Provisions ........................................... 21-59[B][2] Record Retention ............................................. 21-60

§ 21:3.4 Communications with the Public........................ 21-60[A] Websites ............................................................... 21-60[B] Hyperlinks............................................................ 21-61[B][1] Ongoing Hyperlinks to Internet Sites.............. 21-61[B][2] Hyperlinks to Educational Material................. 21-62[B][3] Hyperlinks to a Home Page ............................. 21-63[C] Use of Social Media ............................................. 21-63[C][1] Recordkeeping.................................................. 21-63[C][2] Suitability ........................................................ 21-65[C][3] Supervision ...................................................... 21-65[C][4] Types of Interactive Electronic Forums............ 21-67[C][5] Third-Party Posts, Links, and Content ............ 21-68[C][6] Personal Communications and Other

Devices ............................................................ 21-70[D] FINRA Disciplinary Actions ................................ 21-70[D][1] Failure to Supervise ......................................... 21-71[D][2] Failure to Comply with Advertising

Requirements, Including Registered PrincipalApproval............................................................ 21-73

[D][3] False, Misleading, or Inadequate Disclosures .....21-76[D][4] Failure to Safeguard Customer Information .... 21-77

§ 21:4 Conclusion ................................................................. 21-78

PART I-E:COMPLIANCE AND REGULATORY EXAMINATIONS

Chapter 22 Separate Account Compliance ProgramsClifford E. Kirsch

§ 22:1 Background ................................................................... 22-1§ 22:1.1 Text of Rule 38a-1.................................................. 22-2§ 22:1.2 Coverage ................................................................ 22-5


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§ 22:2 Adoption and Implementation of Written Policiesand Procedures.............................................................. 22-5

§ 22:2.1 Required Scope of Written Policies andProcedures.............................................................. 22-6

§ 22:2.2 Oversight of Service Providers’ Policies andProcedures.............................................................. 22-7

§ 22:3 Approval of Written Policies and Procedures ................ 22-8§ 22:4 Annual Review.............................................................. 22-9§ 22:5 Chief Compliance Officer ............................................. 22-9§ 22:6 Record Keeping ........................................................... 22-10§ 22:7 Special Issues Related to Variable Products................. 22-11

§ 22:7.1 Satisfying the Oversight ResponsibilityProvisions............................................................. 22-11

§ 22:7.2 Determining Who Is a Service Provider............... 22-11§ 22:7.3 Living with a Separate Account Compliance

Program................................................................ 22-12§ 22:8 SEC Enforcement Activity Related to Compliance

Program Deficiencies .................................................. 22-13

Chapter 23 SEC Insurance Product SeparateAccount ExamsClifford E. Kirsch

§ 23:1 Introduction.................................................................. 23-2§ 23:2 History of the Variable Products Inspection Program..... 23-3

§ 23:2.1 Background ............................................................ 23-3§ 23:2.2 Office of Compliance Inspections and

Examinations ......................................................... 23-4§ 23:2.3 SEC and FINRA Joint Variable Product

Examinations ......................................................... 23-5§ 23:2.4 SEC, FINRA, and NASAA Free Lunch Seminar

Sweep Examinations .............................................. 23-9§ 23:3 OCIE Variable Products Inspection Focus................... 23-10Diagram 23-1 Broader OCIE Examination Focus....................... 23-13§ 23:4 The Mechanics of Variable Products Inspections ....... 23-13

§ 23:4.1 Inspection Site ..................................................... 23-14[A] Home Office Versus Off-Site ................................ 23-14[B] Third-Party Service Provider ................................ 23-15[C] Sales Office........................................................... 23-15

§ 23:4.2 Frequency of Variable Product Inspections........... 23-15§ 23:4.3 Inspection Targets ................................................ 23-16§ 23:4.4 Notice Period ....................................................... 23-17§ 23:4.5 Requests for Documentation ............................... 23-17

[A] Phase I Request for Information for VariableProduct Sponsors ................................................. 23-18


lx

[A][1] Customer Transactions.................................... 23-18[A][2] Replacement Transactions ............................... 23-19[A][3] Financed Transactions ..................................... 23-20[B] Phase II Request for Information for Variable

Product Sponsors ................................................. 23-20[B][1] Legal, Back-Office Administration, and

Customer Transaction Files ............................. 23-21[B][2] Accounting Documents ................................... 23-22[B][3] Market Conduct and Sales Practices ............... 23-22[B][4] Rule 38a-1 Program Documentation ............... 23-24[C] Request for Information for Broker-Dealers

That Solicit Variable Products.............................. 23-24[C][1] Financial and Corporate Books and Records..... 23-24[C][2] Sales Practice Information Request.................. 23-25[C][3] Variable Annuity Information Request ............ 23-26

§ 23:4.6 Duration of Inspection......................................... 23-27§ 23:4.7 Inspection Follow-Up........................................... 23-27

[A] Evaluation and Reporting Components ............... 23-27[B] Deficiency Letter and Response to Inspection

Findings ............................................................... 23-28§ 23:5 An In-Depth Look at Variable Product Back-Office

(Administration) Inspections ...................................... 23-28§ 23:5.1 Opening Interview/Outline of Review Points ....... 23-28§ 23:5.2 Compliance Policies and Procedures and

Designated CCO Manuals ................................... 23-34§ 23:5.3 Transaction Processing and “As of” Pricing ......... 23-34§ 23:5.4 NAV and AUV Computations.............................. 23-36§ 23:5.5 Walk-Through ...................................................... 23-37

§ 23:6 An In-Depth Look at Variable Product MarketConduct and Sales Practice Inspections ..................... 23-39

§ 23:6.1 General ................................................................ 23-39§ 23:6.2 Supervisory and Market Conduct Compliance

Procedures Manual .............................................. 23-40§ 23:6.3 Supervisory and Compliance Systems ................. 23-40§ 23:6.4 Sales Office Activity ............................................. 23-41§ 23:6.5 Sales Office Component ...................................... 23-41§ 23:6.6 Opening Interview/Outline of Review Points ....... 23-42§ 23:6.7 Request for Documentation ................................. 23-46

§ 23:7 Frequently Cited Exam Deficiencies ........................... 23-47§ 23:8 Conclusion ................................................................. 23-47

Appendix 23A Examination Request List ........................ App. 23A-1


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PART I-F:SPECIAL TOPICS

Chapter 24 Private Placement Variable Life InsuranceDavid N. Brown & Kerry Shannon Burke

§ 24:1 Introduction.................................................................. 24-3§ 24:1.1 Structure ................................................................ 24-4§ 24:1.2 Insurance Regulation ............................................. 24-4§ 24:1.3 Tax Treatment........................................................ 24-5§ 24:1.4 Fees and Charges ................................................... 24-5§ 24:1.5 Distribution ........................................................... 24-6

§ 24:2 Regulatory Treatment of PPVLI Products ..................... 24-6§ 24:3 The Securities Act of 1933 ........................................... 24-8

§ 24:3.1 Exemptions ............................................................ 24-8§ 24:3.2 Rule 506 Offerings ................................................. 24-9

[A] Accredited Investors ............................................... 24-9[A][1] Natural Persons ............................................... 24-10[A][2] Corporations, Limited Liability Companies,

Partnerships, and Business Trusts ................... 24-13[A][3] Common Law and Similar Trusts ................... 24-14[A][4] Employee Benefit Plans—Rule 501(a)(1).......... 24-15[A][5] “Formed for the Specific Purpose” ................... 24-16[B] Regulation D—Conditions................................... 24-18[B][1] Integration ....................................................... 24-18[B][2] Information ..................................................... 24-19[B][2][a] Offerings to Accredited Investors .................. 24-20[B][2][b] Offerings to Non-Accredited Investors .......... 24-20[B][2][c] Offerings to Both Accredited and

Non-Accredited Investors .............................. 24-21[B][2][d] Disclosures Generally.................................... 24-22[B][3] Manner of Offering.......................................... 24-22[B][4] Resale Restrictions ........................................... 24-25[B][5] Notice of Offering ............................................ 24-25[C] Rule 506(b)—Specific Terms ................................ 24-26[D] Rule 506(c)—Reasonable Verification................... 24-28[E] Rule 506(d)—Bad Actor Disqualification ............. 24-29

§ 24:3.3 State Securities Law Registration and Filing ........ 24-32§ 24:4 Investment Company Act of 1940 ............................. 24-33

§ 24:4.1 Exclusions Under the InvestmentCompany Act ....................................................... 24-33

[A] Section 3(c)(1) Separate Accounts ........................ 24-33[A][1] “Look-Through” Provisions ............................. 24-35[A][2] Anti-Circumvention Principles........................ 24-38

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[A][3] Integration ....................................................... 24-40[A][4] Estates and Donees.......................................... 24-42[A][5] General Considerations ................................... 24-42[B] Section 3(c)(7) Separate Accounts ........................ 24-42[B][1] Qualified Purchasers ........................................ 24-43[B][1][a] Natural Persons............................................. 24-45[B][1][b] Corporations, Partnerships, and Other

Entities .......................................................... 24-45[B][1][c] Common Law and Similar Trusts................. 24-47[B][1][d] Pension Plans and IRAs ................................ 24-48[B][2] “Formed for the Specific Purpose” ................... 24-49[B][3] Estates and Donees.......................................... 24-49[B][4] Anti-Circumvention Principles........................ 24-50[B][5] Integration ....................................................... 24-50[B][6] Investments ..................................................... 24-50[C] Section 12(d)(1)—Anti-Pyramiding ...................... 24-51

§ 24:4.2 Fees and Expenses................................................ 24-51§ 24:5 Securities Exchange Act of 1934................................. 24-51

§ 24:5.1 Section 12(g) Registration .................................... 24-51§ 24:5.2 Antifraud Provisions ............................................ 24-52

§ 24:6 Commodity Exchange Act .......................................... 24-52§ 24:7 Tax Considerations ..................................................... 24-53

§ 24:7.1 Diversification...................................................... 24-53§ 24:7.2 Investor Control................................................... 24-54

§ 24:8 Insurance Agencies and Other Distributors ............... 24-55§ 24:8.1 Broker-Dealer Registration ................................... 24-55§ 24:8.2 FINRA Regulation................................................ 24-56§ 24:8.3 Investment Adviser Registration .......................... 24-57§ 24:8.4 Commodity Trading Advisor Regulation.............. 24-58

§ 24:9 Funding Vehicles......................................................... 24-59

Chapter 25 Asset Allocation Programs and Funds ofFunds in Variable Insurance ProductsPaul G. Cellupica

§ 25:1 Introduction.................................................................. 25-2§ 25:2 Asset Allocation Programs............................................ 25-2

§ 25:2.1 Background ............................................................ 25-2§ 25:2.2 SEC Staff Guidance on Asset Allocation

Programs in Variable Products ............................... 25-4[A] Generally................................................................ 25-4[B] Investment Company Act Issues ........................... 25-5[C] Investment Advisers Act Issues ............................. 25-6

(Ins. Inv. Prods., 3rd ed., 11/18) lxiii

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§ 25:2.3 Implementation Issues Under the SEC ’sGuidance................................................................ 25-7

[A] Selection of Investment Adviser for Program......... 25-7[B] Role of Broker-Dealer ............................................. 25-9[C] Updates to Static Asset Allocation Models .......... 25-10[D] Notice Required by Opt-Out Programs................ 25-10

§ 25:2.4 ERISA Concerns Regarding Selection of MutualFunds in Asset Allocation Programs.................... 25-11

§ 25:3 Funds of Funds ........................................................... 25-16§ 25:3.1 Generally.............................................................. 25-16§ 25:3.2 Statutory Restrictions and Exceptions Under

Section 12 of the Investment Company Act........ 25-17§ 25:3.3 SEC Exemptive Relief for Funds of Funds in

Variable Products.................................................. 25-19[A] Generally.............................................................. 25-19[B] Compliance with Section 17(e) ............................ 25-22[C] Mixed and Shared Funding Issues ....................... 25-25

§ 25:3.4 Funds of Funds Exemptive Rules ......................... 25-26[A] Generally.............................................................. 25-26[B] Rule 12d1-1 (Money Market Fund Cash

Sweep Arrangements)........................................... 25-27[C] Rule 12d1-2 (Expanded Investment in Other

Types of Issuers for Affiliated Funds of Funds) ...... 25-28§ 25:3.5 Disclosure Requirements for Funds of Funds

in Variable Products ............................................. 25-29§ 25:3.6 Proposed Rules Regarding Funds Investing

in ETFs ................................................................ 25-30§ 25:3.7 Use of Target-Date Funds in Variable Annuities .....25-31

Chapter 26 Variable Annuities in Retirement PlansEvan Giller & Weiyen “Ann” Jonas

§ 26:1 Introduction.................................................................. 26-2§ 26:2 Regulatory Environment ............................................... 26-3

§ 26:2.1 Internal Revenue Code........................................... 26-3§ 26:2.2 ERISA..................................................................... 26-4§ 26:2.3 Federal Securities Laws .......................................... 26-5§ 26:2.4 State Laws.............................................................. 26-6

§ 26:3 Overview of Retirement Plans ...................................... 26-7§ 26:3.1 Defined Contribution Plans Compared to

Defined Benefit Plans............................................. 26-7§ 26:3.2 Trust Requirement ................................................. 26-8

§ 26:4 Defined Contribution Plan Types ................................. 26-8§ 26:4.1 Qualified Plans Under Code Section 401(a)

(Including 401(k) Plans)......................................... 26-9

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§ 26:4.2 Section 403(a) Annuity Plans .............................. 26-10§ 26:4.3 Section 403(b) Plans ............................................ 26-10§ 26:4.4 Section 457(b) Plans ............................................ 26-12§ 26:4.5 Variable Annuity Contract Designs for

Retirement Plans.................................................. 26-13[A] Deferred Annuities............................................... 26-13[B] Immediate Annuities ........................................... 26-14[C] Individual and Group Annuity Contracts............ 26-14[D] Allocated and Unallocated Group Annuity

Contracts ............................................................. 26-16[E] Forms of Distributions from Retirement Plans..... 26-17[F] Spousal Rights Requirements............................... 26-18[G] Specific Defined Contribution Plan Provisions .... 26-19[G][1] Required Distribution Requirements ............... 26-20[G][2] Contribution Limitations ................................ 26-20[G][3] Right to a Direct Rollover................................ 26-20[G][4] Distribution Restrictions ................................. 26-20[G][5] Distributions Without Consent....................... 26-22[G][6] Hardship Distributions.................................... 26-22[G][7] Loans ............................................................... 26-23[G][8] No Assignment................................................ 26-24[G][9] Vesting ............................................................. 26-24[H] Specific Requirements for 403(b) Plans................ 26-24[H][1] Nonforfeitability .............................................. 26-24[H][2] Limitations on Elective Deferrals .................... 26-25[H][3] Nontransferability............................................ 26-25[H][4] Rollover Distributions...................................... 26-25[H][5] Limitation on Incidental Benefits .................... 26-25

§ 26:5 Enrollment Processes .................................................. 26-25§ 26:6 Other Issues Relating to the Use of Annuities in

Retirement Plans ........................................................ 26-27§ 26:6.1 Selecting an Annuity Provider ............................. 26-27§ 26:6.2 Qualified Longevity Annuity Contracts ............... 26-29§ 26:6.3 Participant Disclosures Related to Variable

Annuity Contracts ............................................... 26-31§ 26:6.4 Use of Deferred Annuities in Target Date

Funds ................................................................... 26-37

Appendix 26A 29 C.F.R. § 2550.404a-5—FiduciaryRequirements for Disclosure inParticipant-Directed Individual AccountPlans......................................................... App. 26A-1

Appendix 26B 29 C.F.R. § 2550.404c-1—ERISASection 404(c) Plans ................................. App. 26B-1

Appendix 26C SEC No-Action Letter(October 26, 2011) ...................................App. 26C-1

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Appendix 26D SEC No-Action Letter(February 18, 2015) ..................................App. 26D-1



PART II:OTHER INSURANCE INVESTMENT PRODUCTS

Chapter 29 Registered Index-Linked Insurance ContractsDodie C. Kent & Clifford E. Kirsch

§ 29:1 Introduction.................................................................. 29-2§ 29:2 Design of Registered Index-Linked Insurance

Contracts ...................................................................... 29-3§ 29:2.1 A Glance at the Investment Advisers Act

Regulatory Framework ........................................... 29-3§ 29:2.2 Key Elements ......................................................... 29-4

Table 29-1 Calculation of Investor Rate of Return................... 29-7§ 29:3 Registering an Index-Linked Annuity Contract:

Process, Decision Points, and Challenges..................... 29-8§ 29:3.1 Background ............................................................ 29-8§ 29:3.2 Forms S-1 and S-3 ............................................... 29-10

[A] Filing on Form S-1............................................... 29-10[A][1] Rule 12h-7 ....................................................... 29-10[A][2] Form S-1 Content............................................ 29-11[B] Filing on Form S-3............................................... 29-12[B][1] Eligibility Requirements................................... 29-12[B][2] Exchange Act Reporting................................... 29-14[B][3] Ability to Reduce or Omit Certain Disclosure.... 29-14[C] Considerations Common to Both Form S-1

and Form S-3 ....................................................... 29-16[C][1] GAAP............................................................... 29-16[C][2] Incorporation by Reference and Aging-Out

of Financial Statements ................................... 29-17[C][3] Registration Fees.............................................. 29-18[C][4] General Filing Requirements ........................... 29-18

Table 29-2 Form S-1 and Form S-3—Key Similarities andDifferences............................................................ 29-20

§ 29:4 Potential Regulatory Relief from Certain Ill-FittedRequirements for State-Regulated Annuity ContractsRegistered on Forms S-1 and S-3 ................................. 29-21

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§ 29:5 Distributing Registered Index-Linked Contracts......... 29-25§ 29:5.1 Registration and Authority to Sell ....................... 29-25

[A] Series 6 Versus Series 7........................................ 29-25[B] Application of Corporate Financing Rule............. 29-25[C] Authority to Offer a New Line of Business .......... 29-26

§ 29:5.2 Suitability and Supervisory Issues........................ 29-26[A] Complex Product Guidance ................................. 29-26[B] Application of FINRA’s Suitability Rules ............. 29-26

§ 29:5.3 Marketing Material .............................................. 29-27[A] Approval, Review and Recordkeeping................... 29-27[B] Filing with FINRA ............................................... 29-27[C] Hypothetical Illustrations or Examples................ 29-28

§ 29:6 Conclusion ................................................................. 29-29

Chapter 30 Introduction to Life SettlementsGary M. Brown

§ 30:1 Background ................................................................... 30-3§ 30:1.1 Life Insurance ........................................................ 30-3§ 30:1.2 Life Insurance Policies as Transferrable Property .... 30-4§ 30:1.3 Life Settlements ..................................................... 30-5

§ 30:2 The Life Settlement Marketplace.................................. 30-8§ 30:2.1 Generally................................................................ 30-8§ 30:2.2 Characteristics of Life Insurance Policies............. 30-10

[A] The Insurance Policy—Generally......................... 30-10[B] Types of Insurance Products................................. 30-11[B][1] Term Insurance................................................ 30-11[B][2] Permanent Life Insurance................................ 30-11[B][2][a] Whole Life Insurance .................................... 30-12[B][2][b] Universal Life Insurance (UL) ....................... 30-12[B][2][c] Limited Pay Life Insurance............................ 30-13[C] Parties to the Insurance Contract/Policy .............. 30-13[D] Special Policy Provisions ...................................... 30-15[E] Contestability....................................................... 30-15[F] Underwriting by the Insurance Company ........... 30-17[G] Maturity—Collection of the Death Benefit.......... 30-19

§ 30:3 The Players in the Life Settlement Marketplace......... 30-20§ 30:3.1 Insured/Policy Owner........................................... 30-20

[A] Generally.............................................................. 30-20[B] Issues and Risks................................................... 30-21[B][1] Possible Alternatives ........................................ 30-21[B][2] Insured’s Identity and Medical Records........... 30-21[B][3] Insured Contacts and Future Disclosure

Obligations ...................................................... 30-21[B][4] Need For Insurance Coverage .......................... 30-22

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[B][5] Policy Replacement Issues ............................... 30-22[B][6] Public Assistance ............................................. 30-22[B][7] Taxation ........................................................... 30-22[B][8] Creditors and Bankruptcy................................ 30-22

§ 30:3.2 Financial Advisors/Producers/Brokers................... 30-22§ 30:3.3 Life Settlement Providers ..................................... 30-23§ 30:3.4 Investors or “Funders” ......................................... 30-24

[A] Generally.............................................................. 30-24[B] Issues and Risks................................................... 30-25[B][1] Suitability for Purchase.................................... 30-25[B][2] Lack of Liquidity .............................................. 30-25[B][3] Pricing Risks and Valuation Issues .................. 30-25[B][4] Time Risks....................................................... 30-25[B][5] Life Expectancy Reports ................................... 30-26[B][6] Premium Optimization ................................... 30-26[B][7] Mistakes in Servicing Policies.......................... 30-26[B][8] Missing Insureds ............................................. 30-26[B][9] Possible Insolvency of Insurance Companies.... 30-26[B][10] Life Insurance Companies’ Aversion to

Investment Transactions Involving LifeSettlements ...................................................... 30-27

[B][11] Impact of Increase in Cost on LifeInsurance Policies ............................................ 30-27

[B][12] Insurance Companies’ Contestability ofLife Insurance Policies ..................................... 30-27

[B][13] Termination of Policy before Deathof Insured......................................................... 30-28

[B][14] Sale Contested By Family Members ................ 30-28[B][15] Stranger Originated Life Insurance Policies ..... 30-28[B][16] Refusal to Pay Benefits on Certain Policies ..... 30-28[B][17] Certain Fraudulent Activities........................... 30-28[B][18] Life Settlements Regulation ............................. 30-29

§ 30:3.5 Life Expectancy Providers..................................... 30-29§ 30:4 Life Settlement Transaction........................................ 30-30Figure 30-1 Individual Policy Acquisition Flow....................... 30-30§ 30:5 Regulatory Treatment ................................................. 30-30

§ 30:5.1 Generally.............................................................. 30-30§ 30:5.2 State Insurance Laws ........................................... 30-34§ 30:5.3 Securities Laws..................................................... 30-34

[A] Federal Level......................................................... 30-34[B] State Level............................................................ 30-39

§ 30:6 Litigation Involving Life Settlements.......................... 30-41§ 30:6.1 Overview .............................................................. 30-41§ 30:6.2 Significant Cases.................................................. 30-43

[A] Grigsby v. Russell ................................................. 30-43

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[B] New England Mutual Life Insurance Co. v.Caruso.................................................................. 30-43

[C] Kramer v. Phoenix Life Insurance Co. ................. 30-44[D] PHL Variable Insurance Co. v. Price Dawe

2006 Insurance Trust ........................................... 30-45[E] Settlement Funding L.L.C. v. AXA Equitable

Insurance Co........................................................ 30-46[F] Berkshire Settlements, Inc. v. Ashkenazi ............. 30-48[G] The Lincoln Life and Annuity Company of

New York v. Berck ................................................ 30-49[H] Ohio National Life Assurance Corporation v.

Davis .................................................................... 30-52[I] Pruco Life Insurance Co. v. Brasner..................... 30-52[J] Sciarretta v. The Lincoln National Life

Insurance Company ............................................. 30-53[K] PHL Variable Insurance Co. v. The Faye Keith

Jolly Irrevocable Life Insurance Trust ................... 30-54[L] Principal Life Insurance Co. v. Lawrence Rucker

2007 Insurance Trust............................................. 30-55[M] Penn Mutual Life Insurance Co. v. Greatbanc

Trust Co. .............................................................. 30-56[N] PHL Variable Insurance Co. v. Virginia L.

Lankow Life Insurance Trust ............................... 30-57§ 30:7 Tax Issues ................................................................... 30-57

Appendix 30A Policy Closing Checklist........................... App. 30A-1

Chapter 31 Insurance-Linked SecuritiesDaniel A. Rabinowitz

§ 31:1 Introduction.................................................................. 31-2§ 31:2 General Types of ILS..................................................... 31-3

§ 31:2.1 ILS Based on Insurable Events ............................... 31-3[A] Reinsurance............................................................ 31-3[B] Components/Issues ................................................ 31-4[B][1] Threshold Regulatory Issues.............................. 31-4[B][1][a] Statutory Definitions of Insurance.................. 31-4[B][1][b] Regulatory Relief ............................................. 31-5[B][1][c] Regulatory Risk and Offering Restrictions ...... 31-7[B][2] Components and Structuring .......................... 31-10[B][2][a] The SPV........................................................ 31-10[B][2][b] The Indenture ............................................... 31-11[B][2][c] Allocation of Loss Provisions ........................ 31-12[B][2][d] Reinsurance or other Risk-Transfer

Agreement ..................................................... 31-13

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[B][2][e] Offering Materials ......................................... 31-15[B][2][f] Service Providers ........................................... 31-17[B][2][g] Other Lines ................................................... 31-18

§ 31:2.2 ILS Based on Redundant Reserves ....................... 31-18[A] Closed Block Securitization ................................. 31-18[B] Redundant Reserve Securitizations More

Broadly ................................................................. 31-20§ 31:3 NAIC and State Developments .................................. 31-22

§ 31:3.1 Protected Cell Company Model Act .................... 31-22[A] Securitization ....................................................... 31-23[B] Protected Cell....................................................... 31-23[C] Legal Identity ....................................................... 31-24[D] Directors’ Duty to Maintain Separateness ........... 31-25[E] Bankruptcy Remoteness Issues ............................ 31-25

§ 31:3.2 Special Purpose Reinsurance Vehicle Act ............. 31-26[A] SPRV Insurance Securitization............................. 31-26[B] Forming an SPRV................................................. 31-27[C] Limitations on Use .............................................. 31-27

§ 31:3.3 Other State Laws ................................................. 31-28[A] Captive Insurance Generally................................ 31-28[B] The Rise of Special Purpose Captives .................. 31-29[C] Regulatory Activity............................................... 31-30

Appendix A Statutory Material ..................................... App. A-1

Table of Authorities ......................................................................T-1

Index................................................................................................. I-1

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Introduction

This book has its origin as Variable Annuities and Variable LifeInsurance Regulation. In recent years, we’ve seen other insuranceinvestment products, such as SEC-registered fixed annuities, grow inimportance. This new edition seeks to keep pace with thesedevelopments.

With the practitioner in mind, we organized the material in a waythat helps the reader to quickly access the needed information, whilealso allowing those newer to the subject to gain the necessary back-ground in an organized and logical manner. To that end, our subjectmatter is grouped broadly into two sections: one that focuses onvariable annuities and variable life insurance and another that coversother types of insurance investment products.

Variable annuities and variable life insurance products are subjectto a complex regulatory framework, which includes the federal secu-rities laws, state insurance laws, ERISA, and tax. We help navigatethese multiple laws with the following sections: Overview of theRegulatory Framework; Product Design and Approvals; Product Ad-ministration; Product Distribution; Regulatory Examinations; andSpecial Topics:

Part I: Variable Insurance Products

Part I-A: Overview of the Regulatory Framework

Chapter 1, An Introduction to Variable Insurance Products, pro-vides a historical look at variable annuities and variable life insurance,as well as their place in today ’s marketplace, with a review of the legalstructure and regulatory treatment of these products.

Chapter 2, Status of Insurance Products Under the Securities Actof 1933, explores the coverage of variable products under the SecuritiesAct. In particular, it examines which types of insurance products areexcluded from that Act’s coverage and which are subject to itsregulatory regime.

Chapter 3, Status of Insurance Companies and Insurance Com-pany Separate Accounts Under the Investment Company Act, exam-ines these items and discusses the current regulatory scheme ofseparate accounts under the Investment Company Act.

(Ins. Inv. Prods., 3rd ed., 11/18) lxxi

Chapter 4, Regulation of Variable Insurance Products Under theInvestment Company Act of 1940, explains the unit investment truststructure for variable contract separate accounts, and provides a broadoverview of how the Investment Company Act applies to underlyingfunds and registered separate accounts.

Chapter 5, Tax Treatment of Variable Contracts, provides back-ground into the tax treatment of insurance companies, and lifeinsurance and annuity products. It also discusses special contractholder tax rules applying to variable products.

Chapter 6, ERISA Issues, examines the issues arising when avariable annuity contract serves as a funding vehicle for an employeebenefit plan subject to the requirements of ERISA.

Part I-B: Product Design

Chapter 7, Variable Insurance Product Design, examines productdesign issues from the perspectives of both federal securities and stateinsurance law.

Chapter 8, The Funding Vehicle, examines the regulation of theunderlying funding vehicle.

Chapter 9, SEC Registration, explores the SEC registration processfor variable products.

Chapter 10, State Contract Issues, examines compliance require-ments for broker-dealers emanating from state insurance laws.

Part I-C: Product Administration

Chapter 11, Issues Related to Product Administration, discussesregulations impacting contract administration with a particular focuson SEC regulations.

Chapter 12, Redemption Fee Rule, examines the InvestmentCompany Act’s Rule 22c-2, the redemption fees permitted by therule, requirements for shareholder information agreements, industrystandardization efforts, and special issues raised by the rule.

Chapter 13, Insurer Exchange Programs, looks at the regulatoryframework applying to exchange programs in which a company offerscustomers the ability to exchange one variable product for another.

Part I-D: Product Distribution

Chapter 14, SEC Regulation of Product Distribution, discusses theSEC requirements applicable to the distribution of variable products.

Chapter 15, FINRA Regulation of Product Distribution, focuses onthe NASD regulations governing product distribution.

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Chapter 16, FINRA Suitability, Supervision, and Sales Practices,looks at securities and insurance regulations imposing a suitabilityobligation with respect to the sale of variable products.

Chapter 17, State Insurance Regulation Applying to the Distributionof Variable Insurance Products, discusses state laws and regulations,including licensing and standard of care, which apply to sales of variableinsurance products.

Chapter 18, Replacement of Insurance Products, examines stateand securities regulations governing replacements.

Chapter 19, Advertising, provides background into the SEC, theNASD, and state insurance requirements applicable to advertising andother types of marketing material.

Chapter 20, Variable Life Insurance Illustrations, looks at theregulatory framework applied to variable life illustrations.

Chapter 21, Marketing on the Internet, examines the regulatorytreatment of marketing material over the Internet.

Part I-E: Compliance and Regulatory Examinations

Chapter 22, Separate Account Compliance Programs, reviews SECRule 38a-1’s requirement that registered separate accounts establishand maintain a compliance program.

Chapter 23, SEC Insurance Product Separate Account Exams,looks at the SEC examination program and examines both aspectsof the SEC’s inspection program—product administration and salesdistribution.

Part I-F: Special Topics

Chapter 24, Private Placement Variable Life Insurance, reviews theregulatory treatment governing private placement variable lifeinsurance.

Chapter 25, Asset Allocation Programs and Funds of Funds inVariable Insurance Products, looks at regulatory requirements withrespect to asset allocation strategies used in variable insuranceproducts.

Chapter 26, Variable Annuities in Retirement Plans, describes thetypes of retirement plans for which variable annuities may be used asfunding vehicles and emphasizes the differences among plan typesthat are most relevant to variable annuity contract design, anddiscusses some of the design, administrative, and operational issuesthat should be addressed by retirement plan sponsors and record-keepers under the federal and state laws that are exclusively applicableto variable annuities.

(Ins. Inv. Prods., 3rd ed., 11/18) lxxiii

Introduction

Our coverage of Other Insurance Investment Products includeschapters on Registered Index-Linked Insurance Contracts, Introduc-tion to Life Settlements, and Insurance-Linked Securities:

Part II: Other Insurance Investment Products

Chapter 29, Registered Index-Linked Insurance Contracts, coversthe regulatory framework applying to this newer insurance invest-ment product.

Chapter 30, Introduction to Life Settlements, looks at the uniqueissue governing life insurance policies and transferable property.

Chapter 31, Insurance-Linked Securities, examines the legal frame-work applying to financial instruments whose performance is basedon insurance or actuarial risks.

Special thanks to the contributing authors who strive to ensure theinformation remains current and accessible in this developing field.And a very special thanks to PLI and in particular, editor CarolBenedicto, who is not only great to work with, but also critical inmaking sure we meet deadlines with a quality end-product in mind.

CLIFFORD E. KIRSCH

November 2018

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