March 2011

REGULATORY DEVELOPMENTS

FDIC NPR Implementing Certain Liquidation Authority Provisions of Dodd-Frank

On March 15, the Federal Deposit Insurance Corporation (FDIC) issued a notice of proposed rulemaking (NPR) implementing certain orderly liquidation authority provisions of the Dodd-Frank Act.  Dodd-Frank gives the FDIC broad authority to use receivership powers to liquidate failing systemic financial firms in an orderly manner.  The NPR establishes a comprehensive framework for the priority payment of creditors and for the procedures for filing claims with the receiver and, if dissatisfied, pursuing the claim in court.  The NPR also defines the ability of the receiver to recoup compensation from persons who are substantially responsible for the financial condition of the company.  There will be a presumption for the most senior executives, including those performing the duties of CEO, COO, CFO and the Chairman of the Board, that they are substantially responsible and thus subject to recoupment of up to two years of compensation.  One exception to the FDIC’s resolution authority is if the financial company to be liquidated is an insurance company, then the state regulator is charged with resolving the company under applicable state law.  Only if the state regulator does not act within 60 days would the FDIC step in, and even then it would act under state law.  The comment period ends May 23, 2011.

 

Joint Proposed Rule on Resolution Plans and Credit Exposure Reports for Systemic Entities

On March 29, the Federal Deposit Insurance Corporation (FDIC) approved a joint notice of proposed rulemaking (NPR) to be issued jointly with the Federal Reserve Board (FRB) regarding section 165 of the Dodd-Frank Act.  Under that section, holding companies with assets of $50 billion or more and other covered non-bank financial companies supervised by the FRB must periodically provide details of their resolution plans and report significant credit exposures.  In the NPR, covered companies would be required to identify and map their business lines to legal entities and provide integrated analyses of their corporate structure; credit and other exposures; funding, capital, and cash flows; domestic and foreign jurisdictions in which they operate; their supporting information systems and other essentials services; and other key components of their business operations.  On a quarterly basis, covered companies would be required to submit a Credit Exposure Report to outline the nature and extent of credit exposures.  Resolution Plans would have to be submitted within 180 days of the effective date of a final regulation, and Credit Exposure Reports would have to be filed 30 days after the end of each calendar quarter.  The comment period will end 60 days after publication in the Federal Register.

 

Joint Proposed Rule on Incentive Compensation

In the February LRA, we noted that the FDIC approved a joint proposed rule that requires regulated financial institutions to design their incentive compensation arrangements to better account for risk.  This month, the remaining regulators each independently approved the proposed rule.  The agencies are proposing that financial institutions with $1 billion or more in assets be required to have policies and procedures to ensure compliance with requirements of the rule, and submit an annual report to their federal regulator describing the structure of their incentive compensation arrangements.  Additionally, larger financial institutions, generally those with $50 billion or more in assets, would have to defer at least 50 percent of the incentive compensation of executive officers for at least three years and the amounts ultimately paid would have to reflect losses or other aspects of performance over time.  Comments on the proposed rule will be accepted for 45 days after its publication in the Federal Register, which is expected soon.

 

New Federal Insurance Office Director Appointed

The Obama administration has selected Illinois Department of Insurance Director Michael McRaith to run the newly created Federal Insurance Office (FIO).  Treasury Secretary Geithner announced the appointment at the March 17 meeting of the Financial Stability Oversight Council.  As the FIO Director, McRaith will serve as a nonvoting member of that body.  McRaith is currently secretary-treasury of the National Association of Insurance Commissioners and has testified frequently before Congress on the importance of retaining state authority over insurance.  The FIO will advise federal authorities on insurance matters, prepare reports and analyses, and have some limited preemption power over state laws that affect international insurance arrangements.

Section 502 of the Dodd-Frank Act mandates the FIO to conduct a study on the regulation of insurance.  One component of the study, which we will be following closely, is to examine the potential consequences of subjecting insurance companies to a federal resolution authority, including the effects of any federal resolution authority on the operation of state insurance guaranty fund systems and the loss of the special status of separate account assets and separate account liabilities.

 

TAX DEVELOPMENTS

IRS Revenue Ruling on Certain § 1035 Exchanges

On March 3, the Internal Revenue Service (IRS) issued Revenue Ruling 2011-09 addressing Internal Revenue Code (IRC) section 1035 exchanges of life insurance policies and the application of IRC section 264(f).  The revenue ruling also affirms the IRS position in an earlier private letter ruling (PLR 200627021 dated April 6, 2006) that the new policy does not qualify for the employee exception to section 264(f), if the insured is not an active employee at the time of the exchange.  Section 264(f) disallows deduction for interest expense on unrelated borrowings unless the insured is (i) a 20 percent owner of the employer or (ii) an officer, director, or employee.

The Revenue Ruling specifically acknowledged that in some circumstances the issue date or other attributes of a contract carry over in a section 1035 exchange pursuant to an explicit rule.  For example, in the case of consent requirements under section 101(j), Congress in the Pension Protection Act of 2006 grandfathers exchanged contracts replacing original contracts issued on or before August 17, 2006.  This ruling was largely based on the fact that Congress did not provide a rule under which the status of the insured as an employee “at the time first covered” for purposes of section 264 would carry over from a contract replaced in a section 1035 exchange. This Locke Lord Bissell & Liddell Client Alert further summarizes the topic.

 

ACCOUNTING DEVELOPMENTS

FASB and IASB Convergence Projects Update

We continue to follow the various convergence initiatives of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), including the project related to insurance contracts.  From March 21-23, a joint meeting was held in Connecticut to discuss various topics, including a potentially material discussion with respect to lease accounting.  Specifically, the boards discussed whether it is appropriate to provide a practical expedient.  By a majority vote, both boards supported the use of a practical expedient that allows the time value of money to be disregarded when the time period is one year or less.  However, there was significant minority opposition from both boards and the issue will be reexamined in connection with the final model.

Similar principles apply to two aspects of BOLI accounting: (1) DAC asset amounts receivable within one year are generally not discounted to reflect present value; and (2) upon conforming surrender requests, stable value protection (SVP) contracts delay payment of book value, typically for 180 or 360 days.  If FASB reverses this position due to concerns about the materiality of high interest rate environments, it may impact how banks have to account for SVP agreements and DAC receivables.  For this reason, we will monitor this issue closely.

 

LEGISLATIVE DEVELOPMENTS

Amendments to Dodd-Frank Act Introduced in the House

This month several bills introduced in the House were designed to amend or supplement the Dodd-Frank Act.  The Burdensome Data Collection Relief Act, H.R. 1062, would repeal the requirements of Dodd-Frank section 953(b) which state that publically traded companies must disclose their median annual total compensation of all employees.  The Small Company Capital Formation Act, H.R. 1070, would amend the Securities Act of 1933 (’33 Act) to increase the offering threshold for companies exempted from Securities and Exchange Commission (SEC) registration under Regulation A from $5 million to $50 million.  The Small Business Capital Access and Job Preservation Act, H.R. 1082, would amend section 203 of the Investment Advisors Act to exempt advisors to private equity funds from the registration requirements imposed on such advisors under Dodd-Frank.  A discussion draft of the Asset-Backed Market Stabilization Act provides for the repeal of Dodd-Frank section 936G and the restoration of Rule 436(g) of the ’33 Act, which was repealed by Dodd-Frank.  The repeal of Rule 436(g) in effect required issuers to obtain and file a consent from the credit rating agency with any registration statement if ratings were to be disclosed.  Since rating agencies refused to provide such consent, the asset-backed securities market effectively ceased to function, forcing the SEC to issue a temporary no-action letter on July 21, 2010, and a permanent no-action letter on November 23, 2010.  Another bill is expected to be introduced to shield end-users of over-the-counter derivatives from new central clearing requirements and associated costs.  Doubt has been cast on the ability of any of these proposed bills to pass the Senate.  Furthermore, the current administration would have the opportunity to veto even if any did pass the Senate.

 

JUDICIAL DEVELOPMENTS

Atkinson v. Wal-Mart Stores (Update)

On March 15, the parties filed a status update with the Florida Supreme Court.  The parties reported that they had concluded their preparation of the settlement agreement and were preparing to present the settlement to the district court for approval.

 

BB&T v. Pacific Life Insurance Company (Update)

On March 29, a federal judge entered his final decision in favor of BB&T.  In this matter, BB&T sued to recover losses to its BOLI cash surrender value that occurred over a three-month period when Pacific Life Insurance Company failed to execute a surrender request due to corporate formalities.  The court ruled that the effective date of a surrender request is the date of receipt, even if that request is incomplete at the time.  Pacific Life argued that BB&T could have mitigated the loss by transferring the funds to another account during the dispute; however, the court declined to impose any principles of mitigation.  The court reasoned that whether the return on investment would have been better or worse than the actual return was a matter of pure speculation.  BB&T was awarded approximately $260,000 with 8 percent prejudgment interest and 12 percent post-judgment interest compounded.

 

Jones v. Bridgestone Americas (Update)

The parties have resolved the claims out of court.  The plaintiff in this matter challenged Bridgestone’s insurable interest in the life of a deceased employee and claimed that Bridgestone fraudulently concealed the existence of the life insurance proceeds.  A court order granting joint stipulation of dismissal with prejudice was entered on January 25, 2011.  Settlement details were not filed with the court.

 

OTHER DEVELOPMENTS

NAIC Observations on Separate Account Products

On a March 8 conference call, a working group of the National Association of Insurance Commissioners (NAIC) made a summary report on separate accounts available to the public.  The working group expressed concern about the solvency risks posed by non-variable products written in separate accounts and how such products would interact with the general account of a troubled company.  Additional concern was expressed about how such products interact with state guaranty funds.  In a survey of state insurance departments, the working group identified 300 non-variable products in separate accounts, including BOLI/COLI.  Overall, 81 products were deemed not legally insulated.  Of 40 BOLI/COLI products, one was found not to be legally insulated.  The summary noted that there were different views on what is defined as legally insulated, but did not specifically identify the definition used in the survey.

On the same conference call, a December 2010 report by the Separate Account Risk working group was also made available to the public.  That report expressed concern that the current NAIC Variable Contract Model Law, with its provision regarding guarantees and insulation of separate account assets, could elevate certain separate account policyholders unfairly to a position of preferred class.  These would include policyholders with both general account guarantees and preferential treatment of separate account assets within a liquidation.  The working group updated its objective to further study the need to modify existing regulatory guidance related to separate accounts where in recent years various products and contract benefits have increased the risk to the general account.

 

SEC Delaying Implementation of Broker-Dealer Fiduciary Standard

The Securities and Exchange Commission (SEC) planned to have proposed rules based on its Dodd-Frank study on the obligations of broker-dealers and investment advisors completed by July 2011.  However, the SEC’s study recommendation to impose a uniform fiduciary standard on broker-dealers and investment advisors has been met with strong resistance.  At industry events, SEC staff members have indicated that the SEC is no longer working to have the proposed rulemaking issued within the scheduled time frame.  Financial Industry Regulatory Authority (FINRA) CEO Richard Ketchum has been quoted as saying that he does not expect the SEC to issue proposed rules on the fiduciary standard until late 2012.  Broker-dealers currently operate under a suitability obligation, which generally requires a broker-dealer to make recommendations that are consistent with the interests of its client, while the fiduciary standard would require broker-dealers to serve the best interests of its client.

 

Ad Hoc LRA – March 4, 2011

IRS Revenue Ruling on Certain § 1035 Exchanges

Yesterday, the IRS issued Revenue Ruling 2011-09 addressing IRC section 1035 exchanges of life insurance policies and the application of IRC section 264(f). The ruling clarifies that a new policy received in a section 1035 exchange does not qualify for the employee exception to section 264(f) if the insured is not an active employee at the time of the exchange. Section 264(f) disallows deduction for interest expense on unrelated borrowings unless the insured is a (i) a 20-percent owner of the employer; or (ii) an officer, director, or employee. For your convenience, this Locke Lord Bissell & Liddell Client Alert further summarizes the topic.