Regulators Propose Stress Testing Rules
In January, both the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) proposed rules to implement capital adequacy stress testing under Dodd-Frank section 165(1)(2). The annual stress tests conducted by covered institutions under the proposed rules are to provide forward-looking information to supervisors to assist in their overall assessments of a covered institution’s capital adequacy and to aid in indentifying downside risks and the potential impact of adverse outcomes on covered institutions. The applicable regulator will provide covered institutions with a minimum of three sets of economic and financial conditions, including a baseline, adverse, and severely adverse scenario. The annual stress test cycle will consist of three key events: 1) publication of the stress test scenarios by the primary regulator by mid-November; 2) covered institutions conduct the stress test and submit a report to their primary regulator and the FRB by January 5; and 3) covered institutions make required public disclosures by early April.
The OCC and FDIC are developing their respective rules in coordination with the Federal Reserve Board and the Federal Insurance Office as required by Dodd-Frank. The FDIC rules will apply to FDIC insured state nonmember banks and FDIC insured state chartered savings associations with total consolidated assets of more than $10 billion. The OCC rules will apply to national banks and federal savings associations with total consolidated assets of more than $10 billion. The FDIC’s comment period closes on March 23, 2012 and the OCC’s comment period ends March 26, 2012.
FDIC Approves Final Rule Requiring Resolution Plans
On January 17, the Federal Deposit Insurance Corporation (FDIC) approved a final rule requiring an insured depository institution with $50 billion or more in total assets to submit to the FDIC periodic contingency plans for resolution in the event of the institution’s failure. The resolution plans are supposed to improve the FDIC’s ability, as receiver, to resolve an institution in a manner that ensures: depositors receive access to their insured deposits within two business days of the institution’s failure; the return from the sale or disposition of assets is maximized; and the amount of any losses to be realized by the institution’s creditors is minimized. Currently, 37 insured depository institutions are covered by the final rule which will be effective April 1, 2012. Those institutions held approximately $4.14 trillion in insured deposits, or nearly 61 percent of all insured deposits, as of September 30, 2011. This final rule is a complement to the joint Federal Reserve Board and FDIC rulemaking for the so-called “living wills” for certain systemically important nonbank financial companies and bank holding companies to be resolved under the Bankruptcy Code.
Volcker Rule Questioned Further at Congressional Hearing
On January 18, a congressional hearing was held examining the Volcker Rule where Republican lawmakers and a few Democrats again questioned the merits of the Volcker Rule. One major theme related to how the regulators plan to distinguish between banned proprietary trades and legitimate market making, underwriting, and risk-mitigating hedging activities. Another theme concerned fears that US banks may face a competitive disadvantage since foreign banks remain unaffected by the rule.
A number of notable letters have been submitted to regulators including a December 20, 2011 letter signed by more than 120 House members that asked the regulators to extend the comment period by at least 30 days, consider producing an interim proposed rule reflecting the comments from affected stakeholders, and extend the implementation deadline. As noted in the January LRA, the regulators extended the comment period by one month to February 13, 2012.
On January 17, the American Bankers Association requested that Congress ask the agencies charged with drafting the Volcker Rule, which would curtail proprietary trading and private equity and hedge fund investments by banks, to start over. The letter states: “The proposed rules as written are unworkable and fail to carry out the intent of Congress to clearly define prohibited activity in proprietary trading and investments in hedge funds and private equity funds. ABA therefore requests that Congress (1) communicate its Volcker Rule objectives to the agencies in writing and at the hearing, and (2) call for a re-proposed set of rules for public comment that readily align with such objectives.” The regulators are moving ahead with the rule, but will continue to consider adjustments as may be appropriate. Dodd-Frank mandated that the rules be in place by July 2012.
Regulators Issue an FAQ on Interest Rate Risk Management
On January 12, the financial regulators issued a “Frequently Asked Questions” (FAQ) to clarify points in the 2010 Interagency Advisory on Interest Rate Risk Management. The advisory reiterated the need for sound management of interest rate risk (IRR) and highlighted sound practices. The regulators expect all institutions to manage IRR exposures using processes and systems commensurate with earnings and capital levels, complexity, business models, risk profiles, and the scope of operations. The FAQ answers 12 questions that were commonly asked of the regulators and covered issues such as how financial institutions should determine which IRR vendor models are appropriate, the types of IRR measurement methodologies institutions are expected to use, examples of effective back-testing practices, and deposit decay-rate assumptions.
Hunnicutt v. Zeneca, Inc. (Update)
On January 13, a decision and order was filed in this matter denying the defendants’ motions to dismiss (which were converted into summary judgments), denying the defendants’ motion to certify a question to the Oklahoma Supreme Court, and granting the defendants’ motion to stay discovery. Zeneca was also ordered to complete some additional briefing regarding standing and class certification issues. Zeneca is not precluded from filing an additional summary judgment motion during later stages of the proceedings.
The defendants in this matter argued that California law governed instead of Oklahoma, because the insured was employed exclusively in California. The defendants further argued that the plaintiff’s claims should be dismissed since California does not provide an insured’s representative with a cause of action to recover COLI policy benefits. The court disagreed and determined that Oklahoma law governed the dispute. The court reasoned that the insured was an Oklahoma resident when crucial events took place. According to the court, crucial events include the purchase of the allegedly illegal policy and collection upon the allegedly illegal policy. One noteworthy fact about this case is that the employer purchased the policy 3 years after the insured had retired and relocated to Oklahoma. This court district has consistently found Oklahoma law applicable in COLI disputes, so it is likely that the decision would have been the same even if the policy had been purchased when the insured was a resident of California.
In the decision, the court also declined to certify the following question: “Under Oklahoma law, does the filing by an insurance company of a generic life insurance policy form with the Oklahoma Insurance Department, as required by Okla. Stat. tit. 36, § 3610(A), constitute, as a matter of law, the “delivery” in the State of Oklahoma of all insurance policies or contracts which include that form, no matter where the policies or contracts were issued or received?”
The court provided three reasons for its decision: 1) that the Tenth Circuit predicted the Oklahoma Supreme Court’s answer to such question in Tillman ex rel. Estate of Tillman v. Camelot Music (Tillman II) (holding that a COLI policy was “constructively delivered” in Oklahoma by virtue of insurer’s prior filing of generic form policy with Oklahoma Department of Insurance, where actual policy was never delivered to anyone but was instead stored electronically in a different state); 2) that another court in the district in Lewis v. Wal-Mart Store, Inc. applied and followed the Tillman II decision; and 3) that the present court predicts that the Oklahoma Supreme Court would concur with Tillman II and Lewis’s reasoning that “interpreting the statute to require physical delivery of the contract within state borders would allow all insurance companies to skirt Oklahoma insurance regulations merely by electronically storing the insurance contracts in another jurisdiction.”
Case References: Hunnicutt v. Zeneca, Inc., Stauffer Management Co., No. 10-cv-708 (N.D. Okla.); Tillman ex rel. Estate of Tillman v. Camelot Music, Inc., 408 F.3d 1300 (10th Cir. 2005); Lewis v. Wal-Mart Stores, Inc., No. 02-cv-944 (N.D. Okla. Dec., 1, 2005).
2013 Budget Proposal Expected on February 13
The White House announced that the 2013 budget proposal will be released on February 13, 2012. The budget is supposed to be released on the first Monday in February, which this year would have been the February 6. While it is uncertain which, if any, proposals will be acted upon by Congress, we will send out an Ad Hoc LRA once the proposals are released. Every budget released by the Obama Administration has included a proposal to expand the Internal Revenue Code § 264(f) pro rata interest expense disallowance such that only insurance contracts insuring the lives of 20% owners are exempted. Under the current law, employees, directors, officers, and 20% owners are exempted from the interest disallowance rule.
COLI in the News
On January 10, an article titled, “Why Your Company May Want You Dead,” was posted on TheStreet.com. The article consists largely of the opinion and quotes of Michael Myers of the Texas firm McClanahan Myers Espey who specializes in COLI actions. Myers has represented plaintiffs in a number of COLI cases against Wal-Mart, Hartford Life Insurance Company and the ongoing matters against American Greetings and Zeneca, Inc.
The article attempts to convey that COLI programs commonly insure “rank and file” employees and are often implemented as secret arrangements whereby companies benefit from the deaths of employees. Of course, the article does not accurately convey the legitimate business purpose of BOLI programs or note that the examples provided are indicative of a small minority of very old COLI programs. Further, financial institutions are required to report BOLI holdings on a quarterly basis, so the existence of such policies is hardly a secret. The article also references a recent book by Ellen Schultz, Retirement Heist: How Companies Plunder and Profit from the Nest Eggs of American Workers (Penguin, 2011). Readers may recall that Ellen is a former reporter for The Wall Street Journal who published articles covering “dead peasant” insurance. She inaccurately suggests that life insurance covering the majority of employees is used to fund executive deferred compensation and pensions.
We highlight articles of this nature (especially if they are published in the mainstream media) because they can increase headline/reputation risk since average readers are not aware of the inaccuracies presented.
Prudential Agreement Regarding Benefit Pay Practices
On January 13, Massachusetts State Treasurer Steven Grossman announced that Massachusetts, along with 19 other states, had reached an agreement with The Prudential Group regarding the industry-wide practice of failing to use available data to determine whether death benefit payments are due under life insurance policies. In some cases, carriers would pay beneficiaries in an untimely manner or not pay them at all if the beneficiaries were unaware of the policies’ existence. The Prudential agreement requires the company to cross-reference its policy database with public death records such as the Social Security Death Master File (DMF). A similar agreement was put in place in March 2011 with John Hancock Life Insurance Company. In Massachusetts, the effort has resulted in the state taking custody of over $20 million in policy proceeds.
Fitch Ratings issued a statement on the impact the regulatory changes and legal challenges will have on insurers. Fitch expects that the changes will result in an increase in claim payments and additional expenses as insurers adapt to the new regulatory requirements. The ratings agency did note that there were no ratings implications at this time. One concern of insurers related to using the DMF is that the master file contains inaccuracies. On February 2, there will be a House hearing on the accuracy and uses of the DMF. Related, House Representative Samuel Johnson (R-Texas) introduced H.R. 3475 “Keeping IDs Safe Act of 2011” (introduced November 18, 2011) to restrict the use of the DMF to federal and state agencies for statistical and research activities.