Centers for Better Insurance Issues Reply to RFI From Financial Crimes Enforcement Network

WASHINGTON, Feb. 16 -- The Centers for Better Insurance LLC, Frederick, Maryland, has issued a public comment in response to the Financial Crimes Enforcement Network request for information entitled "Review of Bank Secrecy Act Regulations and Guidance". The comment was written on Feb. 10, 2022, and posted on Feb. 11, 2022:

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To: Financial Crimes Enforcement Network (FinCEN), Treasury

Re: Review of Bank Secrecy Act Regulations and Guidance

Docket Number FINCEN-2021-0008

The Centers for Better Insurance, LLC (CBI) is an independent organization focused on optimizing the value insurance delivers to all stakeholders (including policyholders, employees, and society at large). CBI does so by making available unbiased analysis and insights about key regulatory issues facing the industry for use by insurance professionals, regulators, and policymakers. CBI receives no outside funding.

In response to this request for information and comment, CBI draws FinCEN's attention to two "rough edges" in the current exemption afforded property and casualty insurance products under Bank Secrecy Act (BSA) guidance:

1. Current FinCEN guidance on the exemption of property and casualty insurance from the BSA is internally inconsistent, inconsistent with other rules promulgated by Treasury, and inconsistent with OECD standards in an analogous context; and

2. Current FinCEN guidance on the exemption of property and casualty insurance from the BSA cannot be reconciled with Internal Revenue Service's concern and other indicia of high-risk with respect to secretive and lightly regulated captive insurance companies.

I. Inconsistencies in Cash Value Insurance Contract Definitions

A. BSA Regulatory Provisions

31 CFR Sec. 1025.210(a) provides that "each insurance company shall develop and implement a written anti-money laundering program applicable to its covered products." 31 CFR Sec. 1025.100(b) defines a "covered product" as:

(1) A permanent life insurance policy, other than a group life insurance policy;

(2) An annuity contract, other than a group annuity contract; or

(3) Any other insurance product with features of cash value or investment.

B. FinCEN's Internally Inconsistent Guidance on Cash Value Insurance Contracts

In an FAQ dated October 31, 2005, FinCEN first provides for a conditional exemption of property and casualty insurance:

To the extent that ... property and casualty insurance ... do[es] not exhibit these features [of cash value or investment], they are not products covered by the rule.

In that same FAQ, FinCEN then appears to recognize an absolute exemption of property and casualty insurance:

[T]he following products are not defined as 'covered products' in the final rule: ... property, casualty ... insurance.

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Contracts of indemnity and structured settlements (including workers' compensation payments) are not within the definition of "covered products" for purposes of the final rule.

In Guidance FIN-2006-G010 (May 31, 2006), FinCEN seems to confirm that its interest with respect to insurance is limited to life insurance and annuity products:

[F]eatures of cash value or investment [is intended] to ensure that any newly developed products in the life insurance and annuity areas having these characteristics, and that are particularly vulnerable to money laundering, would be covered.

The update to this guidance FIN-2008-G004 (March 20, 2008) repeats these same provisions.

As it stands, FinCEN guidance may be read to exempt from the BSA only those property and casualty insurance products that do not have a cash value or investment feature or FinCEN guidance may be read to exempt from the BSA all products that can be classified as property and casualty insurance.

This is not an academic dispute. A number of insurers have begun marketing "parametric insurance" products that contain investment-like features. Such insurance products may pay out based on foreign exchange markets, economic performance indicators, the parameters of weather events, or even violent crime statistics in a designated neighborhood.

For example, First Insurance Company of Hawaii's parametric insurance contract, FirstTrack, "pays out a predetermined amount based on the strength and proximity of a hurricane." If a parametric such a product was sold under the CFTC's jurisdiction as a "swap" it would most certainly fall within the scope of the BSA. However, it appears from FinCEN's current guidance that the very same non-indemnity product marketed instead as property and casualty insurance is exempt from the BSA.

As the property and casualty insurance industry continues to test its regulatory frontier, FinCEN should update its guidance to be clear whether the exemption of property and casualty insurance from the BSA is absolute or conditional. In any event, FinCEN should be mindful of the risk of regulatory arbitrage over AML controls as between the CFTC and state insurance regulators.

C. Treasury's More Expansive Definition of Cash Value Insurance under FATCA

On the assumption that the exemption of property and casualty insurance from the BSA is properly conditioned on having no cash value or investment feature, FinCEN should update its guidance to reconcile with the definition of cash value adopted by Treasury and the IRS in a closely analogous context.

A few years after FinCEN issued its guidance on cash value insurance under the BSA, Treasury and the Internal Revenue Service promulgated regulations relating to the Foreign Account Tax Compliance Act (FATCA). Those regulations extend the scope of that program to "an insurance company ... [that] issues, or is obligated to make payments with respect to, a cash value insurance ... contract." 26 CFR Sec. 1.1471-5(e)(1)(iv).

In the context of FATCA, a "cash value insurance contract" is defined at 26 CFR Sec. 1.1471-5 (b)(3)(vii) as:

(B) [T]he term cash value means any amount (determined without reduction for any charge or policy loan) that-

(1) Is payable under the contract to any person upon surrender, termination, cancellation, or withdrawal; or

(2) Any person can borrow under or with regard to (for example, by pledging as collateral) the contract.

(C) Amounts excluded from cash value. Cash value does not include an amount payable

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(2) As a .... benefit providing indemnification of an economic loss incurred upon the occurrence of the event insured against;

(3) As a refund of a previously paid premium (less cost of insurance charges whether or not actually imposed) under an insurance contract (other than a life insurance or annuity contract) due to cancellation or termination of the contract, decrease in risk exposure during the effective period of the contract, or arising from the correction of a posting or similar error with regard to the premium for the contract; or

(4) As a policyholder dividend (other than a termination dividend) provided that the dividend relates to an insurance contract under which the only benefits payable are described in paragraph (b)(3)(vii)(C)(2) of this section.

(5) As a return of an advance premium or premium deposit for an insurance contract for which the premium is payable at least annually if the amount of the advance premium or premium deposit does not exceed the next annual premium that will be payable under the contract.

In other words, a cash value insurance contract includes a property and casualty insurance contract that pays some benefit other than for indemnification of a loss or that is designed to store and then return premium later in time.

FinCEN's guidance for the BSA has not carried forward any of considerations that drove Treasury and the IRS to develop FATCA's expansive definition of cash value. Yet, FATCA and the BSA have the broadly similar objectives to identify and risk-mitigate products that may be exploited for purposes of financial crime. FinCEN's guidance should be revised to align BSA and FATCA's criteria for evaluation whether a property and casualty insurance product contains a "cash value" feature.

D. Consideration of OECD Standards

The OECD Common Reporting Standard defines "cash value" in generally the same manner as FATCA:

[T]he greater of (i) the amount that the policyholder is entitled to receive upon surrender or termination of the contract (determined without reduction for any surrender charge or policy loan), and (ii) the amount the policyholder can borrow under or with regard to the contract.

Notwithstanding the foregoing, the term "Cash Value" does not include an amount payable under an Insurance Contract:

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b) as a ... benefit providing indemnification of an economic loss incurred upon the occurrence of the event insured against;

c) as a refund of a previously paid premium (less cost of insurance charges whether or not actually imposed) under an Insurance Contract (other than an investment-linked life insurance or annuity contract) due to cancellation or termination of the contract, decrease in risk exposure during the effective period of the contract, or arising from the correction of a posting or similar error with regard to the premium for the contract;

d) as a policyholder dividend (other than a termination dividend) provided that the dividend relates to an Insurance Contract under which the only benefits payable are described in subparagraph C(8)(b); or

e) as a return of an advance premium or premium deposit for an Insurance Contract for which the premium is payable at least annually if the amount of the advance premium or premium deposit does not exceed the next annual premium that will be payable under the contract.

In the same way that FinCEN's guidance should be revised to align BSA and FATCA's criteria for determining whether a property and casualty insurance product contains a "cash value" feature, FinCEN should review and align with the OECD standard for the identification of insurance products presenting a risk for abuse in the context of financial crime.

II. Captive Insurance Companies

For many years, the IRS has sounded an alarm over potential financial abuse by captive insurance company arrangements. Most recently, the IRS has included certain captive arrangements in its "Dirty Dozen" of tax fraudsters and has driven an increasingly intense campaign scrutinizing alleged financial abuses by these entities./1

According to the Insurance Information Institute there are more than 3000 captive insurance companies domiciled in the U.S. and another roughly 3000 domiciled offshore.

The financial crime risks associated with captive insurers go well beyond tax fraud. Through independent research, CBI has identified two captive insurance companies (regulated by the Vermont and District of Columbia departments of insurance) whose ultimate beneficial owner is Aviation Industry Corporation of China (AVIC)./2

AVIC is on U.S. Treasury's list of sanctioned Communist Chinese Military Companies because it is "directly supporting the efforts of the [People's Republic of China's] military, intelligence, and other security apparatuses [and] constitutes an unusual and extraordinary threat . . . to the national security, foreign policy, and economy of the United States." Other state-licensed captive arrangements exclusively and expressly serve the (federally) illegal marijuana trade./3

For example, the National Cannabis Risk Management Association provides its members with access to a specialized cannabis captive:/4 TRICHOME(TM) was established in 2020 and is the first risk-bearing captive insurance model in the cannabis industry to deliver the essential, industry-specific, and risk management anchored insurance products that the cannabis vertical needs to expand and sustain their business. TRICHOME(TM) an NCRMA endorsed product, initially offers general liability, premises liability, product liability and property coverages for dispensaries and those with associated grow facilities.

State departments of insurance are generally prohibited from sharing information about the captives they regulate. Some have gone so far as to assert confidentiality over even the corporate names of the captives they license./5

The South Dakota division of insurance sums up this "hands-off" regulatory philosophy succinctly:/6

1 IRS urges participants of abusive micro-captive insurance arrangements to exit from arrangements (April 9, 2021); and https://www.irs.gov/newsroom/dirty-dozen.

2 https://jason-schupp.medium.com/tria-eligible-insurers-include-subsidiaries-of-a-sanctioned-communist-chinese-military-company-c1d4fe947e35

3 Alternative Risk Strategies Closes $10 Million D&O Captive Insurance Arrangement for Large Cannabis Client, www.altrisks.com/news/alternative-risk-strategies-closes-%2410-million-d%26o-captive-insurance-arrangement-for-large-cannabis-client

4 www.trichomerisk.com.

5 Respondent's Brief, Schupp v. Ohio Department of Insurance, No. 2021-00199PQ, Court of Claims of Ohio (claiming the "General Assembly did not need to specify that the company names were confidential when the names are already protected as 'information' provided to the superintendent); Motion to Dismiss Complaint for Writ of Mandamus, Schupp v. Navarro, C.A. No. K21M-05-020 (recounting Delaware Department of Insurance efforts to prevent public access to "captive insurance company licenses").

6 Appellee's Brief, Schupp v. South Dakota Division of Insurance, No. 32 CIV21-000107, 6th Judicial Circuit of South Dakota (claiming that state law "create[es] a 'need to know' atmosphere around captive insurer information).

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[C]aptive insurers do not serve the public at large, they only serve their creator. It is only necessary to regulate captive insurers at a high level, i.e., to prevent the captive from financially harming its parent companies or itself and to prevent outright illegality.

In short, captive insurance companies are secretive corporate vehicles regulated (at least in some states) with what can only be described as a "see no evil, hear no evil" attitude./7

Yet, the Financial Action Task Force has warned that close surveillance of the ownership of financial institutions is critical to reduce the risk of money laundering and other illegal activity:/8

Competent authorities or financial supervisors should take the necessary legal or regulatory measures to prevent criminals or their associates from holding, or being the beneficial owner of, a significant or controlling interest, or holding a management function in, a financial institution.

FinCEN's current guidance exempts from the BSA any captive insurance company that characterizes the products its offers as "property and casualty insurance". Given the institutional secrecy, light regulation, and existing red flags surrounding captive insurance companies, FinCEN should urgently consider explicit inclusion of captive insurance companies within the scope of the BSA regardless of the claimed nature of the products they offer.

7 See United States of America v. Delaware Department of Insurance, CA No. 20-CV-829-MN-CJB (D. Del.) (resisting IRS summons that "seeks information pertaining to approximately 200 insurance certificates of authority that DDOI issued to micro-captive insurance companies").

8 FATF Recommendation #26 (corresponding interpretive note recommending "supervisors should take into consideration the characteristics of the financial institutions/groups, in particular the diversity and number of financial institutions, and the degree of discretion allowed to them under the [risk-based assessment]").

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The request for information can be viewed at: https://www.regulations.gov/document/FINCEN-2021-0008-0001

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