April 2015


Tax Reform Update

As we reported in our March LRA update, Senate Finance Committee Chairman Orrin Hatch (R-UT) and Ranking Member Ron Wyden (D-OR) announced a bipartisan effort to begin soliciting ideas from interested members of the public and stakeholders regarding tax reform. Five bipartisan tax working groups have been established to address: 1) individual income tax; 2) business income tax; 3) savings and investment; 4) international tax; and 5) community development and infrastructure.

On April 29, the senators made the comments that were submitted available on the Committee’s website. Overall, more than 1,400 comments were submitted. Various financial services industry trade groups submitted comments, including AALU, ACLI, SIFMA.

AALU’s comment submission included a 5-page appendix advocating against changing the tax treatment of business-owned life insurance. It included a discussion of the recurring proposal to expand interest expense disallowance, provided a number of real-world examples of how businesses have used life insurance, and described the wide use of nonqualified deferred compensation (NQDC) plans financed/hedged with COLI.

The working groups have a goal of completing recommendations by the end of May.



DMF Certification Process – Update

In our December LRA update, we noted that the NTIS published a Notice of Proposed Rulemaking (NPR) to establish, pursuant to Section 203 of the Bipartisan Budget Act of 2013 (Pub. L. 113-67), a certification program to replace the temporary certification program currently in place for access to the DMF. The deadline for comment submissions was March 31.

We found the following comment submissions to be noteworthy:

NCOIL: Stressed the importance of granting life insurers continued access to the DMF and noted a 2011 model law for Unclaimed Life Insurance Benefits that requires insurers to routinely identify deceased policyholders through use of the DMF in order to facilitate timely payments of death proceeds.

American Benefits Council and SPARK Institute: Stressed the need for retirement plan administrators to be able to communicate participant dates of death without requiring recipients (e.g., employers and plan sponsors) to be certified. The commenters noted that employers and administrators already have information such as names, SSNs, and dates of birth. To require effectively all employers to meet the certification requirements was characterized as being unworkable. These commenters expressed further concern regarding the proposed rule’s requirement that a person seeking certification must submit an attestation from an Accredited Certification Body (ACB) and be subject to periodic audits from that ACB. The commenters note that such an industry doesn’t currently exist and would, at a minimum, require a lengthy phase-in period.

Financial Services Roundtable (FSR): Suggests that the final rule allow financial firms to satisfy data security requirements through adherence to existing requirements under Gramm-Leach-Bliley. The FSR also encourages the NTIS to clarify that using DMF data to facilitate payment to beneficiaries is a “legitimate business purpose” within the meaning of Section 203.

Institutional Longevity Markets Associations (ILMA): Noting that a number of its members participate in longevity-related financial businesses, including the business of life settlements, the ILMA stressed the need for access to dates of death. Accordingly, the ILMA recommended that the definition of “Limited Access DMF” be revised to provide that Limited Access DMF does not include date of death information, provided that it is not accompanied by other information about the deceased individual from the DMF.


NAIC Adopts Guidance on Acquisition of Control of U.S. Insurers

Over the past couple years, we’ve reported on increased regulatory scrutiny surrounding private equity and hedge fund investors acquiring control of U.S. insurers. The NAIC established a Private Equity Issues (E) Working Group to develop processes to mitigate and monitor risks associated with these types of acquisitions.

On March 29, the working group adopted guidance that will be reflected in a revised Financial Analysis Handbook. The guidance includes additional considerations that the regulators will assess with respect to M&A approval requests and identifies a number of potential stipulations that may be imposed on the acquirer (including higher capital requirements, requiring approval for any dividends or shareholder distributions, requiring approval of reinsurance treaties, and various disclosure items related to controlling parties).


Senate Banking Committee Hearings on Insurance Industry and Regulation

The Senate Committee on Banking, Housing and Urban Affairs conducted hearings on the State of the Insurance Industry and Insurance Regulation (April 28) and Examining Insurance Capital Rules and FSOC Process (April 30).

The hearings focused on recent developments in the insurance sector, including: 1) the status of Federal Reserve capital rules for covered insurers (e.g., SIFIs) called for under Dodd-Frank and modified recently through the Insurer Capital Standards Act; 2) FSOC’s SIFI designation process and transparency; and 3) the interplay with European insurance regulatory efforts arising out of the IAIS and FSB.


Ad Hoc LRA- April 6, 2015

Regulatory Capital Rules: Frequently Asked Questions

Today, the FDIC, OCC and FRB released answers to frequently asked questions (FAQs) regarding the regulatory capital rule. A few of the FAQs are particularly relevant to BOLI owners.

The table below includes three excerpted Q&As along with our brief observations.

Regulatory Q&A Observations from MBSA
QUESTION: A banking organization has an equity exposure to an investment fund.  The investment guidelines of the fund permit it to hold securitization positions up to a specified limit.  Under the standardized approach, can the banking organization use the alternative modified look-through approach of section 53(d) of the regulatory capital rule to calculate the risk weight for its equity exposure to the investment fund?  What risk weight should the banking organization assign to the portion of its investment in the fund that, according to the investment limits of the fund, would be securitization exposures? This response is consistent with previous informal regulatory guidance from as far back as November 2013.

Investment guidelines-based SSFA risk weight constraints may be used in conjunction with an alternative modified look-through approach if all of the following apply:

  1. The institution satisfies the due diligence requirements of the final rule;
  2. The institution risk weights all securitizations using the SSFA; and
  3. The guidelines require “prompt” divestiture of non-conforming securitizations.

It is worth noting that the due diligence requirements apply irrespective of which look-through approach an institution chooses to apply.

Institutions can rely upon the investment manager to conduct the requisite due diligence, provided that the institution has appropriate processes in place to assess and manage the risk of using a third party.

ANSWER: The banking organization may use the alternative modified look-through approach set forth in section 53(d) of the regulatory capital rule to assign the adjusted carrying value of its equity exposure to an investment fund on a pro rata basis to different risk-weight categories based on the investment limits for various asset types contained in the fund’s prospectus, partnership agreement, or similar contract that defines the fund’s permissible investments (investment guidelines).  If all due diligence requirements under section 41(c) of the regulatory capital rule are met, the banking organization may assign a risk weight to the securitization portion using either the gross-up approach or the simplified supervisory formula approach (SSFA) under section 43 of the regulatory capital rule depending on which of these approaches the banking organization has chosen to use across all of its securitization exposures, among other factors specified in section 42 of the regulatory capital rule.  The banking organization may use the SSFA for all of its directly owned securitization exposures and the securitization exposures held by the investment fund, if the investment guidelines limit the investment fund’s holdings of securitization exposures to only exposures that would be subject to a specific risk weight under the SSFA in section 43 of the regulatory capital rule.  For example, the investment guidelines could limit the fund’s holdings of securitization exposures only to exposures that would be subject to a 20 percent risk weight under the SSFA.  Importantly, the investment guidelines would have to specify that any securitization exposure would be divested promptly if its risk weight calculated under the SSFA goes above the specified threshold.

In order for the banking organization to apply the risk weight limit specified in the investment guidelines, it also would need to meet the due diligence requirements in section 41(c) of the regulatory capital rule, which require the banking organization to demonstrate a comprehensive understanding of the features of the securitization exposure that would materially affect its performance.  The banking organization could rely on a third party (for example, the fund manager) to conduct the due diligence on the securitization exposures held by the investment fund and provide the analysis to the banking organization, provided that the banking organization has a process to assess and manage the risk of using a third party.  (See, for example, the guidance issued by each agency related to outsourcing risk.  Refer to www.occ.gov/news-issuances/bulletins/2013/bulletin-2013-29.html, http://www.fdic.gov/news/news/financial/2008/fil08044.html, and http://www.federalreserve.gov/bankinforeg/srletters/sr1319.htm.)

QUESTION: Could an investment in a bank-owned life insurance (BOLI) hybrid product in which the gains and losses on the pool of assets are reflected in the cash surrender value recorded on the banking organization’s balance sheet meet the definition of separate account under the regulatory capital rule? As referenced in the answer, Paragraph 4 of the definition of “separate account” has been identified as a significant question as it relates to whether hybrid BOLI qualifies for a look-through treatment.

We will perform some additional research on hybrid BOLI products in the market to gauge the degree of fit with this fact pattern.

ANSWER: Yes, as long as the account meets all the requirements of a separate account as defined in section 2 of the regulatory capital rule, which refers to a legally segregated pool of assets owned and held by an insurance company for the benefit of an individual contract holder.  Paragraph 4 of the definition of a separate account requires, in part, that all investment gains and losses, net of contract fees and assessments, be passed through to the contract holder.  Paragraph 4 would be satisfied if the gains and losses on the investment are passed through to a banking organization via changes in the on-balance sheet cash surrender value of the investment.  The banking organization must not receive cash payments of any gains or earnings of the assets in the pool.
QUESTION: Under the SSFA, how does a banking organization calculate KG (that is, the weighted average capital requirement of the underlying exposures) for a securitization exposure backed by Sallie Mae student loans that are guaranteed by the U.S. government? What risk weight does the banking organization use for the portion of the underlying exposure that is guaranteed? This description is consistent with our understanding of how BOLI asset managers have been asked to compute the KG parameter.

This FAQ does not clarify the computation of KA for these types of exposures.

ANSWER: The portion of a Sallie Mae loan conditionally guaranteed by the U.S. government is subject to a risk weight of 20 percent, pursuant to sections 43(b) and 32(a)(1)(ii) of the regulatory capital rule. If 97 percent of an underlying exposure is conditionally guaranteed by the U.S. government, 97 percent of that exposure would be risk weighted at 20 percent. The portion of the remaining 3 percent that is performing would be risk weighted at 100 percent and any portion of the remaining 3 percent that is 90 days or more past due or on non-accrual would be risk weighted at 150 percent. See sections 43(b) and 32(k) of the regulatory capital rule.

Also, late last week, the regulators released updated call report instructions and supplemental instructions for March 2015. Of note, the regulators have provided an additional clarification with respect to the KG parameter of the SSFA computation for securitizations. The instructions clarify that exposures that are 90 days or more past due are to be factored into the measure of both parameters KG and W for purposes of calculating the regulatory capital treatment of securitization exposures using the SSFA. Below is an excerpt from the instruction book that provides an example of the computation (emphasis added).

Parameter KG is expressed as a decimal value between zero and one (e.g., an average risk weight of 100 percent represents a value of KG equal to .08). “Underlying exposures” is defined in the regulatory capital rules to mean one or more exposures that have been securitized in a securitization transaction. In this regard, underlying exposures means all exposures, including performing and nonperforming exposures. Thus, for example, for a pool of underlying corporate exposures that have been securitized, where 95 percent of the pool is performing (and qualify for a risk weight of 100 percent) and 5 percent of the pool is past due exposures that are not guaranteed and are unsecured (and thus are assigned a risk weight of 150 percent), the weighted risk weight for the pool would be 102.5 percent [102.5% = (95% * 100%) + (5% * 150%)] and the total capital requirement KG would be equal to 0.082 (102.5% divided by 1,250%). This treatment is consistent with the regulatory capital rules.

This clarification is consistent with feedback we previously received as well.

Finally, there does not appear to be any changes to the reporting instructions for Schedule RC-F (Other Assets) where the asset values associated with BOLI are reported.