[Federal Register: March 25, 2008 (Volume 73, Number 58)]
[Notices]
[Page 15799-15805]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr25mr08-102]
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SECURITIES AND EXCHANGE COMMISSION
[Rel. No. IC-28197; File No. 812-13445]
American Family Life Insurance Company, et al.
March 19, 2008.
AGENCY: U.S. Securities and Exchange Commission (``Commission'').
ACTION: Notice of application for an order under Section 26(c) of the
Investment Company Act of 1940, as amended (the ``Act'').
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Applicants: American Family Life Insurance Company (the ``Company''),
American Family Variable Account I (the ``Life Account''), and American
Family Variable Account II (the ``Annuity Account,'' and together with
the Company and Life Account, the ``Applicants'').
Summary of Application: Applicants request an order of the Commission,
pursuant to Section 26(c) of the Act, approving the substitution of (1)
Service Class Shares of the Fidelity Variable Insurance Products
Investment Grade Bond Portfolio (``Replacement Portfolio A'') of the
Fidelity Variable Insurance Products Fund V (``Fidelity Fund'') for
shares of the Federated Quality Bond Fund II (``Replaced Portfolio A'')
of the Federated Insurance Series (``Federated Fund'') and (2) shares
of the Vanguard International Portfolio (``Replacement Portfolio B'')
of the Vanguard Variable Insurance Fund (``Vanguard Fund'') for shares
of the Federated International Equity Fund II (``Replaced Portfolio
B'') of the Federated Fund, currently held by the Life Account and the
Annuity Account (each an ``Account,'' together, the ``Accounts'') to
support variable life insurance and annuity contracts issued by the
Company (collectively, the ``Contracts'').
Filing Date: The application was filed on November 2, 2007 and amended
and restated on March 14, 2008.
Hearing or Notification of Hearing: An order granting the application
will be issued unless the Commission orders a hearing. Interested
persons may request a hearing by writing to the Secretary of the
Commission and serving Applicants with a copy of the request,
personally or by mail. Hearing requests must be received by the
Commission by 5:30 p.m. on April 15, 2008, and should be accompanied by
proof of service on Applicants in the form of an affidavit or, for
lawyers, a certificate of service. Hearing requests should state the
nature of the requester's interest, the reason for the request, and the
issues contested. Persons who wish to be notified of a hearing may
request notification by writing to the Secretary of the Commission.
ADDRESSES: Secretary, Securities and Exchange Commission, 100 F Street,
NE., Washington, DC 20549-1090. Applicants, c/o James F. Eldridge,
Esq., American Family Life Insurance Company, 6000 American Parkway,
Madison, Wisconsin 53783-0001. Copy to Thomas E. Bisset, Esq.,
Sutherland Asbill & Brennan LLP, 1275 Pennsylvania Ave., NW.,
Washington, DC 20004-2415.
FOR FURTHER INFORMATION CONTACT: Michael Kosoff, Staff Attorney, at
(202) 551-6754 or Harry Eisenstein, Branch Chief, Office of Insurance
Products, Division of Investment Management, at (202) 551-6795.
SUPPLEMENTARY INFORMATION: The following is a summary of the
application. The complete application may be obtained for a fee from
the Public Reference Branch of the Commission, 100 F Street, NE.,
Washington, DC 20549 (202-551-8090).
Applicants' Representations
1. The Company is a stock life insurance company organized under
Wisconsin law in 1957. The company is a wholly-owned subsidiary of
AmFam, Inc. AmFam, Inc. is a downstream holding company and a wholly-
owned subsidiary of American Family Mutual Insurance Company
(``American Family Mutual''). American Family Mutual is one of the
leading property/casualty insurance companies in the United States with
operations in eighteen states. As of December 31, 2006, the Company had
assets in excess of $4.2 billion.
2. The Company conducts a conventional life insurance business and
is authorized to transact the business of life insurance, including
annuities, in eighteen states. For purposes of the Act, the Company is
the depositor and sponsor of each of the Accounts as those terms have
been interpreted by the Commission with respect to variable life
insurance and variable annuity separate accounts.
3. Under the insurance law of Wisconsin, the assets of each Account
attributable to the Contracts issued through that Account are owned by
the Company, but are held separately from the other assets of the
Company for the benefit of the owners of, and the persons entitled to
payment under, those Contracts. Each Account is registered with the
Commission as a unit investment trust. Each Account is comprised of a
number of subaccounts and each subaccount invests exclusively in one of
the insurance dedicated mutual fund portfolios made available as
investment vehicles underlying the Contracts. Currently, Replaced
Portfolio A and Replaced Portfolio B are each available as an
investment option under the Company's variable life insurance and
variable annuity contracts.
4. The Life Account is currently divided into nine subaccounts. The
assets of the Life Account support variable life insurance contracts
and interests in the Account offered through such contracts have been
registered under the Securities Act of 1933, as amended (the ``1933
Act''), on Form N-6 (File No. 333-44956).
5. The Annuity Account is currently divided into nine subaccounts.
The assets of the Annuity Account support variable annuity contracts
and interests in the Account offered through such contracts have been
registered under the 1933 Act on Form N-4 (File No. 333-45592).
6. The Federated Fund is registered as an open-end management
investment company under the Act (File No. 811-08042) and currently
offers twelve (12) separate investment portfolios (each, a
``Portfolio''), two of which would be involved in the proposed
substitution. The Federated Fund issues a separate series of shares of
beneficial interest in connection with each Portfolio and has
registered those shares under the 1933 Act on Form N-1A (File No. 33-
69268).
7. Federated Investment Management Company (``FIMC'') serves as the
investment advisor for Replaced Portfolio A. The advisor manages the
Fund's assets, including buying and selling portfolio securities.
Federated Advisory Services Company (``FASC''), an affiliate of the
advisor, provides certain support services to the advisor. The fee for
FASC's services is paid by FIMC and not by the Fund.
[[Page 15800]]
8. Federated Global Investment Management Corp. (``FGIMC'') serves
as the investment advisor for Replaced Portfolio B. The advisor manages
the Fund's assets, including buying and selling portfolio securities.
FASC provides research, quantitative analysis, equity trading and
transaction settlement and certain support services to the advisor. The
fee for FASC's services is paid by FGIMC and not by the Fund.
9. Neither the Federated Fund, any of its portfolios, FGIMC, FIMC,
nor FASC is affiliated with the Applicants. Neither Replaced Portfolio
A nor Replaced Portfolio B has exemptive relief from Section 15(a) of
the Act and Rule 18f-2 under the Act to permit the hiring of sub-
advisors and the revision of sub-advisory agreements without obtaining
a shareholder vote (``manager-of-manager relief'').
10. The Fidelity Fund is registered as an open-end management
investment company under the Act (File No. 811-05361) and currently
offers twenty-three (23) investment portfolios, including Replacement
Portfolio A. The Fidelity Fund issues a series of shares of beneficial
interest in connection with each portfolio and has registered such
shares under the 1933 Act on Form N-1A (File No. 033-17704).
11. Each portfolio of the Fidelity Fund has entered into an
advisory agreement with Fidelity Management and Research Company
(``FMR'') under which FMR acts as investment advisor for the portfolio.
Under each investment advisory agreement, FMR has overall
responsibility for the selection of investments in accordance with the
investment objective, policies, and limitations of the portfolio and
for handling the portfolio's business affairs. FMR, at its own expense,
provides or arranges for the provision of substantially all management
and administrative services required by each portfolio. Each portfolio
of the Fidelity Fund does, however, pay its own auditor's fees,
compensation to (and expenses of) trustees who are not interested
persons, independent counsel fees, custodian fees and extraordinary
expenses.
12. Fidelity Investments Money Management, Inc. (``FIMM''), an
investment advisor affiliate of FMR, has entered into a sub-advisory
agreement with FMR under which FIMM acts as sub-advisor for the
Fidelity Fund, including Replacement Portfolio A. FIMM has day-to-day
responsibility for choosing investments for Replacement Portfolio A.
FMR pays FIMM for providing sub-advisory services. As of March 29,
2007, FMR and FIMM had over $1.6 billion and $370 billion in assets
under management, respectively.
13. Fidelity Research & Analysis Company (``FRAC''), an affiliate
of FMR, also serves as sub-advisor for the Fidelity Fund and may
provide investment research and advice for the Fidelity Fund, including
Replacement Portfolio A.
14. Fidelity International Investment Advisors (``FIIA'') and
Fidelity International Investment Advisors (U.K.) Limited
(``FIIA(U.K.)'') investment advisor affiliates of FMR, assist FMR with
the investment and reinvestment of assets in Replacement Portfolio A in
foreign investments. FIIA and FIAA(U.K.) have each entered into a sub-
advisory agreement with FMR and each acts as sub-advisor to Replacement
Fund A. Under the sub-advisory agreements, FMR may receive from FIIA
and FIAA(U.K.) investment research and advice on issuers based outside
the United States and, in particular, makes minimal credit risk and
comparable quality determinations for foreign issuers that issue U.S.
dollar-denominated securities. FMR or FIMM pays FIIA for providing sub-
advisory services. In turn, FIIA pays FIIA(U.K.) for providing sub-
advisory services.
15. Neither the Fidelity Fund, any of its portfolios, FMR, FIMM,
FRAC, FIIA nor FIAA(U.K.) is affiliated with the Applicants. The
Fidelity Fund does not have manager-of-managers relief.
16. The Vanguard Variable Insurance Fund is registered as an open-
end management investment company under the Act (File No. 811-05962)
and currently offers fifteen (15) portfolios. The Vanguard Fund issues
a series of shares of beneficial interest in connection with each
portfolio and has registered such shares under the 1933 Act on Form N-
1A (File No. 33-32216).
17. The Vanguard Fund uses a multi-manager approach to investing
the assets of Replacement Portfolio B, and has entered into investment
advisory agreements with Baillie Gifford Overseas Ltd. (``Baillie
Gifford'') and Schroder Investment Management North America Inc.
(``Schroders''). The board of trustees of the Vanguard Fund designates
the proportion of Replacement Portfolio B assets to be managed by each
advisor, and may change those proportions at any time. Under the
supervision and oversight of the trustees and officers of the Vanguard
Fund, each advisor independently selects and maintains a portfolio of
common stocks for its assigned portion of the assets of Replacement
Portfolio B. The Fund pays each advisor a fee at the end of each
quarter.
18. Baillie Gifford--located at Carlton Square, 1 Greenside Row,
Edinburgh, EH1 3AN, Scotland--is wholly-owned by Baillie Gifford & Co.,
one of the largest independently owned investment management firms in
the United Kingdom. As of December 31, 2006, Baillie Gifford & Co. had
assets under management that totaled approximately $95 billion.
19. Schroders has entered into a sub-advisory agreement with its
affiliate, Schroder Investment Management North America Limited
(``Schroder Limited''), pursuant to which Schroder Limited has primary
responsibility for choosing investments for Schroder's assigned portion
of the Replacement Portfolio B assets. Schroders pays Schroder Limited
a portion of the management fees payable to Schroders under the
management agreement between Schroders and the Vanguard Fund. Both
Schroders and Schroder Limited are wholly-owned subsidiaries of
Schroders plc, the ultimate parent of a large world-wide group of
financial service companies. As of September 30, 2006, Schroders,
together with its affiliated companies, managed approximately $229.4
billion in assets.
20. Neither the Vanguard Fund or any of its portfolios, Baillie
Gifford, or Schroders is affiliated with the Applicants. The Vanguard
Fund has manager-of-manager relief.\1\
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\1\ Vanguard Convertible Securities Fund, et al., Inv. Co. Act
Rel. No. 26089 (June 25, 2003 (Order), File No. 812-12380.
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21. The Contracts are flexible premium variable annuity and
variable life insurance contracts. The variable annuity Contracts
provide for the accumulation of values on a variable basis, fixed
basis, or both, during the accumulation period, and provide settlement
or annuity payment options on a fixed basis. The variable life
insurance Contracts provide for the accumulation of values on a
variable basis, fixed basis, or both, throughout the insured's life,
and for a substantial death benefit upon the death of the insured.
Under each of the Contracts, the Company reserves the right to
substitute shares of one Fund for shares of another, or of another
investment portfolio, including a portfolio of a different management
company.
22. The Company proposes to substitute Service Class shares of
Replacement Portfolio A for shares of Replaced Portfolio A, and to
substitute shares of Replacement Portfolio B for shares of Replaced
Portfolio B held in the Accounts (the ``proposed substitutions'').
[[Page 15801]]
23. The proposed substitutions are part of an effort by the Company
to provide a portfolio selection within the Contracts that: (1)
Provides a more competitive fee structure relative to other funds in
the asset class peer group; (2) provides more competitive long-term
returns relative to other funds in the asset class peer group; and (3)
maintains the goal of offering a mix of investment options covering
basic categories in the risk/return spectrum.
24. The following charts set out the investment objectives,
principal investment strategies, and principal investment risks of each
Replaced and Replacement Portfolio, as stated in their respective
prospectuses.
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Replaced Portfolio A Replacement Portfolio A
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Federated Quality Bond Fund II Fidelity VIP Investment Grade Bond
Portfolio
Investment Objective Investment Objective
Current income High current income consistent with
preservation of capital.
Principal Investment Strategies Principal Investment Strategies
The fund invests in a diversified FMR normally invests at least 80%
portfolio of investment-grade, of the fund's assets in investment-
fixed-income securities, grade debt securities (those of
consisting primarily of corporate high and medium quality) of all
debt securities, U.S. government types and repurchase agreements
and privately issued mortgage- for those securities. FMR manages
backed securities, and U.S. the fund to have an overall
Treasury and agency securities. interest rate risk similar to the
The investment advisor seeks to Lehman Brothers Aggregate Bond
enhance the fund's performance by Index. The investment advisor
allocating relatively more of its allocates assets across different
portfolio to the security type market sectors and maturities and
that the advisor expects to offer invests in domestic and foreign
the best balance between current issuers. FMR analyzes the credit
income and risk. Some of the quality of the issuer, security-
corporate debt securities in which specific features, current and
the fund invests are considered to potential future valuation, and
be ``foreign securities.'' The trading opportunities to select
fund may invest in derivative investments for the fund.
contracts to implement its
investment strategies.
Although the value of the Fund's The fund may invest in lower-
shares will fluctuate, the quality debt securities, sometimes
investment advisor seeks to manage referred to as ``junk bond
the magnitude of the fluctuation securities,'' and in Fidelity's
by limiting, under normal market central funds. The fund may engage
conditions, the Fund's dollar- in transactions that have a
weighted average maturity to leveraging effect.
between three and ten years and
dollar-weighted average duration
to between three and seven years.
Principal Investment Risks Principal Investment Risks
Interest Rate Risk. Prices of fixed- Interest Rate Changes. Interest
income securities generally fall rate increases can cause the price
when interest rates rise. Interest of a debt security to decrease.
rate changes have a greater effect Foreign Exposure. Foreign markets
on the price of fixed-income can be more volatile than the U.S.
securities with longer durations. market due to increased risks of
Credit Risk. Issuers of securities adverse issuer, political,
in which the fund may invest may regulatory, market, or economic
default in the payment of interest developments, and can perform
or principal on securities when differently than the U.S. market.
due. Prepayment. The ability of an
Call and Prepayment Risk. An issuer issuer of a debt security to repay
of a security held by the fund may principal prior to a security's
redeem the security prior to maturity can cause greater price
maturity at a price below its volatility if interest rates
current market value. change.
Risks of Foreign Investing. Share Issuer-Specific Changes. The value
price may be more affected by of an individual security or
foreign economic and political particular type of security can be
conditions, taxation policies and more volatile than the market as a
accounting standards than would whole and can perform differently
otherwise be the case. from the value of the market as a
Liquidity Risk. Fixed-income whole. Lower-quality debt
securities may be less readily securities (those of less than
marketable and subject to greater investment-grade quality) involve
fluctuation in price than other greater risk of default or price
securities. Also, the fund may not changes due to changes in the
be able to sell a security or credit quality of the issuer. The
close out a derivative contract value of lower-quality debt
when desired. securities can be more volatile
due to increased sensitivity to
adverse issuer, political,
regulatory, market, or economic
developments.
Leverage Risk. Leverage can
increase market exposure and
magnify investment risks.
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Replaced Portfolio B Replacement Portfolio B
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Federated International Equity Fund Vanguard International Portfolio
II
Investment Objective Investment Objective
Total return on assets by investing Long-term capital appreciation.
primarily in equity securities of
companies based outside the United
States. Total return will consist
of two components: (1) changes in
the market value of portfolio
securities (both realized and
unrealized appreciation); and (2)
income received from portfolio
securities. Changes in market
value are expected to comprise the
largest component of total return.
Principal Investment Strategies Principal Investment Strategies
The investment advisor uses a The portfolio invests predominantly
``bottom-up'' approach to stock in the stocks of companies located
selection and selection of outside the United States. In
industry and country are secondary selecting stocks, the portfolio's
considerations. The fund is not investment advisors evaluate
limited to investing according to foreign markets around the world
any particular style or size of and choose companies with above-
company, or to maintaining minimum average growth potential. The
allocations to any particular portfolio uses multiple investment
region or country. However, the advisors.
investment advisor anticipates
that normally the fund will
primarily invest in mid-to large-
capitalization companies based
outside the United States that
have been selected using a growth
style of stock selection. The fund
may invest up to 20% of its assets
in foreign companies based in
emerging markets.
[[Page 15802]]
Principal Investment Risks Principal Investment Risks
Stock Market Risks. The value of Stock Market Risk. Stock market
equity securities in the fund's risk is the chance that stock
portfolio will fluctuate and, as a prices overall will decline. Stock
result, the fund's share price may markets tend to move in cycles,
decline suddenly or over a with periods of rising prices and
sustained period of time. periods of falling prices. In
Risks of Foreign Investing. Share addition, investments in foreign
price may be more affected by stock markets can be riskier than
foreign economic and political U.S. stock investments. The prices
conditions, taxation policies, and of foreign stocks and the prices
accounting and auditing standards of U.S. stocks have, at times,
than would otherwise be the case. moved in opposite directions.
Currency Risks. Because the Investment Style Risk. Investment
exchange rates for currencies style risk is the chance that
fluctuate daily, prices of the returns from non-U.S. growth
foreign market securities in which stocks, and, to the extent that
the fund invests are more volatile the portfolio is invested in them,
than prices of securities traded small- and mid-capitalizations
exclusively in the United States. stocks, will trail returns from
Emerging Market Risks. Securities the overall domestic stock market.
issued or traded in emerging Historically, small- and mid-cap
markets generally entail greater stocks have been more volatile in
risks than securities issued or price than large-cap stocks that
traded in developed markets. dominate the market, and they
Emerging market countries may have often perform quite differently.
relatively unstable governments Country Risk/Regional Risk. Country
and may present the risk of risk/regional risk is the chance
nationalization of businesses, that domestic events--such as
expropriation, confiscatory political upheaval, financial
taxation or, in certain instances, troubles, or natural disasters--
reversion to closed market, will weaken a country's or
centrally planned economies. region's securities markets.
Liquidity Risks. Trading Because the portfolio may invest a
opportunities are more limited for large portion of its assets in
equity securities that are not securities of companies located in
widely held. This may make it more any one country or region, its
difficult to sell or buy a performance may be hurt
security at a favorable price or disproportionately by the poor
time. Consequently, the fund may performance of investments in that
have to accept a lower price to area. Country/regional risk is
sell a security, sell other especially high in emerging
securities to raise cash, or give markets.
up an investment opportunity, any Currency Risk. Currency risk is the
of which could have a negative chance that the value of a foreign
effect on the fund's performance. investment, measured in U.S.
dollars, will decrease because of
unfavorable changes in currency
exchange rates.
Manager Risk. Manager risk is the
chance that poor security
selection will cause the portfolio
to underperform relevant
benchmarks or other funds with a
similar investment objective.
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25. The following charts compare advisory fees, other expenses,
total operating expenses (before and after any waivers and
reimbursements), and portfolio turnover rates for the year ended
December 31, 2006, expressed as an annual percentage of average daily
net assets, of the Replaced and Replacement Portfolios. Although
Replacement Portfolio A is subject to a distribution (12b-1) fee of the
Act, and none currently applies to Replaced Portfolio A, the net
operating expenses for Replacement Portfolio A are still significantly
less than the total operating expenses for Replaced Portfolio A.\2\
Neither the Replaced Portfolios nor the Replacement Portfolios impose a
redemption fee.
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\2\ With regard to the Replaced Portfolios, the investment
adviser for each Portfolio has entered into an agreement with the
Company for the payment of a fee equal to an annual percentage of
the assets of the Replaced Portfolio attributable to the Contracts
for the performance of administrative services. With regard to
Replacement Portfolio A, the investment adviser for the Portfolio
and the Company have entered into a similar agreement, however, the
fee payable under that agreement is significantly less than the fee
payable under the agreement between the Company and the investment
adviser for Replaced Portfolio A. With regard to Replacement
Portfolio B, the investment adviser for the Portfolio and the
Company have not entered into a similar agreement. As such, the
Company will not receive revenue sharing payments from the
investment adviser for Replacement Portfolio B.
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Replaced Portfolio A Replacement Portfolio
----------------------- A
----------------------
Federated Quality Fidelity VIP
Bond Fund II Investment Grade Bond
(percent) Portfolio (percent)
----------------------------------------------------------------------------------------------------------------
Advisory Fee...................................................... 0.60 0.32
Distribution (12b-1) Fee.......................................... 0.25 \a\ 0.10
Other Expenses.................................................... 0.39 0.12
Total Operating Expenses.......................................... 1.24 0.54
Less Expense Waivers and Reimbursements........................... \b\ 0.54 N/A
Net Operating Expenses............................................ 0.70 0.54
Portfolio Turnover Rate........................................... 64 34
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\a\ With regard to Replacement Portfolio A, its Service Class is authorized to pay a 12b-1 fee at an annual rate
of 0.25% of its average net assets, or such lesser amount as the Portfolio's Trustees may determine from time
to time. The Service Class currently pays a 12b-1 fee at an annual rate of 0.10% of its average net assets
throughout the month. The 12b-1 fee rate may be increased only when the Trustees believe that it is in the
best interests of variable product owners to do so.
\b\ With regard to Replaced Portfolio A, the investment adviser waived and the distributor and shareholder
services provider elected not to charge certain amounts. The investment adviser voluntarily waived a portion
of the advisory fee which waiver the investment adviser may terminate at any time. The advisory fee paid by
Replaced Portfolio A (after the voluntary waiver of the advisory fee) was 0.56% for the fiscal year ended
December 31, 2006. Replaced Portfolio A did not pay or accrue the distribution (12b-1) fee during the fiscal
year ended December 31, 2006. The prospectus for Replaced Portfolio A notes that there is no present intention
for Replaced Portfolio A to pay or accrue a distribution (12b-1) fee during the fiscal year ended December 31,
2007. Also, Replaced Portfolio A did not pay or accrue the shareholder services fee/account administration fee
during the fiscal year ended December 31, 2006. Total other expenses for Replaced Portfolio A (after the
voluntary waiver of the shareholder services fee/account administration fee) were 0.14% for the fiscal year
ended December 31, 2006.
[[Page 15803]]
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Replaced Portfolio B Replacement Portfolio
----------------------- B
----------------------
Federated Vanguard
International Equity International
Fund II (percent) Portfolio (percent)
----------------------------------------------------------------------------------------------------------------
Advisory Fee...................................................... 1.00 0.39
Distribution (12b-1) Fee.......................................... N/A N/A
Other Expenses.................................................... 0.77 0.05
Total Operating Expenses.......................................... 1.77 0.44
Less Expense Waivers and Reimbursements........................... \c\ 0.28 N/A
Net Operating Expenses............................................ 1.49 0.44
Portfolio Turnover Rate........................................... 83 29
----------------------------------------------------------------------------------------------------------------
\c\ With regard to Replaced Portfolio B, the administrator and shareholder services provider waived and/or
elected not to charge certain amounts. Replaced Portfolio B did not pay or accrue a shareholder services fee
during the fiscal year ended December 31, 2006. The prospectus for Replaced Portfolio B notes that there is no
present intention for Replaced Portfolio B to pay or accrue a shareholder services fee during the fiscal year
ended December 31, 2007. Also, the administrator voluntarily waived a portion of its fee which waiver the
administrator may terminate at any time. Total other expenses for Replaced Portfolio B (after the voluntary
waivers and reduction) were 0.49% for the fiscal year ended December 31, 2006.
26. The following tables compare the respective asset levels,
expenses ratios (after expense waivers and reimbursements) and
performance data for each Replaced Portfolio and each Replacement
Portfolio for fiscal years 2004, 2005 and 2006.
----------------------------------------------------------------------------------------------------------------
Net assets at Expense ratio Total return
end of period (percent) (percent)
----------------------------------------------------------------------------------------------------------------
Federated Quality Bond Fund II
----------------------------------------------------------------------------------------------------------------
2004........................................................... $518,023,000 0.70 3.62
2005........................................................... 480,859,000 0.70 1.30
2006........................................................... 390,738,000 0.70 4.15
----------------------------------------------------------------------------------------------------------------
Fidelity VIP Investment Grade Bond Portfolio
----------------------------------------------------------------------------------------------------------------
2004........................................................... 1,611,417,000 0.66 4.32
2005........................................................... 1,649,333,000 0.58 2.08
2006........................................................... 1,782,079,000 0.54 4.30
----------------------------------------------------------------------------------------------------------------
Federated International Equity Fund II
----------------------------------------------------------------------------------------------------------------
2004........................................................... 53,093,000 1.57 14.06
2005........................................................... 58,700,000 1.58 9.08
2006........................................................... 70,213,000 1.49 18.89
----------------------------------------------------------------------------------------------------------------
Vanguard International Portfolio
----------------------------------------------------------------------------------------------------------------
2004........................................................... 557,000,000 0.41 19.42
2005........................................................... 840,000,000 0.41 16.31
2006........................................................... 1,562,000,000 0.44 26.75
----------------------------------------------------------------------------------------------------------------
27. Replaced Portfolio A, which has a high concentration in
corporate debt securities, is positioned on the conservative end of the
risk/return spectrum for fixed income investment options and offered
Contract owners a fixed income option with limited risk. Over the past
seven years, Replaced Portfolio A has significantly underperformed its
peers leading the Company to reassess the position of its fixed income
investment option. In an attempt to improve overall returns for the
fixed income investment option while still maintaining a relatively low
level of risk, the Company decided to select a fixed income investment
option which is more representative of the overall bond market.
Applicants believe that Replacement Portfolio A meets this goal.
28. The Company selected Replaced Portfolio B to diversify the
investment options under the Contract to include a portfolio selection
that pursued international investment opportunities. The managers of
Replaced Portfolio B pursue positive total return on assets invested
primarily in equity securities of mid- to large-capitalization
companies based outside the U.S. Over the past five years, however,
Replaced Portfolio B has underperformed the Morgan Stanley Capital
International, Europe, Australasia, Far East Index (``MSCI EAFE
Index''), the benchmark used by Replaced Portfolio B as well as peer
funds. Replacement Portfolio B uses a multiple manager approach to
pursue long-term capital appreciation by investing primarily in non-
U.S. growth stocks of large, stable companies diversified across
countries that the investment managers believe demonstrate above-
average growth potential. Although the overall characteristics of the
assets of Replacement Portfolio B may differ from broad international
stock indices, over the past five years, the performance of Replacement
Portfolio B has, in each of the last three years, exceeded the
performance of Replaced Portfolio B.
29. In the case of Replaced Portfolio A, performance has been in
the bottom quartile for comparable funds over the last three years, and
has been lower than
[[Page 15804]]
its benchmark for the past five years. In the case of Replaced
Portfolio B, performance ranks in the bottom decile for comparable
funds over the last 1-, 3-, and 5-year periods.
30. The stated investment objective, principal investment
strategies and principal investment risks of the Replacement Portfolios
are substantially similar to those of the Replaced Portfolios, so that
Contract owners will have continuity in investment and risk
expectations. The net expenses of each Replacement Portfolio is
substantially less than those for the corresponding Replaced Portfolio
for the year ended December 31, 2006, even after expense waivers and
reimbursements for the Replaced Portfolio have been taken into account.
31. Replacement Portfolio A has a substantially identical
investment objective as that of Replaced Portfolio A. Both pursue their
investment objective by investing, under normal market conditions, in a
diversified portfolio of investment grade fixed-income securities,
consisting of corporate debt securities, U.S government issued
mortgage-backed securities and U.S. Treasury and agency securities.
Each retains the flexibility to invest in corporate debt securities of
foreign issuers and in derivative instruments, such as options, futures
and swap contracts.
32. The primary difference in the implementation of investment
strategies of Replaced Portfolio A and Replacement Portfolio A manifest
in the degree of flexibility exercised by their advisors in
implementing the strategies. Replaced Portfolio A's investment advisor
emphasizes an active trading approach and relies on a fundamental
analysis of each company in making an investment decision while the
investment advisor for Replacement Portfolio A uses the Lehman Brothers
U.S. Aggregate Index (the ``Lehman Index'') as the primary guide to
structure Replacement Portfolio A and select investments with the goal
of managing Replacement Portfolio A to have an overall interest rate
risk similar to the Lehman Index. Conversely, whereas Replaced
Portfolio A's investment advisor invests exclusively in fixed-income
securities rated investment grade, the investment advisor for
Replacement Portfolio A is not so constrained and may invest up to 10
percent of Replacement Portfolio A's assets in lower quality debt
securities, sometimes referred to as junk bond securities.
33. Notwithstanding some difference in the stated investment
objectives of Replacement Portfolio B and Replaced Portfolio B, both
emphasize capital appreciation as the primary investment objective and
both follow substantially identical investment strategies to pursue
their investment objectives. Both pursue their investment objectives by
investing primarily in equity securities of well-capitalized companies
based outside the United States that have favorable growth prospects.
The investment advisor for Replaced Portfolio B and the investment
advisors for Replacement Portfolio B each use an active management
approach and rely on a combination of fundamental analysis of each
company and an analysis of stock market and economic cycles before
making an investment decision. None of the investment advisors are
limited with respect to the countries and industries in which they may
invest. Each investment advisor retains the flexibility to invest in
securities issued by mid-cap and small-cap companies as well as
securities of companies in emerging markets.
34. The primary difference in investment objectives of Replaced
Portfolio B and Replacement Portfolio B manifests in the degree to
which Replaced Portfolio B emphasizes income from portfolio securities
as a secondary investment objective. In that regard, Replaced Portfolio
B's investment advisor may purchase a security solely to generate
income or for the potential to generate income without regard to
capital appreciation whereas the investment advisors for Replacement
Portfolio B would not purchase a security solely for that purpose.
Replaced Portfolio B also places a slightly greater emphasis on
investment in securities of mid-cap companies than Replacement
Portfolio B.
35. Replacement Portfolio A has available to it transactional
advantages attributable to achieved economies of scale greater than
those of Replaced Portfolio A and has a significantly lower expense
ratio than Replaced Portfolio A even after expense waivers and
reimbursements for Replaced Portfolio A have been taken into account.
Although Replacement Portfolio B has not yet achieved a level of assets
equal to or greater than Replaced Portfolio B, Replacement Portfolio B
has a significantly lower expense ratio than Replaced Portfolio B even
after expense waivers and reimbursements for Replaced Portfolio B have
been taken into account.
36. For Contract owners on the date of the proposed substitutions,
the Company will reimburse, on the last business day of each fiscal
period (not to exceed a fiscal quarter) during the twenty-four months
following the date of the proposed substitutions, the subaccount
investing in the Replacement Portfolio such that the sum of the
Replacement Portfolio's operating expenses (taking into account fee
waivers and expense reimbursements) and subaccount expenses for such
period will not exceed, on an annualized basis, the sum of the
corresponding Replaced Portfolio's operating expenses (taking into
account fee waivers and expense reimbursements) and subaccount expenses
for the fiscal year preceding the date of the proposed substitution. In
addition, for twenty-four months following the proposed substitutions,
the Company will not increase asset-based fees or charges for Contracts
outstanding on the date of the proposed substitutions.
37. By the May 1, 2008 prospectuses for the Contracts and the
Accounts, the Company will notify owners of the Contracts of their
intention to take the necessary actions to carry out the proposed
substitutions. The current prospectus for each Replacement Fund, as
well as the current prospectuses for all other portfolios available as
investment options available under the Contracts, will be bound
together with the May 1, 2008 prospectuses for the Contracts and the
Accounts.
38. The prospectuses for the Contracts will advise the Contract
owners that from the date of the prospectus until the date of the
proposed substitutions, the Company will not exercise any rights
reserved by it under any Contract to impose additional charges for
transfers until at least 30 days after the proposed substitutions.
Similarly, the prospectus will disclose that, from May 1, 2008 until
the date of the proposed substitutions, the Company will permit
Contract owners to transfer Contract value out of each subaccount
currently holding shares of a Replaced Portfolio to other subaccounts
and the fixed account without those transfers being treated as
transfers for purposes of determining the remaining number of transfers
that may be permitted in the Contract year without a transfer charge.
The prospectuses will also advise Contract owners that if the proposed
substitutions are carried out, then each Contract owner affected by the
substitutions will be sent a written notice (described immediately
below) informing them of the facts and details of the substitutions.
39. Within five days after the proposed substitutions, Contract
owners who are affected by the substitutions will be sent a written
notice informing them that the substitutions were carried
[[Page 15805]]
out. The notice will also reiterate the facts that the Company: (1)
Will not exercise any rights reserved by it under any of the Contracts
to impose additional charges for transfers until at least 30 days after
the proposed substitutions, and (2) will, for at least 30 days
following the proposed substitutions, permit such Contract owners to
transfer Contract values out of the subaccounts holding shares of the
Replacement Portfolios to other subaccounts and the fixed account
without those transfers being treated as transfers for purposes of
determining the remaining number of transfers permitted in the Contract
year without a transfer charge. The notice as delivered in certain
jurisdictions may also explain that the right of a Contract owner to
make transfers in connection with the proposed substitutions will not
affect such Contract owner's right, under insurance regulations in
those jurisdictions, to exchange his or her Contract for a fixed-
benefit life insurance contract or a fixed-benefit annuity Contract
during the 60 days following the substitutions.
40. The Company will carry out the proposed substitutions by
redeeming shares of each Replaced Portfolio held by the Accounts for
cash and applying the proceeds to the purchase of shares of the
Replacement Portfolios. The proposed substitutions will take place at
relative net asset value with no change in the amount of any Contract
owner's Contract value or death benefit or in the dollar value of his
or her investment in any of the Accounts. Contract owners will not
incur any fees or charges as a result of the proposed substitutions,
nor will their rights or the Company's obligations under the Contracts
be altered in any way. All applicable expenses incurred in connection
with the proposed substitutions, including brokerage commissions and
legal, accounting, and other fees and expenses, will be paid by the
Company. In addition, the proposed substitutions will not impose any
tax liability on Contract owners. The proposed substitutions will not
cause the Contract fees and charges currently being paid by existing
Contract owners to be greater after the proposed substitutions than
before the proposed substitutions.
Applicants' Legal Analysis
1. The Applicants request that the Commission issue an order
pursuant to Section 26(c) of the Act approving the substitution by the
Company of Service Class shares of Replacement Portfolio A for shares
of Replaced Portfolio A, and the substitution of shares of Replacement
Portfolio B for shares of Replaced Portfolio B held by the Accounts.
2. The Applicants assert that all the Contracts expressly reserve
for the Company the right, subject to compliance with applicable law,
to substitute shares of one fund or portfolio held by a subaccount of
an Account for another. The prospectuses for the Contracts and the
Accounts contain appropriate disclosure of this right.
3. Applicants maintain that Contract owners will be better served
by the proposed substitutions and that the proposed substitutions are
appropriate given the Replacement Portfolios, the Replaced Portfolios,
and other investment options available under the Contracts. In the last
three years, Replacement Portfolio A has had investment performance
superior to that of Replaced Portfolio A, and Replacement Portfolio B
has had investment performance superior to that of Replaced Portfolio
B. In addition, Replacement Portfolio A has had substantially lower
expenses over this same period than Replaced Portfolio A, and
Replacement Portfolio B has had substantially lower expenses over this
same period than Replaced Portfolio B.
4. Applicants believe that Replacement Portfolio A and Replaced
Portfolio A are substantially the same in their stated investment
objectives and principal investment strategies, and that Replacement
Portfolio B and Replaced Portfolio B are substantially similar in their
stated investment objectives and principal investment strategies, as to
afford investors continuity of investment and risk.
5. Although each Replaced Portfolio benefits from an expense
reimbursement arrangement that reduces the Portfolio's expenses, even
after the reimbursement for each Replaced Portfolio has been taken into
account, the expenses of the corresponding Replacement Portfolio are
still significantly lower.
6. The Applicants represent that the proposed substitutions retain
for Contract owners the investment flexibility that is a central
feature of the Contracts. If the proposed substitutions are carried
out, all Contract owners will be permitted to allocate purchase
payments and transfer Contract values between and among the remaining
subaccounts as they could before the proposed substitutions.
7. The Applicants maintain that the proposed substitutions are not
the type of substitution that Section 26(c) was designed to prevent.
Unlike traditional unit investment trusts where a depositor could only
substitute an investment security in a manner which permanently
affected all the investors in the trust, the Contracts provide each
Contract owner with the right to exercise his or her own judgment and
transfer Contract values into other subaccounts and the fixed account.
Moreover, the Contracts will offer Contract owners the opportunity to
transfer amounts out of the affected subaccounts into any of the
remaining subaccounts without cost or disadvantage. The proposed
substitutions, therefore, will not result in the type of costly forced
redemption that Section 26(c) was designed to prevent.
Conclusion
Applicants submit that, for all the reasons stated above, the
proposed substitutions are consistent with the protection of investors
and the purposes fairly intended by the policy and provisions of the
Act.
For the Commission, by the Division of Investment Management,
under delegated authority.
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E8-5919 Filed 3-24-08; 8:45 am]
BILLING CODE 8011-01-P