On September 19, the U.S. Department of the Treasury announced an emergency, temporary guaranty program to protect shareholders of money-market mutual funds from losses if their funds are unable to maintain a $1.00 net asset value (“NAV”). Insurance-dedicated money-market funds supporting non-qualified variable life insurance and annuity contracts need guidance as to how participation in the proposed guaranty program would affect compliance with the diversification requirements of section 817(h) of the Internal Revenue Code and other tax provisions. Details of the guaranty program have not yet been finalized, but it appears from information currently available that—
- All money-market mutual funds that are regulated under Rule 2a-7 of the Investment Company Act of 1940 and are publicly offered and registered with the Securities and Exchange Commission will be eligible to participate in the program.
- Funds will have to elect to enroll voluntarily in the program and pay a fee for coverage.
- If a fund enrolls, its shareholders will be protected for assets they have in their accounts as of the close of business on Friday, September 19.
- The plan will cover all shareholders, retail and institutional, domestic and foreign, in the eligible funds that enroll.
- If a covered fund cannot maintain a $1.00 NAV, and the fund sponsor chooses not to provide credit support, the fund board would notify the guaranty program that it has determined to liquidate the fund. The fund would then close and liquidate. The Treasury guaranty plan would pay the fund the difference between a $1.00 NAV and its shareholder payout; the fund would distribute that payment to shareholders.
For “insurance-dedicated” money-market funds supporting non-qualified variable contracts, it is currently unclear how enrollment in the guaranty program would affect compliance with the section 817(h) diversification requirements. In this regard, the following specific questions are presented:
- Would the entire portfolio of an insurance-dedicated money-market fund enrolled in the Treasury guaranty program be treated as consisting of securities “issued by” the United States for purposes of the issuer aggregation rule set forth in Treas. Reg. § 1.817(b)(ii)? In this regard, Treas. Reg. § 1.817-5(h)(1)(i) classifies as a “government security” “any security issued or guaranteed by the United States or an instrumentality of the United States, or any certificate of deposit for any of the foregoing” (emphasis supplied).
- Would the entire portfolio of an insurance-dedicated money-market fund enrolled in the Treasury guaranty program be treated as consisting of “Treasury securities” for purposes of the alternative diversification test for variable life insurance contracts (but not variable annuity contracts) set forth in Treas. Reg. § 1.817-5(b)(3)
There is also arguably a question as to whether allocating funds to an insurance-dedicated money-market fund enrolled in the Treasury guaranty program would cause a variable contract owner to be treated as the owner of the underlying mutual fund shares under the investor control rulings, including Rev. Rul. 77-85, 1977-1 C.B. 12; Rev. Rul. 80-274, 1980-2 C.B. 27; Rev. Rul. 81-225, 1981-2 C.B. 13; Rev. Rul. 2003-91, 2003-2 C.B. 347; Rev. Rul. 2003-92, 2003-2 C.B. 350.
Depending on how these questions are answered, insurance-dedicated money-market funds, by enrolling in the new Treasury program, could cause owners of variable contracts they support to be taxed currently on the assets underlying their contracts. The Treasury has announced that the guaranty program will be available to tax-exempt money-market funds and will not affect their tax-exempt status. However, this does not address concerns about insurance-dedicated money-market funds, which are technically not tax-exempt.
We have made both the Department of the Treasury and the Internal Revenue Service aware of the special issues that may affect variable insurance contracts under the proposed emergency, guaranty fund, and it seems unlikely that they would allow the potentially harsh results discussed above to occur, especially in the current financial climate. In the absence of guidance, however, enrolling in the Treasury guaranty program is not risk-free for insurance-dedicated money-market funds.
Links to Treasury Department press releases regarding the guaranty program for money-market mutual funds: