The U.S. Commodity Futures Trading Commission (CFTC) and the U.S. Securities and Exchange Commission (SEC) have defended the idea of keeping actively traded insurance products out of the insurance products exclusion in a proposed swaps definition.

The CFTC and the SEC also are considering a provision that could let variable life insurance products and variable annuities be classified as swaps.

The CFTC and the SEC talk about the relationship between insurance products and swaps in the preamble to joint proposed rules giving definitions of terms such as “swap,” “security-based swap agreement” and mixed swaps.”

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 requires the CFTC and SEC to set up a new system for regulating swaps. The new rules could affect the swaps insurers use to hedge their own investments, and, in theory, the rules also could affect the insurance products that insurers sell.

The agencies began asking for public comments on the definitions needed to implement the regulations about a year ago.

In summaries released in April, the CFTC and the SEC said they would automatically exclude insurance products that met a multi-part test from the definition of the term “swap,” and that they also would exclude several common insurance products from the definition.

The agencies now have published an 83-page collection of proposed swaps rules and interpretations in the Federal Register. A discussion of the insurance products exclusion takes up about 7 pages.

The Dodd-Frank definition of “swap” includes “any agreement, contract, or transaction that provides for any purchase, sale, payment, or delivery (other than a dividend on an equity security) that is dependent on the occurrence, nonoccurrence, or the extent of the occurrence of an event or contingency associated with a potential financial, economic, or commercial consequence.”

The CFTC and the SEC want to avoid letting the Dodd-Frank definition turn insurance products into swaps, but they also want to keep loophole seekers from dressing swaps up as insurance products to avoid swaps regulation, officials say.

The agencies would exclude an arrangement from the definition of “swap” if the arrangement:

  • Requires the beneficiary to have an insurable interest throughout the duration of the arrangement.
  • Requires the covered loss to occur and to be proved, with any payment being limited to the value of the insurable interest.
  • Is not traded, separately from the insured interest, on an organized market or over-the-counter.

In addition, the provider of the arrangement would have to be an insurer or reinsurer regulated by a state insurance commissioner or the equivalent, a non-U.S. reinsurer, or a federal government program.

“The fact that an agreement, contract, or transaction qualifies as an insurance product does not exclude it from the swap or securitybased swap definitions if it is not provided by a qualifying person or entity,” officials say.

The CFTC and SEC observe in a footnote that life settlements are traded on organized markets.

But officials say the proposed rules would require that an insurance product eligible for the insurance products exclusion “not be traded, separately from the insured interest, on an organized market or over-the-counter.”

“With limited exceptions, insurance products traditionally have been neither entered into on or subject to the rules of an organized exchange nor traded in secondary market transactions,” officials say.

The CFTC and SEC also are weighing comments that could affect the status of variable life and variable annuity products.

A lawyer suggested that the agencies separate real insurance products from swaps in insurance wrappers by filtering out products with payments “based on the price, rate, or level of a financial instrument, asset, or interest or any commodity.”

A commenter from the American Council of Life Insurers, Washington, noted that following the lawyer’s suggestion could shut out variable annuities and variable life products.

The CFTC and the SEC ask whether they should follow the lawyer’s suggestion.

“If so, the commissions also request comment on whether variable annuity contracts (where the income is subject to tax treatment under Section 72 of the Internal Revenue Code) and variable universal life insurance should be excepted from such a requirement,” officials say.

The CFTC and SEC also are proposing a second method for excluding insurance products from the swaps definitions: Excluding many specific types of common insurance products.

The list includes:

  • Surety bonds.
  • Life insurance.
  • Health insurance.
  • Long term care insurance.
  • Title insurance.
  • Property and casualty insurance.
  • Annuityproducts the income on which is subject
    to tax treatment under Section 72 of the
    Internal Revenue Code.

In a list of questions for commenters, officials ask for comments about whether requiring the presence of an insurable interest is an effective way to determine whether a product is insurance; whether shutting out actively traded products makes sense; and whether the list of common insurance products that are clearly not swaps is complete.

Comments on the proposed rules are due July 22.

Other swaps coverage from National Underwriter Life & Health: