Why certain investors may wish to purchase such products, and why insurers wish to issue them.
The past few years have seen a significant increase in interest in private placement variable insurance products--both variable annuities and variable life insurance. These products are useful for high net worth individuals and are available from both domestic U.S.-based insurers and from insurers located outside of the U.S. We will devote the next series of articles to a discussion of these products, their features, qualification requirements, and the differences between domestic products and those offered outside of the U.S.
It is really a misnomer to characterize variable insurance products that are offered by non-U.S. domiciled insurers that are not authorized to do business in the U.S. as "private placement" products. The entire concept of "private placement" derives from U.S. securities laws that afford an exemption from registration with the SEC for "securities" that are offered solely to individuals who meet the criteria of "sophisticated" investors. This concept does not exist for insurance products offered by non-U.S. insurers in compliance with the insurance laws of their domiciliary jurisdiction.A non-U.S.-domiciled insurer that is not authorized to do business in the U.S. cannot lawfully solicit for the sale of or issue any insurance policy in the U.S.--private placement or otherwise. Therefore, the concept of "private placement" exists only for insurance products that are deemed to be securities when they are issued by a U.S.-domiciled insurer in accordance with U.S.-state and federal laws.
Nevertheless, the types of insurance products offered by many non-U.S.-domiciled insurers are similar to those that are issued on a private placement basis by U.S. insurers. Indeed, many of the non-U.S.-domiciled insurers that issue such products are affiliates of U.S. insurers that issue "private placement" products. We will explore why such insurers would be interested in issuing these types of variable insurance products by both U.S. and non-U.S. insurers.
In 1959 the U.S. Supreme Court determined that variable annuities were not exempt from the federal securities laws as was the case with other traditional types of insurance products. Thus, variable annuities were "investment company securities" and were subject to registration and regulation in the same manner as with mutual funds. This decision was based on the belief of the court that variable annuities were not the type of insurance products that Congress intended to qualify for the insurance product exemption from the federal securities laws. This decision assumed that the primary purpose for the purchase of a variable annuity was "investment," not "insurance." Thus, consumers were to be afforded the same protections that applied to mutual funds.
This decision was rendered long before variable life insurance was a reality in the U.S. Variable life insurance came into being in the U.S. only after variable annuities had been regulated by the SEC for many years. Thus, although it was arguable that the primary motivation for the purchase of variable life insurance was "insurance" and not "investment," the life insurance industry chose not to contest the issue of the applicability of federal securities laws to the product, and variable life insurance has been subjected to the full scope of federal securities laws that are applied to variable annuities. As a result, variable life insurance products are required to be registered with the SEC as investment company securities and are regulated as such by the SEC unless they qualify for some exemption specified in the federal securities laws.
At the time the federal securities laws were initially enacted during the Great Depression, Congress believed that consumer protections were not necessary for "sophisticated" investors who possessed the resources and experience to enable them to make investment decisions without the protections that were to be afforded to non-sophisticated investors. The Securities Act of 1933 provides for an exemption from registration for securities issued solely to "sophisticated" investors. A similar exemption for regulation of the entities issuing such securities exists under the Investment Company Act of 1940. The statutes themselves do not define what constitutes a "sophisticated" investor. Instead, the burden of determining whether an investor is "sophisticated" is left on the issuers and sellers of such securities.
This sophisticated investor exemption is absolute and is a fact-and-circumstances type of test. Over the years since the federal securities laws were enacted, cases and regulations have interpreted what is meant by the term "sophisticated investor." Fortunately, the SEC has adopted regulations that have more clearly defined standards that will constitute qualifications for the sophisticated investor exemption. It is important to note that, although these regulations as adopted by the SEC provide what amounts to a "safe harbor" for issuers of securities claiming the sophisticated investor exemption, an exemption exists for a truly sophisticated investor even if the qualification standards specified in the SEC rules are not met.
It is rare in practice for any issuer of securities to attempt to claim the sophisticated investor exemption unless the qualification standards specified in the SEC rules are met. As a practical matter, our experience has been that all "private placement" variable insurance products are issued only in compliance with the SEC rules. In the articles to follow, we will discuss the compliance requirements for the sophisticated investor exemption and the methods necessary to ensure compliance. The remainder of this article will be devoted to a discussion of why investors wish to purchase private placement insurance products and why insurers wish to issue them.
The regulatory costs for creation, sale, issuance, and administration of private placement insurance products are much less than is the case with registered products. This enables insurers to offer purchasers more competitive products than is possible with fully registered products. For instance, a fully registered variable insurance product must be valued each day that the New York Stock Exchange is open for business. In essence, this means that each insurance contract must be "handled" administratively every day. There is no such requirement for private placement products, which simplifies the administration and reduces the cost to the insurer. It is not unusual for private placement insurance products to be valued only on a monthly basis.
Private placement variable insurance products also frequently offer more flexible underlying investments than is possible with fully registered products. Such investments can include those with less liquidity or with more exotic objectives than those that can be used with fully registered products.
It is important to note that private placement products that qualify are exempt from some of the federal securities laws; however, they are still subject to the full scope of state insurance laws and regulations. Private placement products must also comply with the requirements of the Internal Revenue Code and Treasury Regulations that apply to variable insurance products. Moreover, private placement products must also be sold only by persons that possess the state insurance licenses and federal securities registrations that apply to the sales of all variable insurance products.
It is also important to note that although a number of U.S. residents purchase variable insurance products from non-U.S. insurers each year, no such insurer can solicit or issue products in the U.S. All such transactions must be entirely completed in a jurisdiction where the insurer is legally authorized to conduct business. An offshore insurer that solicits or issues its insurance products in the U.S. cannot legally do so unless it is authorized to do business not only in the U.S. but also in the state in which the transaction takes place. Any transaction in the U.S. involving an insurer that is not authorized to do business in this country subjects the insurer to action by the federal government and by state insurance regulators.
In later articles we will discuss not only the details of private placement variable insurance products and the qualification standards that apply to them, but some of the uses for these products as offered by both domestic and offshore insurers.