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November 14, 1996

Michael E. Phenner, Esq.
Hopkins & Sutter
Three First National Plaza
Chicago, Illinois 60602

Dear Mr. Phenner:

This is in response to your letter requesting confirmation that reinsurance by a captive insurance subsidiary of a bank holding company ("Captive") of corporate owned life insurance policies ("COLI") purchased by the bank holding company and its bank and nonbank subsidiaries on the lives of their respective directors, officers, or employee (1) is a permissible servicing activity under sections 4(a)(2) and 4(c)(1)(C) of the Bank Holding Company Act ("BHC Act");1 and (2) is not a covered transaction for purposes of section 23A of the Federal Reserve Act.2

Under your proposal, a bank holding company and its subsidiaries would purchase COLI on the lives of their directors, officers, and employees from an unaffiliated insurance company ("Direct Writer") in order to pay projected future employee compensation and benefit program liabilities.3 The Direct Writer would then enter into a reinsurance agreement on the COLI with the Captive to reinsure a percentage of the risk associated with the policy (probably, 50 to 70 percent).4 Pursuant to the reinsurance agreement, the Direct Writer would deposit funds in a trust account to maintain reinsurance reserves in proportion to the percentage of risk reinsured by the Captive.5

The Direct Writer would remain directly liable to policyholders for all claims and for the cash surrender value of the policy. The Direct Writer, however, would have a claim against the Captive for a portion of each COLI claim, and would substitute the reinsurance agreement for a substantial portion of the reserves it would be required to maintain under state law. Funds in the trust account would be used to reimburse the Direct Writer for the Captive's portion of a paid claim.6

Sections 4(a)(2) and 4(c)(1)(C) of the BHC Act provide exemptions from the nonbanking prohibitions of the BHC Act to permit a bank holding company to acquire shares of a company engaged in furnishing services to, or performing services for, such bank holding company or its banking and nonbanking subsidiaries.7 The legislative history of section 4(c)(1)(C) indicates that Congress favored an expansive and flexible definition and that the term "services" was to be broadly construed provided that the activity was performed for, or on behalf of, the holding company or its bank subsidiaries.8

It previously has been determined that a bank holding company may use a captive nonbanking subsidiary to underwrite various types of insurance for the bank holding company and its affiliates.9 A captive credit-life insurance subsidiary of a bank holding company also has been permitted to underwrite and reinsure life insurance policies that the bank holding company and its subsidiaries purchase on the lives of their respective employees.10 Based on a review of the legislative history of the BHC Act and previous application of the servicing exemptions, the proposed reinsurance by a Captive of COLI owned by a bank holding company or its subsidiaries is a servicing activity permissible under sections 4(a)(2) and 4(c)(1)(C) of the BHC Act. The proposed activities may be conducted by a Captive established solely to reinsure insurance risks of its affiliates or by a subsidiary also engaged in credit-related insurance activities pursuant to Regulation Y.11

You also seek a determination as to whether the proposed activities would be considered "covered transactions" for purposes of section 23A of the Federal Reserve Act.12 Section 23A is designed to protect insured depository institutions from abuses that may result from an insured depository institution engaging in certain transactions with an affiliate. Section 23A imposes quantitative limits on "covered transactions" between insured depository institutions and their affiliates that limits such transactions to 10 percent of the institution's capital and surplus for any single transaction and a 20 percent aggregate limit for such transactions with all affiliates.

The purchase of an insurance policy that is reported as an asset on the books of a bank is an asset for purposes of section 23A. Therefore, a bank's purchase of COLI directly from Captive would be considered a "purchase of assets," and thus, a "covered transaction" with an affiliate, subject to the quantitative limitations of section 23A.13 The question presented in this case, however, is whether the purchase of COLI by a bank from a Direct Writer, where the Direct Writer reinsures the policy with a Captive, also would be a "covered transaction" for purposes of section 23A.

Section 23A provides that any transaction by a bank with any person is a transaction with an affiliate if the proceeds of the transaction are used for the benefit of, or transferred to, that affiliate ("Attribution Rule").14 For the reasons stated below, however, the proposed transaction is not subject to the Attribution Rule if certain conditions are met.

Section 23A is designed to restrict banks in their transactions with their affiliates in order to limit the potential for abuse that the law presumes may arise from such transactions. In each of the five "covered transactions" listed in the statute, the bank is at a risk of loss for the actions that have been or may be taken by an affiliate.15 In this case, however, the affiliate's reinsurance of the insurance policy would not expose the bank to a risk of loss if the Direct Writer is liable to the bank for all claims and the cash surrender value of the policy, and is responsible to the bank for payment, even if the Direct Writer can not obtain reimbursement from Captive.

However, because the bank and Captive are under common control, Direct Writer could try to offset what it owes to the bank by reducing the bank's payment by the amount Captive, as reinsurer, owes Direct Writer. This offset could adversely affect the bank. For example, if the bank filed a $100 claim, and the Direct Writer "offsets" the 40 percent of the claim that is reinsured by Captive and owed to Direct Writer, then Bank would receive only $60. Accordingly, to avoid the potential risk of loss to the bank, any agreement between the bank and Direct Writer must require that for any claim filed by the bank, Direct Writer will not have a right of offset for any funds owed to it by the Captive or any other affiliate, and Direct Writer will not seek reimbursement from Captive until after it pays the claim to the bank. This provision will ensure that the bank receive the full amount of its claim and will protect the bank from being at risk of loss because of an affiliate's actions. Accordingly, if the bank, Captive, and Direct Writer agree to this restriction, based on the facts of this case, Captive's reinsurance of the policy should not result in a transaction that is subject to the Attribution Rule. If, however, Captive does not agree to the restrictions, then the Attribution Rule and the restrictions of section 23A will apply to the transactions.

In addition, the transaction is subject to 23B because the bank's purchase of COLI from the Direct Writer where the Captive is reinsuring the policy is a transaction with a third party where an affiliate is a participant in the transaction. Therefore, the transactions must be conducted on market terms.

These determinations are based upon representations in your letter and on the conditions described above. Any changes in the circumstances or the facts relied upon in making these determinations could result in reconsideration of the determinations made herein. If you have any further questions regarding this matter, please contact Pamela Nardolilli (202/452-3289) or Diane Koonjy (202/452-3274) of my staff.


(signed) J. Virgil Mattingly

J. Virgil Mattingly

General Counsel

cc: Robert L. Bevan, Esq.


1. 12 U.S.C. 1843(a)(2) and (c)(1)(C). Return to text

2. 12 U.S.C. 371c. Return to text

3. The bank holding company and its bank and nonbank subsidiaries would each separately purchase COLI on the lives of their own employees. The purchasing institution would treat the COLI as an asset and would be the policy's sole beneficiary. The present value of projected cash flow from the COLI would not substantially exceed the present value of the projected cost of the employee benefit liabilities. See FRB SR 94-23 (April 12, 1994). Return to text

4. The Direct Writer would retain the remaining portion of the risk (30 to 50 percent) and would be responsible for (a) clearing policy forms with state authorities, (b) complying with state laws, (c) issuing COLI policies, (d) performing the actuarial analysis to set premiums, and (e) paying claims. Return to text

5. The Direct Writer would be the sole beneficiary of the trust account. Before depositing funds into the trust account, the Direct Writer would deduct all costs incurred in establishing the COLI. The Captive would be responsible for contributing additional assets to the trust in order to bring it up to the required reserve levels. Return to text

6. Funds in the trust account would be invested by a committee comprised of representatives of the Direct Writer and the Captive, or by the Captive with oversight from the Direct Writer. Investment earnings (in excess of funds required to maintain reserves and pay reinsurance claims) would be distributed to the Captive as income. If funds in the trust account are less than the amount of reserves required, the Captive would be required to contribute assets to bring the trust up to requisite levels. Return to text

7. 12 U.S.C. 1843(a)(2) and (c)(1)(C). Return to text

8. S. Rep. No. 1095, 84th Cong. 2d Sess., Part 2, p. 3 (1956). Return to text

9. See letter dated April 12, 1995, from J. Virgil Mattingly, Jr., General Counsel, to Michael E. Briggs, Barnett Banks, Inc. (permitting a captive insurance subsidiary of a bank holding company to underwrite commercial general liability, automobile liability, workers' compensation, property, and bankers' transportation coverages for the bank holding company and its subsidiaries). Return to text

10. See letter dated August 19, 1981, from Robert E. Mannion, Deputy General Counsel, to Russell A. Freeman, Security Pacific Corporation. Return to text

11. See 12 C.F.R. 225.25(b)(8)(i). Return to text

12. 12 U.S.C. 371c. Return to text

13. Captive is an affiliate of the bank because both entities are controlled by the same company. 12 U.S.C. 371c(b)(1)(A). Return to text

14. 12 U.S.C. 371c(a)(2). Return to text

15. Section 23A defines covered transactions with respect to an affiliate of a member bank as (1) loans or extensions of credit to the affiliate, (2) purchase of, or investment in securities issued by an affiliate, (3) purchase of assets from an affiliate, (4) acceptance of affiliate's securities for a loan, and (5) guarantees, acceptances or letters of credit on behalf of an affiliate. Return to text

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