New Guidance on Model Risk Management
On April 4, the Office of the Comptroller of the Currency (OCC) adopted new supervisory guidance developed with the Federal Reserve Board to replace Bulletin OCC 2000-16, “Model Validation.” The new guidance incorporates a broader scope of model risk management. A central principle is the need for “effective challenge” of models: critical analysis by objective, informed parties who can identify model limitations and assumptions and produce appropriate change. The guidance provides that banks should objectively assess model risk using a sound model validation process, including evaluation of conceptual soundness, ongoing monitoring, and outcome analysis.
This guidance may be instructive for BOLI policyholders and their model developers since a variety of models are used in the ongoing risk management of BOLI programs (e.g., modeling SVP exposures, the impact of changing interest rates, the relationship between the BOLI program and the liability being hedged, etc.). Accordingly, we will review the guidance closely to determine possible implications on the models we develop as well those developed by our clients.
SEC Proposes Product Definitions for Swaps
On April 27, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) jointly proposed rules to clarify whether particular agreements, contracts or transactions are swaps, security-based swaps, or mixed swaps. Dodd-Frank established a comprehensive framework for regulating the over-the-counter swaps markets. Under the proposed rule and interpretive guidance, insurance products would not be considered swaps or security-based swaps. To be considered insurance, the rules would require that both the product as well as the person or entity providing the product must meet certain criteria. Comments will be accepted for 60 days after publication in the Federal Register which is expected shortly.
We are still awaiting the Dodd-Frank study on whether 401(k), 403(b) and other plan stable value contracts fall within the definition of “swap” and, if so whether an exemption will be provided. We think the results of that study may influence how stable value contracts outside of those plans are viewed by regulators. Under Dodd-Frank, the study should be conducted by October 21, 2011.
SEC Money Market Fund Reform Roundtable
The Securities and Exchange Commission (SEC) will host a roundtable discussion on May 10, 2011 to identify an approach with the goal of preventing another instance of a money market fund “breaking the buck.” The roundtable will allow select stakeholders in money market funds to exchange views on the potential effectiveness of certain options in mitigating systemic risks associated with such funds. This will include options raised by the President’s Working Group report on the subject issued last October. Some of the leading proposals include the Investment Company Institute (ICI) proposal for a liquidity bank and a proposal by Fidelity for a NAV buffer. Although the roundtable is not open to the public, the SEC is accepting public comments on the subject.
Attacks Continue on the Dodd-Frank Regulatory Regime
Attacks on the current regulatory regime under Dodd-Frank have continued. Various republican senators have been quoted in the media regarding their intent to overturn Dodd-Frank. A number of bills have been introduced in both the House and Senate. Senator Jim DeMint (R-SC) introduced such a bill just last month and it has 26 co-sponsors. Related, a number of legislators and insurance regulators have spoken out regarding the interests of insurance being inadequately represented on the Financial Stability Oversight Council (FSOC). Missouri Insurance Director John Huff, who is also the non-voting insurance regulator on the FSOC, raised concerns at a congressional hearing about the lack of insurance expertise on the FSOC as well as the current Treasury restriction that prohibits Huff from consulting with other insurance regulators on matters before the FSOC. Illinois Insurance Director Michael McRaith is expected to assume his role as the first director of the Federal Insurance Office in June. The one insurance voting member of the FSOC has yet to be selected.
Collier v. American Greetings (Update)
On April 11, American Greetings filed a summary judgment motion to dismiss the lawsuit against them. American Greetings’ main argument is that the plaintiff’s claims are all violations of Oklahoma law and that Oklahoma law does not apply. American Greetings reasoned that Oklahoma law specifically provides that it does not apply to life insurance policies issued and delivered outside of Oklahoma. The brief further argued that even if Oklahoma law did not explicitly exclude foreign policies, Oklahoma law would still be inapplicable under Oklahoma’s choice of law rules, since Oklahoma lacks significant contact with the 1989 COLI purchase. At the time American Greetings purchased the policy, the insured was an Arkansas resident working at an Arkansas facility, the issuing insurance company was not an Oklahoma domestic insurance company, and according to American Greetings, the policies were issued in Georgia and delivered in Florida. American Greetings distinguished its matter from other COLI cases brought in Oklahoma such as Tillman v. Camelot Music, Inc., where the insured was a resident of Oklahoma at the time the policy was purchased. American Greetings was one of the twelve corporate employers related to the Havenstrite v. Hartford lawsuit that settled last year.
Hunnicutt v. Akzo Noble, AstraZeneca (Update)
On April 12, a federal judge entered a minute order to give notice that the case will be dismissed for lack of prosecution if no action is taken within 30 days of the order. Before this order, there have not been any additional filings since the complaint and summons were filed last November. The defendants in this matter were among the corporate employers related to the Havenstrite v. Hartford lawsuit that settled last year.
NAIC Observations on IRC Section 1035 Exchanges
National Association of Insurance Commissioners (NAIC) Director of Regulatory Services Eric Nordman tasked the Life Insurance and Annuities (A) Committee to consider actions on employer-owned life insurance and Internal Revenue Code (IRC) § 1035 exchanges. In a memorandum dated March 27, 2011, Nordman highlighted the absence of state statutory guidance regarding insurable interest in the context of § 1035 exchanges. Over time, COLI/BOLI policyholders invariably come to possess policies covering the lives of both active and former employees. While policyholders can generally reestablish an insurable interest in the lives of active employees, they may not be able to do so with policies covering retirees or terminated employees. The memo raised the uncertainty surrounding the need for employers to reestablish insurable interest under state law and how that uncertainty discourages corporate policyholders from utilizing § 1035 exchanges to improve their COLI/BOLI portfolios.
The memo included a recommendation that state insurable interest laws be amended to permit an employer to exchange a COLI/BOLI policy covering the life of an active or inactive employee for a new COLI/BOLI policy on that insured in a § 1035 exchange, provided that the new policy continues to be held for the original permitted purpose of financing employee benefits. The memo also provided that an employer should not be required to provide new advance notice to the insured regarding its intent to insure his/her life or to obtain a new consent from the insured, provided that 1) the original policy was purchased in conformity with applicable state laws and 2) the amount of protection under the policy issued in exchange for the original policy does not increase as a consequence of the exchange, except to the extent necessary to conform to the actuarial test requirements of IRC § 7702. We see this as a positive development for corporate policyholders regardless of whether model legislation is ultimately promulgated or adopted. By acknowledging the issue, the memo may pave the way for individual states to provide greater clarity on the issue. Regardless, the recently issued Internal Revenue Service (IRS) Revenue Ruling 2011-9 (see our March LRA) is still likely to discourage corporate policyholders from pursuing § 1035 exchanges of policies covering former employees due to the IRS’s stated position on the applicability of IRC § 264(f) to such transactions.
CMBS Assessments Produce Little Impact on Insurer Capital Requirements
On April 14, the National Association of Insurance Commissioners (NAIC) announced that assessments for commercial mortgage-backed securities (CMBS) did not result in substantial shifts in risk-based capital designations. Based on insurer financial filings, the NAIC provided analysis on its assessment efforts that began year-end 2009. Prior to 2009, the NAIC relied on ratings by nationally recognized statistical ratings organizations for CMBS as well as residential mortgage-backed securities (RMBS). The CMBS modeler is BlackRock Solutions and PIMCO is the modeler for RMBS.
Report on Long-Term Investments After the Financial Crisis
Recently, the World Economic Forum issued a report entitled, “The Future of Long-term Investing.” The report discusses the benefits of long-term investing and the negative impact regulatory responses to the financial crisis have had on long-term assets. According to the report, global regulatory and accounting trends that were in motion before the crisis have been pushing long-term investors towards mark-to market accounting and therefore increased the sensitivity of those investors to short-term volatility in asset prices. These trends, therefore, have begun to negate the key advantage that a long-term liability profile gives long-term investors. The report offers six recommendations which include long-term investors developing performance measurement systems that balance fostering a long-term perspective with short-term accountability and policymakers considering the unintended impact of regulatory decisions on investors’ ability to make long-term investments.