In a recently released Corporate Decision, the OCC approved a request from a federal savings association (FSA) to treat the cash surrender value of certain BOLI policies as a contribution to capital. The policies were on the lives of certain officers and were transferred from the holding company to the FSA as a contribution of capital in 2010. The FSA stated that it did not need to raise additional capital, but that the contribution was made to enhance its capital levels for possible long-term growth. The Decision was based on the guidelines contained in Section 110 of the Examination Handbook of the former OTS, which continue to be applicable to federal savings associations.
In the Decision, the OCC concluded the FSA could count the CSV of the BOLI contributed to it by the FSA’s holding company because: (1) the BOLI is clearly identifiable and can be sold separately from the FSA; (2) the FSA had established an independent market value for the BOLI and the BOLI was likely to hold its market value; (3) the transaction did not involve a purchase of assets from an affiliate or another type of covered transaction under the FRB’s Regulation W; (4) the FSA was well capitalized; and (5) the proposed noncash contribution of capital to the FSA involved less than 25% of the FSA’s capital.
On July 6, the Securities and Exchange Commission (SEC) and the Commodity and Futures Trading Commission (CFTC) approved long-awaited joint rules and interpretations concerning certain key derivative regulation definitions, including “swap” and “security-based swap.” Included in the rules and interpretations is an Insurance Safe Harbor. There is also an expanded and revised list of exempted products that will not be considered a swap or security-based swap including: life insurance, annuities, health insurance, disability insurance, long-term care insurance, surety bonds and fidelity bonds. Provided that such products are issued by an insurance company. Unlike the proposed rules, the exclusion for specific products has been codified in the rules rather than merely being a part of the interpretive material. Transactions entered into before the effective date of the final rules will be “grandfathered” (as not involving a swap), if the product was issued by an insurance company and regulated as insurance at the time of the transaction. The rules will become effective 60 days after publication in the Federal Register which is expected shortly.
On July 18, the Financial Stability Oversight Council (FSOC) released its second annual report to Congress as required by the Dodd-Frank Act. The report describes the activities of the FSOC and outlines significant developments in financial markets and makes relevant recommendations. Important new FSOC recommendations instruct regulators to incorporate extreme interest rate risk (IRR) scenarios into stress testing, mandate new governance standards for complex trades, address cyber threats and bolster regulations for protecting customer funds deposited for foreign futures trading.
The FSOC also released its study on contingent capital requirements for nonbank financial companies and large bank holding companies which was mandated by Dodd-Frank. For purposes of the study, contingent capital meant regulatory capital and other financial instruments that generate additional common equity capital upon the occurrence of a trigger event. Such instruments may create additional capital in various ways, including conversion and write off or write down of the value of the instrument. Some of the potential drawbacks of such instruments are whether the instrument would actually convert to common equity in time to effectively absorb losses, further interconnectedness if institutions invest significantly in each other’s contingent capital instruments and the possible negative signals to the market about the health of a firm whose instrument has been converted that could lead to a “death spiral” effect. While the study acknowledged that such instruments can provide firms with a useful tool to lower cost capital, it concluded that more analysis is needed.
The Office of Financial Research (OFR) issued its inaugural annual report to Congress as required by the Dodd-Frank Act. The OFR has no supervisory responsibilities; instead, the OFR’s mission is to analyze threats to financial stability, conduct research, address data gaps and promote data standards. The report examines factors affecting financial stability and the need for more and better data on leverage, liquidity, and interconnectedness, with a focus on derivatives and short-term funding markets. The report also discussed that the lack of high-quality, consistent, and accessible data was a key source of risk during the recent financial crisis. Noting that as concerns spread about certain assets, particularly those related to subprime mortgages, financial companies often were unable to aggregate their own exposures or evaluate the exposures of their counterparties. As a result, the OFR’s first priority is to support domestic and global efforts to establish a Legal Entity Identifier which would enable accurate and unambiguous identification of entities engaged in financial transactions.
Recently, the Internal Revenue Service (IRS) issued proposed regulations to clarify the application of Internal Revenue Code (IRC) § 83, which provides that property transferred in connection with the performance of services is included in the service provider’s income once it is transferable or no longer subject to a substantial risk of forfeiture. The proposed regulations clarify that: (i) a substantial risk of forfeiture may be established only through a service condition or a condition related to the purpose of the transfer, (ii) both the likelihood that the forfeiture event will occur and the likelihood the forfeiture will be enforced need to be considered in determining whether there is a substantial risk of forfeiture, and (iii) transfer restrictions do not create a substantial risk of forfeiture except as specifically provided under IRC § 83(c)(3) or related regulations. The regulations are proposed to apply to property transferred on or after January 1, 2013 and can be relied upon for property transferred after May 30, 2012. The comment period ends on August 28, 2012.
This matter terminated on July 6 and was transferred from Oklahoma to federal court in Ohio (under Baker v. American Greetings). Although the plaintiff filed timely objections to a recommendation and report that the matter be transferred, the objections seemingly were not compelling enough to convince the district court judge. Both Baker and Collier are class action lawsuits that alleged American Greetings wrongfully obtained life insurance on is employees without the employees’ knowledge. We will continue to track Baker developments.
Case Reference: Collier v. American Greetings Corp, N.D. Okla. No. 4:10-cv-625; Baker v. American Greetings, N. D. Ohio No. 1:12-cv-65
On July 26, an appellate court judge affirmed a summary judgment in favor of Sun Life in a 12-year patent infringement case. Bancorp sued Sun Life for infringement of two 1996 patents that provided a computerized means for tracking the book value and market value of the policies and calculating the credits representing the amount a stable value writer must guarantee and pay should the policy be paid out prematurely. In 2009, Sun Life moved for summary judgment of invalidity under 35 U.S.C. § 101 for failure to claim patent-eligible subject matter. The matter was stayed pending the 2010 Supreme Court’s decision in Bilski v. Kappos. The district court found the asserted patent claims deficient under the “machine-or-transformation test” and concluded that the claims were invalid under § 101 as directed to patent-ineligible abstract ideas. The appellate court affirmed. Prior to the Sun Life matter, Bancorp brought similar suits against MetLife and Hartford.
Case Reference: Bancorp Services v. Sun Life, Fed. Cir. No. 11-cv-1467
On July 3, the European Commission proposed a revision to the Insurance Mediation Directive (IMD), which currently regulates selling practices for all insurance products including those that contain investment elements. One change is that insurance sellers will need to disclose the nature of compensation (e.g., based on fee, commission, or salary), the commission structure (e.g., paid directly by the client or insurance carrier) and what the premium encompasses in terms of services (e.g., advice, administration, etc.). The insurance seller also must clearly demonstrate the role in which he is acting (e.g., agent, broker, direct writer, etc.). The Commission has proposed to make the commission disclosures mandatory for life insurance products and “by customer request” for all other insurance products for the first five years after adoption. The EU Commission proposes laws for adoption by the European Parliament and the Council of the EU (national ministers). Once EU legislation has been adopted, the Commission ensures that it is correctly applied by the 27 EU member countries.
In a recently released Corporate Decision, the OCC approved a request from a federal savings association (FSA) to treat the cash surrender value of certain BOLI policies as a contribution to capital. The policies were on the lives of certain officers and were transferred from the holding company to the FSA as a contribution of capital in 2010. The FSA stated that it did not need to raise additional capital, but that the contribution was made to enhance its capital levels for possible long-term growth. The Decision was based on the guidelines contained in Section 110 of the Examination Handbook of the former OTS, which continue to be applicable to federal savings associations.
In the Decision, the OCC concluded the FSA could count the CSV of the BOLI contributed to it by the FSA’s holding company because: (1) the BOLI is clearly identifiable and can be sold separately from the FSA; (2) the FSA had established an independent market value for the BOLI and the BOLI was likely to hold its market value; (3) the transaction did not involve a purchase of assets from an affiliate or another type of covered transaction under the FRB’s Regulation W; (4) the FSA was well capitalized; and (5) the proposed noncash contribution of capital to the FSA involved less than 25% of the FSA’s capital.
We are still reviewing this matter for broader implications for BOLI policyowners (e.g., unwrapped variable separate account policies) and may expand upon this topic in our August LRA.