| The Best of the Best 2011
The insurance industry and international security
Vince VitkowskyEdwards Angell Palmer & DodgeNew York
It has been almost ten years since the terrorist attacks of 9/11. Since then, there have been horrific attacks in London, Madrid, Mumbai and elsewhere. Several nations in the Middle East are in transition, and some are in turmoil. Iran and North Korea continue to seek weapons of mass destruction. And new threats to international and national security continually arise.
Life insurance and annuity products have been used for terrorist finance money laundering. Terrorist organisations attempt to buy auto insurance so their operatives can drive car bombs to their intended targets. Malevolent nations and their parastatals obtain and transport lethal materials in international commerce, and build facilities to develop weapons of mass destruction, at times protected by commercial insurance.
Insurance companies can assist in promoting international security by carefully observing the restrictions created by the economic sanction programs administered and enforced by the Office of Foreign Asset Control (OFAC) of the US Department of Treasury. As the Treasury Department has stated, "these programs are a frontline defence against foreign threats to our national safety, economy and security."
OFAC actively enforces these restrictions and imposes penalties, which for the most part are based on strict liability. That is, even unintentional violations may result in penalties. Penalties can be imposed not only on companies, but also on individuals involved in underwriting, administration and claims, even if they work for non-US companies. Penalties can be civil or criminal, with fines as high as $10 million for each violation, and prison terms of up to 30 years.
There have been approximately 50 enforcement matters involving insurance transactions. One company paid a $2.4 million penalty for issuing life reinsurance covering Cuban nationals. OFAC is now demonstrating a growing interest in the insurance industry. Recently, a Texas-based reinsurance broker was fined for allegedly facilitating the placement of a facultative retrocession reinsurance agreement covering the construction risks of a petroleum project on Kharg Island in Iran. The retrocedent and retrocessionaires were European.
OFAC administers 20 separate programs, and the specific restrictions and penalties vary for each of the programs. But broadly, OFAC prohibits the issuance of insurance and reinsurance involving nations, companies, organisations, individuals or vessels that are subject to a sanctions program (OFAC Targets). Under some programs, OFAC also prohibits actions approving, guaranteeing, financing or facilitating these transactions. OFAC also requires that any funds in which an OFAC Target has a direct or indirect interest must be "blocked," that is to say, premiums must be deposited into a US bank in a separate interest bearing account. Claims cannot be adjusted or paid. Exemptions or exceptions can be made only by obtaining a licence from OFAC.
The largest OFAC Targets are nations. However, the complete list of OFAC Targets includes about 6,000 companies, organisations, individuals and vessels on a "Specially Designated Nationals and Blocked Persons List" (the SDN List), which is continually updated.
The obvious cases are straightforward. Clearly, a company should not issue a life insurance or auto insurance policy involving an SDN. It should not provide liability insurance for a construction project in a sanctioned nation. Challenges arise, however, because OFAC Targets can appear in transactions in many ways, such as insureds and additional insureds, policyholders, payers of premium, beneficiaries, loss payees, intermediaries and administrators of all variety, banks as lien holders, and banks to which premiums and claims payments are deposited or routed.
Issues also arise whenever a claim involves an OFAC Target in any way. For example, a properly-insured vessel may collide with a vessel listed, owned or controlled by an OFAC Target. This means that potential payees, including third-party liability claimants, should be checked against the SDN List. An insurer may not pay amounts related to damage mitigation or prevention, or amounts to evaluate and adjust claims, defend an insured, or reimburse an insured party or a third-party liability claimant. Any claim payments due or to be deposited to or transferred through a bank which is an OFAC Target must be stopped.
Most OFAC restrictions apply to "US persons." These include insurers, reinsurers, agents, brokers, reinsurance intermediaries, and third-party administrators. They also include the overseas branches of US companies, but not overseas subsidiaries (except that the Cuba and North Korea programs do include overseas subsidiaries). They include individuals who are US citizens or permanent residents, wherever they are located, and whoever they work for. Also, non-US persons outside the US may be prosecuted for conspiracy with a US person.
One program of great current interest to insurers is the Comprehensive Iran Sanctions, Accountability, and Divestment Act (CISADA) enacted in 2010. The CISADA program extends sanctions to the non-US insurers and non-US ship owners who provide insurance or transportation services for certain trade with Iran, notably in the petroleum industry. Its sanctions, however, require knowing violations, and it provides a safe harbour for companies that establish compliance policies and procedures.
For all OFAC programs, the most basic ways to avoid violations are declinations and exclusions. In OFAC's view, a company cannot issue a global insurance policy without an OFAC exclusion. For large commercial insurers, bespoke exclusions should be considered.
OFAC has stated that a facultative reinsurance placement should receive the full scrutiny of a direct insurance policy. Facultative reinsurance certificates should also have an OFAC exclusion. Reinsurance treaties should contain a variety of geographical and substantive exclusions.
But insurers and reinsurers cannot rely solely on declinations and exclusions. Although there is no requirement that companies establish a compliance program, in practice, every company should establish some OFAC Policies and Procedures, with variations based on the specific nature and scope of its business. This will both prevent violations and mitigate penalties.
An insurer may seek exemptions by applying to OFAC for a general or specific license. A company may have a compelling reason to issue coverage that might involve an OFAC Target, such as insuring humanitarian relief or missionary expeditions. Or there may be other reasons why the transaction would promote security.
The EU has its own economic sanctions regime, frequently consisting of legislation implementing resolutions of the UN Security Council. These apply to all persons and companies doing business in the EU, and EU nationals and entities doing business outside the EU. Unfortunately, EU restrictions are not always consistent with other sanction regimes. In fact, one of the special challenges is the existence of an EU Council Regulation "blocking statute," which makes it illegal for any EU company to comply with certain specified US sanctions.
OFAC restrictions also present coverage issues in claims by insureds. Some violations are unintentional. Unfortunately, others are not. For example, in the last few years, there have been several high profile enforcement actions involving non-US banks, which allegedly designed processes to deliberately disguise transactions to avoid OFAC restrictions. These transactions have had aggregate values as high as $800 million, and the banks have paid penalties as high as $500 million. It appears that eight banks are still under current investigation.
Insureds have also been fined and prosecuted for payments made in other contexts. Some companies made payments, which they assert were in the nature of required extortion payments, to the left-wing Revolutionary Armed Forces of Columbia, and the right-wing United Self-Defense Forces of Columbia, both of which were SDNs.
When penalties paid by the insured arise from violations of OFAC restrictions, insurers and reinsurers can promote international security by carefully exploring all potential grounds to resist coverage.
Vince Vitkowsky is a partner in the New York office of the international law firm of Edwards Angell Palmer & Dodge LLP. He represents insurers and reinsurers in disputes across all lines of business, in their general commercial arbitration and litigation, and in national security and terrorism matters. He can be reached at firstname.lastname@example.org and at (212) 912-2828.