Sales of Credit Life Insurance

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 2

[Docket No. 96-22]

RIN 1557-AB49

Sales of Credit Life Insurance

AGENCY: Office of the Comptroller of the Currency, Treasury.

ACTION: Final rule.

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SUMMARY: The Office of the Comptroller of the Currency (OCC) is

revising its

[[Page 51778]]

regulation governing national bank sales of credit life insurance and

the disposition of credit life insurance income. This final rule is

another component of the OCC's Regulation Review Program to update and

streamline OCC regulations, focus regulations on key safety and

soundness concerns and agency objectives, and eliminate requirements

that impose unnecessary regulatory burdens on national banks. The final

rule eliminates unnecessarily detailed provisions, reorganizes the rule

into a more helpful format, and refocuses the regulation to better

address areas presenting potential safety and soundness and conflict of

interest issues.

EFFECTIVE DATE: December 31, 1996.

FOR FURTHER INFORMATION CONTACT: Stuart E. Feldstein, Assistant

Director, Legislative and Regulatory Activities, (202) 874-5090; Karen

E. McSweeney, Attorney, Legislative and Regulatory Activities, (202)

874-5090. Office of the Comptroller of the Currency, 250 E Street, SW,

Washington, DC 20219.

SUPPLEMENTARY INFORMATION:

Background

On September 13, 1995, the OCC published a notice of proposed

rulemaking, 60 FR 47498 (September 13, 1995) (proposal), to revise 12

CFR part 2--the OCC's regulation governing credit life insurance and

the disposition of credit life insurance income. The proposal

reaffirmed the OCC's commitment to addressing the concerns that gave

rise to the former part 2 and did not contemplate altering the

fundamental standards reflected in the former rule.

As noted in the proposal, there are two principal concerns that

part 2 is intended to address. First, part 2 is ``premised on the

judgment that income earned from credit life insurance sales to bank

customers by bank officers using bank premises and good will in the

creation of bank assets (loans) should be credited to bank earnings

rather than be paid directly to and retained by officers, directors or

selected stockholders.'' See 42 FR 48518 (September 23, 1977). Second,

a conflict of interest may exist when a loan officer's receipt of

commissions for the sale of the credit life insurance is tied to the

number of loans he or she makes. This prospect of financial reward

based solely upon loan volume may induce loan officers to make unsound

loans or unsound insurance recommendations to the bank's customers. \1\

See generally First National Bank of La Marque v. Smith, 610 F.2d 1258

(5th Cir. 1980).

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\1\ Additional safety and soundness concerns cited when the rule

was adopted included that: (1) arrangements permitting employees,

officers and directors to use bank premises and good will for

personal profit were inimical to the trust and confidence depositors

place in financial institutions; (2) the acquisition of a bank by

investors who rely on the credit life insurance income to service

their debt was inherently unsafe and unsound because it decreases

their interest in running a profitable bank; and (3) incentives to

increase bank profits were diminished if money was distributed other

than through dividends. See 41 FR 29846 (July 20, 1976); 42 FR 48518

(September 23, 1977).

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The courts have confirmed the authority of a national bank to sell

credit life insurance. See IBAA v. Heimann, 613 F.2d 1164 (D.C. Cir.

1979), cert. denied, 449 U.S. 823 (1980). In Heimann, the D.C. Circuit

stated that 12 U.S.C. 24 (Seventh) grants national banks all incidental

powers necessary to carry on the business of banking and found that the

sale of credit life insurance is within the incidental powers of

national banks. As the court noted, credit life insurance is both

commonplace and essential where ordinary loans on personal security are

involved. Id. at 1170. The court also found that the then-current part

2 regulations were well within the OCC's rulemaking authority. Id. at

1171.

Comments Received and Changes Made

The proposal revised part 2 by streamlining the overly detailed

format of the former part 2 and reorganizing the rule into more

readable and concise provisions. The OCC received 25 comments on the

proposal. The commenters included 17 banks and bank holding companies,

four trade associations, two law firms, one public interest

organization, and one insurance company.

The commenters generally supported the proposed changes to part 2,

and the final rule implements most of the initiatives contained in the

proposal, including the revised structure and format. However, many

commenters recommended changes to specific sections. The OCC carefully

considered each comment and has responded by making certain changes.

The section-by-section discussion of this preamble identifies and

discusses comments received and any changes made to the proposal.

Distribution and derivation tables summarizing sections of former part

2 as changed by the final rule are included at the end of this

preamble.

Section-by-Section Discussion

Section 2.1--Authority, Purpose, and Scope

The proposal added an ``Authority, purpose, and scope'' section

that briefly described the objectives and scope of the regulation. This

section also restated language from former Sec. 2.6 relating to

national bank authority to provide credit life insurance under 12

U.S.C. 24 (Seventh).

The OCC received no comments on this section. The final rule adopts

the section substantially as proposed.

Section 2.2--Definitions

The proposal defined ``credit life insurance'' to mean ``credit

life, health, and accident insurance.'' The OCC requested comment on

whether the scope of this definition was appropriate. The OCC received

11 comments on this issue. Most commenters recommended expanding the

definition to include, for example, all types of credit-related

insurance.

The OCC declines, at this time, to expand the regulatory definition

of ``credit life insurance,'' but notes that it has approved, on a

case-by-case basis, bank sales of other types of credit-related

insurance. The OCC recognizes that national banks are authorized to

offer credit-related insurance other than credit life insurance

pursuant to 12 U.S.C. 24(Seventh) and will continue to consider these

types of credit-related insurance on a case-by-case basis.

A number of commenters also noted that the OCC had removed language

from the definition of credit life insurance and questioned whether the

OCC intended to change the meaning of the definition. In addition to

stating that credit life insurance ``means credit life, health and

accident insurance,'' the former rule also noted that this is

``sometimes referred to as credit life and disability insurance, and

mortgage life and disability insurance.'' The proposal did not include

this latter language. However, the OCC did not intend to change the

definition of credit life insurance. Thus, to avoid any confusion, the

final rule retains the language contained in the former rule.

In addition, the final rule retains the definition of the term

``bank'' contained in the former rule and makes a technical change by

replacing the defined term ``interest'' with ``owning an interest.''

Section 2.3--Distribution of Credit Life Insurance Income

The proposal provided that the means of distributing credit life

insurance income must be consistent with certain requirements and

principles identified in proposed Sec. 2.3. These requirements included

prohibiting a director, officer, employee, or principal shareholder

(bank insider), or an entity in which a bank insider has a voting

interest of five percent or more, from retaining

[[Page 51779]]

commissions or other income from the sale of credit life insurance to

loan customers of the bank, subject to certain exceptions for bonus and

incentive plans. Proposed Sec. 2.3 also provided that it is unsafe and

unsound for a bank insider, or an entity in which the insider has a

voting interest of five percent or more, to take advantage of that

business opportunity for personal profit.

The proposal defined the term ``principal shareholder'' as any

shareholder who directly or indirectly owns or controls an interest of

more than five percent of the bank's outstanding shares. The OCC asked

commenters to address whether the five percent ownership test for a

``principal shareholder'' and for covered entities in which bank

insiders have an interest is an appropriate ownership test to use in

these contexts, and, if not, what alternative percentages or more

flexible standards would be appropriate.

The OCC received seven comments on this issue. Six commenters

recommended increasing the ownership test to ten percent. One commenter

stated that the definition of principal shareholder is too broad and

should not include holding companies.

The final rule increases the ownership test from five percent to

ten percent. The ten percent ownership level is used to define a

``principal shareholder'' for purposes of other safety and soundness

regulations, and the OCC does not believe safety and soundness concerns

require a lower threshold in the context of the part 2 definition. For

example, a ``principal shareholder'' for purposes of insider lending

standards is defined using a ten percent voting securities ownership

test. 12 CFR 215.2(m)(1).

Thus, the final rule defines a ``principal shareholder'' as any

shareholder who directly or indirectly owns or controls an interest of

more than ten percent of the bank's outstanding voting securities. The

final rule also provides that it is an unsafe and unsound practice for

any bank director, officer, employee, or principal shareholder, or any

entity in which this person owns an interest of more than ten percent,

who is involved in the sale of credit life insurance to loan customers

of the national bank, to take advantage of that business opportunity

for personal profit. In this regard, the final rule states that

recommendations to customers to buy credit life insurance should be

based on the benefits of the policy, not the commissions to be received

from the sale. In addition, except as provided in Secs. 2.3(d), 2.4,

and 2.5(b), a bank insider, or an entity in which the bank insider owns

an interest of more than ten percent, may not retain commissions or

other income from the sale of credit life insurance in connection with

any loan made by that bank, and income from credit life insurance sales

must be credited to the income accounts of the bank.

The OCC also requested comment on situations where banks share

space and employees with other non-bank entities. In some instances,

the bank and another entity that uses bank premises may share employees

to sell products, potentially including credit life insurance, to the

bank's customers. To the extent these shared employees received

commissions from the sale of the credit life insurance, the arrangement

arguably fell within the prohibitions contained in the proposal.

The OCC received one comment on this issue. The commenter

recommended that the bank receive the profits from sales of credit life

insurance by shared employees.

The OCC agrees that in some cases this is the appropriate result.

However, there are situations where the concerns underlying part 2

would not, generally, be implicated. Accordingly, the final rule

focuses on the objectives underlying part 2 and does not apply the part

2 restrictions in certain cases to dual employees, provided that

specified conditions are met. Thus, under the final rule, a director,

officer, employee, or principal shareholder is not subject to the

specific limits of part 2 if he or she is: (1) Employed by a third

party that has contracted with the bank on an arm's-length basis to

sell financial products on bank premises; and (2) not involved in the

bank's credit decision process.

The first requirement ensures that the third party will compensate

the bank for the use of the bank's premises, thus addressing the

concern that the bank be properly reimbursed for the use of its

premises and good will. The second requirement addresses potential

conflicts of interest that may arise when the individual selling the

insurance is involved in the credit decision. The OCC believes that

these conditions effectively adapt the part 2 safeguards to the dual

employee situation.

The proposal also requested comment on whether to retain a

provision that permitted income from the sale of credit life insurance

to be credited to a holding company affiliate of the bank or to a trust

for the benefit of all shareholders, if the holding company affiliate

or trust paid reasonable compensation to the bank for the use of its

personnel, premises, and good will. Under the former rule, it was

suggested that reasonable compensation meant an amount equivalent to at

least 20 percent of the affiliate's net income attributable to the

bank's credit life insurance sales.

The OCC received only a few comments addressing this issue. After

considering these comments, the OCC has decided to retain the current

provision with a few modifications. Thus, under the final rule, income

derived from the sale of credit life insurance to loan customers may be

credited to an affiliate operating under the Bank Holding Company Act

of 1956, 12 U.S.C. 1841 et seq., or to a trust for the benefit of all

shareholders, if the holding company affiliate or trust pays reasonable

compensation to the bank for the use of the bank's personnel, premises,

and good will. The OCC does not believe, however, that it is

appropriate for it to suggest what constitutes reasonable compensation

in these arrangements. Thus, the final rule states that reasonable

compensation generally means an amount equivalent to at least 20

percent of the affiliate's net income attributable to the bank's credit

life insurance sales. This provision has been transferred a new section

2.5(b).

The proposal also requested comment on whether to apply the

prohibition against the retention of income derived from the sale of

credit life insurance to sales of credit life insurance to loan

customers of an affiliate bank. The OCC received several comments on

this issue, which raised issues warranting further study. Therefore,

this issue is not addressed in the final rule.

Section 2.4--Bonus and Incentive Plans

Both the proposal and the former regulation permitted limited bonus

and incentive arrangements for employees and officers notwithstanding

the general prohibition against paying insiders income derived from the

sale of credit life insurance. Bonuses and incentive payments based on

credit life insurance sales in any one year are limited to the greater

of five percent of the recipient's annual salary or five percent of the

average salary of all loan officers participating in the plan. The bank

may not pay bonuses more frequently than quarterly.

The OCC requested comment relating to both the frequency and amount

of the bonus and incentive payments. Specifically, the OCC asked

commenters to address whether the periodic payment standard and the

percentage limits are appropriate safeguards for bonus and incentive

programs, and, if not, what alternative safeguards would deter

inappropriate sales activities by insiders in connection with the sale

of credit life insurance.

The OCC received 22 comments addressing the permissible amount of

[[Page 51780]]

bonus and incentive plan payments. Nineteen commenters supported either

eliminating or increasing the five percent limit on the amount that a

bank may pay its employees under an incentive or bonus plan. Commenters

recommended alternatives including: (1) Permitting any compensation

plan approved by the bank's board of directors; (2) permitting up to

five percent of premiums sold; and (3) expanding the percentage from

five percent to up to ten percent. Other commenters suggested that the

sole limitation should be the requirement contained in the proposal

that the bank not structure its sales practices in a manner that could

create incentives for persons selling credit life insurance to make

inappropriate recommendations.

Those supporting the retention of the current standards asserted

that the five percent standard is reasonable and provides sufficient

safeguards against abuses. One commenter stated that the five percent

limit provides a necessary bright-line test to prevent banks from

coercing customers.

The OCC agrees with the reasons offered by the commenters for

retaining the five percent limit on bonus and incentive plan payments

based on credit life insurance sales. The OCC shares the concerns

expressed that the prospect of increased financial reward could create

an inappropriate incentive for salespersons to make financially unsound

loans or to recommend insurance based on the amount of commissions paid

rather than the benefits of the policy itself, thereby undermining the

purpose of the regulation. Thus, the final rule retains the five

percent limit on the amount of permissible bonus and incentive plan

payments based on credit life insurance sales.

The OCC also received 18 comments addressing the frequency of

permissible bonus payments. Several commenters suggested either

eliminating or changing to monthly the quarterly limitation on the

frequency with which a bank could make bonus payments.

The OCC is not aware that the frequency--as opposed to the amount--

of the bonus payments has any demonstrable relationship to the

potential for coercing customers to purchase credit life insurance.

Moreover, removing this requirement could reduce burden and increase

flexibility for national banks that have separate payment procedures

for employees selling credit life insurance. Therefore, the final rule

removes the limitation on the frequency of bonus payments.

The proposal also added a new provision requiring the bank to avoid

structuring its bonus or incentive plan in a manner that could create

incentives for persons selling credit life insurance to make

inappropriate recommendations or sales of credit life insurance to bank

customers. The OCC received four comments on this provision. Several

commenters expressed concern that the provision was too vague and could

thereby encourage litigation against banks by disaffected purchasers of

credit life insurance.

The OCC agrees that the proposed provision was potentially vague.

However, the OCC believes that the issue nevertheless needs to be

addressed. As noted in the discussion of Sec. 2.3, the OCC believes

that encouraging a customer to buy credit life insurance on the basis

of commissions to the seller rather than the benefits of the policy is

an example of taking inappropriate advantage of a business opportunity

for personal profit. This is a concern regardless of the percentage

limitations that apply to bank insiders' and principal shareholders'

receipt of incentive and bonus payments and, accordingly, is

specifically referenced in Sec. 2.3 of the final rule.

Section 2.5--Bank Compensation

The OCC has made one clarifying structural change to the final

rule. The final rule transfers to a new Sec. 2.5(a) a concept from the

former rule and the proposal relating to the permissibility of a bank

insider compensating the bank for the use of bank premises, employees,

or good will. Also, as noted earlier, Sec. 2.5(b) contains a provision

from the former rule which allows income derived from credit life

insurance sales to loan customers to be credited to a holding company

affiliate or a trust for the benefit of all shareholders, provided that

the bank receives reasonable compensation in recognition for the role

played by its personnel, premises, and good will in the sale of the

credit life insurance. Reasonable compensation generally means an

amount equivalent to at least 20 percent of the affiliate's net income

attributable to the bank's credit life insurance sales.

Other Changes

The proposal also made a number of additional changes to the

regulation. For example, the proposal removed former Sec. 2.5 which

relates to director responsibilities because that issue was addressed

in a different section of the regulation. The proposal also removed

language in former Sec. 2.6 that contained a list of OCC approved

methods of distributing credit life insurance income that identified

alternatives to the assignment of commissions to the bank. The proposal

substituted a simple statement that the means of distribution of credit

life insurance income must be consistent with the requirements and

principles of Sec. 2.3. The final rule adopts, substantially as

proposed, these changes.

The proposal also removed former Sec. 2.7, which reserved the

Comptroller's authority to modify the applicability of part 2 based on

the particular circumstances of the bank. The final rule removes this

provision. However, as stated in the proposal, the OCC will continue to

consider requests for waivers of part 2 on a case-by-case basis.

Distribution Table

The distribution table indicates where, if applicable, each section

of the former part 2 will appear in the final part 2.

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Original provision Revised provision Comment

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Sec. 2.1...................... Sec. 2.1(a)....... Modified.

Sec. 2.2(a)................... Sec. 2.1(c)....... Modified.

Sec. 2.2(b)................... Sec. 2.1(b)....... Modified.

Sec. 2.3...................... Sec. 2.2.......... Modified.

Sec. 2.4(a)................... Secs. 2.3, 2.4.... Modified.

Sec. 2.4(b)................... Secs. 2.3(c), Modified.

2.5(b).

Sec. 2.4(c)................... Sec. 2.5(a)....... Modified.

Sec. 2.5...................... Sec. 2.3(b)....... Modified.

Sec. 2.6...................... ................... Removed.

Sec. 2.7...................... ................... Removed.

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Derivation Table

This derivation table illustrates the former sections of part 2

upon which the final sections are based.

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Revised provision Original provision Comment

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Sec. 2.1(a)................... Sec. 2.1.......... Modified.

Sec. 2.1(b)................... Sec. 2.2(b)....... Modified.

Sec. 2.1(c)................... Sec. 2.2(a)....... Modified.

Sec. 2.2...................... Sec. 2.3.......... Modified.

Secs. 2.3(a), (b), and (c).... Secs. 2.4(a), (b). Modified.

Sec. 2.3(d)................... ................... Added.

Sec. 2.4...................... Sec. 2.4(a)....... Modified.

Sec. 2.5(a)................... Sec. 2.4(c)....... Modified.

Sec. 2.5(b)................... Sec. 2.4(b)....... Modified.

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Regulatory Flexibility Act

Pursuant to section 605(b) of the Regulatory Flexibility Act, 5

U.S.C. section 605(b), the Comptroller of the Currency certifies that

this rule will not have a significant economic impact on a substantial

number of small entities. This final rule eliminates unnecessary or

confusing language and restructures part 2 to clarify regulatory

requirements. This final rule reduces, somewhat, regulatory burden on

national banks,

[[Page 51781]]

regardless of size. This final rule has minimal impact. Accordingly, a

regulatory flexibility analysis is not required.

Executive Order 12866

The OCC has determined that this final rule is not a significant

regulatory action under Executive Order 12866.

Unfunded Mandates Reform Act of 1995

Section 202 of the Unfunded Mandates Reform Act of 1995 (Unfunded

Mandates Act), 2 U.S.C. 1532, requires that an agency prepare a

budgetary impact statement before promulgating a rule that includes a

Federal mandate that may result in the expenditure by state, local, and

tribal governments, in the aggregate, or by the private sector, of $100

million or more in any one year. If a budgetary impact statement is

required, section 205 of the Unfunded Mandates Act, 2 U.S.C. 1535, also

requires an agency to identify and consider a reasonable number of

regulatory alternatives before promulgating a rule. Because the OCC has

determined that this final rule will not result in expenditures by

state, local, and tribal governments, or by the private sector, of more

than $100 million in any one year, the OCC has not prepared a budgetary

impact statement or specifically addressed the regulatory alternatives

considered. As discussed in the preamble, the final rule has the effect

of reducing burden and increasing the flexibility of national banks,

consistent with safe and sound banking practices.

List of Subjects in 12 CFR Part 2

Credit, Life insurance, National banks.

Authority and Issuance

For the reasons set out in the preamble, part 2 of chapter I of

title 12 of the Code of Federal Regulations is revised to read as

follows:

PART 2--SALES OF CREDIT LIFE INSURANCE

Sec.

2.1 Authority, purpose, and scope.

2.2 Definitions.

2.3 Distribution of credit life insurance income.

2.4 Bonus and incentive plans.

2.5 Bank compensation.

Authority: 12 U.S.C. 24 (Seventh), 93a, and 1818(n).

Sec. 2.1 Authority, purpose, and scope.

(a) Authority. A national bank may provide credit life insurance to

loan customers pursuant to 12 U.S.C. 24 (Seventh).

(b) Purpose. The purpose of this part is to set forth the

principles and standards that apply to a national bank's provision of

credit life insurance and the limitations that apply to the receipt of

income from those sales by certain individuals and entities associated

with the bank.

(c) Scope. This part applies to the provision of credit life

insurance by any national bank employee, officer, director, or

principal shareholder, and certain entities in which such persons own

an interest of more than ten percent.

Sec. 2.2 Definitions.

(a) Bank means a national banking association or a bank located in

the District of Columbia and subject to the supervision of the

Comptroller of the Currency.

(b) Credit life insurance means credit life, health, and accident

insurance, sometimes referred to as credit life and disability

insurance, and mortgage life and disability insurance.

(c) Owning an interest includes:

(1) Ownership through a spouse or minor child;

(2) Ownership through a broker, nominee, or other agent; or

(3) Ownership through any corporation, partnership, association,

joint venture, or proprietorship, that is controlled by the director,

officer, employee, or principal shareholder of the bank.

(d) Officer, director, employee, or principal shareholder includes

the spouse and minor children of an officer, director, employee, or

principal shareholder.

(e) Principal shareholder means any shareholder who directly or

indirectly owns or controls an interest of more than ten percent of the

bank's outstanding voting securities.

Sec. 2.3 Distribution of credit life insurance income.

(a) Distribution of credit life insurance income by a national bank

must be consistent with the requirements and principles of this

section.

(b) It is an unsafe and unsound practice for any director, officer,

employee, or principal shareholder of a national bank (including any

entity in which this person owns an interest of more than ten percent),

who is involved in the sale of credit life insurance to loan customers

of the national bank, to take advantage of that business opportunity

for personal profit. Recommendations to customers to buy insurance

should be based on the benefits of the policy, not the commissions

received from the sale.

(c) Except as provided in Secs. 2.4 and 2.5(b), and paragraph (d)

of this section, a director, officer, employee, or principal

shareholder of a national bank, or an entity in which such person owns

an interest of more than ten percent, may not retain commissions or

other income from the sale of credit life insurance in connection with

any loan made by that bank, and income from credit life insurance sales

to loan customers must be credited to the income accounts of the bank.

(d) The requirements of paragraph (c) of this section do not apply

to a director, officer, employee, or principal shareholder if:

(1) The person is employed by a third party that has contracted

with the bank on an arm's-length basis to sell financial products on

bank premises; and

(2) The person is not involved in the bank's credit decision

process.

Sec. 2.4 Bonus and incentive plans.

A bank employee or officer may participate in a bonus or incentive

plan based on the sale of credit life insurance if payments to the

employee or officer in any one year do not exceed the greater of:

(a) Five percent of the recipient's annual salary; or

(b) Five percent of the average salary of all loan officers

participating in the plan.

Sec. 2.5 Bank compensation.

(a) Nothing contained in this part prohibits a bank employee,

officer, director, or principal shareholder who holds an insurance

agent's license from agreeing to compensate the bank for the use of its

premises, employees, or good will. However, the employee, officer,

director, or principal shareholder shall turn over to the bank as

compensation all income received from the sale of the credit life

insurance to the bank's loan customers.

(b) Income derived from credit life insurance sales to loan

customers may be credited to an affiliate operating under the Bank

Holding Company Act of 1956, 12 U.S.C. 1841 et seq., or to a trust for

the benefit of all shareholders, provided that the bank receives

reasonable compensation in recognition of the role played by its

personnel, premises, and good will in credit life insurance sales.

Reasonable compensation generally means an amount equivalent to at

least 20 percent of the affiliate's net income attributable to the

bank's credit life insurance sales.

[[Page 51782]]

Dated: August 30, 1996.

Eugene A. Ludwig,

Comptroller of the Currency.

[FR Doc. 96-25158 Filed 10-3-96; 8:45 am]

BILLING CODE 4810-33-P