This is part 3 of a 4 part blog on the final rules, issued July 18, 2012, that describes certain transactions outside the scope of the definitions of swaps and security-based swaps, such as certain insurance products and consumer and commercial products.

According to the Dodd-Frank Act, the CFTC is given regulatory authority over swaps, the SEC is given regulatory authority over security-based swaps, and the Commissions shall jointly prescribe such regulations regarding mixed swaps as may be necessary to carry out the purposes of Title VII of the Act.  In addition, the SEC is given antifraud authority over, and access to information from major swap participants.

The main intent of these new rules is the Commissions concern that certain agreements, contracts, or transactions that are swaps or security-based swaps might be characterized as insurance products to evade the regulatory regime directed by Title VII of the Act.

These final rules contain four subparts which address the above-mentioned concerns: the first subpart addresses the agreement, contract, or transaction; the second subpart addresses the person providing that agreement, contract, or transaction; the third subpart includes a list of traditional insurance products that do not have to meet the requirements set out in the first subpart; and the fourth subpart contains the insurance grandfather exclusion.

[I. Product Test]

The Commissions adopted new rules collectively called the “Product Test” as proposed, with certain modifications to respond to commenters’ concerns.   As adopted, the Product Test provides that the terms “swap” and “security-based swap” will not include an agreement, contract, or transaction that, by its terms or by law, as a condition of performance: (i) requires the beneficiary of the agreement, contract, or transaction to have an insurable interest that is the subject of the agreement, contract, or transaction and thereby carry the risk of loss with respect to that interest continuously throughout the duration of the agreement, contract, or transaction; (ii) requires that loss to occur and be proved, and that any payment or indemnification therefore be limited to the value of the insurable interest;  (iii) is not traded, separately from the insured interest, on an organized market or over the counter; and (iv) with respect to financial guaranty insurance only, in the event of payment default or insolvency of the obligor, any acceleration of payments under the policy is at the sole discretion of the insurer.

[II. Provider Test]

The Commissions also issued new rules collectively called the “Provider Test” as proposed, with certain modifications to respond to commenters’ concerns.  As adopted, the Provider Test requires that an agreement, contract, or transaction that satisfies the Product Test must be provided: (i) by a person that is subject to supervision by the insurance commissioner (or similar official or agency) of any state or by the United States or an agency or instrumentality thereof, and such agreement, contract, or transaction is regulated as insurance under applicable state law or the laws of the United States (the “first prong”); (ii) directly or indirectly by the United States, any state or any of their respective agencies or instrumentalities, or  pursuant to a statutorily authorized program thereof both above part together, the (“second prong”); or (iii) in the case of reinsurance only by a person to another person that satisfies the Provider Test, provided that: {a} such person is not prohibited by applicable state law or the laws of the United States from offering such agreement, contract, or transaction to such person that satisfies the Provider Test; {b} the agreement, contract, or transaction to be reinsured satisfies the Product Test or is one of the Enumerated Products (as defined below); and {c} except as otherwise permitted under applicable state law, the total amount reimbursable by all reinsurers for such agreement, contract, or transaction may not exceed the claims or losses paid by the cedant {a}, {b, and {c}, (collectively, the “third prong”).  Or in the case of non-admitted insurance by a person who: {a} is located outside of the United States and listed on the Quarterly Listing of Alien insurers as maintained by the international insurers Department of the National Association of insurance Commissioners; or {b}meets the eligibility criteria for non-admitted insurers under applicable state law {a} and {b} (together, the “fourth prong”).