On guard: one year ago, insurers implemented tough new federal anti-money-laundering regulations. Whether they're effective in fighting terrorism waits to be seen.

Since May 2006, insurers have been required the USA Patriot Act to have anti-money-launering programs, known as AMLs, in place. So far, large insurers have done a good job meeting this mandate but continue to face challanges, according to a recent report by global firm Ernst &Young LLP.

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The report was based on a survey distributed to 26 of America's largest insurers, which had average admitted assets of more than $100 billion. Sixteen responded, showing eight of the respondents had filed a total of 55 Suspicious Activity Reports (SARs) in 2006--"surprisingly few," according to the report. "While there is no specific number of SARs filed to be considered an industry standard, the actioning of so few SARs may indicate either an initial lack of AML program maturity, perceived lesser risk of insurance products as a vehicle for money laundering, or potentially a lack of effectiveness of current programs" the report said. The Patriot Act has required other kinds of Money Services Businesses (MSBs), including banks and securities firms, to establish AML programs as early as 2002.

Despite the low number of SARs, report said the large insurers "appear to have taken their mandate seriously, and the industry benefits from the open sharing of best- and common-control practices"

To provide companies with guidance, the act outlines what are commonly referred to as the "four pillars" of enforcement, as denoted by the U.S. Treasury Department:

* Implementation of internal policies, procedures and controls based on a company's assessment of its money laundering/terrorist financing risks;

* Designation of a compliance officer;

* Establishment of an ongoing employee-training program; and

* Establishment of an independent audit function to test the program.

"What we're seeing as a first-year goal is ensuring baseline compliance with the four pillars," said Steven Beattie, principal and AML services leader at Ernst & Young. "After the first year, we'll see more effectiveness and more efficiency as insurers get these new processes embedded in the organization to a standard way of doing business."

Fighting Terrorism

Money laundering fuels crime by providing criminals, such as drug dealers, smugglers, terrorists, arms dealers and tax evaders, a legitimate cover for their sources of income, according to the Internal Revenue Service. The IRS reports as much as $2 trillion annually is laundered worldwide through financial institutions and businesses. Congress passed the Patriot Act after the Sept. 11 attacks in 2001 to help cut off funding for terrorist groups. SARs are one of the government's main weapons in fighting money laundering, since they generate leads for law enforcement agencies, according to the IRS.

Companies file SARs with the Treasury's Financial Crimes Enforcement Network, known as FinCEN. FInCEN has tapped the IRS to conduct AML examinations of insurance companies.

"The key thing to recognize is that money launderers are very intelligent people who are dedicating their lives to trying to get around our efforts to intercede7 said Beattie. Insurers recognize their programs will require constant effort to be more effective and efficient, he added.

"This will continue to evolve," said Tom Ward, who leads insurance-specific AML services at Ernst & Young. "It's definitely a long-term effort. The IRS recognizes that fact with its approach to the examinations it is now starting. It really wants to see some good-faith efforts from insurers to comply."

Insurance products covered by the AML rules are: individual permanent life insurance policies; individual annuity contracts; and any other products with cash value or investment features. Products not covered include reinsurance contracts; property/casualty insurance; group life; group annuities; term life and credit life policies; health insurance; and title insurance.

Products most susceptible to money laundering are fixed and variable annuities, single-premium life insurance, and policy riders that permit large cash deposits, said Brian Loutrel, vice president and compliance officer at New York Life Insurance Co., who spoke in April about AML programs at a life insurance conference. Nearly all annuities are issued without underwriting, Loutrel pointed out, and annuities with no surrender charges make especially attractive places to hide ill-gotten gains. And, he said, the free-look feature of life insurance "is a money-launderer's dream."

Insurers look for suspicious activity at the time of purchase if a buyer uses large amounts of cash or cash equivalents. They also may investigate if a buyer cancels a policy during the freelook period, takes an early full or partial withdrawal, or takes an early loan, Loutrel said in a recent interview.

Basic Training

Under the law, insurers are responsible for training and monitoring their producers to comply with AML programs. Some insurers have struggled with this requirement, because AML training means agents and brokers could lose business and commissions. Loutrel said last April that some producers may even seek out insurers with weaker compliance programs--that way, they wouldn't be away from the office losing business and commissions. He said New York Life has had an easier time training its producers about AML because the company's primary distribution system is a career agency. The company faces the same challenges with independent distribution channels as other insurers.

Insurers are required to collect information about customers. This includes verifying the identity of a customer opening an account, maintaining records used to verify identities, notifying customers about these activities, and ensuring that a customer is not on any lists of known or suspected terrorists or terrorist organizations, said Loutrel. Since agents and brokers interact with customers, they are an important part of any company's first line of defense, he said.

New York Life and other insurers that own broker/dealers and/or mutual funds got a "head start" on developing AML regulations because programs were required in those businesses beginning in 2002, Loutrel said. "Our training programs are very effective," said Loutrel. "We've been training agents and employees for several years. We didn't wait for insurance company AML regulations to come out."

In fact, the company assisted the American Council of Life Insurers in developing their own training program, he said. Guidance in training program development also is available from the National Association of Securities Dealers; Limra International, the industry's research and marketing firm; and RegEd, an online provider of compliance training solutions, Loutrel said.

As of early August, the IRS did not yet have an AML examiner's handbook for the insurance industry. Loutrel said insurers are eager to learn how the IRS will conduct AML exams and are working through the ACLI to show the IRS how their products differ from those of banks, securities firms and other financial-services companies. Insurance products covered by AML rules are designed to be held for lengthy periods and are "relationship sales,' so they appear to pose less of a risk than banking transactions, he said. However, money launderers may perceive new opportunities in the insurance industry, he said.

A Growing Role for IT

Information technology has played a big role in the insurance industry's first year of AML compliance and will continue to do so, said Ernst & Young's Ward. The company's report showed that 21% of AML programs were "highly IT-dependent" and 50% were "somewhat" dependent. The remaining programs were termed "predominantly manual."

According to Beattie, if insurers follow the path taken by industries already subject to AML rules, they will use technology to assist in better knowing their clients, to monitor transactions and to compile information that could lead to an SAR. Technology also will help to handle case management, which Beattie said will give insurers the ability to shepherd files on potentially suspicious activity through their complex global organizations without losing any important data along the way.

The Ernst & Young report further found that 64% of insurer IT solutions are developed in-house, while 43% come from vendors. Beattie said insurers are likely to use vendors more in the future "as we see a maturing of the landscape and a few proven solutions emerging." This is particularly true for firms that have grown through acquisitions and are burdened with information systems that do not communicate well with each other, he said.

New York Life has developed its own IT solution for suspicious activity, Loutrel said, adding that most vendors offer software that is primarily for the banking and securities world. He expects the company to stick with its in-house program in coming years. However, he said the company uses some vendor software to meet its responsibilities under the Office of Foreign Assets Control, a Treasury Department agency that for more than 50 years has administered and enforced sanctions policy and economic embargo programs.

Another challenge in developing AML programs is gaining the commitment of senior management. Ward said AML officers must be able to articulate that they need enough funding for a robust program, especially since no high-profile cases yet have emerged in the industry. "If I'm an AML compliance officer, I don't right now have that industry event ... in order to say, 'here is the imperative, this is what can happen if things don't go well," said Beattie. "You don't want to be that first case study of AML failure ... those case studies live for some time after the fact"

Some 88% of the large insurers in the Ernst & Young report have five or fewer employees engaged full time with AML responsibilities. But Ward said AML is a "considerable undertaking" for insurers. "This isn't just the AML officers doing it on their owns 'he said. "They have to bring in the distribution force, and the underwriting and claims departments. It really encompasses the entire organization."

"It requires people, technology and senior-management commitment," said Loutrel, whose company employs three full-time and two part-time employees to AML. "Many compliance functions will be expanding, as well as the depth and breadth of technology."

Brian Cromwell, former federal prosecutor in North Carolina and now a member of the law firm Hunton & Williams, said AML has been "an extreme burden" for companies.

"Routinely, companies will tell us that, thanks to laws like the USA Patriot Act, there are so many reporting requirements that they feel inundated," said Cromwell. "The larger financial institutions have internal teams that dedicate almost all their time to AML work, and they engage law firms like ours to review their work. In fact, in the past we were approached by a very large domestic bank that is engaged in certain real estate transactions with a foreign bank. The domestic bank wants to make sure every one of their transactions complies with all AML requirements"

Beattie added, though, that companies shouldn't lose sight of the fact that AML rules were put into place to counteract terrorism to safeguard national security."I think reinforcing the primary purpose of these programs is a healthy exercise," he said.

Key Points

* Anti-money-laundering programs, required for insurers since May 2006, are part of the nation's plan to constrict the flow of funds to terrorists.

* Insurers are responsible not only for their own compliance, but also for their product distributors'.

* AML software programs from vendors are still in their early stages.

Doing the Laundry

"Money laundering is a process in which assets obtained or generated by criminal activity are moved or concealed to obscure their link with the crime. Terrorist activities are sometimes funded from the proceeds of illegal activities, and perpetrators must find ways to launder the funds in order to use them without drawing the attention of authorities."

Source: International Monetary Fund

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Risk Business

Insurance companies developed
their views of money-luandering
exposure using input from in-house departments:

Internal Audit   13$
Legal            73%
Compliance       87%
Business Units   67%
Outside Firm     20%
Other             7%

Source: Ernst & Young

Note: Table made from bar graph.

Next Stop

Companies have a variety of plans
for expanding their IT capabilities
regarding money laundering:

Cost Reduction              8%
Software Replacement       17%
Process Efficiency         50%
Warning Indicators         50%
Security Controls          17%
Maintenance Improvements   33%
Training                   42%
Other                      17%

Source: Ernst & Young

Note: Table made from bar graph.