On guard: new rules require life insurers to establish programs to prevent their products and services from being used for money laundering or terrorist financing.

Key Points

* The U.S. Treasury now requires life insurers to establish formal compliance programs to prevent their products from being used for money laundering or terrorist financing.

* The law requires insurers to make sure its agents and brokers take appropriate steps to prevent money laundering or terrorist funding.

* Insurers are required to report suspicious transactions totaling at least $5,000 and involving a covered product. Covered products include those with a cash surrender value or those that permit loans.

The Treasury Department's Financial Crimes Enforcement Network recently issued two Bank Secrecy Act regulations that create new responsibilities for companies that sell certain insurance products--and pose significant challenges for companies dealing with brokers and agents. By May 2, 2006, all businesses or individuals associated with the industry must determine whether their products have investment features that could be used for money laundering, and if so, the extent of their responsibilities under the rules. A violation could subject companies or individuals to civil or criminal prosecution.

The hales are not new to the financial services industry. Both rules have been applicable to the banking industry since at least 1987 and extended to other industries after passage of the USA Patriot Act in October 2001.

The rules in their simplest forms require businesses that sell certain insurance products to establish compliance programs to protect themselves from having their products or services used for money laundering or terrorist financing. Likewise, they are required to report potential violations of law or suspicious activities relating to money laundering or terrorist financing to the federal government. Both of these responsibilities are new to the insurance industry but, in light of the importance that regulators and other enforcement agencies place on the subject, will require the immediate and significant attention of the industry. Failure to establish and implement appropriate systems could lead to significant reputation risks, sanctions and criminal prosecutions.

Since insurance companies must know their distribution sources, it is essential that their sales forces establish appropriate compliance and suspicious activity reporting systems. Much of what needs to be done under the rules can only be accomplished through a well-trained and well-tested sales force.

The questions that must be addressed by individuals or entities that deal in insurance products are:

* Is the product covered by the new rules, and is the business required to comply with the rules or to ensure that others are complying?

* What must be contained in the required compliance program?

* What are the Suspicious Activity Reporting requirements?

While the rules indicate that requirements are not being imposed on agents or brokers, it is clear that insurers must truly understand the activities of their agents and brokers given the scope of their responsibilities. Clearly companies need to review their agreements with agents and brokers to ensure they are receiving adequate information concerning the customers. Likewise, companies would be well advised to insist that their agents and brokers establish sufficient systems to prevent the companies' policies and services from being used to launder money or further terrorism.

Suspicious Activity Reporting Requirements

While the Suspicious Activity Reporting rule applies to insurance companies and the covered products--and not to agents and brokers--insurers are required to implement policies and procedures designed to detect suspicious activity from all relevant sources. Agents and brokers clearly play an important role in insurance companies' obligations and as the government points out: "We also expect that an insurance company faced with a non-compliant agent or broker will take the necessary actions to secure such compliance, including, when appropriate, terminating its business relationship with such an agent or broker." Insurance companies should ensure that all persons dealing in their products have appropriate direction on what to do when they uncover a possible reportable transaction.

The establishment of a process is the key. Insurance companies are required to report suspicious transactions that are conducted, or attempted to be conducted, by or through an insurance company totaling at least $5,000 and involving a covered product. The report must be filed within 30 days once a company knows, suspects, or has reason to suspect that the transaction satisfies the following criteria:

* Involves funds derived from illegal activity or is intended to hide or disguise funds derived from illegal activity;

* Is designed whether through structuring or other means, to evade the requirements of the Bank Secrecy Act (report of more than $10,000);

* Has no business or apparent lawful purpose, and the company knows of no reasonable explanation for the transaction after examining the available facts; or

* Involves the use of the insurance company to facilitate criminal activity.

Establish a Reliable Compliance Program

The mantra in the anti-money laundering/anti-terrorism world is that institutions must set up risk-based programs. Companies must assess each of their products and distribution channels for vulnerabilities for money laundering and terrorist financing, and then design and adopt controls and processes to address the identified risks.

The following are important procedures to implement:

* Create a written compliance program and have it approved by senior management. The program must be available for review by the U.S. Treasury Department.

* Assess your customers. Banks verify the identity of their customers pursuant to the Customer Identification Program and understand the source of funds and the expected use of their account.

* Ensure agents and brokers have systems in place to conduct appropriate due diligence. The rule makes clear that while agents and brokers will perform many of the aspects of a compliance program, the company is responsible for its effectiveness. Consequently, companies must monitor and test their distributors.

* Designate a compliance officer to administer the program. The person must monitor compliance by the agents and brokers, update the program to keep current with new developments, and ensure there is adequate training.

* Ensure that personnel has training and receives periodic updates and refresher programs. Although the rule is not applicable to agents and independent brokers, it directs insurers to verify that agents and brokers are adequately trained to understand the responsibilities of the company under their anti-money laundering programs. Records should be maintained to document the training and appropriate personnel must be apprised of any changes in the rules.

* Provide for independent testing of program on a periodic basis. This is in addition to the testing and monitoring that will be performed by, or at the direction of, the compliance officer. Insurers whose sales and distribution are highly dependent on agents and brokers will have to cover those third parties in independent testing programs.

Associations Offer Agent/Broker Training

LIMRA International and the National Association of Independent Life Brokerage Agencies are joining to offer anti-money laundering training. Because the U.S. Treasury rules make insurance carriers responsible for providing training, brokerage producers could be required to take a separate anti-money laundering course for each carrier they represent, the organizations said.

The arrangement between LIMRA and NAILBA allows eligible producers to take the training once, at no cost to themselves, and be certified to work with many carriers.

What's Covered By the Rule?

Covered products are those with investment features that could be susceptible to laundering or transferring funds for terrorism purposes. The rules specifically identify life insurance policies that have a cash surrender value or that would permit loans. Annuity contracts also are included as they could be used to allow tainted money to be exchanged for an immediate or deferred income stream or to obtain clean funds on redemption. Companies must evaluate their products through a risk-based process to determine whether they are covered under the compliance and Suspicious Activity Reporting rules.

The rule covers any person within the United States engaged in issuing or underwriting a covered insurance product. These persons--insurance companies--are required to have an appropriate anti-money laundering] program and are now responsible for filing SARs.

The rule does not mandate that insurance agents and brokers have an anti-money laundering program or the responsibility to file SARs. Instead, the rule depends on the insurance company to oversee its agents and brokers, making the company "responsible for integrating its agents and brokers into its anti-money laundering program and for monitoring their compliance with the requirements of its program." In other words, the regulation makes the insurance company responsible for ensuring its agents and brokers take appropriate steps to prevent money laundering or terrorist funding. It will be the insurance company whose reputation is on the line.

Important Deadline

By May 2, 2006, all businesses or individuals associated with the insurance industry must determine whether their products have investment features that could be used for money laundering or terrorist financing.

Contributor Robert B. Serino is counsel at Buckley Kolar LLC in Washington, D.C.