New anti-money laundering rules for US life business are imminent, says Melvin S Schwechter, but should reinsurers have to comply?

When most people think about money laundering, they probably envisage surreptitious midnight dealings involving narcotics traffickers, front companies, and large sums of cash in small, unmarked bills. Some might think of money orders, credit cards, and wire transfers - maybe even mutual fund or real estate purchases - being made under false names. But would they think of interest-indexed universal life insurance and variable annuities?

The US government now does, with the result that soon most life re/insurers doing business in the US may need to take steps to prevent money laundering activity in their products.

Since the USA Patriot Act was passed in October 2001, the Treasury Department's Financial Crimes Enforcement Network (FinCEN) has been busily publishing regulations to enforce the Act's provisions against anti-money laundering and terrorist financing. The Patriot Act required all financial institutions to implement programmes designed to prevent and detect these activities in their businesses, but left it to FinCEN to determine which financial institutions had to comply, and how they were to do so. FinCEN began its task by focusing on the most obvious and problematic money laundering risk areas: banks, casinos, mutual funds, securities dealers, and 'money services businesses' (companies that cash cheques, sell or redeem money orders or traveller's cheques, exchange currency, etc). However, the result of these regulations was that money launderers found it more difficult to pass large amounts of money through these institutions, so they increasingly turned to other means of laundering. International organisations like the International Association of Insurance Supervisors began raising concerns that insurance products were becoming significant targets for money launderers and, in 2002, FinCEN set itself to studying how it might best propose regulations to thwart these activities in the US.

Why all the attention?

Insurance companies, though they technically fall within the definition of 'financial institutions' subject to the US Bank Secrecy Act1, have been excluded from FinCEN's rule making efforts under that law because most insurance activities are already heavily regulated by state law.

Certain insurance products, however, allow insureds to deposit and redeem, transfer, and borrow against significant sums of money, which has drawn the attention of both money launderers and FinCEN.

Unlike health and property/casualty insurance, many life insurance products offer immediate financial benefits to insureds and can serve as lucrative investment vehicles. In the words of FinCEN, these products "allow a customer to place large amounts of funds into the financial system and seamlessly transfer such funds to disguise their true origin."2 A permanent life insurance policy, for example, can be purchased with illegal funds and then redeemed or used as collateral to borrow 'clean' funds. Term life insurance can be purchased by a launderer who uses a sick or elderly person to serve as the insured life; the launderer then collects clean funds when the insured dies. Annuity contracts are also attractive to money launderers because these products provide an immediate stream of clean income, often linked to performance of investments made via the contract.

Although a money launderer may pay significant penalties for redeeming his policy and recovering cash, this is nevertheless often done, considered by launderers to be a reasonable price to pay for the laundering 'service' performed by the life product.

What will the new requirements look like?

Although the rule in its final form has not yet been issued, the proposed rule has been available for some time. This draft rule closely mirrors the anti-money laundering regulations that many other financial institutions have been required to implement, so it is expected to predict, with some certainty, the main points of what the final rule for insurers will require.

FinCEN's draft rule would oblige companies engaged in the business of life insurance, annuities, and similar products in the US to implement compliance programmes "reasonably designed to prevent the insurance company from being used to facilitate money laundering or terrorist financing".

The rule, therefore, would apply to non-US insurance companies to the extent they issue, underwrite, or otherwise dispose of life insurance policies and annuity contracts in the US. The proposed rule also specifically captures in its reach any company engaged in the US in the business of reinsuring life insurance policies, annuities, or other insurance products that feature the ability to store and transfer value.

Under the rule, life re/insurers who do business in the US must develop and maintain a written anti-money laundering programme, approved by senior management that, at a minimum, includes:

- policies, procedures, and internal controls that reflect the insurer's assessment of the money laundering risks it faces;

- the designation of a compliance officer to ensure the effectiveness of the programme;

- training of employees on compliance responsibilities; and

- independent testing to monitor the effectiveness of the programme.

As written, the proposed rule does not apply to insurance agents or brokers, but FinCEN expects life insurers and reinsurers to "assess the money laundering and terrorist financing risks posed by its distribution channels and to incorporate policies, procedures, and internal controls integrating its agents and brokers into its anti-money laundering program"3. According to FinCEN, the rule is intended to allow insurers the flexibility they need to assess for themselves where their greatest areas of money laundering risk may lie, and to implement a programme tailored to address those risks.

A company can delegate the operation of its programme to a third party or to agents and brokers, but the insurer retains the ultimate responsibility for the programme's effectiveness or failure, and must ensure that federal examiners have access to records relevant to the programme and to the agents, brokers, or other third parties who may have assumed some of the compliance burden.

Under a related proposed rule published on 17 October 2002, life re/insurers would also be required under the proposed rules to report "suspicious transactions" to FinCEN4. Suspicious transactions are those the company knows or has reason to suspect: (1) involve funds derived from illegal activity; (2) are designed to evade reporting requirements or other provisions of the Bank Secrecy Act; (3) have no business or apparent lawful purpose; or (4) involve the use of the company to facilitate criminal activity.

Life insurers would be required to report suspicious transactions of $5,000 or more, but could voluntarily report those of lower value. These reporting obligations would generally be discharged by filing a certain form with FinCEN within 30 days of the initial detection and by maintaining all supporting documentation on file for five years. To protect the insurer from liability arising from suits brought by angered customers, the rule protects the insurer and its directors, officers, employees, and agents from liability for any disclosure made - whether mandatory or voluntary - pursuant to the regulation5.

Should reinsurers be subject to the rule?

As currently worded, the draft anti-money laundering regulations would require reinsurers of life business to establish compliance programmes.

However, many in the industry believe this to be inappropriate, given the fact that reinsurers usually have no contact with the underlying policyholders and are not in a position to prevent abuse of the underlying insured policies.

The Reinsurance Association of America pointed out that "reinsurers simply do not have the primary information about the consumer insurance transactions that would be required for compliance with the proposed rules"6. The National Association for Variable Annuities argued that "the primary insurance company would be in possession of all customer information and records and would have already screened the transaction for potential money laundering at the time the policy was issued. It would also have already filed a suspicious activity report if one was indicated by the circumstances surrounding the sale"7. Commentators have also pointed out that reinsurance products, by their nature, are not prone to manipulation by money launderers and should not be targeted by the regulations.

Preparing for compliance

As it puts the finishing touches on the final version of its anti-money laundering rules, FinCEN will have to consider and resolve several issues: whether reinsurers should be covered by the rule; whether all types of life insurance are significantly exposed to laundering activity; and whether agents and brokers should be required to implement their own anti-money laundering programmes. Whatever the final form of the rules, they are expected to be published by the turn of the year (although FinCEN has been promising imminent publication for several months now).

Although a number of insurers have some anti-money laundering and suspicious activity reporting measures already in place to comply with state laws, many companies will find that they must either refashion their existing policies or create entirely new policies. The life re/insurance industry in the US must therefore keep watch on FinCEN's regulatory activities over the next few weeks so that they can make an appropriate and timely response to the final requirements as they apply to various types of insurers, reinsurers, and insurance products8.

1 31 U.S.C. s. 5312(a)(2)(M).

2 Financial Crimes Enforcement Network; Anti-Money Laundering Programs for Insurance Companies, 67 Fed. Reg. 60625, 60626 (proposed Sept. 26, 2002) (to be codified at 31 C.F.R. Pt. 103).

3 Id at 60628.

4 Financial Crimes Enforcement Network; Amendment to the Bank Secrecy Act Regulations - Requirement That Insurance Companies Report Suspicious Transactions, 67 Fed. Reg. 64067 (proposed Oct. 17, 2002) (to be codified at 31 C.F.R. Pt. 103).

5 Id at 64075; see also 31 U.S.C. s. 5318(g)(3).

6 Letter from Franklin W Nutter, president of the Reinsurance Association of America, to FinCEN (Dec. 27, 2002), also available at
7 Letter from Michael P DeGeorge, general counsel of the National Association for Variable Annuities, to FinCEN (Dec. 16, 2002), also available at
8 FinCEN publishes draft and final regulations promulgated under the Patriot Act on its website; see
- Melvin S Schwechter, president of the Customs and International Trade Bar Association, is a partner in the District of Columbia offices of LeBoeuf, Lamb, Greene & MacRae, LLP, where he assists US and non-US companies in complying with US laws regulating international trade and financial transactions.