Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
The Insurance Provisions
Editor: Allison Bell, firstname.lastname@example.org. Contributors: Brian Anderson, Warren S. Hersch, Christina Pellett, Daniel Williams.
Publisher: Summit Business Media L.L.C., 33-41 Newark St., Hoboken, N.J. 07030, 201-526-1243.
(C) Summit Business Media L.L.C., 2010.
Updated Oct. 8, 2010.
This guide gives an overview of Dodd-Frank Act provisions that relate, or might relate, to insurance, insurers and insurance producers. It is not a substitute for legal, accounting or other professional advice.
In 2007, overextended U.S. homeowners began missing mortgage payments. Foreclosure rates soared, housing prices dropped and the mortgage-backed securities market reeled. Credit default swap traders had to post additional collateral to compensate for an escalating risk of issuer defaults. Frightened bankers stopped lending.
In 2008, one financial services giant after another began to fail, and rumors of a week-long bank holiday cropped up. Treasury Secretary Timothy Geithner, who was president of the Federal Reserve Bank of New York at the time, later said he thought he was seeing the start of a run on the financial system.
Geithner and other officials told Congress that regulators needed better tools to keep that kind of crisis from occurring again.
The Obama administration and Congress responded by developing the proposals now at the heart of the Dodd-Frank Act.
Geithner outlined the Obama administration’s financial services bill principles in March 2009, and the Obama administration released a more comprehensive white paper in June 2009. Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, introduced a financial services bill, the Consumer Financial Protection Act, H.R. 3126, in July 2009.
Sen. Christopher Dodd, D-Conn., chairman of the Senate Banking, Housing and Urban Affairs Committee, unveiled a draft of a different proposal, the Restoring American Financial Stability Act, in November 2009. He filed the proposal as a bill, S. 3217, in April 2010.
The final version of the Dodd-Frank Act includes 16 titles:
The Insurance and Investor Protection titles are of obvious interest to anyone with an interest in insurance, but other sections also will affect insurance companies and insurance marketers.
Title II — the Orderly Liquidation Authority title — does not change the laws that govern the liquidation of insurers, but it may let the Federal Deposit Insurance Corp. push state regulators to shut down troubled insurers.
Section 120 gives the new Financial Stability Oversight Council some say over any financial activity that appears to threaten either banks or the U.S. economy.
The Dodd-Frank drafters often used ambiguous terms such as “nonbank financial company” or “financial institution holding company” in the text. In some cases, the drafters explicitly stated whether specific provisions apply to insurers; in other cases, the scope of provisions may be open to interpretation.
When President Obama signed the Dodd-Frank Act into law July 21, 2010, he created an enormous organizational project for the federal agencies primarily responsible for implementing it – the U.S. Treasury Department, the U.S. Securities and Exchange Commission, and banking agencies such as the Federal Reserve Board of Governors, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp.
The U.S. Chamber of Commerce says the Dodd-Frank Act will require federal agencies to develop 520 rules, conduct 81 studies and issue 93 reports.
The general effective date for the bill as a whole was the day after enactment — July 22, 2010.
The act is creating a Consumer Financial Protection Bureau (CFPB) inside the Federal Reserve System, and an Office of Service Member Affairs, an Office of Financial Education and an Office of Financial Protection for Older Americans inside the CFPB. The director of the CFPB must be appointed by the president and confirmed by the Senate.
The act also is creating a Financial Stability Oversight Council (FSOC), an Office of Financial Research and a Federal Insurance Office (FIO) at the Treasury Department.
The Treasury secretary is the chairman of the FSOC, and the Office of Financial Research will help the FSOC watch for threats to the financial system. The director of the research office will be appointed by the president and confirmed by the Senate. The FIO will help the FSOC keep tabs on insurers, and the Treasury secretary will get to appoint the FIO director.
The drafters of the Dodd-Frank Act used several different systems for indicating when actions required by the act ought to occur.
The major dating systems are based on:
1. July 21, 2010 – The date the act was enacted.
2. The “transfer date” – The date on which several federal agencies will transfer part or all of their authority to other agencies. The Treasury secretary is supposed to publish the transfer date within 270 days after July 21. The transfer date could be between 12 months and 18 months after enactment.
4. July 21, 2011 – The “designated transfer date” – the date when a number of federal regulatory agencies will transfer all or part of their authority to the new Consumer Financial Protection Bureau (CFPB). The date could be between 180 days and 18 months after enactment
THE ENACTMENT DATE CALENDAR
July 21, 2010
- President Obama signed H.R. 4173 and enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
July 22, 2010
- The general effective date for the act. The Consumer Financial Protection Bureau, the Financial Stability Oversight Council, the Office of Financial Research and the Federal Insurance Office came to life.
60 Days After Enactment
- Treasury secretary must publish the designated transfer date, which will govern implementation of federal agency authority transfers involving the CFPB. The transfer date could occur between 6 months and 18 months after enactment. Treasury Secretary Timothy Geithner has made July 21, 2011, the designated transfer date.
6 Months After Enactment
- The FSOC will develop a report on the impact of large, complicated financial institutions and a second report on how to restrict proprietary trading at financial companies while accommodating the business of insurance. The FSOC is supposed to adopt rules related to the proprietary trading report within 9 months after the proprietary trading study is completed.
- The SEC will complete a study on the standard of care for brokers, dealers and investment advisors.
270 Days After Enactment
- The Treasury secretary will publish the transfer date, which will govern implementation of federal agency authority transfers not involving the CFPB. The transfer date could occur between 1 year and 18 months after enactment.
12 Months After Enactment
- Rules putting a reinsurer’s state of domicile in charge of regulating the reinsurer take effect.
15 Months After Enactment
- The FSOC will complete a study on whether stable value contracts are swaps.
18 Months After Enactment
- The latest possible transfer date.
- The comptroller general of the United States will report on bank and bank holding company use of hybrid capital instruments, including trust preferred shares.
- The Federal Insurance Office will report on the state of insurance regulation.
THE TRANSFER DATE CALENDAR
On the Transfer Date (Between 12 months and 18 months after enactment)
- The comptroller of the currency, the Federal Deposit Insurance Corp. and the Federal Reserve Board will transfer powers to other agencies
- Bank holding companies and savings and loan holding companies must be a source of strength for insured depository institutions.
90 Days After the Transfer Date
- The Office of Thrift Supervision will be abolished.
180 Days After The Transfer Date
- The SEC will complete a study on the state of exams for investment advisors and a study on financial planners’ designations.
1 Year After the Transfer Date
- The Federal Reserve Board will release new risk committee rules for nonbank financial companies that come to be supervised by the Federal Reserve Board.
- Federal banking agencies will release new capital level rules.
15 Months After the Transfer Date
- The new Federal Reserve Board rules for risk committees at nonbank financial committees will take effect.
2 Years After the Transfer Date
- The SEC must complete a financial literacy study.
THE DESIGNATED TRANSFER DATE CALENDAR
180 Days After the Designated Transfer Date
- The CFPB must choose an ombudsman.
- The CFPB must set up an Office of Financial Protection for Older Americans.
1 Year After the Designated Transfer Date
- The CFPB must set up an Office of Financial Education and an Office of Service Member Affairs.
24 Months After the Designated Transfer Date
- The Office of Financial Education will report on the state of financial literacy.
INVESTOR PROTECTIONS – STANDARD OF CARE
The Dodd-Frank Act does not directly change the rules that govern life insurance producers’ interactions with customers, but Section 913 creates a framework that the U.S. Securities and Exchange Commission can use to make changes.
Traditionally, brokers, dealers and insurance sales representatives affiliated with broker-dealers have used a suitability standard of care when dealing with customers. The Financial Industry Regulatory Authority requires the representatives using that standard to have reasonable grounds to believe that a product recommended or sold to a customer will suit the customer.
Investment advisors have had to use a fiduciary standard, meaning that they must put customers’ interests ahead of their own, avoid conflicts of interest, and disclose any conflicts that do exist.
Within 6 months after the July 21, 2010, Dodd-Frank Act enactment date, the SEC must complete a study that identifies any gaps or redundancies in standard-of-conduct rules and supervision of brokers, dealers, and investment advisors who offer personalized investment advice about securities to retail customers. When doing the study, the SEC must seek public comments.
After the SEC completes the study, it can set standard-of-conduct rules for brokers, dealers, and investment advisors who provide personalized investment advice to retail customers.
The SEC can require investment advisors to act in the best interest of the customer, without regard to the advisors’ own financial interests or other interests. This standard is supposed to be at least as stringent as the standards established by Section 206(1) and Section 206(2) of the Investment Advisers Act of 1940, and the SEC can hold brokers and dealers to the same standard.
Another part of Section 913, which amends the Securities Exchange Act of 1934, will let the SEC require a broker-dealer to notify retail customers of any limits on the range of products that the broker-dealer sells. Retail customers will have to indicate that they know about the limits.
The SEC can support efforts by investment advisors and broker-dealers to provide “simple and clear disclosures to investors regarding the terms of their relationships…including any material conflicts of interest.” The commission may also “examine, and where appropriate, promulgate rules prohibiting or restricting certain sales practices, conflicts of interest, and compensation schemes for brokers-dealers and investment advisers.”
Section 913 addresses some concerns about what a fiduciary standard might mean for life insurance agents. Early on, some life producers had argued that simply collecting commissions, or simply having a license to sell a limited range of products from one specific company, could lead to inevitable violations of a rigid fiduciary standard.
The final version of Section 913 says a broker-dealer can do the following without violating the applicable standard of care:
- Collect a commission or other standard form of compensation.
- Sell only proprietary products, or sell a limited range of products.
- Decline to be subject to continuing duties of care or loyalty after providing personalized investment advice to customers.
- Have material conflicts of interest, as long as the conflicts are disclosed to the customer.
The standard of care that ought to apply to specific types of financial transactions is a topic that provokes vigorous debate. Some life agents – especially those who are also planners – insist that a fiduciary standard should apply to agents who are offering personalized advice in the course of selling products such as variable annuities, but a large majority says the suitability standard is more appropriate.
Consumer groups have accused insurance agents and other financial services professionals of flooding the SEC with comments opposing a broad fiduciary standard; SEC commissioners seem inclined to support a broad fiduciary standard. SEC Chairman Mary Schapiro has expressed firm support for a uniform fiduciary standard, and Luis Aguilar, another commissioner, has questioned whether applying a different standard to “sophisticated investors,” such as professional pension fund managers, makes sense.
Advocates of adopting a uniform fiduciary standard say few consumers know which financial professionals are now supposed to use a fiduciary standard and which do not; critics argue that a broader standard could force agents who are now regulated as broker-dealers to spend more time and money on compliance and risk management without necessarily doing much to help clients. The critics note, for example, that Bernard Madoff was regulated as an investment advisor.
SENIOR INVESTOR PROTECTIONS
Section 989A of the Dodd-Frank Act offers states incentives to crack down on misleading and fraudulent marketing practices and to educate the public about misleading practices.
Section 989A(b), “Grants to States for Enhanced Protection of Seniors from Being Misled by False Designations,” gives the new Consumer Financial Protection Bureau’s Office of Financial Literacy the authority to distribute the grants.
States can use the grants to hire investigators, buy equipment and training for regulators and prosecutors, and provide educational materials and training on the appropriateness of the use of designations by sales representatives and financial products advisors. States also can use the grants to increase seniors’ awareness and understanding of designations, to fight misleading marketing of products to seniors, and to change state laws to protect seniors against misleading or fraudulent marketing.
States may qualify for grants of up to $500,000 per fiscal year for 3 consecutive years if they have:
- Set rules on use of designations in securities sales that meet the requirements in the Model Rule on the Use of Senior-Specific Certifications and Professional Designations, which was developed by the North American Securities Administrators Association (NASAA), Washington;
-Set rules on use of designations in insurance sales that meet the requirements in the Model Regulation on the Use of Senior-Specific Certifications and Professional Designations in the Sale of Life Insurance and Annuities, which was developed by the National Association of Insurance Commissioners (NAIC), Kansas City, Mo.; and
- Set annuity fiduciary or suitability requirements that are at least as strict as the requirements in the NAIC’s Suitability in Annuity Transactions Model Regulation.
To apply for a grant, a state must submit a proposal explaining how the state plans to protect seniors against fraudulent and misleading marketing, identify the scope of misleading and fraudulent marketing in the state, describe how the proposal would protect seniors against predatory marketing practices, and detail how the proposal would work in conjunction with other efforts to eliminate predatory practices.
A state may qualify for a grant of up to $100,000 for 3 consecutive fiscal years if it is in partial compliance with the standards.
The act drafters appropriated $8 million for the program for each fiscal year from 2011 to 2015.
Other investor protection provisions include Section 919B, which calls for the SEC to conduct a study on investor access to information about broker-dealers, investment advisors and others within 6 months of the Dodd-Frank Act enactment date, and Section 919C, which calls for the comptroller general to complete a study on the state of financial planners’ licensing requirements within 180 days of the enactment date.
Regulators have been working on the designations issue for years.
In 2008, NASAA adopted the Model Rule on the Use of Senior-Specific Certifications and Professional Designations, which introduced guidelines that state securities regulators could use to standardize their professional designations rules.
Later that year, Sen. Herb Kohl, D-Wis., introduced the Senior Protection Act of 2008, S. 2794, which proposed a designations oversight grant program.
The NAIC adopted its Model Regulation on the Use of Senior-Specific Certifications and Professional Designations in the Sale of Life Insurance and Annuities in late 2008.
Controlling misleading use of designations may help consumers and increase the value of credible designations, but some fear that letting each state craft its own rules will lead to conflicts. What happens if an advisor wants to use the same materials in one state that permits use of a designation and in a neigboring state that does not permit use of the designation?
(Title IX; Section 989J)
Section 989J of the Dodd-Frank Act contains a provision that limits the ability of the U.S. Securities and Exchange Commission to classify indexed annuities and other insurance products as securities.
The provision states that an insurance product, annuity product or endowment product with a value that does not vary according to the performance of a separate account is an insurance product, as long as the product meets or exceeds nonforfeiture and suitability criteria set by the National Association of Insurance Commissioners, Kansas City, Mo.
Starting in 2013, a product eligible for Section 989J protection must be issued by an insurer in a state of domicile that adopts any new NAIC suitability rules within 5 years of the rules being established.
The SEC triggered a fight over the indexed annuity issue when it issued Rule 151A, a regulation in which it classified most of the annuities as securities and asserted that it had the right to share jurisdiction over the products with state insurance regulators.
Indexed annuity issuers and marketers mobilized in defense of the products. Product supporters won a major victory in the summer of 2010, when the House and Senate conferees who were writing the final version of the act agreed to add an amendment proposed by Sen. Tom Harkin, D-Iowa.
The Harkin amendment passed and created Section 989J.
Sen. Jack Reed, D-R.I., suggested when the conference committee was in session that the Harkin amendment could lead to the introduction of a wide range of insurance-securities hybrid products.
Although Section 989J will protect indexed annuity sellers against new SEC requirements, the provision has no effect on Financial Industry Regulatory Authority rules. FINRA Notice 05-50 continues to require FINRA member broker-dealers to treat indexed annuities as securities.
Congress made a point of keeping the new Consumer Financial Protection Bureau (CFPB) from regulating insurers. Section 1027(f) prevents the CFPB from “affecting the authority of any state insurance regulator” over a “person regulated by a state insurance regulator,” and Section 1027(g) excludes employee benefit plans and compensation plans from CFPB jurisdiction.
Although the CFPB may have no ability to regulate the business of insurance, it will have several offices that could collect and share information about insurance products:
- The Office of Financial Education (Section 1013(d)) will give consumers information about saving money and building wealth.
- The Office of Service Member Affairs (Section 1013(e)) will serve members of the armed services and their families and help send complaints to the correct federal or state agencies.
- The Office of Financial Protection for Older Americans (Section 1013(g)) will educate individuals ages 62 and older about financial choices and try to protect them against abusive practices.
The CFPB director must set up the Financial Education and the Service Member Affairs offices within 1 year after the CFPB designated transfer date; the director must create the Office of Financial Protection for Older Americans within 180 days of the designated transfer date.
The CFPB will be part of the Federal Reserve System. The director will be appointed by the president to a 5-year term and confirmed by the Senate. (Section 1011)
The CFPB also will have a research unit, and it will have a consumer advisory board that will meet at least twice per year. (Section 1014)
The CFPB will get its funding from the Federal Reserve System. The board can collect an amount equal to as much as 10% of the Federal Reserve System operating expenses in 2011; the cap will increase to 11% of Federal Reserve System expenses in 2012 and to 12% in 2013.
Some supporters of Elizabeth Warren, a Harvard Law School professor and former chairman of the Congressional Oversight Panel, have been campaigning for her to be the CFPB director. President Obama has avoided the prospect of putting Warren through a tough Senate nomination fight for the position by making her a special advisor to U.S. Treasury Secretary Timothy Geithner. Warren will help create the CFPB without facing a confirmation process.
At this point, the ultimate fate of the CFPB is still unclear. The Dodd-Frank Act gives the bureau wide-ranging powers, but members of the Senate nearly succeeded at killing the provision when it considered the bill, and Sen. Richard Shelby, R-Ala., the highest-ranking Republican on the Senate Banking, Housing and Urban Affairs Committee, has said that he would like to see Republicans go back to the act and change or delete the CFPB provision or block CFPB funding if Republicans gain control over the Senate.
If the Obama administration succeeds at bringing the CFPB to life, the bureau may prove to be of interest to the insurance industry.
Insurance industry groups successfully fought to strip the CFPB of regulatory authority over any aspect of the business of insurance, but the offices of Financial Education, Servicemember Affairs and Financial Protection for Older Americans all seem destined to produce reports and roundtable discussions that will refer to life insurance, annuities and related products. If, for example, the Office of Servicemember Affairs were already up and running, it seems like that the office director would comment on retained asset accounts.
SECTION 7: INSURANCE
A Federal Insurance Office (FIO) is one of the agencies that the Dodd-Frank Act created immediately after the act became law.
The FIO is part of the Treasury Department, and the Treasury secretary will appoint its director. The FIO will monitor all sectors of the insurance industry except for health insurance, long term care insurance and crop insurance.
The FIO director will be a non-voting member of the Financial Stability Oversight Council (FSOC). At the FSOC, the FIO director will help identify significant insurers that ought to be supervised by the Federal Reserve Board, and insurance regulatory problems that might be serious enough to hurt the financial system.
The FIO can preempt state insurance laws if the state laws would lead to less-favorable treatment of a non-U.S. insurer or are inconsistent with covered agreements entered into between the United States and one or more foreign governments. When the FIO steps in, it must notify specific congressional committees of its intent to preempt state laws before taking action.
The FIO also will help administer the Terrorism Insurance Program, and it will monitor the extent to which members of traditionally underserved communities have access to affordable insurance products.
The Dodd-Frank Act will keep the current state-run insurance regulatory system, but the act directs the FIO to report to Congress 18 months after enactment on how to modernize the U.S. system of insurance regulation. The FIO is supposed to make recommendations for the legislative, administrative and regulatory changes that are necessary to carry out the findings in the report.
The report will examine:
- The costs and benefits of potential federal regulation of insurance across various lines of insurance (except health insurance).
- The feasibility of regulating only certain lines of insurance at the federal level while leaving other lines of insurance to be regulated at the state level.
- The ability of any potential federal regulation or federal regulators to eliminate or minimize regulatory arbitrage.
- The impact that developments in the regulation of insurance in foreign jurisdictions might have on any federal insurance regulatory system that might arise in the United States.
- The ability of any potential federal regulation or federal regulator to provide robust consumer protection for policyholders.
The Treasury Department posted a classified ad seeking a Federal Insurance Office director Sept. 21.
Members of Congress and others who have discussed Dodd-Frank Act implementation have talked mainly about efforts to establish the Consumer Financial Protection Board over at the Federal Reserve Board, not the FIO.
Standards groups – the Financial Accounting Standards Board, Norwalk, Conn.; the International Accounting Standards Board, London; and the International Association of Insurance Supervisor, Basel, Switzerland – have been increasing the theoretical importance of the FIO and the FIO director by working on ambitious insurance regulatory projects.
IASB is overhauling its insurance contract accounting standards; FASB is debating whether to develop a new standard or tweak existing standards to make them more like the revised IASB standards. The IAIS is developing a Common Framework for the Supervision of Internationally Active Insurance Groups.
The FIO director could play a role in determining what U.S. insurers’ future financial statements look like and how U.S. insurance sregulators share responsibility with other regulators.
ORDERLY LIQUIDATION AUTHORITY
The Financial Stability Oversight Council (FSOC) is a part of the U.S. Treasury Department that came to life immediately after the Dodd-Frank Act was enacted.
The FSOC is responsible for identifying threats to U.S. financial stability; eliminating expectations that the government will bail out troubled financial companies; and responding to threats to financial system stability. (Section 112)
The council is supposed to work with the Federal Insurance Office (FIO) and other regulatory agencies to assess risks; monitor regulatory proposals, including insurance proposals; require the Federal Reserve Board to supervise nonbank financial companies that may pose risks to U.S. financial stability; recommend heightened prudential standards for nonbank financial companies and “large, interconnected bank holding companies” supervised by the Federal Reserve Board; and provide a forum for resolving regulatory agency jurisdictional disputes.
When the council reports to Congress, it is supposed to cover insurance market and regulatory developments as well as other types of financial market developments.
The FSOC can appoint advisory, technical and professional committees to help it do its work.
The Treasury secretary will lead the FSOC, and the Treasury Department will create another major new arm, the Office of Financial Research, to help the FSOC keep track of financial services companies and potential threats to U.S. financial system stability.
The OFR director will be appointed to a 6-year term by the president and confirmed by the Senate. The director can hire OFR employees and set pay levels without complying with General Schedule pay rate rules. Like the FSOC, the OFR can appoint advisory, technical and professional committees. The OFR also has the power to issue subpoenas. (Section 153)
The FSOC will get its funding from the OFR. (Section 118)
The FSOC will meet at least 4 times a year and have 10 voting members (Section 111).
The members are:
- The Treasury secretary (FSOC chairperson).
- The Federal Reserve Board chairman.
- The comptroller of the currency.
- The director of the Consumer Financial Protection Bureau.
- The chairman of the U.S. Securities and Exchange Commission.
- The chairperson of the Federal Deposit Insurance Corp.
- The chairperson of the Commodity Futures Trading Commission.
- The director of the Federal Housing Finance Agency.
- The chairman of the National Credit Union Administration board.
- An independent member, appointed by the president with the consent of the Senate, who has insurance expertise.
The OFR director and the FIO director will be nonvoting members. Other nonvoting members will include a state insurance commissioner, a state banking supervisor and a state securities commissioner.
The independent member of the council who has insurance expertise will serve a 6-year term; the nonvoting members will serve 2-year terms.
The Dodd-Frank Act does not say how the OFR and the FIO will split monitoring of insurance, but the act requires the OFR to reduce burdens on reporting companies by getting data from the FIO and other agencies when possible.
The FSOC and the OFR can keep most of the data they collect confidential, but the agencies are supposed to publish a financial company reference database and a financial instrument reference database. (Section 153-154)
If two-thirds of the FSOC members believe a U.S. nonbank financial company is important enough that it might be important to U.S. financial stability, the FSOC can put the company under the jurisdiction of the Federal Reserve Board. (Section 113) Nonbank financial companies supervised by the Federal Reserve Board must register with the board within 180 days of the FSOC determination.
Section 117 – the “Hotel California” rule – will prevent financial services companies that used bank or thrift units to participate in the Troubled Asset Relief Program Capital Purchase Program (CPP) from avoiding Federal Reserve Board jurisdiction by disposing of the bank or thrift units. If a CPP recipient with more than $50 billion in assets ceases to be a bank holding company, the Federal Reserve Board will treat that company as a nonbank financial company to be supervised by the Federal Reserve Board.
The largest affected companies will undergo stress tests twice a year, and midsize companies must take stress tests once a year. (Section 165) The Federal Reserve Board will provide baseline, adverse and severely adverse scenarios to be used in the tests.
The FSOC can give the Federal Reserve Board recommendations for ways to change prudential standards and reporting requirements to reduce risk. (Section 115) The standards could involve matters such as risk-based capital requirements, leverage limits, liquidity requirements and overall risk management requirements.
Section 120 authorizes the FSOC to advise other regulatory agencies to apply new safeguards to deal with financial activities or practices that might lead to significant liquidity or credit risk.
If two-thirds of the FSOC members and the Federal Reserve Board agree that a bank holding company with $50 billion or more in assets or a nonbank financial company supervised by the Federal Reserve Board poses a “grave threat” to U.S. financial stability, the Federal Reserve Board can restrict the ability of the company to offer a financial product or products; require the company to terminate one or more activities; impose conditions on company operations; or, in some cases, require the company to sell or transfer assets to unaffiliated entities. (Section 121)
The FIO director and the Federal Reserve Board can work on their own, or at the request of the Treasury secretary, to go through a decision-making process that could result in a troubled insurer being referred to the Federal Deposit Insurance Corp. The FDIC can then ask state insurance regulators to place the insurer in an orderly liquidation process. If state regulators do not act within 60 days, the FDIC can go to court in the insurer’s home state to put the insurer in liquidation under the laws and requirements of the home state.
The FSOC is supposed to report within 6 months of enactment on strategies for restricting proprietary trading, and ways to write restrictions on proprietary trading of derivatives that accommodate the needs of insurers. (Section 619)
The National Association of Insurance Commissioners, Kansas City, Mo., already has named its non-voting FSOC representative: Missouri Insurance Director John Huff, and the FSOC held its first meeting Oct. 1. Two positions for members who are supposed to have an interest in insurance – the Federal Insurance Office director and the independent insurance expert to be appointed by the president – had not yet been filled.
The U.S. Treasury Department posted a classified ad seeking candidates for another FSOC member – the director of the Federal Insurance Office – Sept. 21.
Dodd-Frank provisions requiring the FSOC to coordinate efforts to oversee systemically important insurers with the efforts of other state and federal agencies could put some curbs on its reach, but the council could prove to be a visible, powerful new agency.
The FSOC already has published a request for comments on the criteria that should be used when officials are deciding whether an insurer or other nonbank financial services company is important enough to the financial system that it should come under the jurisdiction of the Federal Reserve Board.
The FSOC also has called for comments on efforts to limit proprietary trading at financial services companies, including insurers, that have bank affiliates backed by the Federal Deposit Insurance Corp.
Derivatives users will have to conduct many transactions through clearinghouses. (Section 727); the rules are complicated, and it is not yet clear how they will affect insurers.
One provision in the derivatives title, Section 719, calls for the Financial Stability Oversight Council to report within 15 months of enactment on whether stable value funds are swaps.
Traditionally, a stable value fund has been a product that combines bonds with insurance contracts that guarantee a minimum rate of return. Section 719(d)(2) defines “stable value contract” as “any contract, agreement, or transaction that provides a crediting interest rate and guaranty or financial assurance of liquidity at contract or book value prior to maturity offered by a bank, insurance company, or other State or federally regulated financial institution for the benefit of any individual or commingled fund available as an investment in an employee benefit plan… or a qualified tuition program (as defined in section 529 of such [Internal Revenue] Code).”
If the SEC and the Commodity Futures Trading Commission decide together that “stable value contracts fall within the definition of a swap, the commissions jointly shall determine if an exemption for stable value contracts from the definition of swap is appropriate and in the public interest.”
The SEC and the CFTC have started the process of implementing the derivatives provisions of the Dodd-Frank Act by requesting comments about the precise definitions of the terms used in the act.
Because the Dodd-Frank Act calls on the CFTC to share authority over swaps with the SEC, and because definitions may determine which transactions fall under the jurisdiction over which agency, the definitions could play a role in determining whether the CFTC emerges with a significant role in regulating insurers’ swaps activities.
The definitions also could determine which swaps must be conducted through exchanges or clearinghouses and which can continue to be arranged over the counter.
Life insurers often use derivatives to protect against the investment risk and other types of risk associated with offering annuities. Several large insurers have suggested that the new swaps rules could increase derivatives costs, make some types of deals harder to arrange, and affect annuity hedging operations in ways that are difficult to predict.
The Dodd-Frank Act includes a provision on executive compensation at covered financial institutions, including registered broker-dealers and investment advisors. Covered financial institutions with less than $1 billion in assets are excluded.
Section 956 of the act requires federal regulators to join to prescribe regulations concerning the matter.
The regulations will require covered financial institutions to report the structures of all incentive-based compensation arrangements, and they will prohibit incentive-based payment arrangements that encourage inappropriate risks by providing executive officers, employees, directors or principal shareholders with excessive compensation or rewards that could lead to material financial loss for the covered financial institution.
The “appropriate federal regulators” are the Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp. board, the National Credit Union Administration board, the U.S. Securities and Exchange Commission and the Federal Housing Finance Agency.
In establishing standards for compensation, regulators must ensure that the standards are comparable to the standards established under the Federal Deposit Insurance Act and take into consideration the compensation standards described in Section 39(c) of the Federal Deposit Insurance Act. Considerations include the combined value of cash and noncash benefits provided to an individual and the financial condition of the institution.
The prohibition on compensation plans that could lead to material financial losses is similar to the Troubled Asset Relief Program prohibition on compensation programs that encourage senior executives to take unnecessary and excessive risks. The rule ultimately put forth by federal regulators may or may not amount to a cap on compensation.
Section 409 of the Dodd-Frank Act exempts family offices from a provision requiring managers of private funds–investment companies as defined under Section 3(a) of the Investment Company Act of 1940–to register with the U.S. Securities and Exchange Commission as investment advisors. Section 409 also directs the SEC to promulgate rules pertaining to the exemption.
The family office exemption under Section 409 amends Section 202(a)(11)(G) of the Investment Advisers Act of 1940. In defining “family office,” Section 409 says, the SEC must do so in a manner that:
- Is consistent with the SEC’s existing exemptive orders regarding family offices.
- Recognizes family offices’ range of “organizational, management and employment structures.”
- Does not exclude certain “grandfathered” advisors who were not registered (or required to be registered) under the Investment Advisers Act of 1940 only because they advise (and were engaged prior to Jan. 1, 2010) in advising) “natural persons” and entities connected with a family office.
Though such grandfathered family offices are exempted from the SEC registration requirement, they will still be considered investment advisors for purposes of the Investment Advisers Act anti-fraud provisions, sections 206(1), 206(2) and 206(4).
Advisors who deal regularly with wealthy clients will also want to study Section 413 of the act, which tightens the rules for designating individuals as “accredited investors,” or investors who are sophisticated enough to handle the risks associated with investing in unregistered securities.
While the SEC has yet to precisely define “family office,” experts agree that the exemption will, as under the current regulatory regime, apply not to multi-family offices (which are deemed investment advisors and therefore subject to SEC registration requirements), but only to single-family offices. These include offices serving a single individual, spouse and children; or a trust, private foundation or charity owned by or established for the benefit of such individuals.
The SEC has generally required that a board of directors (or other governing body) composed mostly of family members control the single-family office to qualify for the exemption The SEC has also at times permitted exempt single-family offices to allow key executives and employees involved in investment decisions to participate in the family’s investments on a limited scale.
However Section 409 requires only that the definition of family office be consistent with– and not identical to–the SEC’s previous exemptive policy. The commission could adopt more restrictive requirements, such as provisions limiting or eliminating the ability of family offices to provide co-investment opportunities to employees.
These restrictions could limit the scope of the grandfather provision, which excludes from the definition of investment advisor single-family offices that have officers, directors or employees who co-invested with the family as of Jan. 1, 2010. Co-investment opportunities have been provided as a type of incentive-based compensation; those types of arrangements might not be allowed in the future.
The Dodd-Frank act requires the SEC to release a proposed definition of family office, allow for a period of public comment on the definition, and adopt a finalized definition during a rule-making proceeding. The commission has not yet established a schedule for the rule-making process.
This guide gives an overview of Dodd-Frank Act provisions that relate, or might relate, to insurance, insurers and insurance producers. It is not a substitute for legal, accounting or other professional advice.
In addition to the text of the Dodd-Frank Act and other materials prepared by Congress, the following resources were used in the development of this guide:
Chadbourne & Parke L.L.P., New York, “Summary and Analysis of the Volcker Rule in the Dodd-Frank Act – Prohibiting Bank Proprietary Trading and Investing in Hedge Funds, Private Equity Funds and Other Private Funds – It Affects More Than Just Funds.” (July 29, 2010)
Davis Polk & Wardwell L.L.P., New York, “Regulatory Implementation Slides.” (July 2010)
Skadden, Arps, Slate, Meagher & Flom L.L.P. & Affiliates, New York, “The Dodd-Frank Act: Commentary and Insights.” (July 2010)
Stroock & Stroock & Lavan L.L.P., New York, “Special Bulletin: Significant Insurance Provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.” (July 7, 2010)
U.S. Chamber of Commerce, Washington, “Dodd-Frank: Some Progress on the Big 5, Sequel Already on Tap.” (Tom Quaadman, July 21, 2010)
Sen. Christopher Dodd’s original S. 3217 bill (April 2010)
Wall Street Reform: Conference Base Text (June 2010)
Final version of the Dodd-Frank Act (July 2010)
APPENDIX 2: ACRONYMS
CFPB Consumer Financial Protection Bureau
CDO collateralized debt obligation
CDS credit default swap
CPP: Capital Purchase Program (an arm of the Troubled Asset Relief Program)
CFTC Commodity Futures Trading Commission
FSOC Financial Stability Oversight Council
ERISA Employee Retirement Income Security Act of 1974
FDIC Federal Deposit Insurance Corp.
FINRA Financial Industry Regulatory Authority
FIO Federal Insurance Office
GAO U.S. Government Accountability Office
IRS Internal Revenue Service
NAIC National Association of Insurance Commissioners
NASAA North American Securities Administrators Association
NRSRO nationally recognized statistical rating organization
OCC Office of the Comptroller of the Currency
OFR Office of Financial Research
SEC Securities and Exchange Commission
TARP Troubled Asset Relief Program