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federal reserve Ba n k DALLAS, TEXAS of Dallas 75222 Circular No. 7 b -72 March 20, 197*+ Interpretation of Regulations G and U (Credit in Connection with Insurance Premium Funding Companies) To All Banks, Brokers/Dealers, Regulation G-Registrants and Others Concerned in the Eleventh Federal Reserve District: The Board of Governors of the Federal Reserve System has issued an interpretation of margin Regulation G, "Securities Credit By Persons Other Than Banks, Brokers, or Dealers" and Regulation U, "Credit By Banks For The Purpose Of Purchasing Or Carrying Margin Stocks" dated February 27, 197*+ in the format of questions and answers on the applicability of margin requirements to credit extended in connection with insurance premiums funding p r o g r am s . The text of the interpretation as it appeared in the Federal Register on March 11, 197*+ is reproduced in this attach ment for your information. Yours very truly, P. E. Coldwell, President Attachment This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) the guidelines. Under a typical insurance throughout th e day of purchase of the fund premium funding program, a borrower shares. At any other tim e, th e fund shares be valued at no higher than the redemp acquires m utual fund shares for cash, or may price. takes fund shares which he already owns, tion Q : A program provides for an annual in 2. and th en uses the loan value (currently surance premium of $300 and- Interest 40 percent as set by the Board) to buy charged in advance in th e am ount of $24 for insurance. Usually, a funding company a total extension of credit of $324. What is (the issuer) will sell both the fund shares the collateral requirement? A: $810. The collateral requirement may be and th e insurance through either inde determined (and pendent broker/dealers or subsidiaries or following formula: proved) by applying the affiliates of the issuer. A typical plan may run for 10 or 15 years with annual in Extension of credit X collateral requirement percentage=collateral requirement X maxi surance premiums due. To illustrate, as mum loan valu e= exten sion of credit suming an annual insurance premium of or $300, the participant is required to put $324 X 250% =$810X 40% =$324 up m utual fund shares eqivalent to 250 percent of the premium or $750 (the 250% collateral requirement percentage ($750x40 percent loan value equals $300 is determ ined by the 40% special maximum the am ount of the insurance premium loan value) 3. (a) Q: Using the example in question which is also the am ount of the credit number 2, assume th at fund shares are pur extended). chased on the same day th e credit of $324 is (b) These guidelines also (1) clarify an earlier 1969 Board interpretation to extended. On what basis m ay the fund shares valued? show th a t the public offering price of beA: The fund shares may be valued at no m utual fund shares (which includes the higher than the public offering price. Ac front load, or sales commission) may be cordingly, the customer would purchase fund used as a measure of their current m ar shares w ith a public offering price of at least ket value when the shares serve as col $810. (b) Q: Assume instead that under the lateral on a purpose credit throughout arrangements the shares are the day of the purchase of the fund program in or are deposited fund e accoxmt. already in th shares, and (2) relax a 1965 Board posi The shares may have been purchased prior tion in connection with accepting pur to the actual date of the extension of credit, pose statem ents by mail. I t is the Board’s either in a lump am ount, say a m onth or so Title 12— Banks and Banking view th a t when it is clearly established earlier, or as m ight apply in a m onthly in CHAPTER II— FEDERAL RESERVE SYSTEM th a t a purpose statem ent supports a p u r vestm ent plan. On what basis may the fund pose credit then such statem ent executed shares be valued? SUBCHAPTER A— BOARD OF GOVERNORS OF A: The fund shares may be valued at no TH E FEDERAL RESERVE SYSTEM by the borrower may be accepted by mail, than the redem ption price. [Regs. G & U] provided it is received and also executed higher the customer would have to Accord ingly, deposit PART 207— SECURITIES CREDIT BY PER by tiie lender before the credit is ex in his account, if the 6hares are n ot already in the account, fund shares w ith a net asset SONS OTHER THAN BANKS; BROKERS tended. value «f a* least $810. 4. Q: Is the addition of Interest t« the outstanding debt i s a program treated as a new extension of credit which m ust be margined? For text of this interpretation, see A: The margin regulations do not require § 207.108 of this subchapter. th at interest added to a debt be treated as a new extension of credit if the am ount of Q uestions and answers in connection with § 2 0 7 .1 0 8 A p plicab ility o f M argin R e th e credit provisions in § 207.4(f) Regulation the credit is not otherwise Increased. By qu irem en ts to Credit in co n n ection G, and § 221.3 (x) Regulation U, as they apply contrast, interest charged In advance on new w ith In su ran ce P rem iu m F u n d in g to the combined purchase of m utual fund debt forms part of the new credit. The follow ing illustrates the first few years shares and insurance (usually referred to as P rogram s. "insurance premium funding program” and of a 10-year program commencing July 1, (a) The Board has been asked num ersom etim es referred to herein as '‘program”) 1970 th a t provides for annual insurance ous questions regarding purpose credit in February 1974 Board of Governors of the premium loans of $300 each w ith Interest at the rate of 8% per annum. connection w ith insurance premium Federal Reserve System. 1. Q: At w hat price may m utual fund In Illustration A, Interest Is charged- In funding programs. The inquiries are in cluded in a set of guidelines in the form at shares be valued when they serve as collat advance, whereas in Illustration B, Interest of questions and answers which follow. A eral for an extension of credit in connection Is added at the end of each year. The Illus glossary of terms customarily used in w ith an Insurance prem ium funding pro trations do n ot Include service charges, cus todial fees or inistration fees which connection w ith insurance premium gram?The fund shares may be valued a t no would, of course,admconsidered in an actual A: be funding credit activities is included in higher than the public offering price program. OR DEALERS PART 221— CREDIT BY BANKS FOR THE PURPOSE OF PURCHASING OR CARRY ING MARGIN STOCKS Credit in Connection With Insurance Premium Funding Programs § 2 2 1 .1 2 2 - A p plicab ility o f M argin R e qu irem en ts to C redit in co n n ection w ith In su ran ce P rem iu m F u n d in g P rogram s. FEDERAL REGISTER, VOL. 39, NO. 48— MONDAY, MARCH 11, 1974 RULES AND REGULATIONS tial margin requirements may be applied against a new extension of credit. 8. (a) Q: Using Illustration A in th e an D a te extensio n swer to question number 4 wherein interest is charged in advance, assume m utual fund shares w ith a redemption value of $2,000100 Ju ly 1,1970 Insurance prem ium _________ ___________________ _____ _______________ $800.00 were in the account and collateralized the 24.00 Interest ($300X8%)............................................... ......................................... ......... extension of credit as of July 1, 1971 In the am ount of $349.92. What is the am ount of C o llate ral w ith a v ain e of $810 Is req u ired for th is am o u n t b ased on In itia l margin requirements. . ______ ____________________________ ________ _______ _ $324.00 excess collateral based on initial margin re July 1,1971 Interest on total prior debt ($324X8%)__________________________ ____-................... 25.92 quirements, if any, which could be applied against the July t, 1971' extension of credit? Make computation to determine whether.there is any excess collateral, based A: $1,125.20. Proof: on initial margin requirements and valued at redemption price of fund shares, on this amount........................... ......... .............. _................................................__ 349.92 $34 9 .9 2 X 250% -$ 8 7 4 .8 0 X40=$349.92 (No additional collateral required even though the account is in a so$2,000.00—$874.80 = $1,125.20. called restricted status but above program's minimum collateral (b) Q: Would th is excess collateral based requirements.) on initial margin requirements be sufficient New extension of credit: Insurance premium.......... -................... ........... ................... „........................ 300.00 _________ to margin th e July 1, 1971 extension of credit Interest thereon...... ...................................................... ................................. 24.00 ................... in the am ount of $324? A: Yes. The collateral requirem ent on the Collateral with a value of $810 is required for this amount based on initial new extension of credit would be $810 margin requirements; any excess collateral based on initial margin require ments may be applied toward this collateral requirement............................................. 324.00 ($324X250% =$810X 40 % =$324) and would Total____________________________________________ , __________ ______ 673.92 leave excess collateral based on initial margin 53.91 requirements in the am ount of $315.20 July 1,1972 Interest on total prior debt ($673.92X8%)............ , ..................................... ........................ ($1,125.20 —$810.00=$315.20). Make computation to determine whether there is any excess collateral, based (c) Q: Could the excess collateral based on on initial margin requirements and valued at redemption price of fund shares, on this -amount.................... ...... ............................... ......... ................. ................. 727.83 initial requirements computed as of July 1, 1971, in the am ount of $315.20 be pre (No additional collateral required even though account may be in a soserved and applied against a subsequent ex called restricted status, but above program’s minimum collateral requirements.) tension of credit, presumably at the tim e New extension of credit: of the next anniversary of the program on Insurance premium___ ____ ___________________________ _________ 300.00 July 1,1972? Interest thereon_________________ _________ ____________________ 24.00 A: No. Regulations G and U do not pro Collateral with a value of $810 is required for this amount based on initial vide for the recapture of previously com margin requirements; any excess collateral based on initial margin require 324.00 puted excess collateral. The account m ust be ments may be applied toward this collateral requirem ent.............. ............................... refigured as of any given point in tim e based Total......................................... ........... ......................................................... .............. 1,051.83 upon th e redemption value of the m utual fund shares and the debt in the account ou such date. Prior com putations of the amount I l l u s t r a t i o n B . —Interest added at end of each year of excess collateral are irrelevant. Date Total 9. Q: A participant’s account is in a socalled restricted status. The participant pur chases m utual fund shares on a m onthly in vestm ent basis in an am ount intended to July 1,1970 Insurance premium—collateral with a value of $750 is required for this amount based on initial margin requirements___________________________________________________ $300.00 equal V of 250% of the am ount of the an 12 July 1,1971 Interest ($300X8%)...................................................................... ........................................... . 24.00 nual premium. Assuming the anniversary date in his program is July 1, may he be as Make computation to determine whether there is any excess collateral, based on initial mar gin requirements and valued at redemption price of fund shares, on this amount________ 324.00 sured that fund shares purchased between New extension of credit: Insurance premium—collateral with a value of $750 is required for July 1, 1972 and June 30, 1973, for example, this amount based on initial margin requirements; any excess collateral based on initial margin requirements may be applied toward this collateral requirement______________ 300.00 will be sufficient t6 margin his July 1, 1973 extension of credit? T otal____ ____ ____ ___________________________ __________ ____ ________ 624.00 A: Not necessarily. Unless such fund July 1,11172 Interest ($624X8%)........ ................... .............................................. ............................................ 49.92 shares purchased between July 1„ 1972 and June 30, 1973 have been deposited in a sep Make computation to determine whether there is any excess collateral, based on initial margin requirements and valued at redemption price of fund shares, on this amount____ 673.92 arate (for Regulation U purposes) or escrow New extension of credit: Insurance premium—collateral with a value of $750 is required for (for Regulation G purposes) account for the this amount based on initial margin requirements; any excess collateral based on initial margin requirements aiay be applied toward this collateral requirement_______________ 300.00 purpose of being deposited in to the cus tom er’s loan account as collateral to margin Total___________ ____ _______________________ ______________ -.___________ 973.92 the July 1, 1973 extension of credit, the reg ular loan account would include the shares 5. Q: Using Illustration A I n answer to cess collateral based on initial margin purchased in a m onthly investm ent plan. Thus, the participant may find when the question number 4 wherein interest is requirements? charged in advance, assume m utual fund A: There is no excess collateral in the account is refigured that it is in a so-called shares w ith a redem ption yalue in th« account. In fact, the account is in a so-called restricted status w ith Insufficient excess collateral in the account to margin! the new am ount of $1,050 were in th e account and restricted status in the am ount of $174.80. extension of credit. The account may be Proof: collateralized an extension of credit as of restricted for a number of reasons. The re July 1, 1971 in the am ount of $349.92. W hat $349.92X250 %=$874.80 - $700.00=$ 174.80 7. (a) Q: Same as question number 6.dem ption value of the fund shares serving as is the am ount of excess collateral based on initial margin requirements, If any, which Assume the program prospectus requires, for collateral in the account may have fallen; or could be applied against the July 1, 1971 maintenance purposes, th at fund shares the fund shares purchased on a m onthly in extension of credit in the am ount of $324? pledged as collateral m ust always have a re vestm ent plan m ight not be sufficient to dem ption value at least equal to 150% of margin the July 1, 1973 extension of credit. A: $175.20. Proof: debt. On July 1. 1971 with a debt of $349.92 Unless the redemption value of such fund $349.92 X 250% =$874.80 X 40% =$349.92 shares purchased during the preceding 12Redemption value of fund shares. $1,050.00 and fund shares with a redemption value of m onth period is equal to at least 250% of $700.00, did the custom er’s account have Am ount that would be needed to any excess collateral based on m aintenance the new credit at the time it is extended on m aintain in itial collateral re July 1, 1973, additional fund shares m ust be quirem ents ___________________ 874.80 requirements? A: Yes. The account had excess collateral supplied to properly collateralize the July 1, based on m aintenance requirements in the 1973 extension of credit. (Of course, the Excess collateral based on initial customer would be required to supply no 175.20 am ount of $175.12. r eq u ire m en ts_________________ more th an is needed to support the new ex Proof: This excess collateral could sup tension of credit.) $349.92 X 150 %=$524.88 port new credit in th e am ount Ilhistration $700.00—$524.88 = $175.12 of ($175.20xmaxlmum loan val (b) Q: May the excess collateral based on ue 40%) _____________________ 70.80 On 7/1/73 the account stands as follows: m aintenance requirements in th e am ount of Redemption value of fund shares in 6. Q: Same as question number 5 except account, including shares pur th at the m utual fund shares in the account $175.12 be applied to margin the July 1, 1971 extension of credit in the am ount of $324? chased w ithin th e latest year under have a redemption value of $700.00 on July 1, m onthly investm ent plan_________$3, 500 1971. W hat Is the am ount. If any, of the ex A: No. Only excess collateral based on ini I ll u s tr a ti o n A .—In te re s t ch w ged ta ad v a n ce JLnnnnI T o ta l d e b t of c re d it FEDERAL REGISTER, VOL. 3 9 , NO. 4 8 — MONDAY, MARCH 11, T974 RULES AND REGULATIONS Previous debt_____________________ 3,000 New extension of credit_____ _____ 324 In itia l collateral requirem ent: (D ebt) $2,000 X (Initial collateral re quirem ent percentage) 250% = (Initial collateral requ irem ent)_$5,000 Less: Redem ption value of fu n d shares in account_______________ 8,500 Am ount of restriction—based on in itial collateral requirem ent_____ $1,500 Therefore, additional fund shares In th e am ount of 9810 ($324x250% ) m ust be supplied to m argin a new extension of credit (n et offering price may be used If fu n d shares are purchased on th e same day as th e extension of c re d it). T he account would th e n stan d as follows: Value of fund shares_______________ $4,310 T otal d ebt_______________________I 2,324 In itial collateral requirem ent $2,324 X 250% = ______________________ 5,810 A ccount would still be In a so-called restricted statu s based on in itial m argin requirem ents b u t Regula tions would n o t require custom er to supply additional m argin. M aintenance collateral requirem ents: $2,324X 150% =___ „______________ $3,486 A ccount would be above program m aintenance requirem ents. 10. Q: A program Issuer analyzes cus tom ers’ accounts a m onth or so prior to th e anniversary date of th e program s to deter mine w hether there is any excess collateral based on in itial m argin requirem ents In th e accounts and w hether additional fun d shares w ill be required to m argin th e forthcom ing extensions of credit. M ust th e issuer refigure each account when th e credit is extended? A: Yes. A prelim inary com putation would n o t necessarily assure th a t a forthcom ing extension of credit will be m argined prop erly. For example, even though the account may appear to be m argined properly and have sufficient excess collateral a t th e tim e of th e prelim inary analysis, a decline In th e value of th e fu nd shares before th e credit is extended could cause th e custom er’s ac co unt to become restricted, or have Insuf ficient excess collateral in th e account to m argin th e new extension of credit entirely. Accordingly, th e analysis would have to be updated on th e basis of th e cu rren t m arket value of th e fund shares In th e account w hen th e credit te extended. If th e preftfcntaary analysis took in to con sideration any and all an ticipated charges incidental to th e account and th e redem p tio n price of th e fund shares did n o t decline between th e tim e of th e analysis an d th e date a t th e extension of credit, of course, no fu rth er adjustm ent of th e account would be required a t th a t tim e. 11. Q: A prospectus furnished to th e p ar ticip an t describes a program w hich provides for only th e annual acquisition of insurance on credit and does n o t include a feature per m itting insurance prem ium s to be paid w ith cash, for exam ple (to prevent lapsing). The p articip an t’s account Is in a so-called re stricted status. At th e tim e of th e scheduled annual review of the program , th e p artici p a n t finds th a t he is unable to purchase su f ficient fu nd shares to collateralize a new ex tension of credit based on th e insurance prem ium for a fu ll year. May th e issuer allow th e p articip an t to renew th e insurance por tio n of his program for less th a n one year, and thereby extend new credit on a quarterly or sem i-annual basis, still applying th e spe cial m axim um loan value set fo rth in th e reg u lations on w hatever fu n d shares may be available? A: No. The special m axim um loan value dividing th e n e t assets of th e fund by th e provision set forth in Regulations G and U Is to ta l num ber of shares outstanding. T he re available only for an extension of purpose dem ption price Is som etim es referred to as credit provided for in a program registered th e bid price. R estricted account—An account In which w ith th e Securities and Exchange Commis sion under th e Securities Act of 1933 (15 th e debt exceeds th e m axim um loan value of U.S.C. 77). Accordingly, th e frequency of th e th e collateral. In connection w ith an in su r extensions of credit m ust conform w ith th e ance prem ium funding program, It may also be defined as an account In which th e col program. 12. Q: May an issuer accept by m all a p u r lateral requirem ent exceeds th e redem ption pose statem ent in connection w ith a program , value of th e fund shares in th e account. In terp rets and applies 12 CFR 207.4(f) and provided th e particip an t has properly com pleted th a t p a rt of th e statem en t which he 12 CFR 221.3(x). Is required to complete? By order of the Board of Governors, A: Yes. Since all credit in connection w ith such program s is purpose credit, a face-to- February 27,1974. face m eeting between the Issuer and th e par [s e a l] C h e s te r B. F e ld b e rg , ticip a n t for th e purpose of accepting such Secretary of the Board. statem ent is n o t essential. [FR Doc.74-5309 Filed 3-8-74;8:45 am] Glossary Far th e purpose of these guidelines th e following term s are Intended to represent term inology commonly used In connection w ith tnsuranoe prem ium funding program s as well as Regulations O and U and have th e following m eanings: Collateral requirem ent—Expressed In dol lars, th e collateral requirem ent. In th e form of m utu al fund shares valued a t eith er th e public offering price or th e redem ption price, is th e sum of th e am ount of th e extension of credit (the debt) X the collateral require m ent percentage. Collateral requirem ent percentage—T his is determ ined by dividing th e m axim um loan value percentage into 100% (100% -5-40% spe cial m axim um loan value=250% collateral requirem ent percentage). Excess collateral—The am ount of collateral In an account, valued a t redem ption price, In excess of th e m inim um required to m eet eith er in itial or m aintenance m argin require m ents. In itia l m argin requirem ent—In th e case of insurance prem ium funding credit, a cus tom er p u ts up m argin in th e form of m utual fluid shares. The am ount of th e requirem ent Is determ ined by taking th e am ount of th e extension of credit x th e collateral require m ent percentage. M aintenance margin requirem ent—T his Is th e m inim um value of m utual fund shares in an account, valued a t redem ption prloe, pledged to secure th e extension of credit which m ust be m aintained a t all tim es under contract w ith th e issuer, n o t because of a Board requirem ent. The am ount of m ainte nance m argin, som etimes referred to as m ini m um equity requirem ent, is set fo rth by th e lender in th e prospectus. UttKimum loan value—The Maximum loan value Is th e maximum am ount of credit which th e lender may extend on m utual fu n d shares. A special maximum loan value of 40% is set fo rth in th e m argin regulations by th e Board of Governors of th e Federal Reserve System. Prospectus—This Is th e abbreviated form of th e R egistration S tatem ent on th e in su r ance prem ium funding program security re quired to. be filed by th e Issuer in accordance w ith th e Securities Act of 1933. T he pros pectus m ust be presented to each prospec tive participant in th e program. Public offering price—T his represents the to tal cost to the Investor in m utual fund shares and includes th e sales commission or fro n t load, som etimes referred to as th e asked price. R edem ption price—T his is usually the n et asset value of m utual fund Shares which th e Investor would receive if he liquidated such fund shares. (Some broker/dealers, i t Is u n derstood, may Impose a sm all service charge upon liquidation if, for example, th e fund Shares were n o t purchased through th e m ). H ie actual per share value Is arrived a t by FEDERAL REGISTER, VOL 39, NO. 4 8 — MONDAY, MARCH 11, 197v 4