The U.S. Securities and Exchange Commission announced on October 30, 2018 that it had voted to issue a proposed rule and form amendments1 that would allow insurers offering variable annuity and/or variable life insurance contracts (collectively, variable contracts) to use layered disclosure to satisfy prospectus delivery obligations under the Securities Act of 1933.2
Proposed new Rule 498A under the Securities Act (Proposed Rule) would permit prospectus delivery obligations for a variable contract to be satisfied by sending or giving a summary prospectus to investors, and making other materials (including the statutory prospectus for the variable contract) accessible online. In addition, the Proposed Rule would consider a person to have met prospectus delivery obligations under the Securities Act relating to an underlying mutual fund investment option for the variable contract (portfolio company), by: (i) including certain key information about the portfolio company in the summary prospectus for the variable contract; and (ii) making portfolio company summary and statutory prospectuses available online.
Variable contracts offer potential long-term investment appreciation through exposure to the securities markets while also providing investors with annuity benefits or insurance protections, and such contracts receive favorable tax treatment. Variable contracts achieve market exposure by offering a menu of portfolio companies for allocation as underlying investment options. These portfolio companies separately register as investment companies under the Investment Company Act of 1940 and register their shares with the SEC under the Securities Act. Thus, the offering of a variable contract involves the simultaneous offer of one security in the form of the variable contract as well as securities for the portfolio companies. The variable contract and each portfolio company would be offered through its own prospectus.
Variable contracts and their portfolio companies are both subject to prospectus delivery requirements under the Securities Act. In practice, variable contract issuers often deliver to investors a bundled set of disclosure documents that includes the statutory prospectus for the variable contract and summary prospectuses for its portfolio companies.
The SEC acknowledged in the Proposing Release that these bundled disclosure documents “can be voluminous,” and expressed concern “that the volume, format, and content of disclosures in the variable contract context may make it difficult for some investors to find and understand key information that they need to make an informed investment decision.” Consistent with other recent SEC and staff initiatives,3 the Proposed Rule is intended to facilitate investor understanding of, and access to, variable contracts’ key features, costs and risks. To that end, the Proposed Rule permits the use of a layered disclosure regime – broadly modeled on the existing mutual fund summary prospectus framework – with the proposed optional summary prospectus serving as the “cornerstone” of the framework.
Proposed Rule Highlights
Option to Use a Summary Prospectus
The Proposed Rule would provide that, for variable contract securities registered on Forms N-3, N-4 or N-6, the use of a summary prospectus could satisfy Securities Act prospectus delivery obligations, subject to certain conditions. As proposed, reliance on Rule 498A would be voluntary. Insurers could continue to deliver a full statutory prospectus for a variable contract.
The Proposed Rule would permit variable contract prospectus delivery obligations to be met by sending or giving a summary prospectus to investors while providing online access to the statutory prospectus and statement of additional information (SAI) for the contract. The Proposed Rule contemplates the use of two distinct types of summary prospectuses:
- Initial summary prospectuses covering variable contracts currently offered to new investors; and
- Updating summary prospectuses for existing investors.4
The initial summary prospectus would include certain key information about the contract’s most salient features, benefits and risks, including:
- An overview of the contract;
- Information regarding standard death benefits and other benefits available under the contract (including any optional or standard living benefits and optional death benefits);
- A description of how an investor can buy the contract and make withdrawals and how a contract can lapse (for variable life insurance contracts); and
- Information about contract fees.
The updating summary prospectus would include a brief description of important changes to the contract that occurred during the previous year, as well as certain key information from the initial summary prospectus.
Both types of summary prospectuses would need to include certain key information about underlying portfolio companies.
Availability of Variable Contract Statutory Prospectus and Other Materials
To comply with the Proposed Rule, a variable contract’s statutory prospectus and SAI would need to be publicly accessible, free of charge, at a website specified on, or hyperlinked in, the cover of the summary prospectus. Further, investors receiving the summary prospectus would be permitted to request and receive the statutory prospectus and SAI in paper or electronically, at no cost.
Discontinued Variable Contracts
In accordance with SEC staff no-action letters,5 insurance companies that have stopped offering a variable contract to new investors (while continuing to accept additional payments from existing investors) may also stop updating that variable contract’s registration statement and may stop delivering updated prospectuses to existing investors, subject to certain conditions (including sending alternative disclosures to investors). In the Proposing Release, the SEC clarified that it “would permit contracts operating in the manner that [the no-action letters] describe as of the effective date of any final summary prospectus rules … to continue to operate in such manner [but for] all other contracts, the [SEC’s] position would not be applicable, and therefore variable contract issuers would be required to file post-effective amendments to update their registration statements and provide updated prospectuses under current regulatory requirements, and could avail themselves of the [updating] summary prospectus framework as adopted.”6
Optional Method to Satisfy Delivery Requirements for Portfolio Companies
The Proposed Rule also would provide an optional method for satisfying portfolio company prospectus delivery obligations. As proposed, the summary prospectus for the variable contract would be required to include an appendix that provides information in tabular form about the portfolio companies offered under the contract. These separate columns would provide information regarding each portfolio company, including: type or investment objective; name and adviser or sub-adviser; expense ratio; and average annual returns over the past 1-, 5- and 10-year periods.7 The Proposed Rule also would require that the portfolio companies’ summary and statutory prospectuses be available online and that investors be able to request and receive these prospectuses (and the other related documents) in paper or electronically, at no cost.8
The comment period for the proposal will close on February 15, 2019.9