The Gramm-Leach-Bliley Act, signed into law by President Clinton on November 12, 1999, is a sweeping piece of financial modernization legislation. In broad terms, the Act:
- provides for affiliations among banking, insurance and securities firms
- establishes certain principles of "functional regulation" applicable to such operations
- imposes broad new consumer protections relating to privacy.
This Update summarizes key provisions of the Act, with a particular focus on those provisions of the Act that will be of interest to the insurance industry. Other Updates on the Act include:
- The Gramm-Leach-Bliley Act: What's In It for Banks and Thrifts
- The Gramm-Leach-Bliley Act: What's In It for the Investment Management Industry
- The Gramm-Leach-Bliley Act: New Privacy Provisions Become Law
- SBICs After Gramm-Leach-Bliley
Banking and Insurance Under One Roof
Bank holding company regulation generally takes the approach that any affiliated group of companies that includes a bank should be restricted with respect to the permissible activities of the group. Gramm-Leach-Bliley does not eliminate this fundamental premise, but greatly expands the range of permissible activities within a holding company system that includes a bank.
As a result of these changes, affiliations between insurance companies and banks will now be permissible and affiliations between banks and insurance producers will be less constrained. Except as otherwise noted below, these provisions become effective 120 days after enactment of the Act - approximately March 11, 2000.
Financial Holding Companies
The key to the new ability for insurance companies to combine with banks is the creation of a new kind of bank holding company, called a "financial holding company." Eligible bank holding companies that elect to be financial holding companies are permitted under the Act to engage in any activity that is "financial in nature or incidental to financial activities" or "complementary to financial activities." In becoming familiar with the provision of Gramm-Leach-Bliley, it is important to remember:
- all financial holding companies are bank holding companies
- only bank holding companies that are eligible and have made an appropriate election are financial holding companies.
While the existing provisions of the Bank Holding Company Act expressly excluded insurance underwriting from the permissible activities and limited insurance producer activities based on a narrow "place of 5,000" provision, the Gramm-Leach-Bliley Act expressly identifies the following insurance activities as "financial in nature:"
Insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability, or death, or providing and issuing annuities, and acting as principal, agent, or broker for purposes of the foregoing, in any state.
The Act also specifically identifies a range of other activities that are defined to be "financial in nature," and these should generally cover most activities that an insurance company or insurance producer and other members of its holding company system would be engaged in.
As noted above, the Act retains the basic premise that members of a holding company system that includes a bank can only engage in those activities that are authorized. As a result, any insurance company contemplating an acquisition of or combination with a bank must carefully analyze its existing and contemplated business activities to assure that they would be permitted.
Merchant Banking Activities
Of particular note are the so-called "merchant banking" provisions of the Act. Generally, within the framework of the Bank Holding Company Act, taking a significant equity position in another company can constitute indirectly engaging in the activities of the other company - in which case, if the other company is not solely engaged in activities permissible for the bank holding company, the investment would be impermissible. However, for financial holding companies, the new Act gives authority to take equity positions in virtually any company (including controlling equity positions) subject to certain limitations designed to distinguish permissible merchant banking activities from impermissibly engaging in the activities of the portfolio company.
The investment must be made either (i) by an insurance company engaged predominately in underwriting life, accident and health, or property and casualty insurance (other than credit-related insurance) in the ordinary course of business of such insurance company in accordance with relevant state laws, or (ii) by a securities affiliate, an investment adviser to an insurance company, or affiliate thereof, as part of a bona fide underwriting or merchant or investment banking activity, with the investment held for a period of time to enable the sale or disposition thereof on a reasonable basis. In either case, during the period such investment is held, the bank holding company must not routinely manage or operate the portfolio company except as may be necessary or required to obtain a reasonable return on investment.
Loans by an affiliated depository institution to a controlled portfolio company would be restricted, and for these purposes there is a presumption that any portfolio company is controlled if 15 percent or more of the total equity capital of the portfolio company is controlled directly or indirectly by the financial holding company.
Conditions to Expanded Financial Powers for Financial Holding Companies
In order for a financial holding company to engage in activities that are not permissible under existing law, the financial holding company must maintain compliance with the following requirements at all times:
- all depository institutions within the holding company group must be well capitalized under the risk-based capital system applicable to banks and bank holding companies and
- all depository institutions within the holding company group must be well managed as determined by the applicable banking regulator.
In addition, at the time of commencement (de novo or by acquisition) of any new activity not permissible under current law, all depository institutions within the holding company group must have a "satisfactory" rating under the Community Reinvestment Act.
Limitations on Structure
The Gramm-Leach-Bliley Act generally prohibits insurance underwriting activities from being conducted by a subsidiary of a national bank. Products that had been approved by the OCC or were being lawfully engaged in by national banks prior to January 1, 1999, and were not the subject of any court order overturning the OCC's determination, continue to be permitted for national bank subsidiaries, except for title insurance and except for annuities subject to tax treatment under section 72 of the Internal Revenue Code of 1986.
The Act treats title insurance activities separately, providing that generally title insurance underwriting or agency activities can be housed in a subsidiary of a national bank only if, and to the same extent that, state banks in the State where the activities are conducted are permitted to engage in such title insurance agency activities. The Act grandfathers existing title insurance activities of national banks and their subsidiaries, subject to certain push-out requirements: (i) the national bank may not directly engage in such activities if it has a subsidiary which provides insurance (of any nature) as principal, and (ii) the national bank and its subsidiaries cannot engage in such activities if there is an affiliate that is not a subsidiary engaged in the provision of insurance (of any nature) as principal.
For purposes of the rule that national banks may not provide insurance as principal, the term insurance includes:
- any product regulated as insurance as of January 1, 1999 under the laws of the State where the product is provided
- any product first offered after January 1, 1999 that the State determines to regulate as insurance, except that certain products or services of a bank -- deposit products, loans, letters of credit or other extensions of credit, trust or fiduciary services, qualified financial contracts or financial guaranties -- cannot be defined as insurance, unless (i) the product includes an insurance component that it would be treated as a life insurance contract under section 7702 of the Internal Revenue Code, or (ii) with respect to products other than letters of credit or similar extensions of credit, qualified financial contracts, or financial guaranties, it would qualify for treatment for losses incurred with respect to such produce under section 832(b)(5) of the Internal Revenue Code if the bank were taxed as an insurance company and
- any annuity contract, the income on which is subject to tax treatment under section 72 of the Internal Revenue Code.
Alternatives to Financial Holding Companies
Thrift Holding Companies
Gramm-Leach-Bliley closes the unitary thrift holding company door, pursuant to which the bank holding company activities limitations did not apply to a holding company of a single savings association. Grandfathering is provided for insurance companies and others that were approved as thrift holding companies before, or pursuant to an application filed before, May 4, 1999 (a date carefully chosen to exclude an application from Wal-Mart). Among other issues with respect to these grandfathering provisions, there would appear to be considerable uncertainty as to the ability of an existing unitary thrift holding company to engage in new activities that are not financial in nature, especially where the holding company's existing activities would not exceed those limits.
The grandfathering of existing unitary thrift holding companies would not apply to any new company that becomes a holding company of the savings association, except pursuant to certain permitted corporate reorganizations.
For new thrift holding companies that meet the criteria of a unitary thrift holding company, the new financial holding company powers would be available. There is some uncertainty whether such powers extend to thrift holding companies that do not meet the standards for unitary thrift holding company treatment. However, we expect the OTS to do everything it can to maintain a level playing field for such holding companies.
Limited Purpose Banks
Not all affiliations with banks result in bank holding companies subject to the Bank Holding Company Act. For example, banks limited to trust activities or credit card activities can avoid such regulation. Thus, an insurance holding company system can add those capabilities to its group without regard to the regulatory framework applicable to financial holding companies.
Functional Regulation; Limitations on State Authority
The Act devotes a substantial amount of attention to establishing a system of functional regulation applicable to financial holding company groups, and to addressing the balance of power between state insurance regulators and federal bank regulators.
A holding company system that includes a bank as defined in the Bank Holding Company Act is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the Federal Reserve Board or the Fed). However, under Gramm-Leach-Bliley, the Fed is generally instructed to defer to the supervision and examination of subsidiaries by other regulators. For example, in implementing any reporting requirements it may impose, the Fed is required to accept to the fullest extent possible reports submitted to other regulators, audited financial statements and publicly available information. Similarly, the Fed is generally required to defer to examinations made by other regulators.
Functionally regulated subsidiaries are given additional protections from Fed regulation:
- The Fed may examine functionally regulated subsidiaries only if: (1) the Fed has reasonable cause to believe that such a subsidiary is engaged in activities that pose a material risk to an affiliate depository institution; (2) it reasonably believes after reviewing the relevant reports that examining the subsidiary is necessary to adequately inform the Fed of the systems for monitoring risks; or (3) based on reports and other available information, the Fed has reasonable cause to believe that a subsidiary is not in compliance with the BHCA or other federal law that the Fed has specific jurisdiction to enforce and the Fed cannot make such a determination through examination of an affiliated depository institution or the holding company.
- The Fed is not authorized to prescribe capital requirements for any functionally regulated subsidiary that is in compliance with applicable capital requirements of another federal regulatory authority, a state insurance authority, or is a registered investment adviser or licensed insurance agent.
- The Fed is prohibited from requiring a broker-dealer or insurance company that is a bank holding company to infuse funds into a depository institution if the company's functional regulator determines, in writing, such action would have a material adverse effect on the broker-dealer or insurance company. If the functional regulator makes such a determination, the Fed may require the holding company to divest its depository institution.
The definition of a "functionally regulated subsidiary" includes "an insurance company with respect to the insurance activities of the insurance company and activities incidental to such insurance activities." This definition does not include other activities of an insurance company, nor does it include insurance producers. In addition, these limitations do not apply if the insurance company is itself a bank holding company, as opposed to a sister company under a common holding company with the bank.
State Restrictions on Bank Insurance Activities
Gramm-Leach-Bliley establishes a delicate balance of power between the principle that the States should be the principle regulators of insurance activities, and the principle that the States should not be able to unduly interfere with the ability of banking and insurance activities to be engaged in within a single holding company system.
As a general proposition, the McCarran-Ferguson Act is affirmed as the law of the land. Furthermore, if a depository institution is engaged in the business of insurance, as principal or agent, it must abide by state licensing requirements.
States may not:
- prevent or significantly interfere with the ability of any insurer, or any affiliate of any insurer, to become a financial holding company or to acquire control of a depository institution or
- limit the amount of an insurer's assets that may be invested in the voting securities of a depository institution, except that the domicile State may limit the amount of such investment to an amount that is not less than 5 percent of admitted assets.
However, the Act authorizes states to:
- impose acquisition or change-in-control or continuation of control notice and approval requirements, applied in a non-discriminatory way (though the Act places a 60-day time limit on review by the state regulator)
- require an acquiror to maintain or restore the capitalization of the target insurer to the level required under the state's capital regulations to avoid the requirement of preparing and filing a plan to increase the capital of the insurer (by negative implication, this would appear to preclude greater capital infusion requirements beyond those minimum levels)
- impose restrictions on changes in control after conversion from mutual to stock form, so long as such restriction does not have the effect of discriminating against depository institutions or their affiliates.
In addition, certain kinds of regulation relating to sales, solicitation and cross-marketing are expressly permitted, including:
- restrictions prohibiting the rejection of an insurance policy by a depository institution or affiliate solely because the policy has been issued or underwritten by a person not associated with the depository institution, when the insurance is required in connection with a loan or extension of credit
- restrictions prohibiting a requirement for any debtor, insurer or insurance agent or broker to pay a separate charge in connection with the handling of insurance that is required
- restrictions prohibiting the use of any advertisement or other insurance promotional material that would cause a reasonable person to believe mistakenly that the federal or state government is responsible for the insurance sales activities, or stands behind the credit of the depository institution or affiliate, or guarantees any returns on insurance products, or is a source of payment on any insurance obligation of or sold by the institution or affiliate
- restrictions prohibiting the payment or receipt of any commission or brokerage fee or other valuable consideration for services as an insurance agent or broker to or by any person not licensed for the applicable class of insurance at the time the services were performed, except that the term "services as an insurance agent or broker" does not include a referral by an unlicensed person to a licensed producer that does not include any discussion by the unlicensed person of specific insurance policy terms and conditions
- restrictions prohibiting any compensation paid to or received by any individual who is not licensed to sell insurance, for the referral of a customer based on the purchase of insurance by the customer.
Thus, under these provisions, states may bar commissions paid to unlicensed bank platform personnel based on actual sales, or where the platform personnel provide substantive guidance relating to the insurance products, but cannot bar fixed fees for each referral, without regard to actual sales, where the referring person does not provide substantive guidance but merely refers the customer to a licensed producer.
Regulation of Sales Practices by Federal Banking Regulators
The federal banking regulators are called upon to establish certain customer protection regulations that apply to sales practices, solicitations, advertising or offers of insurance products by depository institutions or by any person engaged in such activities at the office of a depository institution or on behalf of such institution. The regulations are required to be adopted within one year after enactment of Gramm-Leach-Bliley, i.e., by November 12, 2000.
The regulations are required to include anti-tying and coercion rules, and certain disclosures relating to the uninsured nature of the products, the investment risks associated with the product, and the impermissibility of tying or coercion. The regulations will also address required separation of activities on depository institution premises.
Referrals by unlicensed tellers to qualified insurance sales personnel will be permitted only if the person making the referral receives no more than a one-time nominal fee of a fixed dollar amount for each referral that does not depend on whether the referral results in a transaction.
The Act also includes a prohibition on discrimination against victims of domestic violence in the sale of accident and health or life insurance through a bank or on bank premises. It remains to be seen how these provisions are interpreted, but they at least raise the possibility of a duty on the part of an insurer or agent to investigate whether an applicant's medical history is a result of domestic violence.
The regulations adopted by the federal banking regulators will not apply in any State where there are inconsistent state regulations, except that, after notice and consultation with the applicable state regulators the federal regulators can preempt the state law where the federal regulations provide greater protections to the consumer. Even then, however, the state can enact legislation to override the federal preemption.
Disputes Between Federal and State Regulators
The Act seeks to establish an expedited judicial mechanism for resolving disputes between federal regulators and state insurance regulators. In reviewing such disputes, the Act provides that the court shall decide the matter based on its review on the merits of all questions presented under state and federal law, "without unequal deference."
National Association of Registered Agents and Brokers
While state authority to require licensure of agents and brokers is generally preserved under the Gramm-Leach-Bliley Act, as discussed above, the Act also includes provisions that push for standardization of the producer licensure process.
Under these provisions, a single, national source of agent and brokerage licensing will be imposed, unless within three years at least a majority of the States have:
- enacted uniform laws and regulations governing the licensure of individuals and entities autorized to sell and solicit the purchase of insurance within the State or
- have enacted reciprocity laws and regulations governing the licensure of nonresident individuals and entities authorized to sell and solicit insurance within those States.
If a majority of the states do not enact such laws within this three-year period, the National Association of Agents and Brokers will be established, under the aegis of the National Association of Insurance Commissioners, to provide "a mechanism through which uniform licensing, appointment, continuing education and other insurance producer qualification requirements and conditions can be adopted and applied on a multi-state basis."
Mutual Insurance Company Conversions and Reorganizations
Redomestication to Form Mutual Holding Company
The Gramm-Leach-Bliley Act includes a preemptive mechanism for mutual insurance companies located in a State that does not establish reasonable terms and conditions for reorganization into a mutual holding company to redomesticate into a State that does have such provisions.
The redomestication must be a step in a reorganization as a mutual holding company structure, and must be effected in accordance with the laws of the State into which the insurance company is transferring. The plan of reorganization may not be approved by the insurance regulator of the transferee State unless the plan includes the following requirements:
- the reorganization is approved by at least a majority of the board of directors and at least a majority of the policyholders who vote after notice; disclosure of the reorganization and the effects of the transaction on policyholder contractual rights; and reasonable opportunity to vote, in accordance with such notice, disclosure and voting procedures as are approved by the insurance regulator of the transferee State
- after consummation of the reorganization, the policyholders of the reorganized insurer shall have the same voting rights with respect to the mutual holding company as they had before the reorganization with respect to the mutual insurer
- with respect to an initial public offering of stock, the offering shall be conducted in compliance with applicable securities laws and in a manner approved by the state insurance regulator of the transferee State
- during the applicable period provided for under the law of the transferee State following completion of an initial public offering, or for a period of six months if no such applicable period is provided, neither a stock holding company nor the converted issuer shall award any stock options or stock grants to persons who are elected officers or directors of the mutual holding company, the stock holding company, or the converted insurer, except with respect to any such awards or options to which a person is entitled as a policy holder and as approved by the state insurance regulator of the transferee domicile.
Notice must be given to the state insurance regulator of each state in which the redomesticating insurer has a certificate of authority immediately prior to the redomestication (the "licensed states"), and must file any resulting amendments required to be filed by a foreign licensed insurer with the insurance regulator of each licensed state.
Upon completion of the redomestication, all certificates of authority, agents' appointments and licenses, rates, approvals and other items that a licensed state allows will survive, if the insurer remains duly qualified to transact the business of insurance in such state. All outstanding insurance policies and annuities contract remain in full force and effect and need not be endorsed as to the new domicile of the insurer, unless ordered to do so by a licensed state as to the policies or contracts whose owners reside in that state. State law may require a redomesticating insurer to file new policy forms with the licensed state on or before the date of the transfer, but until the new forms are approved, the redomesticating insurer may use existing policy forms with an endorsement to reflect the new domicile.
The authority to redomesticate as provided in the Act is broadly preemptive of any state statutes that would prohibit such redomestication, or would discriminate against the redomesticated insurer on the basis of such redomestication.
Mutual to Stock Conversions
Under the Gramm-Leach-Bliley Act, non-domicile states may not prevent, significantly interfere with, or have the authority to review, approve or disapprove a plan of reorganization from mutual to stock form by an insurer domiciled in another state. No effective date is provided for this provision, which presumably therefore took effect immediately.
Rental Car Insurance
During the three-year period following enactment of Gramm-Leach-Bliley, the Act imposes a presumption that state insurance laws do not impose licensing, appointment or education requirements on any person soliciting insurance connected with, and incidental to, the lease or rental of a motor vehicle for 90 days or less. This provision does not preempt a state law, or a prospective regulatory or judicial interpretation, that expressly regulates or exempts from regulation any person who solicits the purchase of or sells insurance connected with, and incidental to, the short-term lease or rental of a motor vehicle.
The Gramm-Leach-Bliley Act imposes broad and potentially onerous provisions regarding the privacy of consumer financial information, including provisions restricting the transfer of such information to third parties and requiring the adoption and disclosure of privacy policies. For additional information, please refer to our separate Update titled "New Privacy Provisions Become Law."
The Gramm-Leach-Bliley Act is a truly landmark piece of legislation and will shape the financial services landscape for years to come. Please feel free to contact us if you have any questions about the Act or its effect on your company.