On May 23, 2011, the Securities and Exchange Commission (the “SEC”) and the Commodity Futures Trading Commission (the “CFTC”) proposed joint rules in Federal Register 33-9204 (click here for a copy) that define the terms swap, security-based swap, security-based swap agreement, and mixed swaps. On July 22, 2011, Susan E. Voss, Iowa Insurance Commissioner and President of the National Association of Insurance Commissioners (the "NAIC") and Therese M. Vaughn, CEO of the NAIC penned a comment letter to the SEC and CFTC that urged them to make several changes to the proposed rules (the "NAIC Letter"). Click here for a copy of the NAIC Letter.
Background on the Proposed Rules and the Commissions' Request for Comment
The proposed rules came on the heels of the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), which, among other things, required the SEC and the CFTC to further define “swaps,” and other related financial instruments. The SEC and the CFTC were also charged with determining what is not considered a swap or swap-related product, and therefore not federally regulated under the Dodd-Frank Act.
The SEC and CFTC have proposed to issue interpretative guidance that an enumerated list of insurance products are outside of the scope of the Dodd-Frank Act definitions of swaps and swap-related financial instruments. The enumerated list includes "surety bonds, life insurance, health insurance, long-term care insurance, title insurance, property and casualty insurance, and annuity products the income on which is subject to tax treatment under section 72 of the Internal Revenue Code." The SEC and CFTC requested comments on the proposed interpretive guidance regarding property and casualty insurance and the CFTC alone requested comment on whether products such as "private passenger and commercial automobile, homeowners, mortgage, commercial multiperil liability, general liability, professional liability, workers' compensation, fire and allied lines, farm owners multiperil, aircraft, fidelity, surety, medical malpractice, ocean marine, inland marine, and boiler and machinery, should be considered traditional property and casualty insurance."
For those items not on the enumerated list, the proposed rules include an insurance product test to differentiate insurance products from swaps or swap-related products, thereby removing them from regulation by the SEC and the CFTC under the Dodd-Frank Act. The SEC and the CFTC also indicated that the proposed rules were written to prevent the purveyors of swaps and related instruments from masking their products as insurance in order to evade the Dodd-Frank Act.
The insurance product test under the proposed rules generally states, "that the term 'swap' does not include an agreement, contract, or transaction that[ ] by its terms or by law, as a condition of performance on the agreement, contract, or transaction:
- [r]equires the beneficiary to have an insurable interest that is the subject of the agreement, contract, or transaction and thereby carry the risk of loss with respect to that interest continuously throughout the duration of the agreement, contract, or transaction;
- requires that loss to occur and to be proved, and that any payment or indemnification therefore be limited to the value of the insurable interest, separately from the insured interest; and
- is not traded, separately from the insured interest, on an organized market or over-the-counter."
The NAIC Letter
The NAIC Letter urges the SEC and the CFTC to include the following insurance products in the enumerated list: mortgage guaranty, accident, and disability insurance, all of which are currently regulated at the state level.
The NAIC Letter also points out that products typically considered to be insurance would not qualify under the test, thereby placing them in rubric of the Dodd-Frank Act rather than under state regulation, where insurance products are primarily regulated. For instance, the NAIC Letter criticized the first prong of the insurance product test for its insistence that the beneficiary's insurable interest remain "continuously throughout the duration of the agreement." Under current state law, for a "person [who] wishes to procure insurance on the life of another person, . . . he or she only needs to have an insurable interest at the time that he or she procures the life insurance policy." Further, with regard to property insurance, "a person only needs to have an insurable interest at the time of the loss" to make a claim on the policy."
The NAIC Letter also urged that the third prong be eliminated as well, as it would seemingly include the insurance products sold to individuals or small groups in the health benefit exchanges required under the Patient Protection and Affordable Care Act.