A variable contract’s separate account will generally be considered “adequately diversified” pursuant to Code section 817(h) of the Code and U.S. Treasury Regulations § 1.817-5 if the account invests:
(1) no more than fifty-five percent (55%) of the value of the total assets of the account in any one investment; (2) no more than seventy percent (70%) of the value of the total assets of the account in any two investments; (3) no more than eighty percent (80%) of the value of the total assets of the account in any three investments; (4) no more than ninety percent (90%) of the value of the total assets of the account in any four investments. Accordingly, these diversification requirements effectively require a Separate Account to hold a minimum of five (5) investments (taking into consideration the look-through rules discussed below).
In certain circumstances, the diversification requirement may be met by relying upon “look-through” rules, whereby the separate account may benefit from the underlying assets of certain mutual funds, investment trusts and partnerships (each referred to herein as a “fund”) whose interests are held by the separate account. If the look through rule does not apply – and it is limited in its application – the separate account’s investment in a fund will be considered a single investment for purposes of the diversification rules. Subject to certain very limited exceptions, a separate account will be permitted to look through to the underlying assets of a fund in applying these diversification percentages but only if: (1) all beneficial interests in the fund are held by one or more Separate Accounts of one or more insurance companies or those investment funds eligible to purchase and hold interests under section 817(h) of the Code and U.S. Treasury Regulation § 1.817-5 thereunder as permitted by IRS Revenue Ruling 2005-7, and (2) public access to the fund is available exclusively through the purchase of a variable insurance contract. Under all circumstances, the sole responsibility for meeting the adequate diversification guidelines will rest with the investment manager making all of the underlying investment decisions with respect to the separate account.