Insurance Topics We Will Be Watching in 2015

Eversheds Sutherland (US) LLP

With the first month of the year behind us, this report outlines major insurance topics that we will be watching throughout 2015.


Forces, trends and events that we believe will affect regulation, transactions and litigation in the insurance industry during the coming year include:


  • Refinement of U.S. regulators’ approach to group-wide supervision, the development of international capital standards and the U.S. response.
  • Continuing uncertainty concerning the contours of U.S. federal regulation of the insurance industry, particularly as influenced by recent state and federal electoral changes.
  • The impact of alternative capital on the insurance sector with regard to both merger and acquisition activity and capital markets alternatives to traditional reinsurance and insurance.
  • Continued tailoring of products by insurance companies to meet consumer demand and the regulatory and litigation responses to new product disclosures.
  • Incremental progress towards comprehensive federal tax reform and industry response to executive and legislative proposals.
  • Ever-increasing threats from cyber-attack, with data security breaches occurring with greater frequency and severity.

For the reasons indicated in greater detail in the various sections of this report, we expect:


  • If currently prevailing economic conditions continue, momentum in the merger and acquisition sector will continue, although likely not at a breakneck pace.
  • Life insurance companies will be more cautious when entering into reserve financing transactions with captive subsidiaries due to the adoption of new actuarial guidelines for these transactions.
  • In the products space, it is likely that indexed products will be developed and offered by more U.S. life insurers, and the National Association of Insurance Commissioners (NAIC) will likely finalize a framework for indexed universal life products illustrations and make considerable progress on its initiatives relating to contingent deferred annuities.
  • Insurance company IPO and debt issuance activity will continue, barring negative macro-economic or global surprises.
  • The trend of U.S. corporate pension sponsors de-risking through annuity purchases or lump-sum payments will continue, not only for large funds, but also for mid-sized and smaller funds.
  • We will likely see significant developments with regard to life insurers’ unclaimed property settlements, regulation, legislation and litigation.
  • Insurance companies will face greater pressure from regulators to demonstrate they have taken adequate measures to safeguard protected customer information, with a resulting increase in targeted examinations, data calls, investigations and penalties for inadequate controls.

We have addressed each of these topics and others in this report.



Group Supervision


The NAIC Group Solvency Issues (E) Working Group worked quickly in 2014 to consider changes to the Model Insurance Holding Company System Regulatory Act (Model HCA) that would give express authority to state insurance commissioners to act as group-wide supervisors for internationally active insurance groups (IAIGs). This work was propelled by the NAIC’s desire to dodge further criticism of the U.S. state-based system of insurance regulation due to the absence of legal authority to supervise groups, a concept embedded in the International Association of Insurance Supervisors (IAIS) Insurance Core Principles (ICPs) that are being used as the basis for evaluating the adequacy of the U.S. regulatory framework under the Financial Sector Assessment Program (FSAP). The next FSAP review of the U.S. financial sector is expected to be completed in 2015. The proposed group-wide supervisor changes to the Model HCA received much industry comment and were formally adopted at the final 2014 meeting of the NAIC Executive Committee/Plenary. Certain 2010 amendments to the Model HCA addressed other perceived weaknesses in the regulation of insurance holding company systems, particularly with respect to enterprise risk management (ERM), that were highlighted during the 2008 financial crisis. The 2010 Model HCA amendments are required for NAIC state accreditation beginning 2016, whereas the additional 2014 group-wide supervisor amendments are not yet part of the NAIC accreditation requirements and will move forward on a parallel track.


Under the group-wide supervisor changes to the Model HCA, state insurance commissioners are authorized to act as group-wide supervisors for IAIGs that meet the following criteria: (a) the group writes premiums in at least three countries, (b) the percentage of gross premiums written outside the United States is at least 10% of the insurance holding company system’s total gross written premiums, and (c) based on a three-year rolling average, the total assets of the insurance holding company system are at least $50 billion, or the total gross written premiums of the insurance holding company system are at least $10 billion. An insurance holding company system that does not otherwise qualify as an IAIG may request that the commissioner make a determination or acknowledgment as to a group-wide supervisor for the group. The powers and responsibilities of the group-wide supervisor under the amendments consist nearly entirely of information gathering and analysis and coordination among interested regulators.


ORSA and Group Capital Standards


Also on the group supervision front, 21 states have adopted the Risk Management and Own Risk and Solvency Assessment Model Act (ORSA Model Act) since it was adopted by the NAIC in September 2012. January 1, 2015 ended the one-year comment period related to consideration of the ORSA Model Act as a state accreditation standard beginning in 2017. Meant to complement legal-entity, risk-based capital (RBC) requirements, ORSA reporting is scheduled to be required beginning January 1, 2015, in those states that have adopted the ORSA Model Act as of that date. Insurers will be required to conduct stress testing and reviews of their risk management systems at both the insurance entity and consolidated group levels and to report the results to state regulators. According to the ORSA Guidance Manual, which was completed in 2014, one of the two primary goals is “[t]o provide a group-level perspective on risk and capital, as a supplement to the existing legal entity view.” The other is to foster an effective level of ERM at all insurers. While Section 3 of the ORSA Guidance Manual requires a group risk capital assessment, the NAIC has repeatedly affirmed its position that any group capital requirements must only be in addition to, and not a replacement for, traditional RBC requirements that apply at the legal-entity level.


In 2014, insurers won a much-anticipated concession concerning the enhanced supervision that the Dodd-Frank Act mandates the Federal Reserve Board (FRB) apply to insurers that have been designated as non-bank systemically important financial institutions (SIFIs) by the Financial Stability Oversight Council (FSOC). The Insurance Capital Standards Clarification Act of 2014, which became law on December 18, 2014, exempts insurance companies from the minimum leverage capital requirements and minimum risk-based capital requirements applicable to bank holding companies and other non-bank financial companies supervised by the FRB. The act garnered widespread bipartisan support in an atmosphere where some representatives have accused the FSOC of acting without sufficient transparency and not publishing rules tailored to non-bank SIFIs.


On October 23, 2014, the International Association of Insurance Supervisors (IAIS) published Basic Capital Requirements (BCR) for all Global Systemically Important Insurers (G-SIIs). In 2015, G-SIIs will begin to report the BCR on a confidential basis to group-wide supervisors. Additionally, Higher Loss Absorbency (HLA) requirements for all G-SIIs are scheduled to be completed by the end of 2015 and will apply to G-SIIs beginning 2019. These HLA requirements will build on BCR and address additional capital requirements for G-SIIs that reflect their systemic importance. The consultation document on HLA is expected to be released by mid-2015.


The IAIS has also begun public consultation on the development of its risk-based, global Insurance Capital Standard (ICS) for all IAIGs, with an initial response deadline of February 16, 2015. ICS is intended to be completed by the end of 2016 and applied to IAIGs from 2019 after refinement and final calibration in 2017 and 2018. Once finalized, ICS will become a component of the Common Framework for the Supervision of IAIGs (ComFrame) and will replace BCR as the foundation for the HLA requirements applicable to G-SIIs.

ComFrame is built and expands upon the high-level requirements and guidance currently set forth in the IAIS Insurance Core Principles, which generally apply on both a legal-entity and a group-wide level. ComFrame is primarily intended to be a framework for supervisors to efficiently and effectively cooperate and coordinate by providing a basis for comparability of IAIG regulation and supervisory processes. The IAIS released a revised version of ComFrame in September 2014 and expects that jurisdictions will begin implementing ComFrame in 2018.


The IAIS Field Testing Task Force (FTTF) is tasked with (i) performing impact studies to test whether ComFrame promotes effective group-wide supervision of IAIGs and whether the elements lead to practical benefits without undue burden, and (ii) assessing the results of such field testing to determine any changes that are necessary to the draft ComFrame. Field testing will include three modules: identification of IAIGs, scope of supervision and identification of group-wide supervisors (Module 1); qualitative and quantitative requirements for IAIGs (Module 2); and requirements for supervisors and the use of supervisory colleges (Module 3). FTTF began quantitative field testing in March 2014 under the previous draft ComFrame, with 30 IAIGs agreeing to participate in the first round of testing. Quantitative testing focuses on capital and solvency requirements. Qualitative field testing, which began after release of the September 2014 draft, focuses on governance and enterprise risk issues.


Expected to be effective from January 1, 2016, Solvency II passed a milestone in 2014 when, on October 10, 2014, the European Commission adopted a regulation containing implementing rules for the new regime, which will enter into force upon the approval by the European Parliament and Council. Solvency II applies to almost all European Union (EU) insurers and reinsurers on a group-wide basis, including groups headed by non-insurance related parents, which need to meet certain financial conglomerate requirements. Some flexibility is given to groups with ultimate parents outside the EU relating to worldwide supervision. In 2014, the European Insurance and Occupational Pensions Authority began drafting the required implementing technical standards and guidelines and will continue to do so in 2015.


Solvency II requires European insurers to calculate both a Minimum Capital Requirement (MCR) and a Solvency Capital Requirement (SCR), where SCR is more risk-focused than MCR. Supervisory action is required if an insurer’s financial resources fall below SCR with an aim of restoring capital to meet SCR as soon as possible. If resources fall below MCR, then “ultimate supervisory action” will be triggered (i.e., the insurer’s liabilities will be transferred to another insurer, and the license of the insurer will be withdrawn or the insurer will be closed to new business and its in-force business will be liquidated). Any additional capital charge will be applied to insurers that fail to adequately match their investments and capital to their liabilities.


Reinsurance Collateral


During the fall national meeting of the National Association of Insurance Commissioners (NAIC), it was reported that 23 states representing more than 60% of direct insurance premiums have adopted the revised Credit for Reinsurance Model Law and Regulation (Reinsurance Models), and five additional states are expected to adopt the revised Reinsurance Models in 2015, bringing the total direct insurance premiums of adopting states to more than 80% of the U.S. total. The revised Reinsurance Models allow highly rated, non-U.S. reinsurers to reinsure U.S. domestic cedents with reduced collateral. On December 16, 2014, the NAIC approved seven “Qualified Jurisdictions” for purposes of the Reinsurance Models (Bermuda, France, Germany, Ireland, Japan, Switzerland, and the United Kingdom) in connection with the reduced collateral requirements. The NAIC has been acting quickly on the approval of Qualified Jurisdictions in order to obviate the need for “covered agreements” between the United States and foreign countries that would preempt State authority. Industry critics of state law requirements for reinsurance collateral have pointed out that the reduced collateral provisions of the revised Reinsurance Models are optional and that unless states are required to adopt these provisions, the lack of uniformity among states with regard to reinsurance collateral requirements will persist, inviting federal action.


At the federal level, in December 2014, the Federal Insurance Office (FIO) issued its long overdue report entitled, “The Breadth And Scope Of The Global Reinsurance Market And The Critical Role Such Market Plays In Supporting Insurance In The United States” (Reinsurance Report). In the Reinsurance Report, FIO indicates that reinsurance collateral continues to be at the forefront of its thinking with regard to potential direct federal involvement in insurance regulation. Specifically, the Reinsurance Report argues that “federal officials are well-positioned to make determinations regarding whether a foreign jurisdiction has sufficiently effective regulation and, in doing so, consider other prudential issues pending in the United States and between the United States and affected foreign jurisdictions” and notes that work continues towards initiating negotiations for covered agreements with leading reinsurance jurisdictions that may have the effect of preempting inconsistent state laws. This echoes statements in FIO’s 2014 annual report to Congress in which it notes the lack of uniformity in state insurance law collateral requirements for non-U.S. reinsurers despite NAIC efforts and reasserts its prior recommendation that the Treasury Secretary and the U.S. Trade Representative should negotiate and enter into bilateral “covered agreements” with foreign regulatory authorities regarding prudential measures with respect to the business of insurance or reinsurance. Among the possible game-changing developments that could emerge during 2015 is one or more proposed “covered agreements” with major U.S. trading partners (including possibly the entirety of the European Union) that trade collateral reduction—and possibly more—for recognition of the U.S. system of insurance regulation as equivalent.


Federal Designation of SIFIs


On December 18, 2014, the FSOC designated MetLife Inc. as a non-bank SIFI, bringing the total non-bank SIFI designations to four (the others are American International Group Inc., Prudential Financial Inc., and General Electric Co.’s finance unit). On January 13, 2015, MetLife Inc. filed suit seeking to overturn its designation—the first such company to do so. Among other things, MetLife Inc. argued in its complaint that the FSOC’s conclusion was arbitrary and capricious for relying “on vague standards and assertions, unsubstantiated speculation, and unreasonable assumptions that are inconsistent with historical experience (including prevailing conditions in the 2008 financial crisis), basic economic teachings, and accepted principles of risk analysis.” The case will be watched closely as a first test of the growing reach of U.S. federal regulation of insurance.


The FSOC itself has been reviewing its own procedures with regard to labeling both bank and non-bank SIFIs, and on February 4, 2015, voted to adopt certain staff recommendations, including earlier and more detailed disclosures with regard to companies under review for systemic importance, as well as additional opportunities to have their names removed from the list of designated SIFIs. These changes may influence the drafting of the as yet unpublished rules for non-bank SIFIs.


Terrorism Risk Insurance Act


After the last Congress allowed the Terrorism Risk Insurance Act of 2002 (TRIA) to expire at the end of 2014, the new Congress reauthorized it as one of its first items of business, and the Federal terrorism backstop has now been extended through 2020.


TRIA was initially enacted to address the near-complete withdrawal of private terrorism coverage following the September 11, 2001, terrorist attacks and provides commercial property and casualty insurers access to a federal backstop for certain large terrorism events. The trade-off for the backstop is that insurers of certain “covered lines” must make coverage available for losses resulting from certified acts of terrorism. TRIA was originally designed as a temporary program to be in place for several years while a private terrorism coverage market developed. After an initial two-year extension in 2005, TRIA was last reauthorized in 2007.

TRIA’s reauthorization includes certain changes from the prior TRIA program. Key features of the program extension include:


  • The definitions of covered terrorism events and covered lines of insurance remain unchanged. The process for certifying an act of terrorism has changed to require certification by the Treasury Secretary after consulting with the Secretary of Homeland Security and Attorney General. The Treasury Secretary is required to adopt rules governing the certification process, including establishing a timeline for certifying an act of terrorism.
  • Beginning on January 1, 2016, the program trigger amount (the amount of total losses needed for the TRIA program to kick in) will increase from $100 million to $200 million, in $20 million increments each year.
  • The insurer retention remains unchanged at 20% of the prior year’s direct earned premiums for covered lines.
  • Beginning on January 1, 2016, the insurer co-pay, currently set at 15%, will raise 1% each year until reaching 20% in 2020.
  • Beginning on January 1, 2016, the mandatory recoupment threshold will increase by $2 billion per year, from $27.5 billion to $37.5 billion. Until aggregate losses reach this threshold, TRIA provides that federal payments must be recouped (this recoupment is accomplished by the imposition of surcharges on commercial property/casualty policies). In addition to the increase in the recoupment threshold, the recoupment total will also increase from 133% of federal payments to 140% of federal payments.

TRIA’s reauthorization does not provide an exemption for small insurers (as was proposed in prior draft TRIA reauthorization legislation), but it does provide that Treasury will conduct an annual study, the first to be conducted no later than June 30, 2017, of competitive challenges faced by small insurers participating in the program, the results of which will be submitted to Congress. In addition, the Comptroller General of the United States must conduct a study on the viability and effects of (i) requiring insurers to pay upfront premiums for TRIA coverage and (ii) establishing a capital reserve fund under TRIA.


TRIA was reauthorized on January 12, 2015, and is not specifically retroactive to January 1. As a result, there is a 12-day gap in the “make available” requirement. On January 28 and February 4, Treasury issued interim guidance stating that Treasury “expects” insurers to make a new offer of terrorism coverage with respect to any in-force policy that does not provide coverage (with limited exceptions). It is unclear what consequences could ensue for an insurer that fails to satisfy Treasury’s expectation.


National Producer Licensing


After many years of struggle, early 2015 saw Congress enact legislation to establish a national clearinghouse for insurance producers. Title II of H.R. 26 (Title II), entitled the “National Association of Registered Agents and Brokers Reform Act of 2015” provides for the establishment of the National Association of Registered Agents and Brokers (NARAB) The stated purpose of the legislation is to provide “a mechanism through which licensing, continuing education, and other nonresident insurance producer qualification requirements and conditions may be adopted and applied on a multi-state basis without affecting the laws, rules, and regulations, and preserving the rights of a State, pertaining to” certain specific producer-related conduct.


NARAB functions as a membership organization in which a licensed insurance producer (either an individual or business entity) may apply to become a member. To be a member, an insurance producer must be licensed in at least one state. Once a producer becomes a NARAB member, the member will then be authorized to act as a producer in any state for which the required fee has been paid. Individual state requirements for licensing of nonresidents are displaced by membership in NARAB, but states will have continuing authority for licensing, continuing education and qualification requirements for resident insurance producers and insurance producers that are not members of NARAB. They will also retain authority over licensing fees, appointment requirements, and supervising and disciplining producers for their conduct.


The statute provides only a high-level structure for membership criteria, or ineligibility for membership, and indicates that NARAB may “establish membership criteria that bear a reasonable relationship to the purposes for which [NARAB] was established.” It is contemplated that there would be separate categories of membership for insurance producers based on the licensing categories included under state law.


NARAB will be formed as a nonprofit corporation subject to the District of Columbia Nonprofit Corporation Act. It will be managed by a 13-person board of directors appointed by the President with the advice and consent of the Senate. The board has a designated composition as follows:


  • Eight state insurance commissioners (one of whom will serve as chairperson);
  • Three members with expertise in property and casualty insurance producer licensing; and
  • Two members with expertise in life or health insurance producer licensing.

The President has 90 days from enactment to appoint the board (deadline is early April). The board then has to establish the association's rules and procedures for membership. At this point, the timeline for operation is not clear, but it seems likely that producers will not become members any time before 2016 at the earliest. As NARAB begins to form, it remains to be seen how it will meet its goals. Key issues to be resolved include:


  • Will the appointments to serve on the board of NARAB be timely made?
  • Will the preserved states’ rights be easy to determine and navigate as we move into the “weeds” of NARAB’s implementation?
  • Will producers, particularly established business entity producers, embrace the opportunity to move from their existing multistate licensing structure and apply for membership in NARAB?
  • How burdensome will the membership process be under NARAB rules?

Standard of Care of Insurance Intermediaries for SEC-Registered Products


While there have been no “sea changes” with respect to the duty of care imposed on insurance intermediaries distributing insurance products, we will continue to monitor this area with interest as a result of a number of different factors. First, the regulatory suitability obligations imposed on the sale of annuity products are now becoming more established. It remains to be seen whether that initiative might lead to increased consideration of imposing a regulatory suitability duty on producers selling other insurance products, such as life insurance. Second, the debate about potentially imposing a fiduciary duty on securities salespersons (i.e., broker-dealers and their registered persons), is moving forward apace as a result of certain rulemaking authority granted to the Securities and Exchange Commission (SEC) under the Dodd-Frank Act. The SEC Chair, Mary Jo White, seems to have indicated in public comments in 2014 and early 2015 that she wants to move towards resolution on whether or not to move to a fiduciary duty standard in 2015. It is possible that the resolution of that issue, in either direction, could have an impact on possible movement of the standard of care for insurance intermediaries in 2015.


Life Insurance Reserve Financing Transactions and Life Reinsurance Captives


AG 48: History and Application


Following a period of uncertainty surrounding regulations relating to transactions involving life insurer-owned captives and special purpose vehicles, 2014 brought some degree of clarity. On December 16, 2014, the NAIC Executive Committee and Plenary adopted Actuarial Guideline XL VIII (AG 48), which sets forth new actuarial rules regarding the amount and type of security required to support new life reserve reinsurance financing transactions that are not grandfathered after a January 1, 2015, effective date. Because reserves reported in NAIC blanks must be supported by an actuarial opinion that follows AG 48 guidance, AG 48 is in force without the need for state adoption.


Subject to certain exemptions, AG 48 prescribes a required actuarial analysis on each non-exempt reinsurance agreement involving certain policies to determine whether (a) funds consisting of “Primary Security” are held by or on behalf of the ceding insurer as security under the reinsurance contract in an amount at least equal to the “Required Level of Primary Security,” and (b) funds consisting of “Other Security” are held by or on behalf of the ceding insurer in an amount at least equal to the portion of the statutory reserves in excess of the Required Level of Primary Security. Primary security includes only cash and Securities Valuation Office-listed securities, excluding any synthetic letter of credit, contingent note, credit-linked note or other similar letter of credit-like securities. If held as funds withheld by the ceding company, primary security could include policy loans, certain commercial loans and derivatives hedging the risks under the reinsured policies. What constitutes “Other Security” is an open question and will be determined on a case-by-case basis by the commissioner of the ceding company’s domiciliary state. In addition, the RBC asset charge applicable to any “Other Security” has yet to be determined by regulators.


Under AG 48, the appointed actuary of the ceding company (or in some cases, the affiliated reinsurer) must review any non-exempt XXX or AXXX reinsurance transaction and, if the transaction does not follow the rules under AG 48, the actuary must render a qualified actuarial opinion. AG 48 is intended to bridge the gap between now and when the states have adopted revised credit for reinsurance laws and regulations consistent with AG 48.


NAIC Working Group Charges


NAIC working groups have been charged with a variety of tasks in 2015 that will have further impact on reserve financing transactions. The NAIC’s Reinsurance Task Force has been charged with creating a new model regulation to establish requirements regarding the reinsurance of XXX/AXXX policies (which is expected to closely track AG 48) and amending the Credit for Reinsurance Model Act to incorporate this new regulation. In addition, the NAIC’s Life RBC Working Group has been working on RBC Proposal Forms addressing the following three charges: (1) to develop an appropriate “RBC cushion” for an insurer ceding XXX/AXXX policies to an assuming reinsurer that does not file an RBC report using the NAIC RBC formula and instructions; (2) to develop appropriate asset charges for the forms of “Other Security” used by insurers under the XXX/AXXX Reinsurance Model Regulation (which might then be considered for incorporation into the RBC cushion developed under (1) above); and (3) to determine whether the current RBC C-3 treatment of “qualified” actuarial opinions is adequate with respect to the risk of XXX/AXXX reinsurance transactions that receive qualified actuarial opinions. The RBC Working Group is looking to adopt all three proposal forms no later than April 30, 2015.


In its current form, AG 48 is not limited to affiliated reinsurance transactions. As a result, on its face AG 48 applies to any XXX/AXXX reinsurance transaction involving a third party. Traditionally, an unaffiliated third party, if not admitted in the ceding company’s jurisdiction, could post an unconditional letter of credit to collateralize the full statutory reserve and provide the ceding company with full reserve credit. Under AG 48, however, the ceding company’s appointed actuary would be required to render a qualified actuarial opinion under these circumstances unless the transaction is specifically exempted by the ceding company’s domiciliary regulator. In revising the credit for reinsurance laws and regulations to reflect the recommendations in AG 48, the NAIC and state regulators should consider clarifying this issue.


Beyond AG 48: “Accreditation Proposal”


While AG 48 provides a step forward in regulating XXX/AXXX reinsurance transactions uniformly, its scope is limited to life insurance policies that have XXX or AXXX reserves. During the NAIC fall national meeting, the Financial Regulation Standards and Accreditation (F) Committee again discussed whether the definition of “multistate insurer” should be included in the NAIC Accreditation Program Manual. Inclusion of this definition in the accreditation standards would essentially make it harder, if not impossible, for captive transactions to cover life or annuity products. The initial “multistate insurer” definition introduced in March 2014 met strong opposition from state insurance regulators and interested parties because of its broad reach. A revised “multi-state insurer” definition is currently being drafted and potentially covers (i) XXX/AXXX policies, (ii) variable annuities valued under AG 43, and (iii) long-term care insurance valued under NAIC Health Insurance Reserves Model Regulation 10. The scope of the “multi-state insurer” definition is unclear, and we will closely monitor its development in 2015, as it will affect captive transactions for variable annuity and long-term care products.


New York Action


Although steadfast in its opposition to life insurance captive transactions, the New York Department of Financial Services (NYDFS) nevertheless has recognized that level premium term products and universal life policies with secondary guarantees (ULSG) contain an excess layer of reserves. In an effort to minimize the use of captive transactions, the NYDFS in 2014 implemented a revised reserving formula for level premium term products, reducing prospectively the reserves for such policies written on and after January 1, 2015, by 30 to 35%. In a February 4, 2015, letter to the NAIC, the NYDFS proposed modifications to the ULSG reserving formula, proposing to reduce reserves for ULSG policies issued on and after January 1, 2015, by up to 15%. These efforts will only help insurers that write those products in New York and provides no relief to the insurers with XXX/AXXX policies issued outside of New York.




With the adoption of AG 48, the types of reserve financing transactions that have become commonplace over the last several years may now only be used for the refinancing of existing transactions relating to policies issued prior to 2015 that are grandfathered. AG 48 does prescribe parameters for new financing transactions, but it remains to be seen whether it will be economically viable to engage in AG 48-compliant captive financing transactions. New models for these transactions have yet to be developed, and the definition of “Other Security” and the RBC charge applicable to “Other Security” remain to be determined (for example, it remains an open question whether an excess of loss treaty could be used as “Other Security”).


Additionally, we will watch closely to see whether Congress and the IRS will seriously consider the tax issue noted in a November 21, 2014, letter from Superintendent Benjamin Lawsky of the NYDFS to U.S. Treasury Secretary Jacob Lew. In the letter, Lawsky noted that, although insurance companies involved in captive transactions believed that the economic reserve (i.e., the amount of reserve most likely needed to pay claims) for a block of insurance policies was much lower than the level of the prescribed statutory reserve, they were permitted under current tax law to take a (larger) deduction for their tax reserve based on the statutory reserve rather than on the economic reserve.


These issues, and the initiation of a few putative class action lawsuits against insurance companies alleging misrepresentations in connection with captive transactions, are likely to make companies more cautious when entering into captive transactions in the future. Nevertheless, if captive transactions that within the confines of permitted law still provide a sizable economic or capital benefit to insurance companies, we believe that these transactions will continue.


Life and Annuity Product Regulatory Priorities


In 2014, significant industry efforts were devoted to advocating for the prompt proposal of SEC rules and form amendments that would permit the use of summary offering prospectuses for variable annuities, similar to those now being used by mutual funds. Meetings with SEC Chair Mary Jo White and the other four commissioners confirmed strong support for the concept, but other SEC priorities and staff resource allocations have inhibited the project from moving forward. At this juncture, we are hopeful that during 2015 the SEC will formally propose for public comment both a summary offering prospectus and summary update prospectus.


At the state level, there has been regulatory focus by both the NAIC and NYDFS on illustrations being used for indexed universal life products. There has been some controversy within the industry over the proper methodology and assumptions for these illustrations, and so alternative approaches to regulating these illustrations have been submitted to the NAIC. The NAIC is considering these approaches and the comment letters that have been submitted, and is expected to finalize a framework for these illustrations during 2015.


In 2014, the NAIC Separate Account Risk (E) Working Group (SAR Working Group) finalized general recommendations related to the use of insulated separate accounts to fund non-unitized, non-variable stable value contracts, group annuities and funding agreements sold in the retirement market, and forwarded them to the Financial Condition (E) Committee for its consideration. If the recommendations are adopted, the Committee likely will develop charges to working groups to consider changes to existing regulations and financial statement requirements to implement the recommendations. The SAR Working Group did not finish its evaluation of the use of such separate accounts in connection with corporate-owned life insurance and bank-owned life insurance products, as well as indexed and modified guaranteed annuities sold in the individual markets. It had been adamant that use of insulated separate accounts in the individual annuity market should be prohibited. At this point, no chair has been designated for the SAR Working Group, and until one is appointed, it is unclear whether or when further consideration and recommendations related to individual products will be forthcoming.


The NAIC is already at a more advanced stage with respect to the regulation of contingent deferred annuities (CDAs). In 2014, the Contingent Deferred Annuity (A) Working Group undertook the process of reviewing four model regulations (annuity disclosure, suitability, advertisements and replacements) to consider or specifically reference their applicability to CDAs. Various other NAIC committees and other groups also considered issues related to CDAs within their specific subject-matter expertise. We expect that considerable progress will continue to be made on these initiatives in 2015. Although the market for CDAs has been limited to date, and the industry’s appetite for the product has been affected by the market and regulatory developments over the past several years, it seems likely that progress at the NAIC will facilitate more product development in this space.


Meanwhile, another NAIC working group, the Index-Linked Variable Annuities (A) Subgroup, held several meetings during 2014 to consider the proper regulatory treatment of index-linked products that have been registered as securities with the SEC because their minimum values do not meet the requirements of the standard non-forfeiture laws for individual annuities. These products appear to have considerable appeal to both consumers and insurance companies in that they provide some significant, but not complete, protection from market downturns. Unlike traditional variable annuities, however, these products do not directly pass through the investment experience of one or more separate accounts. At this juncture, it is unclear what, if any, recommendations this subgroup will make regarding the proper regulation of the design of these products and the use of separate accounts. It is notable, however, that the several companies offering these products have had considerable success in obtaining the necessary regulatory approvals to offer their products on a nationwide basis.


NAIC Governance


The final weeks leading up to and immediately following January 1, 2015, saw a much higher than average turnover among state insurance commissioners. The changes seem especially pronounced with regard to the departures of two of the NAIC’s key international voices, Michael Consedine (PA) and Thomas Leonardi (CT). The NAIC’s recent creation of a new International Insurance Regulatory Affairs Managing Director position speaks to the importance the organization is placing on international issues. Former Arizona Insurance Director Christina Urias will be the first to fill the role.


A special election to replace Michael Consedine resulted in the election of Director John Huff (MO) as NAIC president-elect. Director Huff previously served as the NAIC-designated representative for state insurance commissioners on the FSOC. That experience should provide the NAIC presidency with visibility at the federal level and insight into Federal Reserve’s strategy for working with the state regulatory framework. Additionally, the NAIC’s Executive Committee has chosen an outside nonprofit, the National Association of Corporate Directors (NACD), to review its corporate governance practices. The NACD is anticipated to begin its review in 2015 and is tasked with making recommendations about NAIC governance procedures consistent with best practices for comparable organizations.


Mergers & Acquisitions


M&A Outlook


As we anticipated last year, some of the conditions that had dampened merger and acquisition activity in prior years began to abate, and new deals began to stir, especially in the property/casualty insurance sector. While substantial macroeconomic uncertainty remains, perhaps this momentum will continue into 2015.


The Non-Life Arena


In 2014, the property/casualty insurance arena had another year of strong results, although observers of the commercial lines and reinsurance sectors see storm clouds on the horizon. Significantly, catastrophe results have continued to be favorable; however, such an environment tends to drive reinsurance rates downward. This favorable experience, coupled with capital accumulating in the sector (from both the profits of established players and also the entry into the market by new players (e.g., private equity, hedge funds)), will continue to put pressure on pricing and returns. Further pressure has resulted from weaker investment experience as maturing investments are reinvested at lower yields. The resulting pressure on margins and headwinds on organic growth should drive a number of activities designed to reduce unit cost and increase margins. Specifically, companies in this sector will have substantial incentives to pursue acquisitions and invest in technologies (to manage their existing businesses and assist in successful integration of targets) and distribution channels.


As we saw toward the end of 2014 and in early 2015 in the Renaissance Re/Platinum, XL/Catlin and Axis/PartnerRe transactions, the quest for scale will continue to be a driver of transactional activity. In addition, there may be opportunities for other players to enter new markets (thus diversifying their businesses), as was the case in the Fosun/Meadowbrook deal. Numerous factors should continue to drive new transactional activity in 2015, but the question remains whether economic uncertainty and perceived price gaps between sellers and buyers will remain as significant deterrents to a further increase in deal flow.


The Life Insurance Arena


2014 showed improvements in annuity sales and steady life insurance sales, and if the economy continues to improve, these markets will continue to increase. Despite this good news, there remains substantial competition in the life insurance and annuity sectors as long-time players begin to expand their access to technology, and new market entrants create interesting challenges and opportunities for the industry. From an M&A standpoint, 2014 saw one blockbuster transaction (Protective/Dai-Ichi), a number of smaller business block and other transactions, and several distribution deals. Many of those 2014 deals continued to feature private equity players. Deal flow still has far to go to match pre-financial crisis levels.


Nevertheless, the quest for new customers, new products, new technologies and new distribution capabilities will inevitably push transactional activity. At this point, many life insurers have focused on their core competencies and have hopefully right-sized their businesses and prepared them for strategic expansion. Simultaneously, new players in the marketplace have weathered the heightened regulatory scrutiny, and they will be here to stay. The resulting mix of players combined with other market forces should stimulate some additional consolidation of insurers as well as investment by life insurers in new types of acquisitions—i.e., new technologies and other tools to reach the digital customer. Likewise, transformational changes to back offices will drive future winners, and in many cases, these transformations may only be economically feasible if scale can be simultaneously achieved.


For those insurers still wishing to shed non-core businesses, the new market entrants should serve as potential buyers. Of course, regulatory scrutiny of these new players will continue, but the novelty has worn off, potentially accelerating the speed of transactions and stimulating additional entrants.

Finally, we expect distribution channels to continue to be ripe for consolidation. Even as insurers search for new ways to reach new customers, they still must economically manage existing distribution. Likewise, competitive and regulatory pressure on agents and registered representatives will compel insurers to operate more efficiently and thus gain scale. Thus, we expect the life distribution sector to be at least as active as it was in 2014.

As with the property/casualty sector, headwinds created by stagnant interest rates, volatile equity markets and tepid consumer confidence could still dampen activity in the life sector. But for those industry participants that have right-sized and prepared for efficient integration, 2015 could be a very fruitful year.


U.S. Life Insurance Industry Product Development


As the U.S. life insurance industry reacted over the past several years to the new economic and market environment characterized by ultra-low interest rates and market volatility, the number of carriers offering SEC-registered variable products consolidated, and the number of carriers offering fixed indexed products has increased significantly. With the continued decline of interest rates, particularly long-term rates in 2014, and the industry’s adjustment to the “new normal,” there has been some notable change in market leadership in the variable product marketplace and continued new entrants into the indexed life and annuity space, including by some major variable product writers. In 2015, we expect to see several general trends in the life insurance and annuity marketplace, including a focus on product simplification and streamlined underwriting and issuance procedures, such as use of predictive analytics in underwriting, and more use of social media and the Internet to reach potential customers.


In the variable annuity market, we expect to see a number of issuers overhauling their underlying fund menu through significant substitution transactions, more companies offering products with limited or no death and living benefit guarantee features, and continued use of product and underlying fund strategies to reduce volatility risk. With respect to fixed indexed annuities, more companies will seek to offer products with managed volatility strategies and no caps. With respect to both variable annuity and fixed indexed annuity products, we believe there likely will be continued regulatory focus on sales practice issues associated with the use of these managed volatility strategies.


Payout annuities—both single premium immediate annuities and deferred income annuities—continued their robust growth 2014, with a number of carriers developing and launching these products, and sales reaching new record levels. While still a relatively small part of the overall retirement planning marketplace, these products have continued to gain widespread acceptance as an appropriate retirement planning tool with a rightful place in the product lineup. We expect more carriers to enter this market in 2015 and expect to see continuing product evolution. Existing state non-forfeiture laws, federal income tax treatment and evaluation of when products may take on securities status will likely play significant roles in the nature and extent of innovation.


In the retirement market, the rulings issued by the U.S. Departments of Labor and Treasury facilitating the use of group fixed annuities in target date funds and the adoption of final Qualified Longevity Annuity Contract (QLAC) regulations have already spurred new product development. The question for 2015 is whether these rulings will be expanded—in the case of target date funds to encompass guaranteed lifetime withdrawal benefits and in the case of QLACs to encompass fixed indexed annuities and variable products.


Index-linked annuity products that tie contract values to stated index returns and provide some downside protection through use of buffers or floors on the amount of downside risk assumed by the customer appear to have found some initial significant acceptance in the marketplace. They can be viewed as a “hybrid” of traditional variable annuities and fixed indexed annuities, and a mix of those characteristics may prove very attractive to consumers. While the NAIC continues to consider the regulatory treatment of these products, because the several carriers currently offering them have had some notable success, we expect to see more carriers launch these products in 2015.

With respect to life insurance, we expect to see continued addition of long-term care features to universal life, indexed universal life and variable life products. While indexed universal life products likely will continue to increase their share of the life insurance market, it is possible that variable life products with long-term care features also will show some renewed signs of life in 2015.


Happenings in the Capital Markets and at the SEC


Robust Capital Market Activity Expected to Continue


We saw the return of the insurance company IPO market in 2013 after a two-year drought, and that upward trend continued in 2014. Eight insurance companies completed IPOs in 2014 as compared to seven in 2013. The 2014 crop included IPOs by James River Group Holdings, Ltd., GWG Holdings, Inc., HealthEquity, Inc., Heritage Insurance Holdings, Inc., National General Holdings Corp., 1347 Property Insurance Holdings, Inc., Trupanion Inc., and Oxbridge Re Holdings Limited. The most interesting aspect of the 2014 IPO crop is that two of them (James River Group Holdings, Ltd. and National General Holdings Corp.) involved sales of shares solely by stockholders (primarily private equity firms and institutional investors) and not by the insurance companies themselves. Insurance companies also sought to take advantage of the continuing low interest rate environment in 2014 and were frequent issuers in the public and private debt markets, including in connection with issuances of senior notes, surplus notes, subordinated debentures and perpetual preferred stock. For example, CNA Financial Corporation sold $550 million aggregate principal amount of 3.950% senior notes due May 15, 2024, in a public offering, while Guardian Life Insurance Company of America sold $450 million aggregate principal amount of 4.875% 50-year surplus notes in a private offering.


Barring negative macroeconomic or global surprises, insurance company IPO and debt issuance activity is expected to continue in 2015, with debt issuances declining slightly given the volatility in the investment grade and junk bond markets, as well as the prospect for higher interest rates.


Things to Watch at the SEC in 2015


SEC’s Disclosure Effectiveness Initiative_


We noted last year that we would be watching to see whether the SEC followed up on a recommendation made in December 2013 by the SEC staff to simplify and eliminate disclosure and financial reporting in SEC reports and registration statements. In 2014, the SEC’s Division of Corporation Finance fully embraced this initiative—which is commonly referred to as the “Disclosure Effectiveness Initiative”—and has dedicated significant staff resources to pushing the project forward. Initially, the initiative will focus on the business and financial disclosures required by periodic and current reports, and by Forms 10-K, 10-Q and 8-K. Subsequent phases of the project will include compensation and governance information included in proxy statements. In 2015, we expect to see the SEC propose rules with respect to discrete parts of this project, including the rumored elimination of the third year of comparative information in the management discussion and analysis (MD&A) and the outdated ratio of earnings to fixed charges requirement.


Dodd-Frank Act Rulemakings


Although the SEC did not finalize and/or propose rules on the four remaining Dodd-Frank Act disclosure-related rulemakings in 2014, the SEC has put them on its priorities short list for 2015. These rulemakings include:


  • Pay-for-performance rules (rules not yet proposed);
  • Compensation clawback requirements (rules not yet proposed);
  • Hedging rules (rules not yet proposed); and
  • CEO pay ratio rules (proposed rules issued in September 2013).

The delay means that public companies do not have to worry about these rulemakings for this year’s proxy statement, but the same may not be the case for next year.


Pension De-Risking


Since GM’s jumbo deal in 2012 ($26 billion for 110,000 retirees), Verizon ($7.5 billion for 41,000 retirees in 2014), Motorola ($3.1 billion for 30,000 retirees in 2012) and Bristol-Myers Squibb ($1.4 billion for 8,000 retirees in 2014) have also executed pension “buyouts” involving the purchase of a group annuity for, or a lump-sum payment to, defined benefit (DB) plan beneficiaries. At the end of 2014, Bloomberg BusinessWeek projected that insurers could take over $100 billion to $150 billion of corporate pensions in the next five years.


A key reason why an increasing number of U.S. corporations have been executing pension buyouts is that the rally in equities over the last two years has resulted in more DB plans being fully funded, or even overfunded, enabling plans to cover most or all of the cost of a group annuity or lump sum payment. The higher the funding ratio, the lower the cost to the sponsor of purchasing an annuity, which makes the use of an annuity as a de-risking option more attractive. Despite slightly lower funding ratios in 2014 (dropping from approximately 95% at the end of 2013 to approximately 87% at the end of 2014), plans have continued to de-risk at a high rate.


For 2015, this pension buyout trend can be expected to continue—not only for jumbo buyouts like GM, Verizon, Motorola and Bristol-Myers Squibb, but also for mid-sized and smaller buyouts—if the yield on 10-year Treasuries rises and the S&P 500 stays near current levels. An important motivation for de-risking is that the cost of staying in the DB plan business continues to rise, even for “frozen” plans, as illustrated by the following:


  • Under changes adopted in the 2013 budget agreement and following the recently enacted Multiemployer Pension Reform Act of 2014, Pension Benefit Guaranty Corporation (PBGC) fixed and variable rate premiums will rise sharply in 2015 and 2016 for all DB plans.
  • The Society of Actuaries released its final reports updating mortality tables and the mortality projection scale for private DB plans in October 2014. Auditors may encourage or require the use of these updated mortality tables for financial statement purposes. Actuarial consultants have suggested that the updated tables could result in a 3% to 8% increase in DB plan liabilities, depending on a plan’s demographics. Use of the updated mortality tables will move sponsors’ book valuations of plan liabilities closer to insurers’ valuations, potentially narrowing the bid/ask spread in annuity purchase negotiations.
  • Based on its past practice, the IRS is expected to evaluate the reports from the Society of Actuaries and update the mortality table used for minimum funding purposes under the Internal Revenue Code. Actuaries currently predict the same 3% to 8% increase in funding obligations in that case.
  • The financial crisis of 2008 was a recent and vivid reminder that DB funding requirements can necessitate a company having to raise capital when it is very costly, or perhaps simply impossible, to do so.

Some plan sponsors are concerned that there may be additional execution risk in connection with annuity buyouts as time passes. Sponsors of large DB plans that are considering an annuity purchase may wonder about the desire or ability of qualifying annuity providers to do several large deals simultaneously.


Furthermore, de-risking may be subject to an uncertain regulatory environment as governmental bodies propose various forms of increased regulation and oversight. For example, the following occurred in 2014:


  • Wyden-Harkin Letter. On October 22, 2014, Senator Ron Wyden (D-OR) and now-former Senator Tom Harkin (D-KS) sent a letter to the Departments of Treasury and Labor, PBGC and the Consumer Financial Protection Bureau noting their concerns with de-risking strategies. The letter requests the establishment of clear and specific rules to ensure that employees and retirees participating in DB plans have their interests protected in connection with de-risking strategies. Specifically, the letter calls for procedural and clarifying guidance (potentially imposing expanded fiduciary duties):
    • Requiring advance notice of de-risking to participants and the government;
    • Establishing standards for employers choosing an annuity provider to ensure an annuity replicates ERISA protections to the extent possible;
    • Requiring specific disclosures and other protections when retirees are offered lump-sum distributions; and
    • Clarifying the circumstances and conditions under which de-risking strategies are permissible in the absence of a formal plan termination.
  • PBGC’s Revised Premium Filing Procedures and Instructions. On September 23, 2014, and January 12, 2015, the PBGC published notices indicating that it is revising the 2015 premium filing procedures and instructions to introduce after-the-fact reporting requirements with respect to certain de-risking transfers through lump-sum windows and annuity purchases. Comments on the latest notice were due by February 11, 2015.
  • ERISA Advisory Council Hearings. The ERISA Advisory Council held two hearings in 2014 on the topic of Facilitating Lifetime Plan Participation. While the primary focus of the testimony the council heard was on maintaining defined contribution accounts balances and related issues, some testimony also addressed potential concerns with lump-sum payments from DB plans.



We continue to be involved in the Department of Labor’s (DOL) exemption program for the assumption of employee welfare benefits by a captive of the plan sponsor. DOL issued in 2014 an exemption for the reinsurance of certain welfare benefits to a captive insurer, which continues a series of such exemptions, but it was only the second exemption issued after a brief hiatus in 2012 and the modification of several conditions or requirements for these exemptions.


A revised ERISA “fiduciary” definition, which continued to absorb DOL’s regulatory resources in 2014 along with the Patient Protection and Affordable Care Act (ACA), is once again scheduled to be re-proposed in the current year. The 2010 fiduciary proposal, had it been adopted without revision or the issuance of additional exemptions, would have compelled significant changes, particularly in the distribution of products and services in the ERISA plan and individual retirement account (IRA) markets. The publication of a re-proposal will be consequential for any life company with an interest in the retirement or IRA markets.


The industry continues to press for needed ERISA and tax guidance on in-plan lifetime income products. Helpful guidance was issued in 2014 with respect to longevity contracts and annuities embedded in target date funds. Treasury is now giving attention to the contingent deferred annuity design, and DOL’s regulatory agenda again includes a proposed safe harbor for annuity selection in defined contribution plans, scheduled for the fourth quarter.


At the Solicitor General’s recommendation, the U.S. Supreme Court granted certiorari in Tibble v. Edison International, to consider whether the ERISA six-year limitations period bars claims against plan fiduciaries regarding plan investment options first selected more than six years before the claim was filed. Arguments are scheduled for February 24, 2015. The decision, which could address a potential duty to reexamine past decisions in the context of a “continuing violation” theory, may affect not only ERISA excessive-fee litigations (where the time bar defense has been effective, particularly in claims against plan sponsors) but also more broadly the understanding of and exposure for ERISA fiduciary responsibilities. In addition, the Court’s expected decision in DeBoer v. Snyder on the constitutionality of state bans on same sex marriages—an issue not addressed in the Court’s prior Windsor decision—may help to clarify spousal rights in benefits plans as well as under insurance contracts.


Alternative Capital and Insurance-Linked Securities


Notable trends in the catastrophe bond market during 2014 once again favored cedents: insured natural catastrophe losses were below the average of the last 10 years, pricing for U.S. wind risk decreased 8% and indemnity triggers were used in about 70% of deals.1 The new issue market for catastrophe bonds began to look a bit more like traditional bond offerings, with bigger average deal sizes and longer average duration. On the regulatory front, we recently reported that the staff of the Commodity Futures Trading Commission’s Division of Swap Dealer and Intermediary Oversight issued a no-action letter providing industry-wide relief from commodity pool operator (CPO) registration to entities operating certain insurance-linked securities (ILS) issuers (see Legal Alert: CFTC Grants No-Action Relief to Commodity Pool Operators with Respect to Certain Insurance-Linked Securitization Vehicles).


In 2014, there continued to be a high level of interest by private fund managers in establishing tax-efficient offshore insurance companies. In light of this activity, Senator Ron Wyden (D-OR) challenged the U.S. Treasury to tighten the insurance exception to the passive foreign investment company (PFIC) rules. Former House Ways and Means Committee Chairman Dave Camp (R-MI) also included modifications to the PFIC insurance exception in a discussion draft for proposed legislation released in 2014. One of the proposals would have required that more than 50% of a non-U.S. insurance company's gross receipts consist of premiums for insurance or reinsurance and that its insurance liabilities constitute more than 35% of the corporation's total assets. We will continue to update our private fund and insurance clients on any developments in this area during 2015.


Unclaimed Property


As 2015 gets underway, many life insurance companies remain under multistate unclaimed property audits and market conduct exams relating to their use of the Social Security Death Master File (DMF) and unpaid death and annuity benefits. State regulators continue to target not only the 40 largest life insurers, but also many small to mid-sized insurers.


Regulatory Settlements


To date, 18 life insurance companies have entered into multistate Global Resolution Agreements with state treasurers to resolve unclaimed death benefit issues on a retroactive basis—a number that remained unchanged during 2014. More than a dozen large insurance companies have agreed to settlements with state insurance regulators, under which the companies would search the DMF going forward for all of their insureds, identify potentially deceased individuals, locate beneficiaries when possible, and remit monies to the states if the beneficiaries could not be located. Three of these agreements were signed in 2014 and early 2015. In addition, four life insurers entered into settlements with the Minnesota Department of Commerce relating to unclaimed insurance benefits during 2014; there had been one prior settlement with Minnesota in 2013. More settlements with multistate insurance regulators and separately with Minnesota are expected in 2015.


State Legislation


On the legislative front, approximately 15 states have amended their insurance statutes and passed a version of the legislation first proposed by the National Conference of Insurance Legislators (NCOIL) in 2011 mandating regular DMF searching of all policies and follow-up with beneficiaries. Seven of the 15 states passed the legislation in 2014; the NCOIL legislation is currently pending in at least three other states and is expected to be introduced in at least nine states in 2015. However, the lack of uniformity among these statutes remains a concern for the industry.

During 2014, insurance regulators at the NAIC continued to move away from their enforcement-only approach to the use of the DMF and have charged the Life Insurance (A) Committee in 2015 with developing a model law regarding unclaimed life insurance benefits. The NAIC is also concerned about possible usurpation of the insurance commissioners’ authority to regulate the death benefit process if unclaimed property administrators and state treasurers succeed in adding a requirement to search the DMF to state unclaimed property laws—a possibility as state treasurers aggressively lobby the Uniform Law Commission (ULC) to add such provisions to the ULC’s revision to the model unclaimed property law expected to be finalized by 2016. We, along with others in the life insurance and financial services industries, are closely watching these developments.


Federal Legislation


The Bipartisan Budget Act of 2013 included a provision requiring the Department of Commerce to develop a fee-based certification program for all persons wanting to access DMF data for any deceased person within three years of death. Only persons that have a valid purpose and sufficient data security measures in place to protect the DMF data may be certified. In March 2014, the Department of Commerce’s National Technical Information Service (NTIS) developed a temporary certification program requiring users, including life insurers, to either become certified under the NTIS rule or obtain recent DMF information from a certified person. In December 2014, NTIS issued a proposed rule setting forth a certification program that requires certified persons to obtain a written certification from an Accredited Certification Body that the person seeking access to DMF data has “information security systems, facilities and procedures in place to protect the security of the DMF information.” This has raised concerns that insurers will be required to meet as yet unspecified cybersecurity requirements in order to comply with their obligations under NCOIL statutes and state settlements. Comments are due to NTIS by the end of March 2015. We will be paying close attention to developments in this area.




In late December 2014, Morgan Stanley and its affiliated companies became the first brokerage firm undergoing a multistate unclaimed property audit conducted by Verus to agree to the use of the DMF or state vital statistics records to identify deceased account owners as a means for triggering reportable unclaimed property. As indicated in the agreement, if the DMF/state vital records match process indicates that an account owner may be deceased, a rebuttable presumption is created that no owner-generated activity has occurred in the account since the date of death and that his or her property is subject to state escheat laws. The agreement also created a rebuttable presumption that mail sent to an account owner by the company is undeliverable if the U.S. Postal Service’s National Change of Address database lists the account owner as having moved from the company’s address of record for the owner for one or more years. For most states, lack of owner-generated activity and/or undeliverable mail trigger the start of the dormancy period for escheating securities. Under the agreement, the audit includes “all brokerage services or customer account[s]...including but not limited to employee stock plan accounts, retail brokerage accounts, and retirement accounts….or other account[s] or fund[s] that [were] reportable or potentially reportable before December 31, 2014”. IRAs are included in the scope of the agreement. Excluded from the scope are education and health savings-related accounts and property related to employment-based defined benefit plans. The possible expansion of DMF audits into the broker-dealer and mutual fund sectors is an area of considerable concern in the financial services industry.


Delaware Unclaimed Property Task Force


In 2014, the Delaware General Assembly authorized a Task Force to make findings and recommendations related to improving fairness and compliance in Delaware’s unclaimed property program. The Task Force was composed of members of the General Assembly, Cabinet-level members of the Governor’s administration, representatives on behalf of the Delaware public, and representatives of several private organizations. After five meetings, the Task Force issued a report on December 23, 2014, with findings and recommendations. Most significantly, the Task Force raised concerns with the length of the “look-back” period and the use of estimation techniques in the auditing process, the dominance of one audit firm in Delaware’s audit portfolio, and the lack of a manual that contains procedural guidelines for unclaimed property audits. The Task Force recommended a shortening of the “look-back” period and modification of the statute of limitations requiring indicia of fraud in the past six years of filed reports before records for earlier years can be audited. The Task Force also recommended that the Delaware Department of Finance publish a detailed manual containing procedural guidelines for Delaware unclaimed property audits and renegotiate downward the length of its current contracts with unclaimed property auditors, while enhancing efforts to bring the audit processes in-house. Legislation has been introduced to implement many of these recommendations. Although concerns about the use of estimation techniques were discussed during the Task Force’s meetings and were referenced in its findings, the Task Force did not make any specific recommendations regarding estimation techniques.




Data Breach, Privacy and Related Coverage Litigation


Since 2005, there have been approximately 590 known data breaches involving insurers and other financial services companies. In addition to litigation from consumers whose personal information is compromised in a data breach, the property/casualty sector continues to see significant litigation over insurance coverage for data breach incidents. Whether consumer-privacy litigation is covered under a commercial general liability (CGL) policy that provides coverage for personal injury caused by “publication” has divided courts to date, but an appellate court in New York is expected to rule on the issue this year in a case that arose out of the Sony PlayStation data breach in 2011.


Cost of Insurance Litigation


Litigation continues in cases challenging cost-of-insurance (COI) rates in life insurance policies, and in the past few years, courts have issued decisions going both ways on the scope of insurer discretion to set and modify COI rates. The cases have turned in part on the meaning of the words “based on” in the terms of universal life insurance policies. If COI rates are to be “based on” certain enumerated factors under the policy, must the rates be “solely based on” those factors, or does the insurer have discretion to consider other factors in determining COI rates? The complaints in the COI cases generally allege that COI rates must be based solely on mortality factors, as defined by plaintiffs (e.g., age, sex, underwriting class).


Two recent court decisions illustrate the split. In late 2013, in a significant victory for the industry, the U.S. Court of Appeals for the Seventh Circuit in Norem v. Lincoln Benefit Life Company affirmed summary judgment in favor of an insurer and held that absent a promise to use a specific formula when calculating a COI rate, an insurer is not bound to consider only those factors listed in a COI provision. In so ruling, the Seventh Circuit rejected or distinguished the reasoning of several lower court decisions that had reached opposite conclusions. In April 2014, however, in Fleisher v. Phoenix Life Insurance Company, a class action challenging a COI rate increase, a New York federal district court declined to follow the reasoning of Norem and instead stated that an insurer may only consider factors specifically enumerated in the policy when raising COI rates. The court stated that the contract was at least ambiguous and construed it against the insurer. Notwithstanding its narrow interpretation of the contract, however, the court in Fleisher found that the insurer had not considered any impermissible factors in raising COI rates and therefore granted the insurer’s motion for summary judgment on that issue. The case is scheduled for trial in mid-2015 on the issue of whether the rate increase was not uniform by class and was therefore in breach of contract.


Telephone Consumer Protection Act


Companies in many industry segments face increased litigation risk under the Telephone Consumer Protection Act (TCPA), and insurance companies have not been immune. Any insurance company that communicates with its customers, potential customers, job applicants or other consumers by automated phone or text communications—or that has independent or semi-independent agents engaging in automated communications—should be cognizant of TCPA compliance and litigation risk.


Among other things, the TCPA prohibits the use of an “automated telephone dialing system” or an “artificial or prerecorded voice” to make calls to cell phones without the prior express consent of the called party. In addition, the TCPA prohibits artificial or prerecorded voice calls to residential telephone lines (without prior express consent) and unsolicited fax advertisements. Because the TCPA provides for statutory damages of $500 per violation (and up to $1,500 per willful violation) with no maximum cap on recovery, class action risk under the TCPA can be considerable. Several insurance companies have recently entered into class action settlements under the TCPA, and a number of others are involved in ongoing litigation. Common issues in cases against insurance companies include consent, the scope of consent, and the standards for third-party liability where communications were initiated by an agent or third-party marketing firm. Insurers are also dealing with coverage issues under commercial liability policies for underlying TCPA claims.


“Shadow” Insurance


Several class actions recently have been filed challenging life insurers’ use of captive reinsurers. These suits allege that insurers knowingly misrepresented to consumers and regulators their financial condition and reserves through the use of affiliated unauthorized captives, which were collateralized using contractual parental guarantees. These putative class actions were prompted by a June 2013 NYDFS report, Shining a Light on Shadow Insurance, which criticized the use of financial captives (dubbed “shadow” insurance) in the life insurance industry. The report summarized the results of a NYDFS investigation into the financial captive practices of New York-based life insurance companies and their affiliates. The report presents case studies of 17 insurance companies, including the two companies that have been sued. These putative class actions, as well as the NAIC Executive Committee and Plenary’s passage of AG 48 (see discussion above), make this a significant issue to continue to watch in 2015.


Unclaimed Property


Disagreements between the industry and state regulators over the application of unclaimed property laws governing life insurance have spilled over into litigation. Courts have thus far uniformly rejected the regulator/auditor positions that dormancy begins at death and that insurers have a legal duty to search for information about possible deaths of insureds.

Thrivent Financial for Lutherans v. State of Florida, Department of Financial Services, the appeals court held that Florida’s unclaimed property law does not trigger obligations by the mere fact of an insured’s death. Instead, an insurer’s duties under Florida’s unclaimed property statute are triggered only by the insurer’s receipt of proof of death, knowledge of death, or when the insured reaches the limiting age under the policy.


The U.S. Court of Appeals for the First Circuit in Feingold v. John Hancock Life affirmed the insurer’s practice of requiring life insurance beneficiaries to submit proof of death before it would pay death benefit proceeds. The court held that this “proof of death notice requirement complies with Illinois law” and is “in accord with Illinois’s unclaimed property statute, which acknowledges that life insurance proceeds are not payable without proof of death.” The First Circuit rejected the beneficiaries’ argument that the insurer was required to consult the DMF to check whether life insurance policy holders were deceased.


In State of West Virginia ex rel. John D. Perdue, the West Virginia State Treasurer is appealing the dismissal of 63 separate but virtually identical cases filed against life insurers, where the trial court rejected the West Virginia State Treasurer’s claim that the dormancy period for life insurance begins upon the date of an insured’s death, as opposed to the date of proof of death. These cases are now pending before the Supreme Court of Appeals of West Virginia, the state’s only appellate court, and an opinion is expected by June 2015.

Several cases involving disputes between insurers and regulators remain pending in courts in California, Delaware and Illinois.


Cybersecurity and Big Data




New risks of cyber-attacks designed to cripple financial institutions have led federal and state regulators to intensify their examinations of the cybersecurity of insurers’ networks and computer systems.


In December 2014, NYDFS Superintendent Benjamin Lawsky issued a guidance letter to all New York State chartered or licensed banking institutions announcing that the NYDFS was expanding its examination procedures to increase its emphasis on cybersecurity and urging all institutions to make cybersecurity an “integral aspect of their overall risk management strategy.” The NYDFS examinations will cover a wide range of topics, including corporate governance, management of cybersecurity issues, the amount and kinds of resources devoted to information security and overall risk management, and the risks posed by shared infrastructure, among others.


NYDFS’ banking guidance was followed by an announcement of its plans for insurance in February of this year. On February 8, Superintendent Lawsky released the results of a study of cybersecurity preparedness in the insurance industry and announced that NYDFS would be conducting targeted cybersecurity assessments of insurers. In his press release, the Superintendent said “[i]n the coming weeks and months, DFS will integrate regular, targeted assessments of cyber security preparedness at insurance companies as part of the Department's examination process; put forward enhanced regulations requiring institutions to meet heightened standards for cyber security; and examine stronger measures related to the representations and warranties insurance companies receive from third-party vendors, among other measures.”


State insurance commissioners and attorneys general reacted quickly to Anthem’s disclosure that a data security breach may have exposed personal information for more than 80 million customers. The NAIC announced a multistate examination of Anthem to be monitored by the NAIC’s Cybersecurity Task Force (chaired by North Dakota Insurance Commission Adam Hamm). The NAIC stated it anticipates all 56 states and territories will sign on to the examinations, which will be inclusive of all subsidiaries and affiliates of Anthem affected by the breach. Expected involvement by state attorneys general is evidenced by the letter to Anthem written by Attorney General George Jepsen on behalf of himself and nine other state attorneys general on February 10. The letter labeled the company’s delay in notifying impacted customers “unreasonable” and expressed “alarm at the failure of the company to communicate with affected individuals and, in particular, to provide them details about the protections the company will make available and how to access those protections.”


In January 2015, the SEC and the Financial Industry Regulatory Authority (FINRA) each announced their 2015 examination priorities, and both agencies emphasized cybersecurity as a primary exam focus. The SEC has designated cybersecurity as a market-wide risk in its examination priorities letter, underscoring how important the SEC believes cybersecurity is to the integrity of the market system and to customer data protection. Last year, the SEC examined the cybersecurity compliance and controls of certain insurance-affiliated investment advisers and broker-dealers. In 2015, the SEC announced that it will continue its cybersecurity exams as it engages in additional separate account exams.


FINRA announced that in 2015, it will focus its cyber exams of broker-dealer firms on a firm’s approach to cyber risk management. This review will include firm governance structures, as well as processes for conducting risk assessments and addressing the output of those assessments. Due to the danger that cyber-attacks likely will destroy firm and customer data, FINRA examiners will also evaluate how firms ensure compliance with SEC Rule 17a-4(f) in the event of a cyber-attack. Rule 17a-4(f) permits firms to store records electronically, provided that the media “preserve the records exclusively in a non-rewriteable, non-erasable format.” Insurance-affiliated broker-dealers are expected to be subject to such FINRA exams in 2015.

The SEC and FINRA each launched cybersecurity examination sweeps in 2014 to better understand the types of threats posed by cyber-attacks and to assess cybersecurity preparedness. FINRA has announced that it will publish the results of its sweep in early 2015, while the SEC has not yet announced whether it will publish its findings.


In November 2014, the NAIC announced the formation of an executive-level Task Force on Cybersecurity, which will monitor developments in the area of cybersecurity and advise, report and make recommendations to the Executive (EX) Committee on cybersecurity issues. We will be monitoring developments in this area in 2015.


Big Data


As insurers develop new and exciting ways to capture, use and share internally and with affiliates the information they collect about their customers, insurers also face a changing and challenging regulatory landscape. Due to rapid improvements in computation power, data storage capacity and statistical analysis techniques over the last several decades, the use of big data to develop predictive modeling is coming into widespread use by insurers looking to gain a competitive advantage.


The principal statutory frameworks affecting the use of big data predictive modeling by property/casualty and life insurers are federal and state laws governing (i) “consumer reporting agencies” and the use by insurers of “consumer reports;” (ii) the collection and sharing of nonpublic personal information, including the use of information collected in connection with SEC-registered products; (iii) requirements to safeguard customer data; (iv) discrimination involving either protected classes or between individuals of the same “class” and equal expectation of life; and (v) obligations to disclose the factual basis for underwriting decisions and the requirements of actuarially sound practices.


During 2015, we expect that tensions will continue to emerge between the development of big data and customer privacy, data security, anti-discrimination and consumer reporting restrictions at the federal and state levels.


Tax Matters


Federal Tax Reform


Tax Reform and its Potential Implications for Insurers


In February 2014, former House Ways and Means Committee Chairman Dave Camp (R-MI) released a “Discussion Draft” of the Tax Reform Act of 2014, which set forth his much-anticipated tax reform proposals. The Discussion Draft offered to transition the corporate tax rate to a flat 25% rate beginning in 2019 and to repeal the corporate alternative minimum tax. However, as part of the revenue raisers for these proposed changes, the Discussion Draft included a number of proposals that target insurance companies or that otherwise would impact them. Those proposals, which were scored by the Joint Committee on Taxation as raising a total of more than $231 billion of revenue over 10 years, would:


  • Replace the prescribed discount rate for computing life insurance reserves for federal income tax purposes with a modified version of the applicable federal mid-term rate;
  • Repeal the special 10-year period afforded life insurance companies for taking into account adjustments with respect to changes in computing reserves;
  • Modify the rules concerning the capitalization of certain policy acquisition expenses;
  • Modify the dividends-received deduction for life insurance company separate accounts;
  • Modify the discounting rules for property/casualty insurance companies;
  • Modify the proration rules for property/casualty insurance companies;
  • Disallow a deduction for reinsurance premiums paid to “non-taxed affiliates;”
  • Repeal the special treatment of Blue Cross and Blue Shield organizations;
  • Impose an excise tax on “systemically important financial institutions;” and
  • Establish a participation exemption system for the taxation of foreign income and make other related changes, including a five-year extension of the Subpart F exception for certain active insurance income.

Although the Discussion Draft was styled as an effort to ensure that the Internal Revenue Code “is fairer, more efficient, and effective for all,” it is plain to see that the insurance industry would be a net loser under the Discussion Draft’s proposals. In this regard, the overall effect of the Discussion Draft would be to more closely align the taxation of insurance companies (both life and property/casualty) with that of other corporate business enterprises. Importantly, however, the Discussion Draft did not propose to change present-law tax incentives for individuals who purchase life insurance products to provide financial protection for themselves and their families, including the well-established rule that exempts “inside build-up” from current taxation.


With the 2014 mid-term elections in the rear view mirror, and the arrival of new chairmen at the House Ways and Means Committee (Chairman Paul Ryan (R-WI)) and the Senate Finance Committee (Chairman Orrin Hatch (R-UT)) who have indicated that tax reform is a significant legislative priority, it seems inevitable that the Discussion Draft’s framework for comprehensive tax reform will receive further consideration in 2015. Taking into account the magnitude of the changes contemplated in the Discussion Draft, and the potentially detrimental interactions between the changes designed to apply to insurers and those intended to impact “regular” corporations, insurers would be well-served to heed the tax reform discussions taking place on Capitol Hill.


Implementation of the Foreign Account Tax Compliance Act


The provisions of the Foreign Account Tax Compliance Act (FATCA) became effective on July 1, 2014, more than four years after being added to the Internal Revenue Code. The FATCA rules have far-reaching implications for both U.S. and non-U.S. insurance companies.


In brief, the FATCA rules generally require that any payor of a “withholdable payment” withhold 30% of such payment, unless (i) the payee of such payment satisfies the relevant FATCA reporting requirements, (ii) the payee fits into an exception to the FATCA rules, or (iii) the payment satisfies such an exception. For purposes of FATCA, a “withholdable payment” includes any U.S. source payment of fixed or determinable annual or periodical income (FDAP income). Importantly, FDAP income includes passive income such as interest, dividends and royalties, as well as insurance and reinsurance premiums.


Pursuant to Notice 2014-33, the IRS announced that it will treat calendar years 2014 and 2015 as a transition period for the administration and enforcement of the due diligence, reporting and withholding provisions of FATCA. During this transition period, the IRS indicated that it will take into account the extent to which a taxpayer has made “good faith” efforts to comply with FATCA’s requirements. Accordingly, a taxpayer’s ability to prove that it has satisfied the good faith standard seemingly will be an important component of the IRS’s enforcement approach during the transition period.


A taxpayer that has not made good faith efforts to comply with FATCA’s requirements should not expect any relief from IRS enforcement with respect to the implementation of the FATCA regime. Good faith efforts seemingly could include undertaking instructional sessions with employees during which FATCA compliance procedures are reviewed and supplementing policy manuals in order to ensure that employees are aware of the need to document a new customer’s FATCA status. It also is advisable to document good faith efforts in a separate, easily accessible file in the event that IRS personnel request proof of those efforts.


Tax Litigation Affecting Captives


In January 2014, the U.S. Tax Court held in favor of the taxpayer in Rent-A-Center, Inc., deciding the first of a number of captive insurance cases moving through the courts. In the case, three entities represented 94% of the insurer’s risk, with one of these entities representing approximately 66%, and the court concluded that risk distribution was present as were the other necessary requirements for insurance treatment for U.S. federal tax purposes. The court did not focus on the number of subsidiaries that were insured but focused on the independence of the risks assumed by the captive (i.e., that the risks were unaffected by the same event). The IRS did not appeal the decision. The case has some bad facts from the taxpayer’s perspective, as pointed out by the dissenting opinions in the case, including that the captive solely invested in its parent’s treasury stock. The captive’s parent also provided a fixed amount guarantee to the captive’s regulators during some years in order to ensure that the captive would be adequately capitalized.


In October, following in the footsteps of the Rent-A-Center case, the U.S. Tax Court issued its opinion in Securitas Holdings, Inc. and Subsidiaries v. Commissioner.2 The court concluded that risk distribution was present, based on a multitude of individual exposure units, and that insurance characterization was appropriate. In the Securitas case one entity represented 37% of the insurance company’s risk in the first year and 79% in the second year; in addition, 91% of the premium was from four entities in the first year and 89% from four entities in the second year. The court did not find problematic (i) that the captive had a parental (non-insured) guaranty as long as the captive was adequately capitalized, (ii) a loss portfolio transfer, or (iii) the periodic netting of premiums and loss payments. It is unclear how the IRS will react to the decisions in this case and the Rent-A-Center case, and it remains to be seen whether the government will appeal the Securitas decision.


Beginning on September 2, 2014, a three-day trial was held at the U.S. Tax Court in the case of RVI Guaranty Co. Ltd. and subsidiaries v. Commissioner. The issue in the case is whether residual value insurance, which insures lessors against an unexpected loss in the value of property they lease, qualifies as insurance for federal tax purposes. Existing U.S. Tax Court precedent applies a three-prong test in determining whether an insurance policy should be treated as insurance for tax purposes, looking at whether (i) the policy constitutes insurance in the commonly accepted sense; (ii) the policy shifts risk, which is distributed among many insureds; and (iii) the policy covers insurance risk. The taxpayer argued that its residual value insurance policies met all three prongs of the test and should be treated as insurance for tax purposes. The IRS contended that the taxpayer’s residual value insurance policies failed all three prongs.


The trial was held before Judge Albert G. Lauber, who wrote one of the dissenting opinions in the Rent-a-Center case. Because the facts in the RVI case were largely stipulated, neither party put on any fact witnesses. Each party presented three expert witnesses, with their written reports serving as their direct testimony, so the trial consisted largely of cross-examination of these experts. The opening briefs of both parties were filed on December 3, 2014, and reply briefs were due on February 2, 2015.


On February 5, 2014 the U.S. District Court for the District of Columbia issued its opinion in Validus Reinsurance, Ltd. v. United States, which is the first case to involve a challenge to the IRS’s position on the “cascading” application of the federal excise tax (FET) to reinsurance agreements covering U.S. insurance risks. In brief, the court held that, although the statute, IRC § 4371, authorizes the imposition of the FET on “reinsurance,” it does not do so with respect to “retrocessions,” and granted Validus’s motion for summary judgment. In so holding, the court reasoned that (i) “reinsurance” between an insurance company and a reinsurer is not the same as a “retrocession” in which a reinsurer purchases insurance from another reinsurer, and (ii) there is no mention of the taxation of retrocessions in IRC § 4371.


The government filed an appeal in the U.S. Court of Appeals for the District of Columbia Circuit on April 9, 2014. The government filed its brief on August 29, 2014, arguing that the District Court had misinterpreted the language of the statute and that Congress clearly intended the FET to have extraterritorial application, even in circumstances in which neither party to the insurance transaction is incorporated or doing business in the United States. Validus filed its brief on October 3, 2014. On October 10, 2014, the International Underwriting Association of London Ltd. and the London & International Insurance Brokers Association filed an amicus brief supporting Validus and urging the affirmance of the holding by the District Court. The amici’s argument focused on alternative bases on which the decision could be upheld, including the lack of clear evidence that IRC § 4371 was intended to be applied extraterritorially and the lack of Congressional intent that the FET “cascade.”


Illinois Industrial Insured Tax


Illinois, after many years being one of the handful of states that did not impose a tax under its industrial insured legislation, added a 3.5% tax in August 2014. Most of the focus on the bill’s effect has been on the tax itself, given the number of large corporations headquartered in the state, which pay premium to both non-admitted commercial insurers and their captive insurer affiliates, and efforts have been undertaken to ameliorate the effect of the tax by new legislation. However, the legislation also amended the definition of an “industrial insured” within the state by, among other things, increasing various factors for the insured to qualify as an industrial insured (e.g., revenue, number of employees) and increasing the requirements for a “qualified risk manager.” The effect is to limit the impact of the statute, which recognized that non-admitted insurers dealing directly with industrial insureds are not considered to be doing business in the state under the statute.


Rev. Rul. 2014-15


Also in 2014, the IRS published Rev. Rul. 2014-15, which had long been on the IRS Priority Guidance list. The ruling deals with an employer that makes payments to a voluntary employee benefit association (VEBA), which is tax-exempt under Section 501(c)(9) of the Internal Revenue Code. The VEBA bought stop loss insurance from a commercial insurer, which reinsured with a captive wholly owned by the employer. Per the facts, this was the only insurance written by the captive, and there were to be no loans of captive funds to the employer.


Given that this was the only coverage written by the captive and given the IRS position in Rev. Rul. 2005-40 indicating that the IRS would not recognize as an insurer a company that only wrote a single risk, it was important for the captive to characterize the risk assumed as reinsurance of the risks of all the underlying captive employees who were covered by the VEBA per Rev. Rul. 2009-26.


The IRS concluded that it was insurance of the individual employees that was assumed by the captive. It is interesting to note, however, that immediately after the ruling was issued, representatives of Treasury and the IRS indicated that the ruling should not be read to generally treat insurance of medical stop loss with a captive without an intervening VEBA as insurance of the underlying risks of employees of a self-insured plan.




Almost five years after the enactment of the ACA, insurers are still navigating the law’s complex regulatory scheme and its impact on various lines of insurance business. In 2015, Sutherland will be closely monitoring several ACA developments that will impact issuers of supplemental health and voluntary benefit products offered in the group and individual markets, including the IRS’s recent introduction of the “wraparound” limited health benefit program.


On December 23, 2014, the Departments of Treasury, Labor, and Health and Human Services published proposed rules outlining a program that would allow employers to offer wraparound health coverage to certain employees. Wraparound, or “wrap” coverage, is a limited benefit health product for employees who choose to forgo their employer’s group health coverage and instead purchase coverage on the individual market or on a public health insurance exchange. While employees may pay lower premiums for the individual coverage, this coverage is often less generous than an employer-sponsored plan. The wrap product would serve as a limited supplemental health plan that adds to and “wraps around” the employee’s individual health coverage, making it more comparable to the employer’s comprehensive health program. Under the proposed rule, wrap coverage would be treated as a HIPAA-excepted benefit product, and thus would not be subject to the ACA’s insurance coverage mandates and would not prevent the employee from obtaining a premium tax credit to help purchase coverage on a public exchange. Wrap coverage would be made available in the group health insurance market, and employer contributions toward premium costs for wrap coverage would be excluded from the employee’s income.


Under the proposed rule, wrap products must comply with certain design and eligibility restrictions in order to avoid becoming subject to the ACA’s general rules for health plan products. The proposed rule would permit employers to offer wrap coverage under a temporary pilot program that would allow the agencies an opportunity to evaluate the efficacy of the product and its impact on the health insurance market.


Final regulations regarding wrap products are expected later this year. However, insurers interested in entering the wraparound health product market will need to carefully navigate not only the new rules, but also the existing excepted benefit regulations and related ACA guidance.


1 Source: Munich RE, Insurance-Linked Securities Market Review 2014 and Outlook 2015.

2 T.C. Memo. 2014-225. There are four other cases involving captives that remain docketed in the Tax Court: Avrahami v. Commissioner (Docket No. 17594-13), Feedback Insurance Co. v. Commissioner (Docket No. 18274-13) (the last two of which are consolidated), and Gregory Lentz, a partner other than the Tax Matters Partner, v. Commissioner, (Docket No. 8269-14), GS Manufacturing Inc. v. Commissioner, (Docket No. 02047-14).




DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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