Chapter 11 - The Impact of Legislation and Regulation on the Life Insurance Industry

Question 1

2 sources of legislation impacting life insurance

Answer 1

1. Federal level - US Congress - routinely passes laws impacting many aspects of financial services, including life insurance.
2. State level - state legislation are the primary source of insurance legislation, enacting a significant body of legislation that regulates the life insurance industry - including licensing, solvency, and market conduct review.

Question 2

McCarran-Ferguson Act (1945) [US]

Answer 2

Continued regulation and taxation of the insurance by states is in the public’s best interest.

Question 3

Model Acts created by [US]

Answer 3

NAIC - National Association of Insurance Commissioners.

Question 4

Dodd-Frank Act (2009) [US]

Answer 4

Included provisions that created a Federal Insurance Office (FIO) in the Treasury Department. The office will be responsible for international insurance agreements, as well as data collection and research.
Also was a mandate to protect the U.S. financial system from systemic risk presented by financial institutions deemed “too big to fail”.
Financial Stability Oversight Council (FSOC) was established and given broad authority to identify and monitor systemic risks.

Question 5

Systemically Important Financial Institution (SIFI) [US]

Answer 5

When a “non-bank” financial institution has over $50 billion in assets and therefore deemed a systemic risk by FSOC.
There are then under supervision by the Federal Reserve and adhere to stricter standards.

Question 6

International Association of Insurance Supervisors (IAIS) [US]

Answer 6

Emergence after 2008 crisis. The NAIC is now actively collaborating with IAIS collecting and sharing information about global insurance holding companies with the international regulators.

Question 7

Health Insurance Portability and Accountability Act of 1996 (HIPAA) [US]

Answer 7

Designed to improve efficiency in health care through the standardization of electronic data interchange, as well as to provide security measure to protect health information its disclosure.

Question 8

US Department of Health and Human Services (HHS) [US]

Answer 8

Issued regulations in 2003 establishing for the first time, a set of national standard for the protection of certain health information.
Privacy Rule

Question 9

Privacy Rule [US]

Answer 9

Is to assure individuals’ health information is property protected while allowing the flow of health information needed to provide and promote high quality health care and to protect the public’s health and well being.
Protects all “individually identifiable health information” held or transmitted by a covered entity or its business associate in any form of media - referred to as protected health information (PHI)

Question 10

Privacy rule includes demographic data that [US]

Answer 10

1. related to the individual’s past, present or future physical or mental health condition.
2. Related to the provision of health care to the individual.
3. Relates to past, present, or future payments for the provision of health care to the individual.
4. Identifies the individual or for which there is a reasonable basis to believe it can be used to identify the individual.
5. Include any common identifier (e.g., name, address, DOB, SIN)

Question 11

Canadian Life and Health Insurance Association Inc (CLHIA)

Answer 11

Developed a comprehensive set of privacy guidelines and in 1980 the Ontario legislature decreed that all life and accident and sickness carriers must follow the guidelines if they want to do business in Ontario.

Question 12

Notification and Consent [Canada]

Answer 12

Authorization means can be employed to collect personal information and that prior to collection the data from a source other than the person in question, the individual must be notified or his authorization must be secured.

Question 13

Personal Information Protection and Electronic Documents Act (PIPEDA_

Answer 13

Established ground rules for how private sector organization can collect, use or disclose personal information in the course of commercial activities. The law gives individuals the right to access and request correction of the personal information these organization have collected about them.

Question 14

Consumer Reporting Act (CRA)

Answer 14

Also plays a significant role in regulating the collection of information in the underwriting process at the provincial level. Specific information cannot be included unless it is well documented with reasonable efforts made to corroborate the information.

Question 15

Quebec Bill 68

Answer 15

Legislation to protect personal information. It establishes specific rules regarding notification, disclosure, and accuracy in the collection of personal information in the underwriting process.

Question 16

USA PATRIOT Act

Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act.

Answer 16

Enhances the authority of US law enforcement for the stated purpose of investigating and pre-empting potential terrorist acts against the US.
Requires certain insurance companies such as providers of life insurance and annuity products to establish formal anti-money laundering (AML) programs.

Question 17

AML Regulations - Definition of Insurance company

Answer 17

1. the issuing, underwriting, or reinsuring of a life insurance policy
2. the issuing, granting, purchasing, or disposing of any annuity contract, or
3. the issuing, underwriting, or reinsuring of any insurance product with investment features similar to those of a life insurance policy or annuity contract, or which can be used to store value and transfer that value to another person.

Question 18

Any insurance company that falls into the AML insurance company definition must establish an AML program that includes, at a minimum

Answer 18

1. the development of internal policies, procedures, and controls
2. the designation of a compliance officer
3. an ongoing employee training program
4. an independent audit function to test the program.

Question 19

Stranger Owned Life Insurance (SOLI or STOLI) or investor owned life insurance (IOLI) steps

Answer 19

1. An individual is solicited with an offer of “free insurance for short duration, typically 2-3 years
2. The individual purchases life insurance policy directly, through a trust or business entity such as limited liability corporation (LLC) or partnership using no-recourse (non-collateralized) or hybrid (partially collateralized) financing of all premiums and accrued interest.
3. As an enticement to enter into the transaction, the individual is often paid an upfront “participation” fee that can be quite significant.
4. When the loan taken to pay the premiums matures, the individual is given 3 choices
   a. keep the policy by repaying the accumulated loan balance.
   b. Relinquish the policy to the lender in satisfaction of the debt
   c. sell the policy on the open market for cash to a life settlement company, repay the loan balance and pocket the difference.

Question 20

Stranger Owned Life Insurance (SOLI or STOLI) or investor owned life insurance (IOLI)

Answer 20

In virtually all of these programs the intent of all the parties to the transaction is to sell the policy in a life settlement transaction when the loan matures. While the transaction is initially made to look like there is an ongoing and underlying need for the insurance coverage, the financing is merely a bridge to the life settlement market.

Question 21

Issues in STOLI Transactions

Answer 21

1. Lack of insurable interest
2. Shifting Legal Landscape
3. Is the Loan a “Bona Fide” Loan
4. Hybrid Financing
5. Insurance Capacity
6. SEC/NASD Action
7. Rebating
8. Legal Complexity
9. Health/Privacy Issues
10. Discrimination
11. Congressional Action Regarding the Tax Treatment of Life Insurance
12. Fraud

Question 22

Issues in STOLI Transactions - Lack of insurance interest

Answer 22

The initial sale of the life insured policy is structured to meet the technical state law requirements of insurable interest while the policy is issued, the subsequent sale in the life settlement market results in the policy being owned by an investor that profits when the insured diets.
In Canada - ULIA (Uniform Life Insurance Act) contain specific rules on when “insurable interest” arises in Canada.

Question 23

Issues in STOLI Transactions - Shifting Legal Landscape

Answer 23

Many states have come to view STOLI transactions as not in the best interest of the citizens of the state and have enacted law placing tighter control on this type of sale. Several states have declared these transactions to be illegal. In civil courts, insurance companies are regularly filing suits have STOLI policies declared void from inception on the basis of misrep and fraud.

Question 24

Issues in STOLI Transactions - Is the Loan a “Bona Fide” Loan?

Answer 24

If the IRS determines that there is no repayment risk to the “lender” because the life settlement is a foregone conclusion, the “loan” could be recharacterized as something other than a loan. If the loan could be characterized as compensation income, this could be a significant planning concern.

Question 25

Issues in STOLI Transactions - Hybrid Financing

Answer 25

The accretive impact of continuously compounding interest will inevitably result in the hybrid financial structure become economically unfeasible prior to the payment of death proceeds. The contract owner is face with the choice of liquidating invested collateral assets or settling the contract.

Question 26

Issues in STOLI Transactions - Insurance Capacity

Answer 26

Those who participate in STOLI programs can unknowingly diminish their future ability to obtain insurance coverage. Insurance companies take into account on in force coverage.

Question 27

Issues in STOLI Transactions - SEC/NASD Action

Answer 27

Policies are being financed and packaged for sale to investors such as domestic and offshore hedge funds, overseas pension, and investment syndicates. Should the package be deemed a security and laws passed.

Question 28

Issues in STOLI Transactions - Rebating

Answer 28

Programs that promise a “participation” fee or provide a period of “free” insurance protection (as no out of pocket expense) can constitute a rebate if:

1. offer an advantage or benefit to a proposed insured not contained in the insurance policy
2. Offer a method of purchasing coverage that is not presented to similarly situated clients.
   * * could be deemed to be taxable income to the insured **

Question 29

Issues in STOLI Transactions - Legal Complexity

Answer 29

Utilize complicated and lengthy legal documents that raise a host of legal and financial issues (e.g., tax implications the insured) that participants need to understand at the time they enter into the transaction.

Question 30

Issues in STOLI Transactions - Health/Privacy Issues

Answer 30

STOLI programs contractually require the insured to provide information regarding health to investors and lenders.

Question 31

Issues in STOLI Transactions - Discrimination

Answer 31

If the sale of life insurance through STOLI programs is targeted at a specific age group, state insurance regulators could say that it is discriminatory and an unfair trade practice.

Question 32

Issues in STOLI Transactions - Congressional Action Regarding the Tax Treatment of Life Insurance

Answer 32

Preferential tax treatment for life insurance.

There is a concern that Congress could take away the tax advantage that make the product so attractive.

Question 33

Issues in STOLI Transactions - Fraud

Answer 33

The lure of such relatively rich compensation for first years premiums has led to highly inflated face amounts, the creation and submission of fraudulent financial documentation, the creation of “master trusts” to mask the transfer of ownership at the time of settlement, and the use of elaborate seminar sales techniques targeting the geriatric population.

Question 34

Charity Owned Life Insurance (CHOLI)

Answer 34

The loan proceeds being used to finance a large block of charitable owned life insurance, either on donors; lives or on lives of parties, unrelated to the charity, who “donate” their insurability to the charity. In some cases, single premium immediate annuities (SPIAs) will be purchased with the loan proceeds.
Insurable interest becomes a problem.

Question 35

Corporate Owned Life Insurance (COLI)

Answer 35

Many corporations have purchased COLI to fund post-retirement benefit liability such as nonqualified deferred compensation and post-retirement medical plans for their key employees.
Viewed as an attractive investment because the policy’s cash values accumulate income tax free and the death benefit proceeds are income tax free.
Insurable interest is a concern. In the early 2000s companies were placing policies on low ranking employees without their knowledge. Dubbed the “dead peasant” insurance.

Question 36

COLI Legislation

Answer 36

1. Restrict COLI To a limited class of highly compensated employees
2. Require employers to provide notice to insured employees and obtain employees’ written consent to be insured.
3. Establish disclosure and record keeping requirements for businesses holding COLI policies
4. Impose a tax on COLI policy death benefit if these requirements were not met.
   * * Incorporated into the Pension Protection Act of 2006 **

Question 37

COLI - Governor of Washington

Answer 37

Signed legislation that states:

1. An employer-owner life insurance policy cannot be made or take effect unless at the time the contract is made the individual insured consents to the contract in writing.
2. An employer cannot retaliate in any manger against an employee for providing written notice that he or she does not want to be insured under an employer-owned life insurance policy.

Question 38

Viatical vs Senior Settlements

Answer 38

Viatical - the purchase of a policy on the life of someone who is terminally ill or chronically ill.
Life settlement or senior settlement involve the purchase of policies on the lives of insured’s who are typically elderly but neither terminally ill nor chronically ill.

Question 39

Viatical vs Senior Settlements - Laws

Answer 39

Shortly after the adoption of the NAIC Viatical Settlement Model, the National Council of Insurance Legislators (NCOIL) adopted a Life Settlement Model act.

Question 40

Secondary Guaranty

Answer 40

Keeps an insurance policy in force and guarantees the death benefit, even when the policy would otherwise lapse because of a lack of cash value, when certain contractual requirements are met. The two most prevalent methods of providing secondary guarantees are specified premium guarantees and shadow accounts.

Question 41

Secondary Guaranty - Specified premium guarantee

Answer 41

Provides policyholders with a guaranteed death benefit as long as the policy owner pays a specified premium each year.

Question 42

Secondary Guaranty - Shadow Account

Answer 42

An alternative or hypothetical account value is calculated using an alternative set of expense charges, costs of insurance, and interest. Both methods allow for the early and late payment of required premiums and can be quite attractive to clients looking for guarantees.

Question 43

Regulation XXX

Answer 43

Adopted by many and requires companies to increase reserves for secondary guarantee features found on UL policies.

Question 44

Regulation AXXX

Answer 44

Increased the reserving requirements for secondary guarantees using the shadow account approach as well as for specified premium guarantees that are pre-funded.

Question 45

Retaliatory premium taxes

Answer 45

Example - states with low premium tax rates can impose a retaliatory tax against insurance companies from high premium tax states who are conducting business in a low premium tax state.

Question 46

Underwriting Issues

Answer 46

1. Travel

2. Genetic Testing

Question 47

Underwriting Issues - Travel

Answer 47

Unfair Trade Practices Standard - in some states legislation is written in a far more restrictive manner, designed to limit or prevent adverse underwriting actions related to travel under certain circumstances.

Question 48

NAIC adopted travel underwriting guidelines that amend the NAIC model Unfair Trade Practices Act

Answer 48

The guidelines make it an at of unfair discrimination to “refuse life insurance… based on an individual’s past lawful travel experience. With respect to future travel, adverse activities can be permitted if “risk of loss for individuals who travel to a specified location at a specified time is reasonably anticipated to be greater than if the individual did not travel to that destination at that time; and the risk classification is based on sound actuarial principles and actual and reasonably anticipated experience.

Question 49

Underwriting Issues - Genetic Testing Legislation

Answer 49

1. Genetic information Non Discrimination Act (GINA) - federal genetic testing law. The legislation intent clearly indicates that the law does not apply to life, disability or LTC insurance.
2. State genetic testing underwriting laws - Focused on restrictions related to health insurance and testing in the insurance environment
3. The Uniform Law Commission (ULC) - now discontinued consideration of the “Protection of Generic Information in Employment and Insurance Model Act”.

Question 50

The drive to consolidate can be d/t a # of factors including

Answer 50

1. Desire to expand distribution beyond that which is capable through organic growth
2. Desire to boost shareholder value
3. Desire to fend off hostile takeover attacks by increasing market capitalization
4. Drive to enter markets not currently served
5. Desire to reduce operating expenses
6. Need to increase Capital

Question 51

Three ways life insurance companies can do business

Answer 51

1. Stock company (The stockholders own the company)
2. Mutual company (policy holders own the company)
3. Mutual holding company (MHC)

Question 52

Securities Act of 1933 and the Securities Exchange Act of 1934 - Main purpose of laws

Answer 52

1. Companies publicly offering securities for investment dollar must tell the public the trust about their business the securities they are selling and the risks involved in investing.
2. People who sell and trade securities - brokers, dealers, and exchanges - must treat investors fairly and honestly, putting investors interests first.

Question 53

Primary Mission of SEC

Answer 53

To protect investors and maintain the integrity of the securities market.

Question 54

SEC - typical infractions

Answer 54

Trading
Accounting fraud
Providing false or misleading information about securities and the companies that issue them.

Question 55

Financial Industry Regulatory Authority (FINRA)

Answer 55

Dedicated to investor protection and market integrity through effective and efficient regulation and complementary compliance and technology based -services.
Licenses individuals and admits firms to the industry, writes rules to govern their behaviour, examines them for regulatory compliance, and disciplines those who fail to comply.
Oversees and regulars trading in equities, corporate bonds, securities future and options, and provides education and qualification exams to industry progressions while supporting securities firm in their compliance activities.

Question 56

FINRA touches the life insurance business in many ways including

Answer 56

1. A producer must successfully pass an exam to become FINRA registered before selling variable insurance product
2. Certain marketing material must be files with FINRA before they can be used with the public
3. The prospectus that must accompany the sale of variable product must typically be reviewed and approved by FINRA in advance of sale.
4. FINRA has jurisdiction over AML activities of life insurance companies and can enforce actions against life insurance producers that sell registered products as well as the insurance carrier themselves.
5. FINRA promulgates rules governing the suitability of registered products - ensuring product recommendations are suitable for purchaser given their financial background.