Official releases: SOP 05-1 ... ethics interpretation and rulings.

Space considerations prevent publishing here the appendix to SOP 05-1. Since the appendices often are important to understanding SOPs, readers are advised to obtain complete copies. To obtain a copy of SOP 05-1 (Product no. 014943), contact the AICPA order department at 888-777-7077.

SOP 05-1--Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts

NOTE

Statements of Position on accounting issues present the conclusions of at least two-thirds of the Accounting Standards Executive Committee, which is the senior technical body of the Institute authorized to speak for the Institute in the areas of financial accounting and reporting. Statement on Auditing Standards No. 69, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles, as amended, identifies AICPA Statements of Position that have been cleared by the Financial Accounting Standards Board as sources of established accounting principles in category b of the hierarchy of generally accepted accounting principles that it establishes. AICPA members should consider the accounting principles in Statement of Position if a different accounting treatment of a transaction or event is not specified by a pronouncement covered by Rule 203 of the AICPA Code of Professional Conduct. In such circumstances, the accounting treatment specified by the Statement of Position should be used, or the member should be prepared to justify a conclusion that another treatment better presents the substance of the transaction in the circumstances.

TABLE OF CONTENTS

Summary
Foreword
Introduction and Background
Applicability and Scope
Conclusions
  Internal Replacements
  Integrated and Nonintegrated Contract Features
  Contract Modifications Involving Nonintegrated
  Contract Features
  Contract Modifications Involving Integrated
  Contract Features
  Determining Substantial Changes
  Accounting for Contracts That Are Substantially
   Unchanged
  Accounting for Contracts That Are Substantially
   Changed
  Contract Assessments Related to Internal Replacements
   of Long-Duration Contracts
  Recoverability
  Disclosures
Effective Date and Transition
  Internal Replacements Occurring Prior to
    the Year of Adoption
  Internal Replacements Occurring After the
    Date of Adoption
Disclosures
APPENDIX A Background and Basis for
 Conclusions
APPENDIX B Application of Statement of
 Position--Product and Product Feature Examples
APPENDIX C Flowchart--Application of
 SOP 05-1 Accounting Model
APPENDIX D Illustration of Deferred Acquisition
 Costs and Unearned Revenue Liability
 Amortization for a FASB Statement No. 97
 Internal Replacement That Is Determined
 to Result in a Substantially Unchanged Contract
GLOSSARY

SUMMARY

This Statement of Position (SOP) provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments

* The SOP defines an internal replacement as a modification in product benefits, features, rights, or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. Modifications that result from the election by the contract holder of a benefit, feature, right, or coverage that was within the original contract are not internal replacements subject to this guidance as long as all of the conditions listed in paragraph 9 of this SOP are met.

* The SOP introduces the terms integrated and nonintegrated contract features and specifies that nonintegrated features do not change the base contract and are to be accounted for in a manner similar to a separately issued contract. Integrated features are evaluated in conjunction with the base contract.

* Contract modifications meeting all of the conditions in paragraph 15 of this SOP result in a replacement contract that is substantially unchanged from the replaced contract and should be accounted for as a continuation of the replaced contract.

* An internal replacement that is determined to result in a replacement contract that is substantially changed from the replaced contract should be accounted for as an extinguishment of the replaced contract. Unamortized deferred acquisition costs, unearned revenue liabilities, and deferred sales inducement assets from the replaced contract in an internal replacement transaction that results in a substantially changed contract should not be deferred in connection with the replacement contract. of the entity.

* Unamortized deferred acquisition costs and the present value of future profits (1) continue to be subject to premium deficiency testing in accordance with the provisions of FASB Statement No. 60, Accounting and Reporting by Insurance Enterprises, as amended.

* The notes to the financial statements should describe the accounting policy applied to internal replacements, including whether or not the company has availed itself of the alternative application guidance outlined in paragraphs 18 and 19 of this SOP and, if so, for which kinds of internal replacement transactions.

This SOP is effective for internal replacements occurring in fiscal years beginning after December 15, 2006, with earlier adoption encouraged. Retrospective application of this SOP to previously issued financial statements is not permitted. Initial application of this SOP should be as of the beginning of an entity's fiscal year (that is, if the SOP is adopted prior to the effective date, all prior interim periods of the year of adoption should be restated).

Disclosure of the effect of the change on retained earnings as of the date of adoption is required. If the financial statements of the year of adoption are presented separately or included in comparative financial statements, the notes to the financial statements should disclose (a) the fact that this SOP has been adopted and the effective date of adoption, and (b) the nature of any differences in accounting principles or financial statement presentation applicable to the financial statements presented that resulted from adoption of this SOP.

FOREWORD

The accounting guidance contained in this document has been cleared by the Financial Accounting Standards Board (FASB). The procedure for clearing accounting guidance in documents issued by the Accounting Standards Executive Committee (AcSEC) involves the FASB reviewing and discussing in public board meetings (1) a prospectus for a project to develop a document, (2) a proposed exposure draft that has been approved by at least 10 of AcSEC's 15 members, and (3) a proposed final document that has been approved by at least 10 of AcSEC's 15 members. The document is cleared if at least four of the seven FASB members do not object to AcSEC undertaking the project, (2) issuing the proposed exposure draft or, after considering the input received by AcSEC as a result of the issuance of the exposure draft, issuing the final document.

The criteria applied by the FASB in its review of proposed projects and proposed documents include the following:

1. The proposal does not conflict with current or proposed accounting requirements, unless it is a limited circumstance, usually in specialized industry accounting, and the proposal adequately justifies the departure.

2. The proposal will result in an improvement in practice.

3. The AICPA demonstrates the need for the proposal.

4. The benefits of the proposal are expected to exceed the costs of applying it. In many situations, prior to clearance, the FASB will propose suggestions, many of which are included in the documents.

INTRODUCTION AND BACKGROUND

1. Insurance enterprises may offer existing contract holders new products or modifications to existing contracts (1a) for various reasons, such as increasing administrative efficiency and improving the competitive position of the contract to enhance contract holder satisfaction and retention. For example, at the time universal life-type contracts became popular, they were often purchased as replacements for traditional life insurance contracts issued by the same enterprise. In those cases, the contract holder generally used the cash surrender value of the previous contract to make an initial premium deposit for the new, universal life-type contract. Further, contract holders often request insurance enterprises to make changes to their existing contracts.

2. Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments, refers to the replacement by an insurance enterprise of one of its traditional life insurance contracts by a universal life-type contract as an internal replacement. FASB Statement No. 97 specifies that unamortized deferred acquisition costs related to traditional life insurance contracts replaced with universal life-type contracts issued by the same insurance enterprise shall not be deferred in connection with the replacement contract.

3. Diversity in practice exists in accounting for internal replacements other than those specified in FASB Statement No. 97, which discusses internal replacements of traditional life insurance contracts with universal life-type contracts only and does not address the accounting for other internal replacements (such as traditional life with traditional life, universal life with universal life, annuity with annuity). AICPA Practice Bulletin No. 8, Application of FASB Statement No. 97 to Insurance Enterprises, issued in November 1990, clarifies that the accounting specified by FASB Statement No. 97 for internal replacement transactions applies only to the replacement of traditional insurance contracts with universal life-type contracts. Practice Bulletin 8 paragraphs 18 and 19 state:

.18 Question 7: Does the accounting specified by FASB Statement No. 97, paragraph 26, for internal replacement transactions apply only to the replacement of traditional insurance contracts by universal life-type contracts?

.19 Answer 7: Yes, FASB Statement No. 97 addresses only replacements of traditional insurance contracts by universal life-type contracts. The accounting for other internal replacements should be based on the circumstances of the transaction. Paragraphs 70 to 72 of FASB Statement No. 97 discuss the Board's rationale for requiring recognition of loss on the termination of the replaced contract.

4. The basis for conclusions of FASB Statement No. 97 discusses alternative views of accounting for internal replacements. Paragraph 71 of the Statement discusses two alternative views rejected by the FASB:

a. Continued deferral of costs related to replacement contracts is appropriate based on the continuation of the customer relationship:

The replacement of a traditional life insurance contract with a universal life-type contract typically results in the need to account for an amount equal to the sum of (a) the unamortized acquisition costs associated with the replaced contract and (b) the difference between the cash surrender value and the previously recorded liability for policy benefits related to the replaced contract. The AICPA Issues Paper suggested that this net amount should be deferred and amortized as part of the capitalized acquisition costs of the new book of universal life-type contracts. The Issues Paper took the position that the universal fife-type replacement contract represented a continuing relationship between the insurer and the policyholder, and maintained that the new contract represented only a change in the form of the insurance protection.

b. Continued deferral of costs related to replaced contracts more closely equates the cost of replacement contracts and contracts issued to new customers:

Some respondents also suggested that the incremental costs of replacement transactions are usually less than the costs of sales to new policyholders. In their view, the continued deferral of net amounts related to replaced contracts more nearly equates the costs of contracts issued to different classes of policyholders.

5. As stated in paragraph 72 of FASB Statement No. 97:

The Board rejected those proposals. The Board recognizes that an insurance enterprise that conducts an internal replacement program may be motivated by a desire to retain its customer base and that the alternative to replacement may be loss of that base. That objective is not, however, different from the objectives of similar transactions undertaken by insurance enterprises and other enterprises for which continued deferral of costs is not permitted, including the refunding of debt.

APPLICABILITY AND SCOPE

6. This Statement of Position (SOP) applies to all entities to which FASB Statement No. 60, Accounting and Reporting by Insurance Enterprises, as amended, applies, hereinafter referred to as insurance enterprises, (2a,3a) and is applicable to modifications and replacements made to contracts defined by FASB Statement No. 60 as short-duration and long-duration contracts, including those contracts defined by FASB Statement No. 97 as investment contracts.

CONCLUSIONS

7. If an internal replacement (as described in paragraphs 8 through 10 of this SOP) occurs and the rights and obligations of the parties to the contract are substantially unchanged (based on an evaluation of the conditions specified in paragraph 15 of this SOP) from those under the replaced contract, the replacement contract should be accounted for as a continuation of the replaced contract in accordance with the guidance in paragraphs 16 through 24 of this SOP. If the internal replacement occurs and results in a replacement contract that is substantially changed from the replaced contract, the replaced contract should be accounted for as extinguished in accordance with the guidance in paragraph 25 of this SOP.

Internal Replacements

8. An internal replacement is a modification in product benefits, features, rights, or coverages that occurs by the legal extinguishment of one contract and the issuance of another contract (a contract exchange), or by amendment, endorsement, or rider to a contract, or by the election of a benefit, feature, right, or coverage within a contract.

9. Modifications (other than partial withdrawals, surrenders or reductions in coverage that are addressed in paragraph 10 of this SOP) that result from the election by the contract holder of a benefit, feature, right, or coverage that was within the original contract are not internal replacements subject to this guidance as long as all of the following conditions are met:

a. The election is made in accordance with terms fixed or specified within narrow ranges in the original contract.

b. The election of the benefit, feature, right, or coverage is not subject to any underwriting.

c. The insurance enterprise cannot decline to provide the coverage or adjust the pricing of the benefit, feature, right, or coverage.

d. The benefit, feature, right, or coverage had been accounted for since the inception of the contract, for example, the option to elect the feature is an embedded option within the contract that is required to be accounted for under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, (or would have been accounted for under FASB Statement No. 133 if the "grandfathering" provisions of the Statement, for embedded derivatives, had not been elected) or the existence of the option to elect a feature was assessed in the classification of and accounting for of the contract, such as the classification of the contract as an insurance contract under SOP 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts.

The annuitization phase of a contract is separate and distinct from and cannot be accounted for as a continuation of the accumulation phase, even if annuitization is in accordance with terms fixed in the original contract.

10. Partial withdrawals, surrenders, or reductions in coverage (for example, reduced face amount on a life insurance contract or higher deductibles on a property casualty contract), as allowed by terms that are fixed and specified at contract inception either in the contract or other information available to the contract holder or, if required by state law or regulation, at terms in effect when the reduction is made for that benefit, feature, right, or coverage, whether or not surrender charges or other termination charges are assessed, are not internal replacements subject to this guidance, as long as there are no reunderwriting or other modifications to the contract, at that time, that would require evaluation under paragraph 15 of this SOP.

Integrated and Nonintegrated Contract Features

11. For long-duration contracts, integrated contract features are those for which the benefits provided by the feature can be determined only in conjunction with the account value or other contract holder balances related to the base contract, and nonintegrated contract features are those for which the determination of benefits provided by the feature is not related to or dependent on the account value or other contract holder balances of the base contract. Underwriting and pricing for nonintegrated contract features typically are executed separately from other components of the contract, and it is inherent in this concept that the premium charged is not in excess of an amount that is commensurate with the incremental insurance coverage provided.

12. For short-duration contracts, nonintegrated contract features are those that provide coverage that is underwritten and priced only for that incremental insurance coverage, and do not result in the explicit or implicit reunderwriting or repricing of other components of the contract. It is inherent in this concept that the premium charged is not in excess of an amount that is commensurate with the incremental insurance coverage provided. Additional coverage provided by a nonintegrated contract feature would be considered nonintegrated even though the entire coverage provided by the short-duration contract may be subject to only one deductible or limit in the event of an insured loss. For short-duration contracts, integrated contract features are those where there is explicit or implicit reunderwriting or repricing of existing components of the base contract.

Contract Modifications Involving Nonintegrated Contract Features

13. If a contract feature or coverage is nonintegrated, the addition or election of that feature or coverage, in and of itself, does not change the existing base contract and, as a result, further evaluation of the base contract under paragraph 15 of this SOP is not required. The nonintegrated contract feature or coverage should be accounted for in a manner similar to a separately issued contract. Subsequent modifications made only to the nonintegrated contract feature or coverage should be evaluated under paragraphs 9 through 15 of this SOP separately from the base contract, and any deferred acquisition costs related to the nonintegrated contract feature or coverage accounted for accordingly. Subsequent termination of a nonintegrated contract feature or coverage should be accounted for as an extinguishment of only the balances related to the nonintegrated contract feature or coverage.

Contract Modifications Involving Integrated Contract Features

14. For contract modifications involving integrated contract features or coverages (other than those contract modifications described in paragraphs 9 and 10 of this SOP), the insurance enterprise should review the conditions set forth in paragraph 15 of this SOP to determine whether the contract has changed substantially as a result of the modification. A contract modification meeting all of the conditions in paragraph 15 of this SOP results in a replacement contract that is substantially unchanged from the replaced contract, and should be accounted for as a continuation of the replaced contract in accordance with paragraphs 16 through 24 of this SOP. A contract modification that fails any of the conditions in paragraph 15 of this SOP results in a replacement contract that is substantially changed from the replaced contract, and should be accounted for as an extinguishment of the replaced contract in accordance with paragraph 25 of this SOP.

Determining Substantial Changes

15. An internal replacement (other than those not subject to the SOP as described in paragraphs 9 and 10 of this SOP) is determined to involve contracts that are substantially unchanged only if all the following conditions exist:

a. The insured event, risk, or period of coverage of the contract has not changed, as noted by no significant changes in the kind and degree of mortality risk, morbidity risk, or other insurance risk, if any.

b. The nature of the investment return rights (for example, whether amounts are determined by formulae specified by the contract, pass through of actual performance of referenced investments, or at the discretion of the insurer), if any, between the insurance enterprise and the contract holder has not changed.

c. No additional deposit, premium, or charge relating to the original benefit or coverage, in excess of amounts specified or allowed in the original contract, is required to effect the transaction; or if there is a reduction in the original benefit or coverage, the deposit, premiums, or charges are reduced by an amount at least equal to the corresponding reduction in benefits or coverage.

d. Other than distributions to the contract holder or contract designee or charges related to newly purchased or elected benefits or coverages, there is no net reduction in the contract holder's account value or, for contracts not having an explicit or implicit account value, the cash surrender value, if any.

e. There is no change in the participation or dividend features of the contract, if any.

f. There is no change to the amortization method or revenue classification of the contract.

If any of the conditions above are not met, an internal replacement is determined to involve a replacement contract that is substantially changed from the replaced contract.

Accounting for Contracts That Are Substantially Unchanged

16. An internal replacement that is determined to result in a replacement contract that is substantially unchanged from the replaced contract should be accounted for as a continuation of the replaced contract. (4a) Unamortized deferred acquisition costs, (5a) unearned revenue liabilities, and deferred sales inducement assets associated with the replaced contract should continue to be deferred and amortized or earned in connection with the replacement contract. Other balances associated with the replaced contract, such as any liability for minimum guaranteed death benefits (MGDBs) or guaranteed minimum income benefits (GMIBs), should be accounted for in a similar manner, that is, as if the replacement contract is a continuation of the replaced contract.

Accounting for FASB Statements No. 91, No. 97, and No. 120 Contracts--General

17. For contracts accounted for under FASB Statements No. 97 and No. 120, Accounting and Reporting by Mutual Life Insurance Enterprises and by Insurance Enterprises for Certain Long-Duration Participating Contracts, the estimated gross profits of the replacement contract are treated as revisions to the estimated gross profits or margins of the replaced contract in the determination of the amortization of deferred acquisition costs and deferred sales inducement assets and the recognition of unearned revenues. For contracts to which the FASB Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, interest method amortization methodology is applied, the replacement contract represents revisions to the cash flows of the replaced contract, and unamortized deferred acquisition costs and deferred sales inducement assets are adjusted accordingly. Other balances that are determined based on activity over the life of the contract, such as a liability for MGDBs (which, under the provisions of SOP 03-1, is determined based on assessments and benefit costs) should be calculated considering the entire revised life of the contract, including activity during the term of the replaced contract.

Accounting for FASB Statements No. 91, No. 97, and No. 120 Contracts-Practicability Considerations

18. If it is not reasonably practicable for an insurance enterprise to account for, in the manner described in paragraph 17 of this SOP, a contract exchange that has resulted in a replacement contract that is substantially unchanged from the replaced contract, the insurance enterprise should determine the balance of unamortized deferred acquisition costs related to the replaced contract to carry forward to the replacement contract and utilize estimated gross profits only of the replacement contract to determine future amortization. The total balance of unamortized deferred acquisition costs prior to the internal replacement should be allocated between replaced contracts and contracts remaining in the original book of business based on a reasonable and systematic allocation process. Appendix D, "Illustration of Deferred Acquisition Costs and Unearned Revenue Liability Amortization for a FASB Statement No. 97 Internal Replacement That Is Determined to Result in a Substantially Unchanged Contract" of this SOP illustrates one such allocation approach.

19. In conjunction with the guidance in paragraph 18 of this SOP, the balance of unamortized deferred acquisition costs and other contract-related balances should be updated based on the most current assumptions at the time of the internal replacement. All related accounting balances that use estimated gross profits or assessments as a base for amortizanon or recognition should be handled in a similar manner.

Accounting for FASB Statement No. 60 Long-Duration Contracts

20. For long-duration contracts accounted for under FASB Statement No. 60, the replacement contract generally should be viewed as a prospective revision of the replaced contract with future amortization of unamortized deferred acquisition costs adjusted, accordingly, on a prospective basis. Under the prospective revision methodology, the unamortized deferred acquisition costs and benefit liability balances at the time of replacement are unchanged. Future increases and decreases to the unamortized deferred acquisition costs and benefit reserve balances should reflect the revised revenue expected from the replacement contract at the time of replacement. This approach preserves the "lock-in" principle and is consistent with the treatment of other premium changes on indeterminate premium life insurance and guaranteed renewable health insurance contracts accounted for under the provisions of FASB Statement No. 60. The prospective revision methodology should be applied consistently for liabilities for policy benefits and unamortized deferred acquisition costs. Where the modificanon is a reduction in benefits with a directly proportionate reduction in premiums, the modification should result in an immediate proportionate reduction in unamortized deferred acquisition costs rather than a prospective revision.

Accounting for FASB Statement No. 60 Short-Duration Contracts

21. Similar to long-duration contracts accounted for under FASB Statement No. 60, a revision to a short-duration contract generally is viewed as a prospective revision with future recognition of unearned premium and amortization of unamortized deferred acquisition costs adjusted, accordingly, on a prospective basis. Consistent with the guidance in paragraphs 13 and 29 of FASB Statement No. 60, unearned premium is recognized as revenue over the period of the contract in proportion to the amount of insurance protection provided, amortization of deferred acquisition costs continues to be recognized in proportion to the premium recognized, and the revised amortization ratio is used prospectively. Where the modification is a reduction in benefits with a directly proportionate reduction in premiums, the modification should result in an immediate proportionate reduction in unamortized deferred acquisition costs rather than a prospective revision.

Costs Related to Internal Replacements That Are Substantially Unchanged

22. Costs incurred in connection with an internal replacement that results in a replacement contract that is substantially unchanged from the replaced contract should be accounted for as policy maintenance costs and charged to expense as incurred. The portion of renewal commissions paid on the replacement contract that meets the criteria for deferral in accordance with the provisions of FASB Statements No. 60 and No. 97, as appropriate, limited to the amount of the future deferrable renewal commissions on the replaced contract that would have met the deferral criteria, continues to be deferrable under the provisions of FASB Statements No. 60 and No. 97.

Sales Inducements to Contract Holders Offered With Internal Replacements of Long-Duration Contracts That Are Substantially Unchanged

23. In certain situations, an insurance enterprise may assess a surrender charge on the replaced contract that is offset by an immediate sales inducement to a contract holder on the replacement contract. In this situation, the insurance enterprise should offset any surrender charges assessed against the contract holder's account balance under the replaced contract against any stated immediate sales inducement to determine whether there has been a net reduction in the contract holder's account value in accordance with paragraph 15 (d) of this SOP.

24. The liability for a sales inducement to a contract holder offered in conjunction with an internal replacement of a long-duration contract that is determined to result in a replacement contract that is substantially unchanged from the replaced contract should be accounted for from the date of its addition to the replacement contract in accordance with the guidance in paragraph 36 of SOP 03-1:

   Sales inducements provided to the contract
   holder, whether for investment or universal
   life-type contracts, should be recognized as
   part of the liability for policy benefits over the
   period in which the contract must remain in
   force for the contract holder to qualify for the
   inducement or at the crediting date, if earlier,
   in accordance with paragraph 20 of this SOP.
   No adjustments should be made to reduce
   the liability related to the sales inducements
   for anticipated surrender charges, persistency,
   or early withdrawal contractual features.

Accounting for Contracts That Are Substantially Changed

25. An internal replacement that is determined to result in a replacement contract that is substantially changed from the replaced contract should be accounted for as an extinguishment of the replaced contract. Unamortized deferred acquisition costs, (6a) unearned revenue liabilities, and deferred sales inducement assets from the replaced contract in an internal replacement transaction that results in a substantially changed contract should not be deferred in connection with the replacement contract. Other balances associated with the replaced contract, such as any liability for MGDBs or GMIBs, should be accounted for in a similar manner; that is, accounted for based on an extinguishment of the replaced contract and issuance of a new contract. Acquisition costs related to the replacement contract should be evaluated for deferral in accordance with the provisions of FASB Statements No. 60 and No. 97, as appropriate.

Contract Assessments Related to Internal Replacements of Long-Duration Contracts

26. Front-end fees assessed in connection with an internal replacement of a long-duration contract should be evaluated for deferral in accordance with existing authoritative accounting literature. For contracts accounted for under FASB Statements No. 91, No. 97, and No. 120, both new and existing front-end fees on an internal replacement that results in a replacement contract that is substantially unchanged from the replaced contract should be adjusted to reflect the revisions to the estimated gross profits.

Recoverability

27. Unamortized deferred acquisition costs and the present value of future profits continue to be subject to premium deficiency testing in accordance with the provisions of FASB Statement No. 60.

Disclosure

28. The notes to the financial statements should describe the accounting policy applied to internal replacements, including whether or not the company has availed itself of the alternative application guidance outlined in paragraphs 18 and 19 of this SOP and, if so, for which types of internal replacement transactions.

EFFECTIVE DATE AND TRANSITION

29. The provisions of this SOP are effective for internal replacements occurring in fiscal years beginning after December 15, 2006, with earlier adoption encouraged, Retrospective application of this SOP to previously issued financial statements is not permitted. Initial application of this SOP should he as of the beginning of an entity's fiscal year (that is, if the SOP is adopted prior to the effective date, all prior interim periods of the year of adoption should be restated).

Internal Replacements Occurring Prior to the Year of Adoption

30. Unamortized deferred acquisition costs and other balances, such as unearned revenue on front-end fees and unamortized deferred sales inducements, related to internal replacement transactions occurring prior to the year of adoption of this SOP should not be adjusted to the amounts that would have been reported had this SOP been in effect when the internal replacements occurred.

Internal Replacements Occurring After the Date of Adoption

31. Prior to the adoption of the SOP, an enterprise's accounting policy would have treated certain internal replacements as continuations of the replaced contract, while others may have been treated as extinguishments. Under the provisions of this SOP, the enterprise's accounting policy may change for certain internal replacements. Changes in unamortized deferred acquisition costs, (7a) unearned revenue liabilities, and deferred sales inducement assets that result from the impact on estimated gross profits of changes in accounting policy due solely to the adoption of this SOP, as applied to previously anticipated future internal replacements, and any related income tax effects, should be reported in a manner similar to the cumulative effect of a change in accounting principle with offsetting adjustments to the opening balance of retained earnings as of the date of adoption.

Disclosures

32. Disclosure of the effect of the change on retained earnings as of the date of adoption is required. If the financial statements of the year of adoption are presented separately or included in comparative financial statements, the notes to the financial statements should disclose (a) the fact that this SOP has been adopted and the effective date of adoption, and (b) the nature of any differences in accounting principles or financial statement presentation applicable to the financial statements presented that resulted from adoption of this SOP. Disclosure of the pro forma effects of retrospective application (or, prior to the adoption of FASB Statement No. 154, retroactive application as discussed in paragraph 21 of Accounting Principles Board Opinion [APB] No. 20, Accounting Changes) or the pro forma effect on the year of adoption is not required.

The provisions of this Statement need not be applied to immaterial items.

GLOSSARY

Base contract. The type of contract specified in the policy form prior to the addition or election of riders or other contract features. For example, for an annuity with a guaranteed minimum income benefit (GMIB) rider, the annuity would be considered the base contract.

Contract exchange. The legal extinguishment of one contract and the issuance of another.

Coverage. An insurance enterprise's exposure to loss. The concept of coverage would typically include policy limits, deductible, insured, and covered property or insured event.

Existing contract. The contract that is currently held by the contract holder and excludes nonintegrated contract features.

General account. All operations of an insurance enterprise that are not reported in a separate account.

Integrated contract feature. A contract feature in which the benefits provided by the feature can be determined only in conjunction with the base contract.

Internal replacement. A modification in product benefits, features, rights, or coverages that occurs by the legal extinguishment of one contract and the issuance of another contract (a contract exchange); or by amendment, endorsement, or rider to a contract; or by the election of a benefit, feature, right, or coverage within the contract.

Nonintegrated contract feature. A contract feature in which the benefits provided are not related or dependent on the provisions of the base contract.

Original contract. The contract that was initially entered into by the contract holder prior to any potential internal replacement activity. Ratchet death benefit. A death benefit equal to the highest account balance among prior specified anniversary dates adjusted for deposits less partial withdrawals since the specified anniversary date.

Replaced contract. The contract that currently is held by the contract holder, and is exchanged or modified in an internal replacement transaction.

Replacement contract. The new or modified contract in an internal replacement transaction.

Return of premium death benefit. A death benefit equal to the total deposits made by the contract holder less any withdrawals.

Reunderwriting. The reexamination of the insurance risk of the entire contract for purposes of acceptance or rejection or for rating the risk for pricing purposes.

Roll-up death benefit. A death benefit equal to the total of deposits made to the contract less an adjustment for partial withdrawals, accumulated at a specified interest rate.

Sales inducement to a contract holder. A product feature that enhances the investment yield to the contract holder. The three main types of sales inducements are (1) day one bonus, which increases the account value at inception, also called immediate bonus; (2) persistency bonus, which increases the account value at the end of a specified period; and (3) enhanced yield, which credits interest for a specified period in excess of rates currently being offered for other similar contracts. Sales inducements are defined as contractually obligated inducements that are explicitly identified in the contract and are in excess of current market conditions.

Separate account. A separate investment account established and maintained by an insurance enterprise under relevant state insurance law to which funds have been allocated for certain contracts of the insurance enterprise or similar accounts used for foreign originated products.

Surrender charge. Charges assessed at contract redemption, whole or partial, regardless of how the charges are labeled, such as contingent deferred sales charges.

(1) The present value of future profits is as discussed in EITF Issue No. 92-9, Accounting for the Present Value of Future Profits Resulting from the Acquisition of a Life Insurance Company.

(2) At the time AcSEC undertook the project, at least five of the seven FASB members were required to not object to AcSEC undertaking this project.

(1a) Terms defined in the "Glossary" are set in boldface type the first time they appear in the text.

(2a) FASB Statement No. 60, as amended, applies to life insurance enterprises, property and liability insurance enterprises, title insurance enterprises, mortgage guaranty insurance enterprises, assessment enterprises, and fraternal benefit societies. Modifications and exchanges of debt issued by insurance enterprises should follow the guidance in Emerging Issues Task Force (EITF) 96-19, Debtor's Accounting for a Modification or Exchange of Debt Instruments.

(3a) Other relevant accounting guidance, for instance FASB Statement No. 113, Accounting and Reporting for Reinsurance of Short Duration and Long Duration Contracts, governs the determination of the implications of modifications to insurance and reinsurance contracts on risk transfer assessment and the classification of short-duration contracts as either retroactive or prospective.

(4a) However, even if both accumulation and annuitization phase contracts are investment contracts involving no life contingencies, the annuitization phase of a contract is separate and distinct from and cannot be accounted for as a continuation of the accumulation phase of the contract. For a short-duration contract, renewal results in a separate and distinct contract that cannot be accounted for as a continuation of the previous contract.

(5a) If the replaced contract was acquired in a purchase business combination, any present value of future profits established in accordance with EITF Issue No. 92-9. Accounting for the Present Value of Future Profits Resulting from the Acquisition of a Life Insurance Company, should be accounted for in a similar manner.

(6a) If the replaced contract was acquired in a purchase business combination, any present value of future profits established in accordance with EITF Issue No. 92-9, Accounting for the Present Value of Future Profits Resulting from the Acquisition of a Life Insurance Company, should be accounted for in a similar manner.

(7a) If the replaced contract was acquired in a purchase business combination, any present value of future profits established in accordance with Emerging Issues Task Force (EITF) Issue No. 92-9, Accounting for the Present Value of Future Profits Resulting from the Acquisition of a Life Insurance Company, should be accounted for in a similar manner.

Copyright [c] 2005 by American Institute of Certified Public Accountants, Inc. All rights reserved. For information about the procedure for requesting permission to make copies of any part of this work, please visit www.aicpa.org. A Permissions Request Form for e-mailing requests and information on fees are available there by clicking on the copyright notice at the foot of the AICPA homepage.

Accounting Standards Executive Committee (2004-2005)

Mark M. Bielstein, Chair

John M. Althoff

Pascal Desroches

Richard R. Jones

Carl Kampel

Peter H. Knutson

Steve B. Lilien

Andrew M. Mintzer

Holly L. Nelson

Benjamin S. Neuhansen

Richard R. Peterson

Coleman D. Ross

Robert Uhl

Dan L. Weaver

Brent A. Woodford

Accounting Standards Executive Committee (2003-2004)

Mark M. Bielstein, Chair

John M. Althoff

Val R. Bitton

Karin A. French

Richard R. Jones

Carl Kampel

Peter H. Knutson

Robert J. Laux

Steve B. Lilien

Andrew M. Mintzer

Holly L. Nelson

Benjamin S. Neuhausen

Coleman D. Ross

Brent A. Woodford

Accounting Standards Executive Committee (2002-2003)

Mark V. Sever, Chair

Mark M. Bielstein

Val R. Bitton

Lawrence N. Dodyk

Karin A. French

James A. Koepke

Robert J. Laux

Francis T. McGettigan

Andrew M. Mintzer

Richard H. Moseley

Benjamin S. Neuhausen

Coleman D. Ross

Ashwinpaul C. Sondhi

Mary S. Stone

Brent A. Woodford

DAC on Internal Replacements Task Force

Deborah H. Whitmore, Chair

Daniel C. Gifford

Ellen Hancock

Mary Beth McCahan

John W. Morris

Rick Sojkowski

Philip Surprenant

James M. Yanosy

AICPA Staff

Daniel J. Noll

Director, Accounting Standards

Kim Kushmerick

Technical Manager, Accounting Standards

AcSEC gratefully acknowledges the contributions of Lisa G. Boy, Tom Campbell, Michael Ernst, Mary Jane Fortin, John Harris, Laura J. Hay, Ken Height, Martin John, Robert Newman, Paula C. Panik, John Reese, Brian Reilly, Mary Saslow, and Chris Schreier.

Ethics interpretation and Rulings

Ethics interpretations and rulings are promulgated by the executive committee of the professional ethics division to provide guidelines as to the scope and application of the rules but are not intended to limit such scope or application. Publication of an interpretation or ethics ruling in the Journal of Accountancy constitutes notice to members. A member who departs from interpretations or rulings shall have the burden of justifying such departure in any disciplinary hearing.

(The Professional Ethics Executive Committee has adopted a new interpretation under Rule 101 of the Code of Professional Conduct [AICPA, Professional Standards, ET section 101.17], "Financial relationships" and has deleted ethics rulings nos. 35, 36, 66, 68, 79 and 109 of ET section 191, Ethics Rulings on Independence, Integrity, and Objectivity [AICPA, Professional Standards, vol. 2, ET sees. 191.069-.070, 191.071-.072, 191.132-.133, 191.136-.137, 191.158-159, and 191.218-.219] because either the substance of these ethics rulings has been incorporated into the new interpretation 101-15, Financial relationships, or because it was necessary to revise the guidance. Deleted text is struck through.)

INTERPRETATION 101-15 UNDER RULE OF CONDUCT 101

.17 101-15--Financial relationships.

Financial Interests

Interpretation 101-1 [ET sec. 101.02A.1] states that independence shall be considered to be impaired if, during the period of the professional engagement, a covered member had or was committed to acquire any direct or material indirect financial interest in the client. When reviewing this interpretation, the covered member should also refer to interpretation 101-1 [ET sec. 101.02] for the application of rule 101 and its interpretations and rulings to the covered member's immediate family and close relatives.

This interpretation provides definitions of direct and indirect financial interests and further guidance on whether various types of financial interests should be considered to be direct or indirect financial interests and provides certain limited exceptions under which a covered member could hold a direct or material indirect financial interest in an attest client without being considered to have impaired his or her independence.

Definitions

A financial interest is an ownership interest in an equity or a debt security issued by an entity, including rights and obligations to acquire such an interest and derivatives directly related to such interest.

A direct financial interest is a financial interest:

1. Owned directly by an individual or entity (including those managed on a discretionary basis by others); or

2. Under the control (1b) of an individual or entity (including those managed on a discretionary basis by others); or

3. Beneficially owned through an investment vehicle, estate, trust, or other intermediary when the beneficiary:

a. Controls the intermediary; or

b. Has the authority to supervise or participate in the intermediary's investment decisions.

An indirect financial interest is a financial interest beneficially owned through an investment vehicle, estate, trust, or other intermediary when the beneficiary neither controls the intermediary nor has the authority to supervise or participate in the intermediary's investment decisions.

A financial interest is beneficially owned when an individual or entity is not the record owner of the interest but has a right to some or all of the underlying benefits of ownership. These benefits include the authority to direct the voting or the disposition of the interest or to receive the economic benefits of the ownership of the interest.

Unsolicited Financial Interests

Independence would not be considered to be impaired if an unsolicited financial interest in a client is received, such as through gift or inheritance, and the financial interest is disposed of as soon as practicable, but no later than 30 days after the covered member has knowledge of and the right to dispose of the financial interest. In addition, when the covered member becomes aware that he or she will receive or has received a material direct or material indirect financial interest in a client requiring independence but does not have the right to dispose of the financial interest, independence would be considered to be impaired unless the covered member does not participate on the attest engagement team and disposes of the financial interest as soon as practicable but no later than 30 days after the right to dispose exists.

Mutual Funds

The ownership of shares in a mutual fund is considered to be a direct financial interest in the mutual fund. The underlying investments of a mutual fund are considered to be indirect financial interests.

If the mutual fund is diversified, (2b) a covered member's ownership of 5 percent or less of the outstanding shares of the mutual fund would not be considered to constitute a material indirect financial interest in the underlying investments.

If a covered member owns more than 5 percent of the outstanding shares of a diversified mutual fund, or if the mutual fund is not diversified, the covered member should evaluate the underlying investments of the mutual fund to determine whether the covered member holds a material indirect financial interest in any of the underlying investments.

For example, if a nondiversified mutual fired owns shares in attest client Company A, and

* The mutual fund's net assets are $10,000,000;

* The covered member owns 1 percent of the outstanding shares of the mutual fund, having a value of $100,000; and

* The mutual fund has 10 percent of its assets invested in Company A; the indirect financial interest of the covered member in Company A is $10,000 and this amount should be measured against the covered member's net worth (including the net worth of his or her immediate family) to determine if it is material.

Retirement, Savings, Compensation, or Similar Plans

A covered member who participates in a retirement, savings, compensation, or similar plan is considered to have a direct financial interest in the plan. (3b)

Investments held by a retirement, savings, compensation, or similar plan sponsored by a covered member's firm would be considered direct

financial interests of the firm. If a covered member controls a retirement, savings, compensation, or similar plan or has the ability to supervise or participate in the plan's investment decisions, the investments held by the plan would be considered direct financial interests of the covered member. Otherwise, the underlying plan investments would be considered indirect financial interests of the covered member.

Investments held in a defined benefit plan would not be considered financial interests of the covered member unless the covered member is a trustee of the plan or otherwise has the ability to supervise or participate in the plan's investment decisions because the benefits are not dependent upon investment performance.

The following examples illustrate these concepts:

1. If a covered member is a trustee of a retirement, savings, compensation, or similar plan or otherwise has the authority to supervise or participate in the plan's investment decisions, the underlying investments would be considered to be direct financial interests of the covered member.

2. If investments in a defined contribution plan are participant directed, whereby a covered member selects his or her underlying plan investments or selects from investment alternatives offered by the plan, the covered member would be considered to have a direct financial interest in those investments.

3. If investments in a defined contribution plan are not participant directed and the covered member has no authority to supervise or participate in the plan's investment decisions, the covered member would be considered to have an indirect financial interest in the underlying plan investments.

Also refer to ethics ruling no. 107, Participation in Health and Welfare Plan Sponsored by Client [ET sec. 191.214-.215], and interpretation 101-1, Interpretation of Rule 101 [ET sec. 101.02], subsections "Application of the Independence Rules to Covered Members Formerly Employed by a Client or Otherwise Associated With a Client," "Application of the Independence Rules to a Covered Member's Immediate Family," and "Application of the Independence Rules to Close Relatives."

Section 529 Plans (4b)

Section 529 plans are sponsored by states or higher education institutions, and may be prepaid tuition plans or savings plans. Both types of plans are established by an account owner for the benefit of a single beneficiary. The account owner may change the beneficiary at any time to another individual who is related to the previous beneficiary.

A covered member who is the account owner of a Section 529 prepaid tuition plan is considered to have a direct financial interest in the plan but not in the investments of the plan because the credits purchased represent an obligation of the state or educational institution to provide the education regardless of the investment performance of the plan or the cost of the education at the future date.

A covered member who is the account owner of a Section 529 savings plan is considered to have a direct financial interest in both the plan and the investments of the plan because he or she decides in which sponsor's Section 529 savings plan to invest and prior to making the investment has access to information about the plan's investments.

If a covered member invests in a Section 529 savings plan that does not hold financial interests in an attest client at the time of the investment, but the plan subsequently invests in an attest client, the covered member should (1) transfer the account to another sponsor's Section 529 savings plan or (2) transfer the account to another account owner who is not a covered member. However, when the transfer of the account will result in a penalty or tax that is significant to the account, the covered member may continue to own the account until the account can be transferred without significant penalty or tax, provided the covered member does not participate on the attest engagement team and is not in a position to influence the attest engagement.

A covered member who is a beneficiary of a Section 529 account is not considered to have a financial interest in the plan or the investments of the plan because he or she does not own the account or possess any of the underlying benefits of ownership and the beneficiary's only interest is to receive distributions from the account for qualified higher education expenses if and when they are authorized by the account owner.

Before becoming engaged to perform an attest engagement for a government or governmental entity that sponsors a Section 529 plan, covered members that are account owners of a Section 529 plan should consider the guidance in interpretation 101-10, The Effect on Independence of Relationships With Entities Included in the Governmental Financial Statements [ET sec. 101.12].

Trust Investments

When a covered member is a grantor of a trust, the trust and the underlying investments held by the trust are considered to be direct financial interests if the covered member retains the right to amend or revoke the trust, or otherwise has the authority to control the trust or to supervise or participate in the trust's investment decisions. However, where the covered member does not have the authority to amend or revoke the trust or to supervise or participate in the trust's investment decisions, he or she is not considered to have a financial interest in the trust or the underlying investments held by the trust.

When a covered member is a beneficiary of a trust, the trust is considered to be a direct financial interest of the covered member and the underlying investments held by the trust are considered to be indirect financial interests of the covered member. However, if the covered member controls the trust or supervises or participates in the investment decisions of the trust, the underlying investments held by the trust are considered to be direct financial interests of the covered member.

In a blind trust, the grantor is also the beneficiary, but does not supervise or participate in the trust's investment decisions during the term of the trust. However, the investments will ultimately revert to the grantor, and the grantor usually retains the right to amend or revoke the trust. Therefore, both the blind trust and the underlying investments held in a blind trust are considered to be direct financial interests of the covered member.

See interpretation 101-1 [ET sec. 101.02A.2] and ethics ruling no. 11 [ET sec. 191.021-.022] for additional guidance on trustee relationships.

Partnerships

The ownership of a general or limited partnership interest is considered a direct financial interest in the partnership.

The financial interests held by a partnership are considered to be direct financial interests of a covered member that is a general partner because the covered member is in a position to control the partnership or to supervise or participate in the partnership's investment decisions.

The financial interests held by a limited partnership are considered to be indirect financial interests of a covered member who is a limited partner as long as the covered member does not control the partnership or supervise or participate in the partnership's investment decisions. However, if the covered member has the ability to replace the general partner or has the authority to supervise or participate in the partnership's investment decisions, the financial interests of the partnership would be considered to be direct financial interests of the covered member.

See interpretation 101-1 [ET sec. 101.02A.3] for additional guidance on joint closely held investments and interpretation 101-8 [ET sec. 101.10] for additional guidance on financial interests in nonclients having investor or investee relationships with a covered member.

Limited Liability Companies

The ownership of an interest in a limited liability company (LLC) is considered a direct financial interest in the LLC.

In an LLC, members who are managers control the LLC and have the authority to supervise or participate in the LLC'S investment decisions. Accordingly, if a covered member is a manager of the LLC, the financial interests of the LLC are considered to be direct financial interests of the covered member. If a covered member is a member but not a manager of the LLC, the covered member should look to the operating agreement of the LLC to determine whether he or she can control the LLC or has the authority to supervise or participate in the investment decisions of the LLC. If the covered member does not control the LLC, or have the authority to supervise or participate in the LLC's investment decisions, the financial interests held by the LLC would be considered to be indirect financial interests of the covered member.

Insurance Products

An insurance policy obtained from a stock or mutual insurance company that does not offer the policy holder an investment option is not considered to be a financial interest. Accordingly, if a covered member owns an insurance policy issued by an attest client, independence is not considered to be impaired, provided the policy does not offer the policy holder an investment option and the policy was purchased under the insurance company's normal terms, procedures, and requirements. If a mutual insurance company begins the demutualization process, covered members who hold an insurance policy from the company should refer to the guidance contained in the "Unsolicited Financial Interests" section of this Interpretation.

Some insurance policies offer an investment option whereby the policy owner may choose to invest part of the cash value in a variety of underlying investments. The underlying investments of this type of insurance policy are considered to be a financial interest, and the covered member should apply the guidance in this interpretation to determine whether the underlying investments are direct or indirect financial interests. For example, if the covered member has the ability to select the underlying investments or the authority to supervise or participate in the investment decisions and the cash value of the insurance policy is invested in a mutual fund, the mutual fund is considered to be a direct financial interest and the underlying investments of the mutual fund are considered to be indirect financial interests.

See interpretation 101-1 [ET sec. 101.02A.3] for additional guidance on joint closely held investments and interpretation 101-8 [ET sec. 101.10] for additional guidance on financial interests in nonclients having investor or investee relationships with a covered member.

ETHICS RULINGS UNDER RULE OF CONDUCT 101

[begin strikethrough]35. Stockholder in Mutual Funds[end strikethrough]

[begin strikethrough].069 Question--A member owns shares in a non-regulated mutual investment fund (the fund) which holds shares of stock in a client. Would independence be considered to be impaired with respect to the client whose stock is held by the fund?[end strikethrough]

[begin strikethrough].070 Answer--Client securities held by the fund represent indirect financial interests. Accordingly, if a covered member has such an indirect financial interest, which is material to the covered member, independence would be considered to be impaired. In addition, if any partner or professional employee in the firm has significant influence over the fund, impaired.[end strikethrough]

[begin strikethrough]36. Participant in Investment Club[end strikethrough]

[begin strikethrough].071 Question--A member participates in an investment club. Would independence be considered to be impaired if a covered member owned stock in a client through an investment club as such holdings would be deemed to be a direct financial interest. Accordingly, any of the club's investments in a client would be deemed to impair independence regardless of materiality of the investment to the covered member's net worth.[end strikethrough]

[begin strikethrough]See interpretation 101-1B for additional restrictions relating to all partners and professionals of the firm.[end strikethrough]

[begin strikethrough]66. Member's Retirement or Savings Plan Has Financial Interest in Client[end strikethrough]

[begin strikethrough].132 Question--A member's retirement or savings plan has a financial interest in a client. Would independence be considered to be impaired?[end strikethrough]

[begin strikethrough].133 Answer--Any direct or material indirect financial interest in a client held through a retirement or savings plan would be considered to be a direct or material indirect financial interest in the client. Accordingly, if a covered member had such a financial interest, independence would be considered to be impaired.

[begin strikethrough]See interpretation 101-1B for additional restrictions relating to all partners and professionals of the firm.[end strikethrough]

[begin strikethrough]68. Blind Trust[end strikethrough]

[begin strikethrough].136 Question--Would independence be considered to be impaired if a member transferred a direct financial interest in a client into a blind trust?[end strikethrough]

[begin strikethrough].137 Answer--Independence would be considered impaired if a covered member had a direct financial interest in a client, whether or not the interest was placed in a blind trust. Further, the covered member should ensure that any blind trust for which he or she is a beneficiary does not hold a direct or material indirect financial interest in any clients with respect to which he or she is a covered member.[end strikethrough]

[begin strikethrough]79. Member's Investment in a Partnership That Invests in Client[end strikethrough]

[begin strikethrough].158 Question--Would independence be considered to be impaired if a member had a direct financial interest in a partnership that invests in a client?[end strikethrough]

[begin strikethrough].159 Answer--If a covered member is a general partner, or functions in a capacity similar to that of a general partner, in a partnership that invests in a client, the covered member is deemed to have a direct financial interest in the client. Independence is considered to be impaired.[end strikethrough]

[begin strikethrough]If a covered member is a limited partner in a partnership that invests in a client, the covered member is considered to have an indirect financial interest in the client. Independence would be considered to be impaired if the indirect financial interest is material to the covered member's net worth.[end strikethrough]

[begin strikethrough]109. Member's Investment in Financial Services Products That Invest in Clients[end strikethrough]

[begin strikethrough].218 Question--Amounts contributed by a member of a member's firm (member) for investment purposes, including retirement plans, are invested or managed by a nonclient financial services company that offers financial services products, for example, insurance contracts and other investment arrangements, which allow the member to direct his or her investment into debt or equity securities. Under what circumstances would independence be considered to be impaired?[end strikethrough]

[begin strikethrough].219 Answer--If a covered member is able to direct and does direct his or her investment through a financial services product into a client, independence would be considered to be impaired because such investment is considered to be a direct financial interest in the client. If the covered member does not exercise his or her ability to direct the investment but the financial services product were to invest in a client, such investment would be a direct financial interest in the client and independence would be considered to be impaired.[end strikethrough]

[begin strikethrough]If the covered member is not able to direct the investment and the financial services product invests in a client, the covered member in considered to have an indirect financial interest in the client. Independence would be considered to be impaired if the indirect financial interest becomes material to the covered member. (See ethics ruling No. 35 under rule 101 for additional guidance with respect to investments in mutual funds.)[end strikethrough]

[begin strikethrough]Further, an investment in a financial services product that invests only in clients with respect to which an individual is considered to be a covered member would be considered to be a direct financial interest in such client, and independence would be considered to be impaired.[end strikethrough]

(1b) When used herein, the term control includes situations where the covered member, individually or acting together with his or her firm or with other partners or professional employees of his or her firm. has the ability to exercise such control.

(2b) To determine if the mutual fund is diversified, the covered member should refer to (1) the mutual fund's prospectus to see if the prospectus discloses that the fund is not diversified or (2) Section 5(b)(1) of the Investment Company Act of 1940.

(3b) A covered member who is an employee of a govern mental organization that is required by law or regulation to audit a retirement plan sponsored by a governmental unit will be permitted to be a participant in the plan, provided the plan is offered to all employees in equivalent employment positions, and the covered member (1) is not associated with the plan in any capacity prohibited by interpretation 101-1.C; (2) has no influence or control over the investment strategy, benefits, or other management activities associated with the plan; and (3) is required to participate in the plan as a condition of employment.

(4b) However, a covered member who is an employee of a governmental organization that is required by law or regulation to audit a Section 529 plan sponsored by a governmental unit will be permitted to be an account owner in the plan for a period not to exceed one year from the effective date of this interpretation.