Dodd-Frank Wall Street Reform and Consumer Protection Act
On July 21, President Obama signed the Dodd-Frank Act into law. Many of the Act’s provisions became effective the next day, and numerous implementation time lines are tied to the date of enactment. The Dodd-Frank Act makes important changes to the structure of bank regulation and expands bank regulatory powers in a variety of areas. It abolishes the Office of Thrift Supervision (OTS) and transfers its function and responsibilities to the Comptroller of the Currency (OCC), which will assume the supervision of federal savings and loan associations, while the Federal Deposit Insurance Corporation (FDIC) will assume responsibility for supervising state-chartered thrifts. The Federal Reserve Board (FRB) will supervise thrift holding companies. The Act also contains the controversial “Volcker Rule,” which prohibits proprietary trading and private fund management activities, subject to narrow exceptions; it also requires systemically important nonbank financial firms to hold additional capital and to comply with additional quantitative requirements with respect to such activities.
The Act establishes a new federal regulatory structure for consumer protection – the Bureau of Consumer Financial Protection (BCFP) – as an independent bureau within the FRB and grants the BCFP sweeping powers to administer and enforce a new federal regulatory scheme.
The Dodd-Frank Act contains several provisions that directly or indirectly affect the insurance industry, which may signal the beginning of greater federal regulation of insurance. The Act creates the Federal Insurance Office (FIO), which marks the first time an entity of the federal government has been created specifically to address the insurance industry. The scope of the FIO’s authority extends to all lines of insurance except health insurance, most long-term care insurance, and crop insurance. The FIO will be housed in the Treasury Department, but will not have regulatory authority, largely preserving the role of state insurance regulators. The FIO’s primary tasks will be to monitor and gather information on insurance issues of national importance, monitor the industry for systemic risk, and serve as a negotiator for international insurance treaties. State law will be preempted only to the extent that it conflicts with a relevant international agreement. The Act specifically states that the FIO’s preemption cannot extend to any state insurance measure that governs rates, premiums, underwriting, sales practices, coverage requirements, the application of state antitrust laws, or state capital or insolvency requirements (unless such requirements result in less favorable treatment of a non-US insurer versus a US insurer).
Derivatives-related provisions of the Act will also have an impact on the insurance industry. Insurers and reinsurers that use derivatives could be subjected to the requirements of central clearing and exchange trading. The Act’s language is not definitive regarding what derivative products and which derivative users will be subject to enhanced regulation (this will be finalized through post-passage rulemaking). The Act states that swaps will not be considered insurance and may not be regulated as such under state law. This provision appears to be in response to the National Conference of Insurance Legislators’ (NCOIL’s) recent formulation of a model bill characterizing “covered” credit default swaps (CDSs) as insurance and empowering states to regulate them as such. The Act postpones the investment fate of stable-value contracts by requiring the Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC) to conduct a study to determine whether stable-value funds of 401(k) plans, 457 plans, 403(b) plans, and 529 plans should be defined as swaps. If the agencies classify stable-value contracts as swaps, then they will need to determine whether the contracts should be exempt from the law. The impact the Act will have on stable-value contracts in bank-owned life insurance (BOLI) programs is unclear and will likely remain so until the SEC/CFTC findings are published.
Basel Committee Reaches Accord on Principles for Capital and Liquidity Rules
On July 26, international banking regulators reached broad agreement on the overarching principles that will shape capital requirements and liquidity rules for banks in the coming years. The new agreement, which revises an earlier set of principles released by the Basel Committee on Banking Supervision in December 2009, tackles what banks can count as Tier 1 capital, including limits on mortgage servicing rights, deferred tax assets, and minority interests. The Committee also endorsed contingent capital, a hybrid instrument that converts debt into equity under certain conditions. The Committee will release its economic impact assessment of the proposed capital and liquidity changes in August. Later, it will release the results of another assessment that will examine the impact of the proposed changes on the biggest banks. Congressional representatives have already begun to lobby for a hearing on the impact of the proposed Basel rules on US banks and their harmonization with the new Dodd-Frank Act.
SEC Proposes New 12b-1 Fee Rules
On July 21, the Securities and Exchange Commission (SEC) voted unanimously to propose measures aimed at improving the regulation of mutual fund distribution fees and providing better disclosure to investors. The marketing and selling costs involved in running a mutual fund are commonly referred to as the fund’s distribution costs. To cover these costs, companies that run mutual funds are permitted to charge fees known as 12b-1 fees. These fees are deducted from a mutual fund to compensate securities professionals for sales efforts and services provided to the fund’s investors. In 2009, these fees amounted to $9.5 billion, and they exceeded $13 billion in 2007 – compared to just a few million in 1980 when they were first permitted. The proposal would limit the amount of asset-based sales charges individual investors pay. The current limit on the charge is 0.75% per year, but there is no limit on how long a fund can pay these charges. Under the proposed rules, firms would be allowed to charge a “marketing and service fee” of up to 0.25% and anything above that amount would be deemed an “ongoing sales charge.” The proposal would restrict these ongoing sales charges to the highest fee charged by the fund for shares that have no such charges. For example, if one class of the fund imposes a 4% front-end sales charge, another class could not charge more than 4% in total to investors over time. The proposal would also encourage retail price competition by enabling funds to sell shares through broker-dealers who determine their own sales compensation, subject to competition in the marketplace. Currently, all broker-dealers who sell shares in a fund must sell those shares under terms established by the fund and disclosed in its prospectus. The comment period ends November 5, 2010.
NAIC Releases RFP to Produce Designations for Commercial Mortgage-Backed Securities
On July 28, the National Association of Insurance Commissioners (NAIC) released a request for proposal (RFP) for a vendor to model expected losses on approximately 7,500 commercial mortgage-backed securities (CMBSs) as of December 31, 2010. This process will determine the NAIC designations to be used by insurance companies to calculate the solvency reserves required to cover their CMBS holdings. At the end of 2009, the NAIC used a similar RFP process to establish designations for more than 21,000 residential mortgage-backed securities (RMBSs) owned by US-domiciled insurance companies.
SEC and GAO Look at Life Settlement Regulations
On July 22, the Securities and Exchange Commission (SEC) Life Settlements Task Force (established in August 2009) issued a report that recommended life settlements be defined as securities so that life settlement investors could receive the protection of federal securities laws. The task force raised questions about life settlement regulation and oversight. Today, 38 states have some legislation addressing life settlement regulation, but 12 states and the District of Columbia have no laws governing the sale of life insurance policies or the investment in life insurance policies.
Also this month, the Government Accountability Office (GAO) issued a report on life insurance settlements. The GAO report also raised concerns about the inconsistent regulation and oversight of life settlements. The report recommended that Congress consider the advantages and disadvantages of providing a federal charter option and creating a federal insurance regulatory entity, as well as the difficulties of harmonizing insurance regulation across states.