On July 21, 2010, after several weeks of deliberations in the Senate and the House of Representatives, President Obama signed HR 4173, the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Of most importance to life insurers, HR 4173 does not alter the current state-based insurance regulatory scheme. However, it: (1) creates the Federal Insurance Office within the Treasury Department; (2) streamlines regulation of reinsurance; and (3) directs the preparation of studies on three topics: (a) the current state regulatory system; (b) the viability and utility of federal regulatory intervention as an alternative or adjunct to the current state-based system; and (c) the state of the surplus lines marketplace. Other insurance-related provisions or exclusions relate to the Consumer Financial Protection Bureau, Financial Stability Oversight Council, Orderly Liquidation Authority, Rule 151A elimination, and Corporate Governance and Executive Compensation requirements for publicly traded insurance companies.
Key Components of the Financial Regulatory Reform Law Affecting Life Insurance
The key components of HR 4173 affecting the life and annuities insurance industry include:
- Financial Stability Oversight Council. The New Law creates the Financial Stability Oversight Council ("Oversight Council") to identify, monitor and address systemic risks. Voting members of the Oversight Council include the Treasury Secretary as chair, Chairpersons of the Federal Reserve (Fed), Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC), Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), Federal Housing Finance Agency (FHFA), and Consumer Financial Protection Bureau, as well as an independent member who has expertise in insurance. Among other non-voting members of the Oversight Council will be a state insurance commissioner. Large bank holding companies and non-bank financial firms deemed to pose a risk to the financial stability of the U.S. would be subject to regulation by the Fed upon a 2/3 vote of the Oversight Council. Several life insurance companies are organized as bank holding companies or non-bank financial firms. One of the duties charged to the Oversight Council is to monitor domestic and international financial regulatory proposals and developments, including issues relating to insurance regulation and accounting issues, and to advise Congress on recommended changes to the system that would enhance U.S. financial markets.
- Funeral Plans. HR 4173 also requires large, complex companies to periodically submit "funeral plans" for their rapid and orderly shutdown or wind-down in the event of economic failure. Companies that fail to submit acceptable funeral plans are subjected to higher capital requirements along with activity and growth restrictions as outlined by the Oversight Council. The Treasury Department, the FDIC, and the Fed all must agree before a company could be placed into liquidation.
- Federal Insurance Office. HR 4173 creates the first-ever office in the Federal government focused on insurance. The Office, established within the Treasury Department, will gather information about the insurance industry and provide informational expertise to Congress as it considers public policy issues affecting the industry. The Office also will monitor the insurance industry for systemic risk purposes. In addition to its informational duties the Office will serve as the federal negotiator on international insurance treaties for the U.S.
- Volcker Rule. The Volcker Rule seeks to force systemically important bank holding companies to sell major interests in hedge funds and private equity firms. Once HR 4173's Volcker Rule provisions are fully implemented, institutions will be able to hold no more than 3 percent of their tangible common equity in hedge funds. HR 4173 does not immediately impose new restrictions on proprietary trading and hedge fund ownership but does mandate a study of the proposed restrictions by the Oversight Council. HR 4173 directs the prudential regulators to implement regulations and determine the time frame companies will be granted to come into compliance with these limitations. Life insurers with bank subsidiaries will be subject to limitations on proprietary trading and hedge and private equity investing created by the Volcker Rule, though state-regulated insurance companies will continue to be allowed to invest premiums subjected to regulated investment standards.
- Fiduciary Standard. HR 4173 requires the SEC to conduct a six-month study on the difference in oversight of investment advisors and brokers. It also permits promulgation of regulations that would subject brokers to the same fiduciary standard of care as investment advisers. Currently, brokers are held to the much lower standard of care. Since most variable insurance and annuity products are sold through brokers, this change could affect how these products are distributed.
- Rule 151A. HR 4173 requires that Equity Indexed Annuities be regulated as an insurance product as long as the state where the annuity is issued has adopted the NAIC Standard Non-forfeiture Law for Individual Deferred Annuities and either, beginning in June 2013, (1) the state of issuance has adopted the NAIC Suitability in Annuity Transactions Model Regulation or (2) the company has adopted and implemented practices on a nationwide basis that meet or exceed the requirements in the NAIC Suitability in Annuity Transactions Model Regulation.
- Executive Compensation and Corporate Governance. HR 4173 provides shareholders with a non-binding vote on executive compensation. To promote independence, compensation committees are required to include only independent directors and are authorized to hire compensation consultants. Companies also are required to establish policies to recover amounts paid in executive compensation if the amount paid was based on inaccurate financial statements not in compliance with accounting standards.
- Derivatives. HR 4173 provides for federal regulation of the derivatives markets, but banks, bank holding companies and their affiliates may continue trading derivatives used to hedge their risks as well as interest-rate and foreign-exchange derivatives. Banks have up to two years to move other types of derivatives, such as credit default swaps that aren't sufficiently standardized to be cleared through a central counterparty, into a separately capitalized subsidiary.
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