February 2011

REGULATORY DEVELOPMENTS

Federal Reserve Board Approves Final Volcker Conformance Period Rules

On February 9, the Federal Reserve Board announced its approval of a final rule to implement the provisions of the Dodd-Frank Act that give banks a period of time to conform their activities and investments to the prohibitions and restrictions of the so-called Volcker Rule.  Generally, all banking firms and nonbank financial companies supervised by the Board have a two-year conformance period after the Volcker Rule’s effective date. The Board can extend the two-year period by up to three one-year periods.  Additionally, a banking entity can request the Board’s approval for an additional extension of up to five years to permit the banking entity to meet contractual commitments in place as of May 1, 2010, to a hedge fund or private equity fund that qualifies as an “illiquid fund.”  While the final rule is substantially similar to the proposed rule issued in November 2010, some modifications were made in response to comments.  One such modification extended from 90 days to 180 days the number of days in advance a request for an extension of the conformance period by a specific company must be filed with the Board.  The final rule clarified that the Board expects to act on an extension request within 90 days of its receipt.  It also expanded the conditions under which an asset may be considered an “illiquid asset” and broadened the types of documents considered in determining whether a banking entity that has sponsored a covered fund is “contractually obligated” to invest or remain invested in the fund.  The final rule is effective April 1, 2011.

 

Federal Reserve Board Proposes Rule for Systemically Important Definitions

On February 8, the Federal Reserve Board issued a notice of proposed rulemaking to (1) establish the criteria for determining whether a company is “predominantly engaged in financial activities,” and (2) define the terms “significant nonbank financial company” and “significant bank holding company” for purposes of Title I of the Dodd-Frank Act.  A company would be found to be predominantly engaged in financial activities if (i) the consolidated annual gross financial revenues of the company in either of its two most recently completed fiscal years represent 85 percent or more of the company’s consolidated annual gross revenues in that fiscal year; (ii) the consolidated total financial assets of the company as of the end of either of its two most recently completed fiscal years represent 85 percent or more of the company’s consolidated total assets as of the end of that fiscal year; or (iii) a case-by-case determination is made by the Board based on certain facts and circumstances described in the notice.  Any nonbank financial company or bank holding company that has $50 billion or more in total consolidated assets as of the end of the most recently completed fiscal year will be deemed “significant” for purposes of Dodd-Frank.  Any nonbank financial company supervised by the Board will also be deemed “significant.”  The comment period ends March 30, 2011.

These terms are relevant to various provisions of Dodd-Frank, including section 113, which authorizes the Financial Stability Oversight Council (FSOC) to designate a nonbank financial company for supervision by the Board if the FSOC determines that the company could pose a threat to the financial stability of the United States.  At least two bipartisan letters have been written by lawmakers to express their concern about the FSOC acting with significant insurance positions still vacant.  Dodd-Frank mandates that the FSOC has a voting member that is an insurance expert and two other insurance officials as non-voting members.  The National Association of Insurance Commissions (NAIC) selected Missouri Insurance Commissioner John Huff to be its non-voting member representative.  However, the voting member has yet to be appointed and confirmed.  Likewise Treasury still has to hire the new Federal Insurance Office Director who will serve as the other insurance non-voting member of the FSOC.  In a joint comment letter, insurance trade groups asked the FSOC to postpone efforts to classify insurers as systemically risky until the FSOC has proposed qualitative and quantitative standards for evaluating insurers and has given the public a chance to comment on those standards.

 

Proposed Interagency Rule on Incentive-Based Compensation

On February 7, the Federal Deposit Insurance Corporation (FDIC) approved an interagency proposed rule to implement section 956 of the Dodd-Frank Act.  The proposed rule would move the U.S. closer to certain aspects of international compensation standards by (1) requiring deferral of a substantial portion of incentive compensation for executive officers of financial institutions with $50 billion or more in total consolidated assets; (2) prohibiting incentive-based compensation arrangements for covered persons that would encourage inappropriate risks by providing excessive compensation; (3) prohibiting incentive-based compensation arrangements for covered persons that would expose the institution to inappropriate risks by providing compensation that could lead to a material financial loss; (4) requiring policies and procedures for incentive-based compensation arrangements that are commensurate with the size and complexity of the institution; and (5) requiring annual reports on incentive compensation structures to the institution’s appropriate federal regulator.  The other members of the Federal Financial Institutions Examination Council (FFIEC), the Securities and Exchange Commission (SEC), and the Federal Housing Finance Agency (FHFA) each must independently approve the proposed rule before it is published in the Federal Register.  Comments will be accepted for 45 days after publication.

 

Dodd-Frank Progress Hearing

On February 17, the Senate Committee on Banking, Housing, and Urban Affairs held a hearing on the progress report by regulators at the half-year mark of the Dodd-Frank Act’s implementation.  The heads of the Commodity Futures Trading Commission (CTFC), Securities and Exchange Commission (SEC), Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency (OCC) testified and answered questions relating to mandated studies, analyses, and rulemaking required by Dodd-Frank.  All the agency representatives commented on the additional funding and staff that will be required for full implementation of Dodd-Frank’s imposed responsibilities.  Acting Comptroller of the Currency John Walsh testified that, after significant study and comment, no practical alternative for credit ratings has been found that could be used across the banking sector.  Walsh argued that the use of credit ratings within defined limits was essential for implementation of capital rules and urged Congress to modify the credit rating prohibition.  In a related move, the SEC recently issued a notice of proposed rulemaking to remove references to credit ratings in rules and forms under the Securities Act and the Exchange Act.  The notice acknowledged that credit ratings play a significant role in the investment decisions of many investors, but stated that the SEC wants to avoid using credit ratings in a manner that suggests in any way a “seal of approval” on the quality of any particular credit rating or credit rating organization.

 

Proposed Revisions to the Market Risk Capital Rule

Last month, the banking regulators issued proposed revisions to the market risk capital rule.  The revisions are intended to broaden the scope of the rules to better capture the risk inherent in trading positions.  Specifically, the proposal would improve the rules’ sensitivity to risks not adequately captured under the current regulatory measurement methodologies, such as the default and migrations risks associated with less liquid products.  These revisions are expected to significantly increase the risk-based capital allocated to market risk.  The comment period ends April 11, 2011.

 

ACCOUNTING DEVELOPMENTS

FASB and IASB on Insurance Contracts

The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have been jointly working to develop common guidance that will address recognition, measurement, presentation, and disclosure requirements for insurance contracts and reinsurance.  The FASB has been deliberating and seeking public comment  on fundamental issues in moving toward converged guidance, such as (1) whether the IASB’s proposed insurance guidance would be a sufficient improvement to U.S. generally accepted accounting principles (GAAP) to justify the cost of change; (2) whether the project goals of improvement, convergence, and simplification would be more effectively achieved by making targeted improvements to existing U.S. GAAP (rather than issuing comprehensive new guidance); and (3) certain critical accounting issues for which the preliminary views of the FASB differ from those in the IASB’s Exposure Draft.

In advance of the February 2011 meeting, the FASB and IASB staff issued a joint paper setting forth “axioms and assumptions” that will guide future deliberations.  The purpose of this document was to express fundamental areas of agreement between the boards so that further deliberations on these items may be limited.  Insurance industry associations (including American Council of Life Insurers (ACLI) and Group of North American Insurance Enterprises (GNAIE) responded with a joint letter asking the staff to withdraw the paper and continue a more expansive due-diligence process for the items identified.  Many commenters have also encouraged the boards not to rush through the process to meet a target date of June 2011.

 

FASB and IASB on Hedge Accounting

On February 9, the Financial Accounting Standards Board (FASB) issued a Discussion Paper on accounting for an entity’s hedging activities.  Current U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS) have differences with respect to the accounting for derivatives and hedging activities.  The International Accounting Standards Board’s (IASB’s) proposed revisions articulated in its recent Exposure Draft, Hedge Accounting, would create additional differences.  The FASB Discussion Paper asks stakeholders whether the IASB’s proposals are a better starting point for any changes to U.S. GAAP as it relates to derivatives and hedging activities.  The comment period ends April 25, 2011.

 

LEGISLATIVE DEVELOPMENTS

Hawaii Tax Bills

A number of bills have been introduced in the Hawaii legislature that would change tax treatment of life insurance proceeds.  HB 1270 and SB 1532 generally require the repeal of a number of tax exemptions and credits by December 31, 2012.  If passed, proceeds of life insurance would be subject to the state’s general excise tax which is currently 4 percent.  A separate bill, HB 798, specifically subjects the death benefit or other gross income derived from BOLI, COLI, and life settlements to the general excise tax.  HB 798 would impact BOLI/COLI policies issued after July 1, 2011.  The bill was initially referred to the Committee on Consumer Protection and Commerce and passed without amendment within 10 days of its introduction.  The bill has been referred to the Committee on Finance.  A number of industry organizations, including the Association for Advanced Life Underwriters (AALU) and the American Council of Life Insurers (ACLI) have expressed their opposition to all three bills and are actively lobbying against their passage.

 

JUDICIAL DEVELOPMENTS

Atkinson v. Wal-Mart Stores (Update)

On February 11, the parties filed a status update with the Florida Supreme Court.  The parties have prepared and agreed to the language of the settlement agreement.  Once the agreement is signed by the appropriate representatives, the parties will file it with the district court and request approval.

 

Collier v. American Greetings (Update)

American Greetings filed its answer to a complaint challenging its insurable interest related to COLI policies issued by Hartford which were related to the Havenstrite v. Hartford lawsuit.  In its answer, American Greetings admitted to purchasing broad-based COLI plans as a means to fund its employees’ post-retirement health care benefits.  The company also admitted to not obtaining written consent or informing its employees that death benefits would be paid to the company.  American Greetings further admitted to taking out life insurance on employees of varying levels as part of a COLI plan.  In the filing, the company maintained that the company derived no overall economic benefit in connection with either the insured’s passing or the COLI plans in general.  Addressing the fraudulent concealment claim, American Greetings denied that it actively concealed any information from its employees.  We will continue to provide updates on this matter.

 

OTHER DEVELOPMENTS

Call Report Revisions approved

The Federal Financial Institutions Examination Council (FFIEC) has approved a number of revisions to the Call Report.  As reported in our 2/15/2011 ad hoc LRA update, BOLI owners should note the changes to Schedule RC-F, which will now require insurance assets to be broken down into three line items to separately report general account, separate account, and hybrid policies.  These revisions will take effect March 31, 2011.

 

Obama Administration Proposed 2012 Budget Released

On February 14, the FY2012 proposed budget and the Treasury Greenbook were released.  The latest budget included familiar insurance-related budget proposals.  One such proposal is an expansion of the pro-rata interest expense disallowance for corporate-owned life insurance.  The COLI proposal would only allow an exception from the pro-rata interest expense disallowance on contracts covering 20 percent owners.  Currently, contracts covering the lives of employees, officers, and directors are also exempted.  It would apply to contracts issued after December 31, 2011.  Another insurance-related budget provision would modify dividends-received deductions for life insurance separate accounts.  The budget also calls for a Financial Crisis Responsibility Fee to be levied against financial firms with assets over $50 billion.  The leading insurance industry trade associations issued a joint statement expressing their opposition to the insurance-related budget provisions.

 

NAIC Working Group on Dodd-Frank Receivership

This month, the National Association of Insurance Commissioners (NAIC) Dodd-Frank Receivership Implementation working group released a preliminary outline of process and coordination items for consideration.  The group has been tasked to review and consider section 203(2e) of Dodd-Frank to determine what, if any, state laws, regulations, or procedures are necessary for state receivers and the NAIC to be prepared for its requirements related to receivership activities, as well as to monitor, review, and provide input on federal rulemaking and studies related to insurance receivership.

 

Ad Hoc LRA – February 15, 2011

Final Revisions to the Call Report Approved

The Federal Financial Institutions Examination Council (FFIEC) has approved a number of revisions to the Call Report.  Notably for BOLI owners, insurance assets in Schedule RC-F will now be broken down into three line items to separately report general account, separate account and hybrid policies.  The final rule differs from the prior proposal in that it distinguishes between all three types of policies; the prior proposal would have only distinguished between general account and separate account.  These revisions will take effect on March 31, 2011.

2012 Budget Proposal Released

Yesterday, the Obama Administration released its proposed 2012 budget. Like the 2010 and 2011 budget proposals, this latest version would expand the pro-rata interest expense disallowance for corporate-owned life insurance (COLI) by repealing the exception from the pro-rata interest expense disallowance rule applicable to contracts covering employees, officers or directors, other than 20-percent owners of a business that is the owner or beneficiary of the contracts.  To date, this proposal has been prospective in nature, and, therefore, would not impact existing policies (except for impacting interest expense disallowance applicable in the event of a 1035 exchange).  Currently, COLI policies covering the lives of officers, directors and employees are also exceptions to the interest expense disallowance.  Another insurance-related budget provision would modify dividends-received deductions (DRD) for life insurance company separate accounts.  The budget also calls for a Financial Crisis Responsibility Fee to be levied against financial firms with assets over $50 billion.  The fee is expected to generate $30 billion over 10 years.

A joint statement was issued by five leading insurance industry trade associations to express their opposition to the insurance-related budget proposals. The statement urged the administration to withdraw its proposals on COLI and DRD.