In July 2012, the SEC and CFTC (the Commissions) approved long-awaited joint rules and interpretations concerning certain key definitions, including “swap” and “security-based swap” (collectively Swaps). The new rules and interpretations will take effect 60 days after the date of their publication in the Federal Register.
The Swap definition is central to the comprehensive new regulatory scheme that Dodd-Frank establishes for instruments that fall within the definition. Following effectiveness of the definition, affected persons must comply with applicable new regulatory requirements in accordance timetables that the respective Commissions have developed and will likely continue to refine.
Under the final rules an insurance agreement, contract or transaction (insurance product) will not be considered a Swap if, as set out in the related SEC “fact sheet,” it meets any of the following three provisions:
Grandfather Provision: The product is an existing agreement, contract or transaction entered into before the effective date of the final rules and was provided by a person or entity that satisfied the “provider test.”
Product Safe Harbor: The product is provided in accordance with the provider test and satisfies the following conditions:
- The beneficiary of the insurance product must have an insurable interest and thereby bear the risk of loss with respect to that interest continuously throughout the duration of the agreement, contract, or transaction.
- The loss must occur and be proved.
- Any payment or indemnification for loss must be limited to the value of the insurable interest.
- The agreement, contract or transaction must not be traded, separately from the insured interest, on an organized market or over-the-counter.
- With respect to financial guaranty insurance only, in the event of a payment default or insolvency of the obligor, any acceleration of payments under the policy must be at the sole discretion of the insurer.
Enumerated Product Safe Harbor: The product is provided in accordance with the provider test and falls within the following categories:
- surety bond
- fidelity bond
- life insurance
- health insurance
- long term care insurance
- title insurance
- property and casualty insurance
- disability insurance
- insurance against default on individual residential mortgages
- reinsurance (including retrocession) of any other enumerated product.
In order for a state-regulated insurance company to satisfy the “provider test,” the product must be regulated as insurance under applicable state or federal law. Notably, the safe harbor for enumerated products is included as part of the final rules, rather than as an interpretation, as proposed. The final rules also were adopted without the proposed requirement that annuities comply with Section 72 of the Internal Revenue Code in order to qualify as an enumerated product.
Products not specifically enumerated in the safe harbor provisions should be considered in a facts and circumstances analysis.
The final rules clarify that the safe harbor provisions are non-exclusive. Accordingly, any insurance product that does not fall within with safe harbor will require further analysis of the applicable facts and circumstances to determine whether it is insurance or a Swap.
While many traditional insurance products will fall within the safe harbor provisions, others clearly will not. For example, the Commissions specifically declined to expand the list of enumerated products to include guaranteed investment contracts (GIC s), synthetic GIC s, funding agreements, structured settlements, deposit administration contracts, immediate participation guaranty contracts, industry loss warrants, and catastrophe bonds. According to the adopting release, these products should be considered in a facts and circumstances analysis.
GIC s and synthetic GIC s are common forms of “stable value contracts” (SVCs) as defined in Section 719(d) of the Dodd-Frank Act. The Commissions’ pending study of SVCs will likely largely resolve the issue of whether these products are swaps. In connection with the study, the Commissions are required to determine whether SVCs fall within the definition of a swap. If they so determine, the Commissions must then determine whether an exemption for SVCs from the definition is appropriate and issue implementing regulations.
Dodd-Frank also provides that SVCs in effect prior to the effective date of the regulations shall not be considered swaps. Unfortunately, for other insurance products that do not fall within the safe harbor provisions, there may be far less legal certainty as to whether those products should be treated as insurance or Swaps.