S. 1282 – 21st Century Glass-Steagall Act
On July 1, Senator Elizabeth Warren (D-MA) introduced a bill (S. 1282) that would reinstate certain Glass-Steagall Act protections that were repealed by the Gramm-Leach-Bliley Act. Among other provisions, the bill would prohibit depository institutions from being affiliated with any insurance company, securities entity, or swaps entity. Existing affiliations would need to be terminated within a 5 year period commencing upon enactment. The proposal would also revise the permitted activities of national banks under 12 U.S.C. 24 (Seventh).
The bill was referred to the Committee on Banking, Housing and Urban Affairs.
Oregon H.B. 3367
As we reported in last month’s LRA, Oregon House Bill 3367 was amended to no longer affect life insurance or annuity taxation. The original version of this bill would have added to taxable income for Oregon tax purposes, amounts from life insurance contracts or annuity policies, excluded from federal taxable income because of operation of federal law, including sections 72, 101, 7702 and 7702A of the Internal Revenue Code.
The amended bill passed the House on July 1 and a further amended bill passed the Senate on July 7. Again, the form of the bill that has passed both the House and Senate does not impact life insurance or annuity products.
Final Regulatory Capital Rules Released
As covered in our Ad Hoc LRA Updates on July 2 and July 10, the U.S. banking regulators have approved a final rule revising the existing capital rules. We continue to work closely with insurance carriers, who, in turn, are working with their investment managers to implement actions that will enable BOLI/COLI policyowners to appropriately compute the risk-weighted assets amounts for BOLI programs.
We will continue to keep clients apprised of material developments and welcome any questions that might arise.
Volcker Rule Update
On July 11, FRB Governor Daniel Tarullo and OCC Comptroller Thomas Curry testified before the Senate Banking Committee regarding Dodd-Frank Implementation. In addition to discussing other financial reform regulatory activities, both provided updates on the status of a final Volcker Rule. Mr. Tarullo noted that the agencies have reviewed the nearly 19,000 comment letters submitted in response to the October 2011 proposed rule and have made substantial progress toward crafting a final rule. He reiterated a goal of completing the final rule before the end of 2013.
Dodd-Frank Act Stress Test Guidance for Medium-Sized Firms
On July 30, the FRB, FDIC and OCC released proposed guidance describing supervisory expectations for stress tests conducted by financial companies with total consolidated assets between $10 billion and $50 billion (“medium sized companies). These companies are required to conduct stress tests beginning this fall.
The proposed guidance addresses the following key areas:
- Supervisory scenarios – The regulators note that companies may use all or, as appropriate, a subset of variables from the supervisory scenarios to conduct a stress test, depending on whether the variables are relevant or appropriate for particular lines of business.
- Data sources and segmentation – Companies should segment portfolios and business activities into categories based on common or related risk characteristics.
- Loss estimation – Loss estimation practices should be commensurate with the materiality of the risks measured and well supported by empirical analysis.
- Pre-provision net revenue (PPNR) – Companies that are less complex could estimate projected PPNR based on the three main components (net interest income, non-interest income, non-interest expense) at an aggregate, company-wide level based on industry experience. More complex companies should consider more sophisticated methods and data.
- Balance sheet and risk-weighted assets projections – Companies are expected to ensure that projected balance sheet and risk-weighted assets remain consistent with regulatory and accounting changes.
Governance and controls – In accordance with the stress test rules, companies are required to establish and maintain a system of controls, oversight and documentation, including policies and procedures relating to the stress testing processes.
Employer Sued for Incorrect Death Benefit Payments under Group Life Insurance Plan
We recently became aware of an interesting case transpiring in the Northern District of Illinois. While it does not directly relate to BOLI/COLI, it may reinforce the importance of employers scrupulously documenting and maintaining clear records related to life insurance beneficiary designations (particularly for split dollar arrangements), especially when conveying changes to insurance companies.
In this action, a group of plaintiffs filed a negligence claim against the U.S. Government (January 2012) alleging that the insured’s employer (i.e., the Small Business Administration or “SBA”) failed to properly maintain and/or forward a form designating the plaintiffs as beneficiaries on a life insurance policy, which, in turn, caused them to lose insurance benefits to which they would have otherwise received. The policy proceeds were instead paid in accordance with a previous beneficiary form.
The Government first sought dismissal of the complaint; however, in January 2013, the District Court ruled that the Government had a duty to maintain and transmit the updated form, and, therefore, the plaintiffs were able to state a claim for negligence.
The Government then filed third-party complaints against the insurance carrier (MetLife) and the beneficiaries that received amounts in excess of the percentages reflected on the updated beneficiary form. According to the Government, following the insured’s death, the updated beneficiary form was found (by the insured’s son who ultimately received a greater percentage of the proceeds than the updated form reflected) in the personnel files of the local office. At that time, the form was forwarded to the regional SBA office and also transmitted along with a note to MetLife indicating that it hadn’t been received by Human Resources prior to the insured’s death. After receiving these documents, MetLife paid benefits as indicated on the original designation; not the more recent form.
On July 15, the court dismissed the third-party complaint against MetLife. According to the ruling, the Government failed to allege that MetLife owed the Government any duty. The Government alleged that MetLife had duties to determine which form was correct and pay benefits accordingly; however, the ruling responds: “…even assuming that those duties exist, they are duties MetLife owed to [the insured] and/or to the beneficiaries, not to the Government.”
The court noted that the alleged fact pattern could be a defense to the plaintiffs’ underlying claims. We will continue to follow this matter.
Citation: Nixon v. United States, No. 12 C 00016
FASB Proposal for Accounting for Credit Losses on Financial Assets
As we reported in our April LRA, FASB sought comments on a proposal to require the timely recognition of all expected credit losses as opposed to maintaining a framework in which a threshold must be met before all expected credit losses are recognized or only some expected credit losses are recognized. The comment period expired on May 31.
On July 11, FASB released a summary of the feedback it received from interested parties (including investors and preparers). FASB noted that investors favor the proposal (by a 3-1 ratio) whereas preparers generally oppose the proposed change.
The summary noted that a majority of preparers do not agree with the proposed update because “…they believe it will result in (1) understating the net asset value of a financial asset measured at amortized cost on “Day 1” (by recognizing expected credit losses that are already reflected in the purchase price or transaction price at initial recognition) and (2) failing to “match” the timing of recognition of credit loss expense with the timing of recognition of compensation for expected credit losses (in the form of interest income).” In addition, financial institutions raised significant concerns regarding the potential impact on regulatory capital.
We will continue to monitor FASB’s deliberations on this topic.
Private Equity Acquisition of Annuity Underwriters – Regulatory Concerns
As we reported in our May LRA, the New York Department of Financial Services (DFS) is continuing its scrutiny of recent and pending transactions in which private equity investors acquire insurance companies (primarily focusing on fixed annuity underwriters). As one example, in late June, Sun Life Financial issued a press release indicating that the 2nd quarter closing date of its transaction with Guggenheim Partners would be delayed pending continued review by the NY DFS. Yesterday, July 31, Sun Life Financial and the NY DFS both issued press releases indicating that regulatory approval has been granted. The NY DFS press release identifies a series of additional policyholder protections that Guggenheim agreed to, including:
- Heightened Capital Standards – Guggenheim will maintain Sun Life New York’s Risk-Based Capital Levels (RBC Levels) at an amount not less than 450 percent.
- Backstop Trust Account – Guggenheim will establish a separate backstop trust account totaling $200 million to provide additional protections to policyholders above and beyond the heightened capital levels.
- Enhanced Regulatory Scrutiny of Operations, Dividends, Investments, Reinsurance; and
- Stronger Disclosure and Transparency Requirements.
In May, the Chair of the NAIC’s Financial Analysis (E) Working Group (“FAWG”) prepared a memorandum to the Chair of the Financial Condition (E) Committee recommending that the Financial Condition committee create a working group to consider implementing additional regulatory best practices in an effort to ensure that policyholders and annuitants are not put at significantly greater risk by changes of control.
The Financial Condition (E) Committee was accepting comments on this exposure draft through July 9.
Ad Hoc LRA – July 2, 2013
Final Capital Rules Approved by OCC and FRB
As we noted in yesterday’s LRA newsletter, today the FRB and OCC released a final rule relating to capital requirements. The release is voluminous (over 900 pages) and we will continue to review and digest the final rule in the coming weeks and months. However, we wanted to provide a brief ad hoc LRA update relating to clarifications provided and aspects of the rules for BOLI assets.
General Account Exposures
Under the final rule, consistent with the proposal, if a general-account exposure is to an organization that is not a banking organization, such as an insurance company, the exposure must receive a risk weight of 100 percent (see page 255).
Separate Account Exposures
Section 51(a)(2) of the rule specifically clarifies that a separate account exposure (such as through BOLI) must be treated as an equity exposure to an investment fund (see pages 392 and 657). Additionally, clarification consistent with OCC 2004-56 was provided relating to risk-weighting the portion of an exposure to a stable value protection provider.
As originally proposed, three look through approaches are available for equity exposures to investment funds:
- Full Look-through Approach: Risk-weighted assets for the investment fund is calculated as if the institution owned a proportionate share of the adjusted carrying value of each exposure.
- Simple Modified Look-through Approach: Sets the risk-weighted asset amount equal to the adjusted carrying value of the equity exposure multiplied by the highest applicable risk weight to any exposure the fund is permitted to hold.
- Alternative Modified Look-through Approach: Assigns the adjusted carrying value on a pro rata basis to different risk weight categories based on the investment limits of the fund.
The final rule acknowledged commenters concerns regarding application of a 1250% risk-weight for securitization exposures if an organization does not have the information required to compute either the gross-up method or the SSFA. However, the regulators elected not to adjust the final rule. As such, it will be critically important to obtain and process the requisite data. Additionally, the application of the look-through approaches requires a full understanding of the risk-weighting rules for each permissible asset class (e.g., corporate exposures, securitizations, sovereigns, derivatives, etc.). We have not yet reviewed these elements in detail.
The final rule also provides guidance for banking organizations that provide stable value protection. The rule addresses determining the adjusted carrying value of such exposures as well as applying risk-weighting to the carrying value (see pages 392-393).
While the treatment of general account exposures and separate account exposures were specifically addressed in the final rule, we did not find any direct guidance in regard to the questions we posed relating to hybrid BOLI. It is possible that the intention is to treat the exposures as separate account. The final rule includes the following definition of “separate account” (emphasis added).
Separate account means a legally segregated pool of assets owned and held by an insurance company and maintained separately from the insurance company’s general account assets for the benefit of an individual contract holder. To be a separate account:
- The account must be legally recognized as a separate account under applicable law;
- The assets in the account must be insulated from general liabilities of the insurance company under applicable law in the event of the insurance company’s insolvency;
- The insurance company must invest the funds within the account as directed by the contract holder in designated investment alternatives or in accordance with specific investment objectives or policies; and
- All investment gains and losses, net of contract fees and assessments, must be passed through to the contract holder, provided that the contract may specify conditions under which there may be a minimum guarantee but must not include contract terms that limit the maximum investment return available to the policyholder.
It is not clear to us whether typical hybrid products fulfill this fourth element (although we imagine one might be engineered to do so). The rules do not appear to explicitly provide for delineating between separate account and general account exposures with hybrid products. However, it seems appropriate for a hybrid policyowner to determine proportionate amounts attributable to the (insulated) separate account and amounts attributable to the carrier’s general account (e.g., during periods when the minimum guaranteed crediting rate is greater than the interest/earnings from the separate account assets).
Ad Hoc LRA – July 10, 2013
FDIC Interim Final Capital Rules and Leverage Ratio NPR
Yesterday (July 9, 2013), the FDIC issued an interim final rule that revises the existing capital rules. The interim final rule contains regulatory text that is identical to the common rule text adopted as a final rule by the Federal Reserve and the OCC. Additionally, the FRB, FDIC and OCC jointly issued a notice of proposed rulemaking (NPR) to strengthen the leverage ratio standards for the largest U.S. banking organizations (i.e., bank holding companies with more than $700 billion in consolidated total assets or $10 trillion in assets under custody). Under the leverage ratio NPR, covered institutions would be required to maintain a tier 1 capital leverage buffer of at least 2 percent above the minimum supplementary leverage ratio requirement of 3 percent, for a total of 5 percent. Failure to exceed the 5 percent ratio would subject covered BHCs to restrictions on discretionary bonus payments and capital distributions. In addition to the leverage buffer for covered BHCs, the proposed rule would require insured depository institutions of covered BHCs to meet a 6 percent supplementary leverage ratio to be considered “well capitalized” for prompt corrective action purposes. The proposed rule would currently apply to the eight largest, most systemically significant U.S. banking organizations.
According to the release, the interim final rule enables the FDIC to proceed on a unified, expedited basis with the other federal banking agencies pending consideration of other issues. The FDIC invites comments on the interaction of this rule with other proposed leverage ratio requirements applicable to large, systemically important banking organizations.
We continue to review the new capital rules and are reaching out to all of our major separate account insurance carriers to fulfill the information requirements under the new rule. We will keep clients apprised of the progress with respect to particular carriers and welcome your calls if any questions or issues arise.