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By WENDY WYSONG, former deputy assistant secretary for export enforcement and a partner with Clifford Chance in Washington, D.C., and PETER CHAFFETZ, also a partner with Clifford Chance and head of the firm's insurance practice in New York

The insurance industry takes great pride in the way its products facilitate all aspects of international commerce. However, it is precisely that global role that may be drawing increased industry scrutiny under the trade sanction program administered by the U.S. Treasury Department's Office of Foreign Assets Control.

This is a serious matter for insurers and their clients, as recent OFAC enforcement initiatives have resulted in fines ranging in the hundreds of millions of dollars. For example on Jan. 9, 2009, Lloyds TSB Bank agreed to forfeit $350 million to resolve its liability for violating OFAC sanctions. While to date OFAC has focused principally on the banking industry, that is now changing.

For example, both Aetna and CNA incurred OFAC penalties, the latter paying a fine of $2.4 million following an investigation that reportedly cost the company an even greater amount in legal expenses.

As recently as September 2008 at a UN Iran Sanctions Committee meeting, a senior U.S. Treasury Department official focused on insurance companies, urging them to refrain from providing coverage to Iranian companies or to firms doing business with Iran. That official warned that insurers must be "as vigilant as possible, both in the area of maritime insurance?and reinsurance."

Moreover, OFAC's Web site admonishes insurers and reinsurers "to gain a better understanding of the economic sanctions and embargo programs," and sets forth four pages of detailed insurance and reinsurance-specific compliance guidance. In 2006, OFAC appointed a senior sanctions advisor from the insurance industry to focus specifically on insurance and reinsurance compliance issues.

At a minimum, these developments suggest that every insurer should have a basic understanding of OFAC requirements.

In essence, OFAC regulations prohibit all transactions between U.S. persons and "sanctions targets." Those include countries such as Cuba, Iran, Burma (Myanmar), and Sudan, as well as more than 5,000 designated individuals and entities, known as Specially Designated Nationals (SDN). Further complicating compliance efforts, the SDN list is subject to constant amendment.

One point that newcomers to the area often find surprising is the broad range of persons and transactions that are covered. Specifically, the rules apply to U.S. underwriters, brokers, agents, primary insurers, and reinsurers, as well as U.S. citizen employees of foreign firms in the insurance industry.

For Cuba, the restrictions are broader and apply to non-U.S. entities that are U.S.-owned or controlled. For example, a company that purchases employee health insurance could be facilitating an illegal transaction.

Some prohibited transactions, such as life or health policies issued to a Cuban citizen, or designating a Cuban citizen as beneficiary, are relatively easy to understand and identify. Others less so, such as an aviation policy issued to a nonblocked airline, but naming a Sudanese bank mortgage holder as an additional insured.

Here's where it gets troublesome for insurance companies: if a policy is deemed to facilitate a prohibited transaction, it can also violate the sanctions requirements. As an example, OFAC points to a policy that has no explicit connection to any sanctioned country, but provides blanket geographic coverage to an airline whose routes include stops in Cuba, or for a hotel chain that has a property in Iran.

To comply with U.S. sanctions requirements, insurers must make sure that policies that otherwise provide worldwide coverage contain explicit exclusions for proscribed beneficiaries or prohibited transactions. OFAC notes that such exclusions are of particular importance in treaty reinsurance, where the reinsurer does not control the selection of individual risks that will be ceded.

A potential wording could be along these lines: "Whenever coverage provided by this policy would be in violation of U.S. export controls or trade sanctions, such coverage is null and void."

Insurers will say that requiring such restrictions may not be competitively feasible in a global insurance market. They will likely hear that from non-U.S. clients who are not themselves subject to these regulations.

On a positive note, the restrictions are not absolute. OFAC has discretion to grant specific licenses and such competitive considerations are one grounds on which it may do so. Another circumstance where OFAC indicates it would be likely to grant a license is that of a policy issued to an SDN, with an innocent third-party beneficiary, such as the victim of an auto accident.

OFAC recommends that every insurer designate a compliance officer who will be responsible for knowing both the regulations and how the company's business potentially intersects with their requirements.

In addition to the appointment of a compliance officer, a solid compliance program will usually include a formal written policy, ongoing training, frequent screening of pending transactions against the current OFAC list, regular compliance audits, and prompt remediation of suspected violations.

A good compliance program not only helps to avoid violations; it can be a major factor in mitigating the consequences where a violation does occur. While OFAC rules impose strict liability, culpability is relevant to the issue of penalties. In past enforcement actions, OFAC has viewed the strength of the target company's commitment to compliance as a major factor in assessing the appropriate severity of penalty.

Given the trends we've seen recently, it may be time to ask if your compliance program can withstand OFAC's scrutiny. The insurance industry may also have to embrace the role OFAC sees for it, as an important source of information for its customers regarding the scope and severity of the U.S. sanctions regime.

March 3, 2009

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