Despite the substantial evolvement of SEC regulation of variable contracts, for the purpose of state law, the issuance of variable contracts by life insurance companies still constitutes doing an insurance business subject to state insurance regulation.

As noted earlier, traditionally state investment law confined life insurer investments primarily to those fixed dollar in nature, mostly bonds and mortgages. To enable insurers to enter into the arena of equity oriented products, such as variable annuities and variable life insurance policies, while at the same time safeguarding insurer assets backing fixed dollar policies, states commenced enacting separate account legislation. In 1970, the NAIC adopted a Model Variable Contract Law which was ultimately adopted by a majority of the states. Other states adopted the Model with significant variations or enacted independent legislation either before or after the Model was adopted. Pursuant to the Model Law, a domestic life insurer is authorized to establish one or more separate accounts and may allocate thereto amounts to provide for life insurance or annuities payable in fixed or variable amounts.

The general pattern of state regulation of separate accounts includes provisions that no insurer may issue contracts in the state which are backed by a separate account without that state’s approval. Also no domestic insurer may establish a separate account unless approved by the state. In addition, specific approval is generally required for a domestic insurer to use a separate account to fund guaranteed amounts and for the transfer of noncash assets to a separate account.

While differing from state to state, such variable contract laws typically contain several key provisions. In order for variable contracts to furnish benefits reflecting the performance of assets held in the separate accounts, the most basic provision in state separate account statutes is that the income, gains and losses (realized or unrealized) from assets allocated to the separate account shall be credited to or charged against the account regardless of the other income, gains or losses of the insurer. Generally, the assets allocated to a separate account shall be valued at market value. While separate account laws are designed to enable contract benefits tied to investment performance of the separate account assets, the laws make clear that the separate account is essentially an accounting mechanism. The statutes usually provide that the amounts allocated to a separate account are owned by the insurer and the insurer is not a trustee with respect to such amounts. Furthermore, while the variable contract owners do not hold legal title or have beneficial ownership interest in the separate account assets, the laws commonly provide that the portion of assets in the separate account equal to the reserves and other liabilities, as to the variable contracts issued through the account, are not chargeable with liabilities arising out of any other business which the insurer might conduct. These provisions serve to provide substantial insulation of separate account assets underlying variable annuity contracts from the liabilities of the insurer with respect to other business.

Also state separate account laws and regulations govern separate account investments and include substantial liberalizations of the traditional statutory investment limitations so as to enable the provision of benefits, which vary according to the investment performance of equity securities. The investment limitations which remain vary among the states. The separate account regulation may include quantitative limitations on separate account investments to promote diversification and limit investment risk. In addition, the separate account laws commonly prohibit, with certain exceptions, any sale, exchange or other transfer of assets between an insurer and any of its separate accounts or between any separate accounts.

In addition to authorizing separate accounts and imposing some limitations thereon, the NAIC Variable Contract Law model established other regulatory requirements as well, as did most states. In the mid-1970s, the NAIC took the next step and adopted the Variable Annuity Model Regulation geared to the variable annuity, defined as any policy or contract which provides for annuity benefits that vary according to the investment experience of any separate account maintained as to such policy or contract. The Model Regulation both repeats and supplements the provisions of the Model Law. Approximately half of the states have adopted the Model or a similar regulation, with most others adopting somewhat different controls.

In determining whether to permit an insurer to issue a variable annuity, not only must the insurer be licensed in the state, the commissioner must also be satisfied that the condition or method of operation as to the issuance of such contracts will not render its operation hazardous to the public or its policyholders. In doing so, the commissioner shall consider the history and financial condition of the insurer, the character and fitness of the officers and directors, and whether the law of a foreign insurer’s state of domicile provides substantially equal protection.

Typically, separate account assets are to be valued at market value or, if there is no readily available market, in accord with the provisions in the contract.

Commonly, states require that the policy must contain a disclosure that the benefits will vary, as well as a statement as to the means by which the insurer shall determine amount of the variable benefits. Investment factors used must be stipulated in the policy. Restrictions are imposed on the computation of variable benefits and other contractual payments or values. The reserve liability shall be established pursuant to the Standard Valuation Law in accordance with actuarial procedures recognizing the nature of the benefits provided and any mortality guarantees. Grace period and reinstatement provisions are required. The Model Regulation also covers nonforfeiture benefits for those states which have enacted the Standard Nonforfeiture Law for Individual Deferred Annuities.

Variable annuity policies must be filed with and approved by the commissioner in the same manner as are other life policy and annuity contract forms.

A state’s general proscriptions as to unfair trade practices apply to variable contract situations. Furthermore, states commonly prohibit illustrations of bene-fits which include projections of past investment experience into the future or make predictions of future investment experience. However, in permitting the use of hypothetical assumed rates of returns to illustrate possible benefit levels, the Model Regulation accepts the argument that illustrations based upon certain specified investment return assumptions, as distinguished from projections of an individual company’s experience, can contribute to a meaningful presentation to prospective purchasers.

Under the Model and similar state regulations, an insurer shall annually provide its variable annuity contractholders both a statement of the investments held in the separate account and information as to the values pertaining to the individual’s own policy.

To sell variable annuities, the agent needs to be licensed as a life insurance agent. The examination for an agent’s license includes questions concerning the history, purpose, regulation and sale of variable annuities which the commissioner deems appropriate. An agent must also comply with the training, examination and business conduct requirements of the federal securities laws and file evidence with the insurance commissioner that he or she is authorized to sell variable annuities under applicable federal and state securities law. The commissioner may deny, suspend or revoke an agent’s license to sell variable annuity contracts on grounds akin to those applicable in nonvariable annuity situations.

As noted above, the NAIC responded to the SEC’s invitation and adopted an extensive variable life insurance regulation to, among other things, provide protections substantially equivalent to those under the federal securities laws. After the SEC decided to resume direct regulation under the Investment Company Act of 1940, in 1982, the NAIC substantially amended its Model Regulation to (1) eliminate restrictions no longer relevant to avoiding SEC assertion of authority, (2) bring the model regulation into conformity with the 1980 changes in the Standard Valuation and Nonforfeiture Laws, and (3) enable the development and sale of flexible premium variable life plans (that is, variable universal life insurance). Over 30 states have adopted the NAIC Model Variable Life Insurance Regulation or something similar thereto. Over 10 additional states have related legislation or regulation.

The current version of the Model Regulation defines a VLI policy as providing life insurance the amount or duration of which varies according to the investment experience of a separate account.

To be qualified to deliver VLI in the state, the insurer must be licensed to write life insurance and must obtain commissioner approval to write VLI also. Such approval shall be granted only if the commissioner finds that (1) the plan of operation to issue VLI is not unsound, (2) the general character, reputation and experience of management and other relevant persons are such as to reasonably assure competent VLI operations, and (3) the method of operations is not likely to render such operation hazardous to the public or policyholders. The commissioner may require specified information to be filed, including description of the VLI policies to be issued, description of the methods of operation, statement of investment policy, description of investment advisory service, biographical information as to the insurer’s officers and directors and an actuarial statement describing the mortality and expense risks which the insurer bears under the policy.

Any material contract between the insurer and the supplier of consulting, administrative, investment, sales, marketing, custodial or other services as to VLI shall be in writing and shall contain a provision that the supplier of such services shall furnish the commissioner such information requested to enable the commissioner to assure that the VLI operations are conducted in a manner consistent with applicable law and regulation.

A VLI insurer shall submit requested reports to the commissioner such as the NAIC annual statement on the business of its VLI separate accounts; prior to use in the state, any information provided to applicants; and prior to use in the state, the form of any reports to policyholders. Such material shall be disapproved if found to be false, misleading, deceptive or inaccurate.

Mandatory policy benefit and design requirements cover several areas. Mortality and expense risks shall be borne by the insurer. Charges therefore are subject to maximums stated in the contract. For scheduled premium policies, a minimum death benefit in an amount at least equal to the initial face amount of the policy must be provided. Changes in the variable death benefit shall be made at least annually. The cash value shall be determined at least monthly. Computation of values must be based upon reasonable approximations acceptable to the commissioner.

A VLI policy must contain certain mandatory provisions, including an information cover page stating specified information as to the variable and fixed nature of the death benefits, statement that cash values may vary subject to specified minimum guarantees, statement of any required minimum death benefit, a grace period provision, and a reinstatement provision. A VLI policy, other than term or pure endowment policies, shall include a policy loan provision meeting specified requirements.

All VLI policies must be filed with and approved by the commissioner before use. The filing requirements are akin to those for other policies. The commissioner shall not approve any VLI policy form filed unless it conforms to the insurance policy requirements.

Reserves for VLI shall be established under the Standard Valuation Law in accordance with actuarial procedures which recognize the variable nature of the benefits provided and any mortality guarantees. The regulation deals with both reserve liabilities for the guaranteed minimum benefit and for incidental insurance benefits.

The insurer shall maintain assets in the separate account possessing a value at least equal to the greater of the valuation of reserves for the variable portion of the VLI policies or the benefit base of such policies. Limitations are imposed on the sale or exchange of assets between accounts. Generally, separate account investments shall be valued at market. The insurer must disclose in writing, prior to or contemporaneously with the delivery of the policy, all charges that might be made against the account such as taxes, broker fees, insurance costs, and mortality and expense guarantees. Every insurer issuing VLI shall adopt by board action standards of conduct for the insurer, officers, directors, employees and affiliates as to the purchase or sale of separate account investments. Standards meeting the requirements of the federal Investment Company Act of 1940 satisfy this requirement.

An insurer shall not enter into a contract under which any person, for a fee, provides investment advice to such insurer with respect to a separate account maintained for VLI unless such person is registered as an investment adviser under the Investment Adviser Act of 1940. The commissioner may order the investment adviser’s contract to be terminated if it is deemed hazardous to the public or the insurer’s policyholders.

Each insurer must establish and maintain a written statement specifying standards of suitability to be used by the insurer. Such standard must include provision that no recommendation shall be made to an applicant for VLI in the absence of reasonable grounds to believe that the purchaser is not unsuitable based upon information furnished after reasonable inquiry as to the applicant’s insurance and investment objectives, financial situation and needs.

The insurer shall deliver specified information to the applicant for a VLI policy prior to the execution of the application. This requirement can be met by the delivery of the prospectus under the Securities Act of 1933 to the extent that the prospectus contains the information required by the regulation.

The insurer must disclose in writing, prior or contemporaneously with the delivery of the policy, all charges that might be made against the account such as taxes, broker fees, insurance costs, and mortality and expense guarantees.

The insurer’s sales materials may not be false, misleading, deceptive or inaccurate. They are subject to the NAIC life insurance advertising rules.

The application for a VLI policy shall contain (1) a prominent statement that the death benefits may be variable or fixed under specified conditions, (2) a prominent statement that cash values may increase or decrease according to the experience of the separate account (subject to minimum specified guarantees), and (3) questions designed to elicit information as to the suitability of VLI for the applicant.

The insurer shall provide its VLI policyholders annual reports as to (1) cash values, death benefits, partial withdrawals and policy loans, (2) a financial statement summary of the separate account, (3) net investment return for the past year, (4) list of investments in the separate account, (5) charges levied against the separate account, and (6) any changes in investment objectives. Prior to use in the state, the VLI insurer shall submit to the commissioner information provided to applicants and the form of any reports to policyholders. Such material shall be disapproved if found to be false, misleading, deceptive or inaccurate.

No person may sell VLI unless such person holds a license to do so. The present division of regulatory authority over VLI between state insurance regulators and the SEC has resulted in dual licensing of agents.

With the increasing presence of variable products, whether or not agents sell such products, they must now know how variable contracts work and are regulated in order to compete in the marketplace. To assure possession of such knowledge, both the VLI Regulation and the Uniform Agent and Broker Licensing Act now contemplate that all agents applying for a license are to be examined with respect to both traditional and variable contracts. The commissioner may reject an application for or suspend or revoke an agent’s license to sell VLI on any ground available to do so as to other forms of life insurance. Also an agent must comply with the federal securities laws requirements as to training, examinations and business conduct.