The life insurance industry will be watching closely the rest of this month as Congress completes work on historic legislation making the most sweeping changes to financial services regulation since the Depression.
While the House and Senate bills are somewhat different, in general they retain the current state-based insurance regulatory system virtually intact.
Congress would complete work on financial services reform before the July 4th recess under an aggressive reconciliation conference schedule outlined by Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee.
The bill is H. 4173.
A priority for insurers is retention of the Senate language dealing with the standard of care agents must use in selling investment products.
Currently, the standard is that the product must be suitable for the investor. Under the House bill, that would rise to a fiduciary standard.
The Senate bill calls for the Securities and Exchange Commission to study the issue and propose to Congress what should be done to address “regulatory gaps and overlaps in existing rules.”
The Obama administration signaled it will add its voice to the issue just before Memorial Day when the Treasury Department undersecretary made clear the administration will push strongly for a fiduciary standard in any final financial services reform legislation.
In a speech, Treasury Undersecretary Neal Wolin also said the administration will fight any attempt to weaken the bill when talks to reconcile differing House and Senate versions of the legislation get underway.
“We will continue to fight for the strongest financial reform bill possible,” he said. “And we will oppose any attempts by particular interests to use the conference process as an opportunity to weaken the final bill,” he added.
But Thomas Currey, president of the National Association of Insurance and Financial Advisers, said the industry will fight strongly for the Senate language.
Currey said the call for an SEC study “would result in a fact-based approach to addressing real problems rather than by adopting a ‘one-size fits all’ amorphous fiduciary standard–the need for which is unsupported by any factual findings.”
He said, “NAIFA believes the best way to protect consumers from bad actors is through strong and effective supervision within financial services firms, and regular, periodic inspections by the SEC and other regulatory bodies.”
Two issues emerged during the Senate floor debate that are of great concern to life insurance companies.
The Senate bill establishes a framework for limiting or prohibiting proprietary trading in most circumstances by a depository institution, as well as by that institution’s holding company and any subsidiary of that institution.
The other provision in the Senate bill that concerns insurers would limit to some extent investment activities conducted by insurers that own banks or thrifts.
On derivatives, the House bill requires the majority of standardized swaps to go through central clearing houses and trade on a transparent exchange, and it imposes significant new requirements on swaps dealers and major swaps participants to prevent abusive practices and ensure that they are financially sound.
One provision in the Senate bill would impose stronger limits on the hedging activities of financial institutions, although Frank and the Obama administration have made clear they do not support them.
Frank Zhang, executive director of the insurance and actuarial advisory services practice of Ernst & Young’s Financial Services Office, said a complete ban on trading of derivatives by an insurance company would generate “significant changes in how insurance companies do business. The life insurance business will be a different industry.”
That’s because “insurers would not be allowed to hedge their activities as they do now,” he said.
But it is unlikely a complete ban on hedging activities would be in a final bill, he said. More likely, some restrictions would be imposed, such as requiring that hedging activities be conducted through exchanges.
The Senate bill proposes strict limits on financial companies that conduct proprietary trading in derivatives or investment in and sponsorship of hedge funds and private-equity funds.
The provision, known as the Volcker rule for its author, former Federal Reserve Board Paul Volcker, generates deep concern in the insurance industry.
“We’re concerned over the proposed Volcker rule in the Senate bill,” said Jack Dolan, a spokesman for the American Council of Life Insurance. “It could cause severe damage to the fundamental business model of life insurance holding company systems that contain ancillary depository institutions.”
Both bills would add a new layer of federal oversight for insurance companies, especially for larger, more complex insurance companies, if they are deemed a potential risk to the stability of the global financial system.
It would do this through the creation of a Systemic Risk Council to monitor large financial companies and establish a Resolution Authority to handle the liquidation of insolvent large financial services companies, including insurers.
However, the Senate bill would mandate that the resolution of the insurance subsidiaries of insurance holding companies will be accomplished by the states.
Key components of the systemic risk provisions for the insurance industry included provisions giving the authority to the Federal Reserve Board to regulate such non-banks as insurers, and creation of an Office of National Insurance within the Treasury Department.
Besides giving the authority to pre-empt state law in negotiating bilateral trade pacts regarding insurance with foreign countries, the ONI under the Senate bill would have the authority to compile data on insurance companies and the industry itself.
The House bill would allow the Treasury Department to enter into bilateral trade agreements only with the concurrence of state regulators.
The Senate bill also calls for the Treasury Department to conduct a more robust study of the usefulness of federal regulation of insurance, including the potential consequences of subjecting an insurer to a federal resolution authority and the ability of federal regulation to provide robust consumer protection.
Among the powers provided under both bills, the insurance office within the Treasury would have the authority to serve as an early-warning system in determining whether an insurance company was troubled, and recommend that the Fed and a new Systemic Risk Council place it under supervision.
The bill would also modernize and create uniformity in the surplus lines and reinsurance markets by establishing the rules of a state in which an insurer is domiciled to govern regulation and tax assessment of these products.
The bill contains several provisions creating a brave new world for large credit rating agencies. Under the Senate bill, a credit rating agency board would be created to choose which rating agency would rate an issuer’s debt.
At the same time, the equity-indexed annuity industry failed to win support for a proposed amendment to the Senate bill that would have barred the Securities and Exchange Commission from overseeing the sale of EIAs.
The SEC published a regulation, 151A, in January 2009, which would regulate EIAs under federal securities law as of January 2011.
However, a panel of the U.S. Court of Appeals for the D.C. Circuit blocked such oversight pending a study by the SEC of the potential impact 151A would have on capital formation and competition.
Sen. Tom Harkin, D-Iowa, sought unanimous consent for floor consideration of such an amendment but was blocked because of opposition by Sen. Daniel Akaka, D-Hawaii.
Kim O’Brien, executive director of the National Association for Fixed Annuities, said the trade group “believes that in spite of the Senate’s failure to adopt any (or nearly any) of the over 400 amendments, including our S.A. 3920, NAFA is committed to continuing efforts to protect consumers of annuities from the deleterious effects of SEC Rule 151A.”
The critical issue for agents and brokers will be the standard of care in sale of investment products.
The fact that the Obama administration has stepped into the debate on the issue for the first time raises the stakes.
In his statement, Treasury’s Wolin said, “We believe that retail brokers offering investment advice should be subject to the same fiduciary standard of care as investment advisors, and we will work to include that provision in the final bill. Clients receiving investment advice don’t distinguish between broker-dealers and investment advisors, and neither should the law.”
But agents and brokers say the Senate language is the better approach.
The Association for Advanced Life Underwriting said in a statement, “Imposing new standards, without justification or analysis, on life insurance agents who sell variable life insurance products and are rigorously regulated both by both state insurance departments and [the Financial Industry Regulatory Authority] would be particularly harmful.”
The proposed standards would “disrupt the current distribution system relied upon by 75 million American families, increasing costs, and decreasing options of products and financial service providers,” AALU added.
The Volcker rule and the derivatives provisions are of deep concern to insurance companies.
The industry did win a change post-passage in the Senate bill that would exempt smaller insurers from the impact of the Volcker rule.
The Senate agreed to instruct its conferees on the bill to win language in final legislation that would exempt from the Volcker rule insurers that provide only limited investment services to their customers through an insured financial institution.
But large life insurers that operate limited trust banks, and that also engage in asset-management activities or private equity and mutual fund activity, are seeking a broader exemption.
Action on the Senate bill was delayed until Rep. Barney Frank, D-Mass., chairman of the House Financial Services committee, expressed support for a broader exemption for large life insurers in a final bill.
In two letters to the Senate leadership, Frank indicated that he supported the request for broader exemption for life insurers.
It was only after Frank’s action that Sen. Scott Brown, R-Mass., agreed to support the bill.
On the derivatives issue, Zhang of Ernst & Young saw positives and negatives to likely final language in the bill dealing with derivatives that would require insurers to conduct derivatives activities through exchanges.
Life insurers are fighting to be classified as manufacturers and retailers in the final bill, but a complete exemption is seen by many as difficult, especially since the government paid out so much money to bail out American International Group.
“Broad relief is needed and appropriate so we can continue serving our customers in the best way possible,” according to the ACLI’s Dolan.
One provision that did not make the Senate bill and is not in the House bill will also be a relief to the insurance industry.
Sen. Claire McCaskill, D-Missouri, and Sen. Herb Kohl, D-Wis., proposed an amendment to the Senate that would have imposed stringent rules on the sale of reverse mortgages and allied insurance products by agents as a so-called “package deal.”
The amendment was not taken up by the Senate despite strong efforts by McCaskill to have it considered.
It would also have made these transactions subject to regulation by the Consumer Financial Protection Agency, a provision of the bill from which insurers are specifically exempt.
Insurance companies sell reverse mortgages, which allow senior citizens to forego mortgage payments on their homes in exchange for the owner turning over the title to the property when they die.
Before 2008, insurance companies were allowed to sell allied products, such as annuities, life insurance and long term care insurance directly in connection with the underwriting of reverse mortgages. But, an amendment to H.R. 3221, a bill aimed at providing additional funds to the troubled Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association, contained a provision sponsored by Sen. McCaskill requiring that the allied products be sold by a third party agent.
The amendment proposed by McCaskill and Kohl would have mandated that the proposed CFPA establish regulations preventing third party agents from engaging in “unlawful, unfair, deceptive or abusive acts” both when selling a reverse mortgage and allied products, according to a spokesman for McCaskill.
“These rules must include strong disclosure requirements before the sale and annually thereafter,” the amendment said.