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ENACTMENT OF LEGISLATIVE OVERHAUL MAKES TENNESSEE ATTRACTIVE DOMICILE FOR CAPTIVES By T. Stephen C. Taylor, Esq.
NEW SUPREME COURT CASES FIND VEHICLE SERVICE CONTRACTS AND GAP PRODUCTS MEET THE DEFINITION OF "INSURANCE" IN OKLAHOMA AND ARE SUBJECT TO TORT RECOVERY FOR BAD FAITH By Angela Ables, Esq.
INSURANCE PRODUCER COMPENSATION IN LOUISIANA By Ronnie L. Johnson, Esq.
SOCIAL MEDIA BEST PRACTICES By Gary A. Hernandez, Esq. and Sean McEneaney
DIRECT PROCUREMENT: RECENT DEVELOPMENTS IN THE LAW By Frederick J. Pomerantz, Esq.
NOT IN MY BACKYARD: NAIC FILES AMICUS CURIAE BRIEF ARGUING FEDERAL COURT HAS NO PLACE IN INSURER LIQUIDATION PROCEEDINGS By Richard J. Fidei, Esq. and Fred E. Karlinsky, Esq.
THE FEDERAL INSURANCE OFFICE By William J. Toman, Esq.

ENACTMENT OF LEGISLATIVE OVERHAUL MAKES TENNESSEE ATTRACTIVE DOMICILE FOR CAPTIVES

T. Stephen C. Taylor, Esq.
BASS, BERRY & SIMS, PLC
(615) 742-7758

On May 21, the Tennessee General Assembly approved sweeping legislation that completely overhauls Tennessee's captive insurance company law, creating new opportunities for holding companies and corporations to self-insure their own risks or to join with others in forming insurance companies to insure similar risks. The legislation also creates the prospect, in some cases, for companies to significantly reduce their premium tax burdens and potentially their workers' compensation expenses. Enactment of the legislation, the Revised Tennessee Captive Insurance Act ("Act") places Tennessee on the short list of states senior management should consider when looking to establish a self-insurance vehicle. Also, Tennessee has now become an ideal domicile for special purpose financial captives ("SPFCs") established by life insurers and other entities to securitize their risk, and for branch captives to insure or reinsure the employee benefits business risk of affiliates.

Passage of the Act (H.B.2007) 1 has been among the top legislative priorities of Governor Bill Haslam, as part of his Administration's broad initiative to encourage establishment of new companies - and jobs - in Tennessee. A detailed bill summary is available here.

When Tennessee originally enacted its captive law (Tenn. Code Ann. Sections 56-13-101 et seq.) in 1978, it was one of the first states in the U.S. to permit formation of captives. Other states soon followed suit and adapted their laws to the evolving needs of self-insurance and financial markets. Commissioner of Commerce and Insurance Julie McPeak said her goal in drafting the Act was to use a "one shot" approach to bring Tennessee's captive law up-to-date and also make it as flexible and broad as possible. The Department of Commerce and Insurance ("Department") relied on statutes in a number of leading captive states, including Vermont, South Carolina, Delaware, Montana, Kentucky and Hawaii, in crafting the Act. The Department also actively sought and considered comments from Tennessee corporations and domestic insurers as part of its efforts to ensure the Act was best in class.

Seven Types of Captives Authorized

The Act provides for the formation of seven types of captives: (1) pure captive insurance companies; (2) association captive insurance companies; (3) industrial insured captive insurance companies; (4) risk retention groups ("RRGs"); (5) protected cell captive insurance companies; (6) branch captive insurance companies; and (7) SPFCs. The Act provides for captives to be established as corporations, limited liability companies and partnerships. The Act sets minimum capital and surplus requirements for these entities at prudent levels that are comparable to other states: $250,000 for pure captives, branch captives and SPFCs; $500,000 for association captives, industrial insured captives and protected cell captives; and $1,000,000 for RRGs. The Commissioner will determine the amount of any additional surplus required based upon review of the applicant's plan of operation and associated insurance risk.

Under the Act, captives are authorized to underwrite the following coverages: professional liability, property, casualty, errors and omissions, comprehensive general liability, life, excess coverage for accident and health, employee benefits for parent companies pursuant to federal law requirements (i.e., ERISA), and workers' compensation. Captives also are authorized to reinsure risks ceded by any other insurer. Such reinsurance could include, for example, insurance provided by the captive to a qualified self-insured plan of a parent or affiliate for workers' compensation or accident and health coverage.

Once licensed, captives are required to file statements of financial condition with the Department on an annual basis. Unlike regular insurance companies however, captives are permitted to file statements in accordance with GAAP, rather than utilizing statutory accounting principles. The Act specifies the types of investments that captives are permitted to hold and imposes certain restrictions on the types of risks they can insure/reinsure. Captives will be subject to examination by the Department at least once every three years; the exam cycle may be extended to every five years at the Commissioner's discretion.

Favorable Tax Treatment

Significantly, the Act establishes premium tax rates that are competitive with other favored captive domiciles and that are, in most cases, substantially lower for risks maintained in captive insurance companies than in other self-insured entities. The direct premium tax rates are as follows:

(1) for the first $20 million in direct net premium collected or contracted - four tenths of one percent (.04%); and

(2) for each dollar of direct net premium above $20 million - three tenths of one percent (.03%).

Assumed reinsurance premium tax rates (applicable only to where the risks are not already subject to direct premium tax above) are as follows:

(1) for the first $20 million of assumed reinsurance premium - 225 thousandths of one percent (.225%); and

(2) for each dollar of assumed reinsurance premium above $20 million - 150 thousandths of one percent (.150%).

The aggregate annual minimum tax due by a captive based on the above direct premium and reinsurance premium rates is $5,000, and the aggregate maximum tax is $100,000. Certain other tax rules apply to cell captives and SPFCs that are a part of a consolidated group.

Effective Date and Licensure Process

The bill provides an effective date of September 1 for issuance of licenses, but is effective upon Governor Haslam's signature for purposes of developing and publishing applications, promulgating rules and accepting applications for new captives. The new form of application is expected to be prepared and released within the next couple of months.

The licensure and supervision of captives is anticipated to be conducted in a new Captives Section of the Department's Insurance Division, which will be overseen by a new director position. Now that the legislation has been passed by the General Assembly, Commissioner McPeak is expected to soon announce the individual who will serve as the new director. She has indicated the individual will have significant experience in the area, probably including having served in a senior position with another state insurance department. The new Captives Section is expected to quickly add analysts and other staff positions, with personnel sourced from both within and outside the Department.

We are in regular and active communication and consultation with the Insurance Division and are monitoring developments closely as the Department gears up to accept new applications during the summer. We welcome comments or questions about technical aspects of the Act, the rationale and process for establishing a captive and the process for seeking and securing a license in Tennessee.

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NEW SUPREME COURT CASES FIND VEHICLE SERVICE CONTRACTS AND GAP PRODUCTS MEET THE DEFINITION OF "INSURANCE" IN OKLAHOMA AND ARE SUBJECT TO TORT RECOVERY FOR BAD FAITH

Angela Ables, Esq.
KERR, IRVINE, RHODES & ABLES, P.C.
(405) 272-9221

All members of FORC are familiar with their own state's definition of "insurance" which has been set forth statutorily by the various state legislatures since the beginning of risk sharing.  A more "squishy" area of the law has been service warranties or, in this case, a vehicle service contract.  In January of this year, the Oklahoma Supreme Court had an opportunity to review a vehicle service contract and determined it to be "insurance" under Oklahoma's statute and consequently subject to "bad faith."

The facts of the case were that the petitioner, Mr. McMullan, bought a used car and with it, a vehicle service contract.  After six months, his used car had experienced a mechanical breakdown, for which he submitted a claim to the vehicle service warranty company.  The claim was denied and Mr. McMullan filed a lawsuit alleging that the provider of the vehicle service contract, Enterprise Financial Group, (1) breached the service contract; (2) committed unfair and deceptive practices under the Oklahoma Service Warranty Insurance Act, Okla. Stat. tit. 36, § 6633 (2001); and (3) acted in bad faith.  The provider, Respondent, filed a Motion for Partial Summary Judgment and immediately certified an interlocutory order for immediate appeal to the Oklahoma Supreme Court.  The Supreme Court granted certiorari to address the question of whether a vehicle service contract is an "insurance" contract and consequently subject to bad faith claims, a question of first impression.  Not wanting to spoil the anticipation of the Court's decision amongst all the insurance regulatory lawyers of the U.S., I must inform you that, at least under Oklahoma law, our insurance regulatory practice has been enlarged to include vehicle service contracts.

The Law of Fair Dealing

The Oklahoma Supreme Court announced initially in the 1977 case of Christian v. Am. Home Assurance Co., 1977 OK 141, 577 P.2d 899, that insurance contracts were subject to bad faith awards.  In the more recent case of Bankers Trust Co. v. Brown, 2005 OK CIV App 1, 917, 107 P.3d 609, the Oklahoma Supreme Court cited the "special relationship between an insurer and an insured" in further enunciating the tort liability for breach of the covenant of good faith and fair dealing in insurance contracts.  The result was that not only may an insured seek damages for the benefits under their policy, but they may also recover as a result of the "harm flowing from insurer's bad faith breach."  Taylor v. State Farm Fire & Cas. Co., 1999 OK 44, 919, 981 P.2d 1258.  Bad faith damages can include "mental pain and suffering,  financial losses, embarrassment, and loss of reputation" according to the 10th Circuit Court of Appeals.  See Vining v. Enter. Fin. Group, Inc., 148 F.3d 1206 (10th Cir. 1998).  The case of Buzzard v. Farmers Insurance Co., 1991 OK 127, ¶24, 824 P.2d 1105, added that punitive damages were also recoverable in insurance bad faith breach cases.  As one can tell from the cited cases, the Supreme Court continued to enlarge the tort liability of insurers, but the Court had not expanded this tort theory of recovery to non-traditional insurance claims, until now.

McMullan v. Enterprise Financial Group, Inc., 2011 OK 7, 247P.3d 1173

On January 31, 2011, the Oklahoma Supreme Court issued its opinion in McMullan v. Enterprise Financial Group, Inc., (cited hereinabove) and not only determined that vehicle service contracts are "insurance" under Oklahoma statutes, but consequently, they are subject to the tort of "bad faith" as all other insurance contracts.

Oklahoma, in its statutory scheme, and within the Insurance Code (Title 36, Oklahoma Statutes) has enacted the Oklahoma Service Warranty Insurance Act (Okla. Stat. tit. 36, §§ 6601-6639 (2001)).  Petitioner argued that regardless of what these vehicle service contracts were labeled, they were, in reality, "insurance contracts" and consequently subject to bad faith breach.  Petitioner relied on not only the public policy considerations of the Oklahoma Service Warranty Insurance Act, but also argued that other jurisdictions have determined service contracts of this type to be "contracts of insurance."  Respondent argued that insurers are regulated under one scheme of regulation and service warranties are regulated under a different set of rules and that service contracts were "warranties" and not "insurance contracts." The Court, in its opinion, however, held that it was not the "extent of regulation" that determines whether a service provider is an "insurance company" nor was the extent of regulation what makes a service agreement an "insurance contract."

"Insurance" in Oklahoma is defined as "a contract whereby one undertakes to indemnify another or to pay a specified amount upon determinable contingencies" (Okla. Stat. tit. 36, § 102 (2001)).  The Court went on to opine that while "indemnity" is not specifically defined within the confines of the Oklahoma Insurance Code, the Service Warranty Insurance Act, which is contained within the Oklahoma Insurance Code, defines indemnity as "undertaking repair or replacement of a consumer product."  Id. §6602.7.  The Court determined that "maintenance service contracts under the terms of which there are no provisions for such indemnification and home warranties are expressly excluded from this definition of 'service warranty'."  Id. §6602.14(a).

The Court quoted the seminal case of Group Life & Health Insurance Co. v. Royal Drug Co., 440 U.S. 205, 211 (1979) in its discussion of what constituted "insurance":

[t]he primary elements of an insurance contract are the spreading and underwriting of a policyholder's risk.  "It is characteristic of insurance that a number of risks are accepted, some of which involve losses, and that such losses are spread over all the risks so as to enable the insurer to accept each risk at a slight fraction of the possible liability upon it."

The Court went on to quote Jordan v. Group Health Ass'n, 71 App. D.C. 38, 107 F.2d 239, 245 (1939):

Whether the contract is one of insurance or of indemnity there must be a risk of loss to which one party may be subjected by contingent or future events and an assumption of it by legally binding arrangement by another.  Even the most loosely stated conceptions of insurance... require these elements.  Hazard is essential and equally so a shifting of its incidence.

The Supreme Court concluded:

Vehicle service contracts are written like insurance policies.... The vehicle service provider agrees to indemnify the consumer for mechanical repair costs.  In other words, the consumer has purchased insurance -- regardless of whether the vehicle service company is labeled as an insurance company and regardless of whether it labels its agreements insurance.

McMullan, 2001 OK 7, 13, 247 P.3d at 1178.

The Court went through a very good analysis of other jurisdictions and their Court's determinations of whether vehicle service contracts constituted insurance.  According to their analysis, the states are split on this issue, but our Court adopted the rationale of an Arizona case, Jim Click Ford, Inc. v. City of Tucson, 154 Ariz. 48, 739 P.2d 1365 (Ct. App. 1987) where the Court recognized five indicia of an insurance contract:

1. An insurable interest;

2. A risk of loss;

 3. An assumption of the risk by the insurer;

4. A general scheme to distribute the loss among the larger group of persons bearing similar risks; and

5. The payment of a premium for the assumption of risk.

Additionally, our Court found the Utah case of Pugh v. North American Warranty Services, Inc., 2000 UT App 121, 1 P.3d 570 to be persuasive in their reasoning where Utah held a vehicle service contract was insurance because if the car broke down during the warranty period, the provider of the vehicle service contract "absorbed the cost of the repair." The Court went on to hold that while the agreement was named a "vehicle service contract" rather than "automobile repair insurance" it served the same purpose and consequently was an insurance contract.

Oklahoma's Supreme Court held as its reasoning:

The consumer pays for indemnity and pays to shift the risk of paying for high repair costs to the vehicle service provider in exchange for a pre-paid premium.  Because these contracts function like insurance, their providers should be subject to the same covenants of good faith that insurers must meet.

McMullan, 2011 OK 7, 19, 247 P.3d at 1180.

As stated hereinabove, this holding means that vehicle service contracts are now considered insurance contracts and consequently are subject to bad faith tort claims and the trial bar has a new cause of action of bad faith tort liability which appears to have grown out of the "special relationship" of an adhesion contract coupled with an agreement to bear risk.

Embry v. Innovative Aftermarket Systems, L.P., 2010 OK 82, 247 P.3d 1158

The Oklahoma Supreme Court also issued a further enunciation of bad faith tort liability outside the traditional realm of insurance contracts in Embry v. Innovative Aftermarket Systems, L.P., 2010 OK 82, 247 P.3d 1158.  Plaintiff sought damages from Defendant for its failure to pay the difference which remained on an automobile loan after the total loss insurance settlement by plaintiff's insurer was applied to the outstanding loan.  This type of product is generally referred to as "Gap Protection" and is oftentimes sold at the time of the car purchase so the debtor will not owe additional money on its loan after the car is totaled for its then value.  The lower court had eliminated bad faith and negligence theories of recovery for Plaintiff and the case was appealed to the Oklahoma Supreme Court.  At issue on the "bad faith" cause of action was a determination of whether this "Gap Protection" was an "insurance" product.

The trial court ruled that the tort recovery for bad faith and the failure to deal fairly and in good faith was limited to insurance contracts and that tortious bad faith could only occur if the parties recognized and believed their contract was insurance.  The Supreme Court recognized that Courts, including the Supreme Court, had been reluctant to extend tort recovery for bad faith beyond the traditional "insurance contract" but said such liability was dependent upon the "special relationship" the contract created.  This "special relationship" that is a predicate to tort liability for bad faith is based upon: "(1) a disparity in bargaining power where the weaker party has no choice of terms, also called an adhesion contract and (2) the elimination of risk."  Rodgers v. Tecumseh Bank, 1988 OK 36, ¶¶ 14-16, 756 P.2d 1223, 1226.  Embry, 2010 OK 82, ¶7, 247 P.3d at 1160.  The Court went on to say:

"Tort liability is allowed in these types of contracts, because bad faith, or, more properly, breach of the implied duty to deal fairly and in good faith, precipitates the precise economic hardship the contract was intended to avoid."  Christian v. American Home Assurance Co., 1977 OK 141, 577 P.2d 899.

Id.

The Court stated that the Defendant wrote the contract, set forth the definitions, described how it would work and even set forth a how to compute the "deficiency."  The Court concluded: "Clearly, the contract to pay the deficiency involves the 'special relationship' necessary to support tort recovery for bad faith."  The Court affirmed the lower court in its elimination of negligence as a cause of action, but reversed the lower court and held that the Defendant breached the implied covenant "deal fairly and in good faith" consequently expanding the tort theory of bad faith to so-called "Gap Products".

Conclusion

With the decisions in McMullan and Embry, Oklahoma's Supreme Court has broadened bad faith tort liability beyond the traditional insurance contract and created two new recoveries of tort liability for bad faith breach of contract: vehicle service contracts and those contracts which involve a "special relationship" between the parties.  Now, at least in Oklahoma, vehicle service contracts and so-called Gap products are subject to the same covenant of good faith and fair dealing to which traditional insurance companies must adhere.  The basis of this expansion into bad faith is the "special relationship" at least ostensibly, which exists whenever an adhesion contract is joined with a contract to eliminate risk; these two ingredients have been combined to create liability in tort for bad faith breach, just like traditional insurers in Oklahoma have been subject to for over three decades.

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INSURANCE PRODUCER COMPENSATION IN LOUISIANA

Ronnie L. Johnson, Esq.
McGLINCHEY STAFFORD, PLLC
(225) 382-3620

There has been much discussion and debate about insurance producer compensation in Louisiana over since August of last year. The scope of this article is to alert the reader to the overall issues and to identify some of the current activity that may effect insurance producer compensation.

On August 9, 2010, Louisiana Commissioner of Insurance, James J. "Jim" Donelon signed two promulgations, Advisory Letter No. 2010-01 ("Advisory Letter") and Bulletin No. 2010-05 ("Bulletin"). The Advisory Letter deals with producer compensation and was addressed to all insurers, brokers and producers. The Bulletin deals with rebating and inducements and was addressed to all brokers and producers selling accident and health insurance.

The Advisory Letter interprets several provisions of the Louisiana Insurance Code to set forth the position of the Louisiana Department of Insurance ("LDI") with regard to flat fee arrangements and quotes net of commission. While the statutes that are cited in the Advisory Letter have been in effect for years, the interpretation of them as set forth in the Advisory Letter is res nova.

First, the Advisory Letter states that an insurer shall use one rating scheme, if required to file rates, that establishes either a commission based on a percentage of the premium or a commission based upon a flat fee. A compensation scheme that would provide both a flat fee and a percentage based on the amount of premium would be prohibited based upon the wording of the Advisory Letter.

Second, it is stated that an insurer, producer or broker shall not quote a premium that is "net of commission." The term insurer is interpreted to include both admitted insurers and approved unauthorized insurers (surplus lines insurers). To support the stated provision, the LDI relies upon La. R.S. 22:855(A) which states in pertinent part "[t]he premium quoted by the insurer shall be a specific dollar amount which shall be inclusive of all fees, charges, premiums, or other consideration charged for the insurance or for the procurement thereof ...."

Many insurance producers with large commercial accounts have historically negotiated the amount of their compensation with their customers in lieu of receiving compensation from the insurer. As this common practice is prohibited by the Advisory Letter, there is an effort underway to seek a statutory exemption for certain commercial transactions. There are two bills pending in the current legislative session that address producer compensation, HB 137 and SB 96. The two legislative bills are similar in that they both create new sections within the Louisiana Insurance Code that permit an insurance producer and a property and casualty insurer to negotiate any combination of commissions and fees to compensate the insurance producer for the placement of commercial property and casualty insurance coverages if the policyholder meets anyone of the following criteria: (1) has total property and casualty insurance premiums in excess of five hundred thousand dollars; (2) obtains insurance coverage with a per occurrence or per claim deductible or self-insured retention of fifty thousand dollars or more for worker's compensation, general liability, or automobile insurance coverages; (3) has a net worth in excess of twenty-five million dollars; or (4) qualifies as a self-insurer with the state of Louisiana. SB 96 provides for a fifth qualifying criteria for a governmental entity that had a contract prior to August 9, 2010 with an insurance producer on a stipulated fee basis for the placement of commercial property and casualty insurance coverages.

The Bulletin, on the other hand, provides guidance and clarification as to the services often referred to as "value added" services that may be provided to insureds or potential insureds without running afoul of the rebating and inducement provisions set forth in the Louisiana Insurance Code. In addition, certain services not specified in the insurance policy if provided by an insurance broker or producer to an insured or prospective insured for free or at less than cost may run afoul of the rebating and inducement prohibitions. Such services include, but are not limited to, COBRA administration, payroll processing, developing of employee handbooks, providing human resource software, risk management or loss control services, and legal services.

Unlike the Advisory Letter, the Bulletin appears to be well received by all in the industry as it establishes a level playing field as to what services may be provided and which services may not be provided by insurance producers.

It should be noted that even though La. R.S. 22:855 which is the basis for the prohibition of quotes "net of commission" specifically excludes life, accident, health, and reinsurance policies, some within the LDI consider that the quoting of a health insurance policy "net of commission" violates the statutory provisions prohibiting rebating and inducements.

Aetna recently submitted notice to the LDI of its intent to no longer pay base commissions or any other form of compensation that is a component of premium. Instead Aetna proposed to transition to a direct, service fee model under which the customer would compensate the producer directly. In response to the notice, the LDI replied that the proposed changes in producer compensation were denied and directed Aetna to advise its producers that the proposed producer compensation plan would not be implemented. The basis for the denial was the LDI's interpretation of La. R.S. 22:34 as requiring that the insurer must ensure that each potential insured is given the same quoted premium from each of its appointed producers. The definition of "premium" as set forth in La. R.S. 46(13) is strictly interpreted as including all sums charged, received, or deposited as consideration for the purchase or continuance of insurance for a definitely stated term. In other words, producer compensation is to be included in the calculation of premium.

The LDI has been gracious with its time in accommodating numerous meetings and discussions on the scope of the Advisory Letter and the Bulletin. Commissioner Donelon himself has been attentive to the issues and has welcomed input from anyone who wanted to voice a position. The debate on the two legislative bills has not yet commenced; however, a resolution should be forthcoming as the session must end no later than June 23rd.  Stay tuned for further developments.

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SOCIAL MEDIA BEST PRACTICES
Navigating Regulatory and Compliance Risks

Gary A. Hernandez, Esq.
SNR Denton US LLP
(415) 882-2466

Sean McEneaney
SNR Denton US LLP
(415) 882-5026

I.     INTRODUCTION1

The use of social media platforms such as Facebook, Linked-In and Twitter is growing exponentially.  Many businesses - including insurers and insurance agents - have taken notice and are utilizing social media to reach new customers and improve interactions with current ones.  In addition to the many insurers and agents now utilizing social media, insurance regulators are also using social media to communicate to the public.  Indeed, numerous state insurance departments currently have a Facebook and/or Twitter account.

This article addresses some of the legal and regulatory issues accompanying the use of social media in the insurance context.  First, we assess the current regulatory environment and identify some of the existing guidance applicable to social media use.  Next, we address a number of legal and operational issues that insurers should consider when using social media.  Finally, we discuss best practices and outline some fundamental aspects of an effective social media policy.

II.     CURRENT REGULATORY ENVIRONMENT

To date, there has been very little insurance regulatory activity directly addressing the use of social media. While some may argue that current laws make such specific regulation unnecessary, the tremendous growth in social media use portends that such tailored regulation is inevitable.

        A.     Application of Current Laws to Social Media Platforms

In the meantime, little doubt exists that an insurer's use of social media will be viewed as traditional insurance marketing/advertising and regulated as such.  While there may be other uses for social media, it would be hard for an insurer or agent to deny that a Facebook/Linked-In page or Twitter account has no relation to the "promotion of" or "creating an interest in" an insurer or insurance product, the terms commonly used in defining an insurance advertisement.2  Indeed, at least one state has indicated that its advertising rules apply to social media platforms in the same way they apply to any other medium:

The use of a Linked-In profile page or a similar website for the promotion of insurance, insurers, or insurance agents or brokers constitutes an advertisement, announcement, or statement under the New York Insurance Law.  (OGC Opinion No. 10-11-07, dated November 22, 2010.)

Virginia has also recently passed legislation, which will be effective July 1, 2011, specifically including "social media" as a form of advertising.3  Accordingly, in the absence of social medial specific regulation, insurers and agents utilizing these platforms should adhere to the core rules applicable to insurance marketing generally, including those governing print advertising.  These can include, inter alia, doing business in the insurer's own name, making sure that required disclosures are present, and avoiding improper inducements, tie-ins, or rebates.

In addition to marketing and advertising, use of social media platforms could also lead to regulatory scrutiny with respect to other typically regulated activities, including:  licensing and jurisdictional issues, consumer complaints, compensation and referral fees, insurer supervision responsibilities, and record retention.

        B.     Guidance Issued by the Financial Industry Regulatory Authority (FINRA)

The Financial Industry Regulatory Authority or "FINRA" is one of the few regulatory bodies that has actually promulgated social media specific regulatory guidance:  FINRA Regulatory Notice 10-06 "Guidance on Blogs and Social Networking Websites" (January 2010).  While FINRA applies to securities firms, some insurance producers are registered broker-dealers subject to FINRA.  Moreover, FINRA's policies on social media are likely to inform future insurance regulation in this area.  Ultimately, consideration of the core elements of the FINRA Guidance should help insurers and insurance agents better manage the regulatory risks inherent in the use of social media.

The FINRA Guidance addresses five key elements:  (1) firm supervision of social media; (2) personal use of social media by representatives and employees; (3) different approaches to static versus dynamic content; (4) third party posts on social media sites; and (5) record retention responsibilities.  We discuss each of these elements below.

               1.     Supervision of Social Media Sites

First, FINRA requires that firms supervise social media communications in a manner designed to ensure they do not violate content requirements imposed by advertising rules.  This includes, inter alia, (a) ensuring that persons who participate in social media for business purposes are appropriately trained and supervised and (b) prohibiting any person from engaging in business communications on a social media site where such communications are not subject to the firm's supervision.  This is an ongoing requirement as FINRA requires that the firm supervise the extent to which its representatives and other employees are complying with the firm's policies and procedures with respect to the use of social media.

               2.     Personal Use of Social Media by Representatives and Employees

Next, FINRA also requires that firms establish clear internal policies regarding the personal use of social media sites by representatives and employees.  Specifically, if the social media site is used for both personal and business purposes, then the site and the representatives or employees' usage must be supervised by the firm.  This may mean, practically speaking, that the firm's policy insists that representatives and employees have separate business and personal social media pages or accounts.

               3.     Interactive Capabilities - Static v. Dynamic Content

FINRA also recognizes that social media sites typically contain both static (i.e., the content that is voluntarily included in the social media platform by the entity) and dynamic (or interactive) content.  As one might expect, the static content that is generated directly by the firm must be in compliance with advertising rules and be approved in advance, according to firm policy.

As for the dynamic content, while it may not be possible for a firm to approve dynamic content in advance, the firm is still responsible for supervising such content.  This is obviously somewhat tricky given the logistics of having to track and monitor content that could change by the minute.  However, it is also important given that, in many instances, it may be hard for the consumer to differentiate the content provided by the firm versus the content that may be originating from other sources (including other consumers).  Firms must also be careful not to adopt, or make "attributable" to themselves as described below, any undesired content that may be originating from unrelated sources.

               4.     Third Party Posts on Social Media Sites Established by the Firm or its Representatives

Under FINRA's guidance, a post by a consumer or other third party is not generally considered a communication of the firm, unless it becomes "attributable" to the firm.  According to FINRA, a post is attributable when the firm is involved in preparation of the content or explicitly or implicitly endorses or approves the content.  This situation, where the firm can be viewed as adopting the content, is referred to as "entanglement."  With respect to third party posts, FINRA recommends establishing the process for screening third party content, disclosing firm policies regarding responsibility for third party posts, and using disclaimers.

               5.     Record Retention Responsibilities

Finally, FINRA also requires that all social media use be in compliance with record retention responsibilities. While this is not surprising given the various supervision and other advertising monitoring obligations imposed by FINRA, actual compliance may be somewhat onerous given the dynamic nature of social media.  FINRA acknowledges that firms may use vendors to satisfy these obligations; however, ultimate responsibility for compliance remains with the firms.

        C.     Insurance Regulators/National Association of Insurance Commissioners ("NAIC")

At present, there is very little in the way of social media specific state insurance regulation.  It should only be a matter of time, however, before states become more active in this area.  The NAIC has previously held meetings on the use of social media in the insurance context, and a NAIC Working Group has reportedly been created in order to draft a white paper addressing and raising awareness of social media issues in the insurance industry.

In the meantime, however, these ever-evolving social media platforms will pose regulatory challenges not only for insurers but also for insurance regulators.  In addition to having to come up to speed with the myriad ways insurers are using social media platforms, insurance regulators will likely need to increase staff and resources to conduct monitoring and review.

From a market regulation standpoint, insurers should assume that regulators will begin to include social media use in market analysis reviews and enforcement investigations.  This could include a whole range of questions regarding the insurer's use of social media stretching beyond advertising or marketing practices.  For instance, examiners may question whether, where necessary, the insurer is using licensed professionals to communicate with consumers.  State regulators may also examine whether the insurer is monitoring its business partners' compliance with such requirements.

III.     POTENTIAL LEGAL AND OPERATIONAL ISSUES

In this section we highlight some of the potential legal and operational issues which could impact an insurer using social media, including:  (1) marketing/advertising; (2) operations and (3) privacy/intellectual property.

               1.     Marketing/Advertising Issues

The most obvious area of concern for insurers should be in the context of insurance marketing.  The main thing to emphasize here is that the medium does not change the rules when it comes to marketing prohibitions.

First, compliance professionals must recognize that social media is a fluid and interactive platform.  Typically, a compliance officer has the ability to preview advertisements.  And, while the same type of review would be available with respect to web pages or "static" social media, such review is harder to conduct with respect to social media marketing which occurs in real time (i.e., if there are direct interactions with consumers).  Nevertheless, such activity should be supervised to the extent it can be construed as advertising.

Second, compliance professionals should ensure that personnel communicating on behalf of the company is licensed where necessary.  For instance, issues may arise if adequate controls are not implemented over who may respond to Facebook posts, tweets, etc.  This review should extend to business partners.  If the insurers' vendors and other business partners are linking to the company's social media site, care should be given to licensing compliance.

Third, issues may arise if the insurer's social media activities could cause confusion as to the entity actually marketing.  Here, it might be easy to fall into some pitfalls.  For example, many states require that marketing be conducted in the insurer's name.4  Thus, to the extent that an insurer is using a Twitter account, compliance professionals will want to ensure that the account name satisfies this requirement.  The insurer should also make sure that if any advertisements direct account followers back to a particular web page, the advertisement and the web page properly identifies the company and otherwise complies with marketing rules.

Finally, compliance professionals will want to make sure that the dynamic content distinguishes between company posts and consumer posts.  Not only could this cause confusion, but the insurer needs to be careful not to adopt comments made by unlicensed third parties that could be viewed as improper endorsements.

               2.     Operational Issues

There are also operational issues that may arise from the use of social media.  For instance, is the insurer properly identifying, monitoring and responding to complaints that may be communicated by consumers through the insurer's social media platforms?  At the same time, is the insurer tracking and retaining records of these complaints?

There may also be claims implications.  For instance, it is possible that an insured may attempt to submit a claim through the insurer's Facebook page.  Here, including a disclaimer regarding the proper reporting of insured claims should be considered.  Even with a disclaimer, however, insurers should consider monitoring social media platforms for claims activity and establishing policies regarding same.

Social media use will likely be encompassed in future market regulation activity.  Either way, record retention protocols are important.  Not only is this consistent with the FINRA guidance discussed above, but also with certain state department of insurance bulletins reminding insurers of the need to retain records with respect to electronic transactions.5

Indeed, record retention may also be applicable in litigation.  In some cases, a policyholder's social media use could provide information or evidence in connection with a claim or lawsuit.  However, social media is a two-way street.  Specifically, litigants may also try to subject an insurer's social media platforms to discovery in litigation.

               3.     Privacy/Intellectual Property Issues

While a full treatment of the privacy and intellectual property issues accompanying the use of social media is beyond the scope of this article, we address three issues here.

First and foremost, insurers need to assess how much personally identifiable information they may be collecting about their insureds and potential insureds through social media platforms.  In short, from a privacy standpoint, insurers need to take care that they do not improperly utilize or disclose such information.

From a trade secret perspective, insurers must also be mindful of how their employees and representative use social media.  Specifically, that when using social media, representatives are not disclosing too much information about the company (either on behalf of the company or on a personal page).

Finally, most insurer websites contain "terms of use."  Given the relationship between social media sites and the insurer's own website, insurers should make sure that social media usage is either encompassed by or is not inconsistent with, existing terms of use.

IV.     SUMMARY OF SOCIAL MEDIA BEST PRACTICES

The issues associated with the use of social media are not confined to just "Regulatory" or "Compliance" matters.  At the end of the day, an insurer's social media presence speaks for the company and, therefore, also poses some reputational risk.  Below we identify some best practices and fundamentals of a social media policy aimed at mitigating this risk.

Initially, those in charge of insurer compliance need to assess how the organization uses social media.  Once an assessment of the current practice has been determined, the insurer should then develop or update its social media policy.  The bottom line is that whatever form regulation and examination takes, insurance regulators will be more comfortable if the insurer has a reasonable policy to which it adheres.  The following are a number of important components to such a policy: 

• Establish protocols for the creation of static content to ensure it is compliant with advertising laws and acknowledging and responding to consumer complaints;
  
• Set clear expectations regarding online privacy when using corporate network access;
  
• Prohibit any use of social media for business purposes that can not be supervised or retained by the   company;
  
• Ensure that persons who participate in social media for business purposes are appropriately trained and supervised;
  
• Consider restriction of continued social media use if an individual poses a compliance risk;
  
• Establish protocols for monitoring third party posts on sponsored social media sites; and
  
• Use disclosures that sufficiently inform users of the company's position regarding third party posts.

Finally, whether or not made part of the social media policy, the insurer should maintain a compliant record retention practice.  While this could include use of a vendor, the insurer should find a technology with which it is comfortable.

V.     CONCLUSION

While social media platforms create tremendous opportunities for insurers to better connect with their customers, these platforms pose some risks and challenges.  Compliance professionals should ensure that any accompanying risks are managed by adopting social media best practices and policies, even in the absence of direct regulations.

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DIRECT PROCUREMENT: RECENT DEVELOPMENTS IN THE LAW

Frederick J. Pomerantz, Esq.
WILSON ELSER LLP
(212) 490-3000

This is an updated article on the subject of direct procurement insurance transactions. The original article appeared in Volume 10, Edition 2, Summer 1999 of the FORC Quarterly Journal of Insurance Regulation. Many state insurance-related laws have been added since 1999 and others have been amended. The specter of the new Nonadmitted and Reinsurance Reform Act (“NRRA”)1 due to become part of federal law on July 21, 2011, weighs upon many of the state insurance laws and state premium tax laws discussed in this article.

Statutes have changed the way insurance business is conducted inside (and outside) the United States.  Many states have enacted laws permitting the formation and use of captive insurance companies, and several of those state laws permit organization and licensing of industrial insured captives and industrial insured group captives as permissible forms of alternative risk mechanisms.  

The NRRA allows the surplus lines broker to place insurance on behalf of large, sophisticated commercial purchasers, as defined in the law, without having to satisfy a state’s diligent search requirement. These purchasers, known as “exempt commercial purchasers” must employ a “qualified risk manager” who has the education and training in insurance/risk management to properly represent the insured in this type of transaction.  The insured must have had business in the previous year in excess of $100,000 in property and casualty insurance premiums on a nationwide basis. In addition, the insured must meet at least one additional criterion relating to:

• net worth ($20,000,000),
• annual revenue ($50,000,000),
• employees (500 full time employees or be an affiliate of a group that employees at least 1,000 employees),
• a municipality must have a population in excess of 50,000,
• a non-profit organization or public entity must have an annual budget of at least $30 million.

The concept of “exempt commercial purchasers” in the NRRA has a purpose and language similar to several state laws introducing and implementing the concept of “industrial insureds”. The congressional intent is that the NRRA pre-empt any state statute with provisions that are inconsistent with providing a unified structure to the regulation of surplus line insurance, reinsurance and direct procurement transactions.

Doing An Insurance Business Defined 

New York Insurance Law §1101 defines the acts that constitute “doing an insurance business” in New York State.  Section 1101 does not prohibit an insurer from soliciting, making or proposing to make, issuing or delivering a policy to a person outside of New York, even though the person is a New York resident, as long as those activities take place outside of the state.  Section 1102 prohibits unauthorized insurers from doing an insurance business in New York State.2

A producer that acts for or aids an unauthorized insurer in soliciting, negotiating or effectuating any insurance  policy by falsely claiming that the solicitation or other actions took place outside New York violates several sections of the New York Insurance Law: 1) Section 2117, prohibiting any person from aiding and abetting an insurer not authorized to do business inside New York; 2) Section 2122, prohibiting any insurance producer or other person from calling attention to any unauthorized insurer by advertisement or other public announcement, and 3) Section 2403 prohibiting any person from engaging in unfair and deceptive acts or practices.3

Federal Constitutional Protection of Direct Procurement Insurance Transactions

Notwithstanding these prohibitions on those who “aid and abet” the transaction of unauthorized business inside the state, the right of an insured to directly place coverage with an insurer of his choice is constitutionally protected, although a state may legitimately assess a tax on the transaction and require it to be reported. State Board of Insurance v. Todd Shipyards Corp., 370 U.S. 451 (1962); Connecticut General Life Insurance Co. v. Johnson, 303 U.S. 77 (1938); St. Louis Compress Co. v. Arkansas, 260 U.S. 346 (1922); Allgeyer v. Louisiana, 165 U.S. 578 (1897).  This constitutional protection has been codified by nearly three-quarters of the states and the District of Columbia, in sections of the state insurance law or sections of the state tax code.4  One state, Delaware, which does not have a statute recognizing direct procurement, however, recognizes in case law that the right to independently procure insurance in the nonadmitted market exists.5

State Tax Laws

The basis for imposing premium taxes on independently procured insurance policies varies from state to state, with many states conditioning the effectiveness of a direct procurement transaction upon reporting of the transaction and the payment of premium tax by the insured. The rate of premium tax on independently procured insurance policies is generally the same as the surplus lines tax rate.

Nearly three-quarters of the states require the payment of a direct procurement tax, calculated generally as a percentage of gross premiums, from a low of 1% of gross premiums written in Iowa, to as much as 6% of gross premiums written in Oklahoma.6  Utah (Ins. Code § 31A-3-301) exempts ocean marine insurance from the tax. Many states tax a reduced percentage for marine insurance and title insurance. In most states, written reports of direct placements are required to be filed with the Insurance Department within 30, 60 or 90 days from the placement, depending on the specific state law. The insured is generally responsible for making the filing and for remitting the tax, which is paid in addition to the premium. Even the owners of captive insurers7 are not exempt from the responsibility to file a return and pay tax on premiums paid for directly procured insurance covering risks that are located in New York.8

The direct procurement taxes tend to apply to property and casualty insurance more than life or health insurance because property and casualty insurance is more likely to be purchased out of state from an unauthorized insurer.9

Limits of the Direct Procurement Transaction

In direct procurement transactions a surplus lines broker (or retail producer) must avoid involvement and the insured typically deals directly with the market. The insured is, in most cases, required to leave the state's borders and to conduct the transaction outside the state's borders. See, e.g., People v. British & American Casualty Co., 133 Misc. 2d 352, 505 N.Y.S.2d 759 (Sup. Ct. N.Y. County 1986). The elements of the transaction, including negotiation, issuance and delivery of the policy, and payment of the premium, must occur principally outside the state of the insured and a broker (retail or wholesale) cannot be involved in the transaction.10

The direct procurement alternative is only available in limited situations and should only be used where there is evidentiary documentation that all the conditions of a direct procurement insurance transaction have been fulfilled. This includes proving that the foreign or alien insurer and its producers were not involved in soliciting or negotiating the business inside the state (although, as mentioned, there are certain states which require the transaction to be "principally negotiated" outside the state). There is some flexibility permitted by the New York Insurance Law, e.g., a proposed insured may learn about a particular insurer (such as at a trade association meeting or other gathering in the ordinary course of business) and may contact that insurer by telephone to request an application. It is nonetheless necessary for the insured, or the insured's representative, to conduct the bulk of the activity of the negotiation regarding coverage terms and pricing outside the state.

Please note, however, that a broker will not be able to place the insurance on behalf of the insured, as a retail broker is limited to dealing with the admitted market and is prohibited from placing business with an unlicensed insurer. [See, e.g., § 2117(a) of the N.Y. Ins. Law and NYID OGC Opinion No. 89-39 (8/17/1989).] A surplus line broker is permitted to deal with the nonadmitted market, but only where the insurer is eligible by virtue of approval of an application to the state insurance regulators, resulting in inclusion on a “white list” maintained by certain states or, in other states, where the surplus line broker verifies to the state insurance regulators that the insurer qualifies with the state’s financial and other requirements for surplus line insurers.

Similarly, in order to comply with the requirement that the policy be "issued and delivered outside the state in a jurisdiction in which the insurer is licensed,"11 it would be necessary for the insured, or the insured's representative, to accept delivery of the insurance policy outside New York. People v. British & American Casualty Co., 133 Misc. 2d 352, 505 N.Y.S.2d 759 (Sup. Ct. N.Y. County 1986).12

Section 1101(b) (2) (E) of the New York Insurance Law provides, in relevant part, as follows:

(2)  Notwithstanding the foregoing, the following acts or transactions, if effected by mail from outside this state by an unauthorized foreign or alien insurer duly licensed to transact the business of insurance in and by the laws of its domicile, shall not constitute doing an insurance business in this state.

(E)  transactions with respect to policies of insurance on risks located or resident within or without this state . . . which policies are principally negotiated, issued, and delivered without this state in a jurisdiction in which the insurer is authorized to do an insurance business; (emphasis added)

(a)  No person, firm, association or corporation shall in this state act as agent for any insurer or health maintenance organization which is not licensed or authorized to do an insurance or health maintenance organization business in this state, in the doing of any insurance or health maintenance organization business in this state or in soliciting, negotiating or effectuating any insurance, health maintenance organization or annuity contract or shall in this state act as insurance broker in soliciting, negotiating or in any way effectuating any insurance, health maintenance organization or annuity contract of, or in placing risks with, any such insurer or health maintenance organization, or shall in this state in any way or manner aid any such insurer or health maintenance organization in effecting any insurance, health maintenance organization or annuity contract. (Emphasis added)

New York case law, as set forth in People v. British & American Casualty, and interpretations of the New York Insurance Department with regard to Sections 2117 and 1101, appear to indicate that the role of a broker in a direct procurement situation is limited to that which the insured, himself, is entitled to do. For example, if a New York insured calls a Lloyd's broker and discusses the insured's coverage requirements and the Lloyd's broker sends the insured information about the rates of an alien insurer and/or a binder from the alien insurer, this would likely be considered illegal solicitation by the alien insurer and, quite possibly, the Lloyd's broker, if he is deemed to be soliciting business inside New York. If, on the other hand, the insured calls the Lloyd's broker and indicates that he will be in London and wishes to meet the broker and/or the alien insurer to discuss coverages, and the Lloyd's broker sets up the meeting which, in fact, occurs in London, resulting in a binder mailed from the alien insurer or by the broker on a subsequent date to the insured in New York, this would appear to meet the requirement that the placement be principally solicited and negotiated outside New York. The Lloyd's broker is not violating section 2117 since he is doing no act inside New York. The alien insurer is violating no law since it falls within the exception as well and is not soliciting or negotiating coverage inside New York.

As another example, if the insured asks its broker in New York to travel to London as its representative to sit down with a Lloyd's broker (or with the alien insurer at its U.K. head office) and negotiate a policy, and the broker returns with a binder, once again, it would appear that this placement is principally solicited and negotiated outside New York and that the New York broker is not violating New York law, provided there were no substantive telephone discussions of or correspondence regarding coverage terms or pricing involving the insured or its New York broker and the alien insurer or the Lloyd's broker prior to the New York broker's departure for London. If there were, the broker would be subject to possible fines and loss of its license. Hammond v. Hunkele, 170 A.D.2d 484, 566 N.Y.S.2d 69 (2d Dept. 1991); People by Abrams v. American Motor Club, Inc., 133 A.D.2d 593, 520 N.Y.S.2d 383 (1st Dept. 1987). However, variations in state laws do exist.13

Although the New York Insurance Law also requires reporting and payment of appropriate taxes, it is clear that there are differences between state direct procurement statutes. Most state statutes are similar to the Colorado Insurance Law14 which allows direct procurement transactions only if all elements (including the negotiation, issuance, delivery of the policy and the payment of premium) occur wholly outside the insured's state. Negotiations by mail or telephone from within the state are not exempted and insurance agents or brokers licensed in the insured's domicile may not generally be involved as such.

Protection of Independently Procured Insurance Transactions Based in U.S. Supreme Court Case law and the McCarran-Ferguson Act;  Erosion of the Protection in Some States

Allgeyer, St. Louis Cotton Compress and Connecticut General Life Insurance were decided before the enactment of the McCarran-Ferguson Act,  15 U.S.C.S. §§1011-1015, in 1945 which reserves to the states the exclusive power to regulate and tax insurance.

Citing these decisions as precedent, the U.S. Supreme Court in State Board of Insurance v. Todd Shipyards Corp., 370 U.S. 451; 82 S. Ct. 1380; 8 L. Ed. 2d 620 (1962) invalidated a Texas premium tax levied on a wholly out-of-state transaction where the only contact with Texas was the location in the state of the insured property. The insurance transaction at issue was a multi-state policy issued by unlicensed alien insurers that insured the Texas property of a New York corporation that owned property in Texas. In finding that due process, as well the McCarran-Ferguson Act, limited the state's power to tax this transaction, the Court gave great weight to the following facts:

• The policy was negotiated and issued outside of Texas;
• The premium was paid outside the state;
• All losses were adjusted and paid outside of Texas;
• The insurers were not licensed in Texas;
• They had no offices or agents in Texas;
• They did not solicit business in Texas; and
• They did not investigate risks or claims in Texas.

... Congress tailored the new regulations for the insurance business with specific reference to our prior decisions. Since these earlier decisions are part of the arch on which the new structure rests, we refrain from disturbing them lest we change the design that Congress fashioned.

Todd Shipyards, 370 U.S. 451, 458.

A number of state supreme courts have, in recent years, recognized the Todd Shipyards analysis as the prevailing approach to determine whether a state has the power to regulate and tax an insurance transaction. In these cases Todd Shipyards was distinguished on the basis that activities relating to the insurance process were conducted in the state.

In Ministers Life & Casualty Union v. Hasse, 30 Wis. 2d 339, 141 N.W. 2d 287 (Sup. Ct. Wis. 1966), the Supreme Court of Wisconsin held that the state could tax a mail order life and health insurer that was not licensed in the state if there was a systematic and continuous solicitation of Wisconsin citizens by mail and the use of Wisconsin investigatory services and physicians for claims settling and underwriting purposes.

Judicial decisions prior to United States v. South-Eastern Underwriters Ass'n, 322 U.S. 533, 64 S. Ct. 1162, 88 L. Ed. 1440 (1944), tended to view insurance contracts as something other than articles of commerce. Hence those contracts were not considered interstate transactions within the commerce clause. Accordingly the State's power to deal with the subject involved only the due process provision. When South-Eastern Underwriters Ass’n held that insurance policies were articles of commerce, Congress promptly enacted the McCarran-Ferguson Act to ensure the State's continuing authority to regulate and tax those transactions.15

Ministers claimed that by virtue of the McCarran-Ferguson Act as construed in Todd Shipyards, the states were granted only a limited power to regulate and tax insurance companies, or that at least the constitutional standard of due process as applied to a state's jurisdiction to regulate insurance, as established in the pre-Southeastern Underwriters Association decisions of the Supreme Court, was “frozen,” thus substituting for a flexible and developing constitutional standard of due process a more fixed and rigid statutory standard.

Thus, Ministers claimed, because Wis. Stats. § 201.42, in effect, prohibited the doing of a mail-order insurance business with Wisconsin residents, that it exceeded this limited grant of power, not because it violated the due-process clause but because it violated the commerce and supremacy clauses of the U.S. Constitution.

However, the court reasoned that the McCarran-Ferguson Act did not specifically grant the states any power, but left them with the power they already possessed, unaffected by reason of the commerce clause, except to the extent provided in the Act.16

Similarly, in Howell v. Rosecliff Realty Co., 52 N.J. 313, 245 A. 2d 318 (Sup. Ct. N.J. 1968) in which premium was paid to an unlicensed insurer outside the state of New Jersey with regard to a public liability policy, the court recognized that the nature of a public liability policy required the insurer to investigate, settle and pay claims within New Jersey.  As such, the policy may be taxed by the State of New Jersey.

In Haisten, v. Grass Valley Med. Reimb. Fund, 784 F. 2nd 1392 (9th Cir. 1986), the United States Court of Appeals for the Ninth Circuit explains that the Todd Shipyard case applies only to cases where the insurer has no contact with the forum state. This explanation misinterprets the Todd Shipyard case and misconstrues the distinctions between the facts of the two cases. The Haisten case involved a medical malpractice insurance fund (“Fund”) based in the Cayman Islands that covered California insureds. The manner in which the Fund was established, appearing to be doing business only in the Cayman Islands, amounted to a conspiracy to evade California law. The Fund was incorporated in the Cayman Islands, where it maintained its sole office. Its directors meetings were held there. All transactions and communications (e.g. the issuance and delivery of the policy, the payment of premiums and claims) were conducted in the Cayman Islands. The insureds worked through an attorney-in-fact or agent in the Cayman Islands. The Fund contended that it does not solicit business or advertise in California. By this elaborate structure, deliberately crafted to evade California state law, the Fund deliberately intended to avoid California insurance regulations, while at the same time, providing physicians at one hospital with malpractice insurance. The Fund was analogous to the offshore captive insurer of the physicians. Further, the contract of insurance stipulated that only California malpractice liability would trigger the reimbursement mechanism. 

Because the sum and substance of the Fund's transactions to insure California doctors against loss from medical malpractice exclusively in California indicate that the Fund purposely directed its activities toward California residents, we conclude that the Fund purposely availed itself of the benefit and privilege of conducting activities in California. In light of its substantive connection with California, the Fund should have reasonably anticipated being haled into court there. 

Haisten, 784 F. 2d 1392, 1400. 

In any event, California does not couch its direct procurement provision as an exemption from, or exception to, the doing-business laws. Instead, the California statute clearly states that "[a]ny person may negotiate and effect insurance to protect himself, herself, or itself against loss, damage or liability with any nonadmitted insurer." Calif.. Ins. Code § 1760. As is the case with most other states, California imposes a tax and reporting requirement on insurance procured in reliance on this provision. Cal. Rev. & Tax Code §13210

Thus, the Ninth Circuit U.S. Court of Appeals cannot restrict the applicability of the Todd Shipyards ruling to cases where the insurer has no contact with the forum state.  Any attempt to do so misinterprets the Todd Shipyards ruling as well as the preceding U.S. Supreme Court rulings in Allgeyer, St. Louis Cotton Compress Co., and Connecticut Gen. Life Ins. Co. and their [incorporation] in the McCarran-Ferguson Act. 

In Associated Electric & Gas Insurance Services, Ltd. v. R. Gary Clark, 676 A. 2d 1357 (Sup. Ct. R.I. 1996), the Rhode Island Supreme Court affirmed a District Court decision holding that the insurer, which was neither a licensed insurer nor an authorized surplus lines insurer in the state, was liable for premium tax on direct procurement coverage provided to several Rhode Island insureds. The taxpayer's defense was based principally on the Todd Shipyards case. The parties stipulated that no representatives from the company came into Rhode Island and no agent fees were paid by the company to Rhode Island residents. The Rhode Island Court found that the tax was due.      

• First, the court referred to a series of cases, each of which had distinguished the Todd Shipyards line of cases, and each of which had its appeal to the U.S. Supreme Court dismissed for lack of a federal question. The Rhode Island Supreme Court found that such a dismissal was a determination on the merits.     
• The Rhode Island Supreme Court also found that the Todd Shipyards doctrine was superseded by Quill Corporation v. North Dakota, 500 N.W. 2d 196 (Sup. Ct. N.D. 1993) in which the U.S. Supreme Court held that Quill Corporation, a mail order business incorporated in Delaware with no sales force and insignificant tangible property in North Dakota, was not required to collect a use tax levied by North Dakota from its North Dakota customers. The court ruled that the imposition of a duty to collect taxes did not violate the due process clause of the Fourteenth Amendment as Quill annually mailed 24 tons of catalogs and flyers into North Dakota and made annual sales approaching $1,000,000 to North Dakota customers. Notwithstanding its holding that the due process clause did not bar the imposition of the tax, the Supreme Court held that the “physical presence” test of National Bellas Hess, Inc. vs. Department of Revenue of the State of Illinois, 386 U.S. 753; 87 S. Ct. 1389; 18 L. Ed. 2d 505 (1967) should be followed on the basis of the Commerce Clause. Associated Electric & Gas Insurance Services, Ltd., 676 A. 2d 1357, 1360-1361.

In any case, the right to independently procure insurance is codified in Rhode Island Law as R.I. Ins. Code § 27-3-38.1.  If the theory of the Rhode Island Supreme Court decision in the Quill decision  were to be widely adopted, if not expanded,  the ability of unlicensed and unauthorized insurers to provide coverage for risks located within a state, with which they have no other contact without being subject to tax, could be largely diminished. Similarly, if the trend of decisions regarding state tax jurisdiction were followed with reference to taxes on insurance premiums without regard to Todd Shipyards or to the principles of Connecticut General Life and the other cases discussed above, the ability of a state to tax insurance transactions would be greatly expanded.

Industrial Insured Exemption

Another form of direct procurement transaction is the industrial insured exemption.  Broadly drafted industrial insured exemption statutes exist in less than one-third of the states (not including such key industrial states as Massachusetts, Michigan, Texas and Washington, among others).17  These exemptions are generally designed to permit sophisticated commercial insureds to procure insurance from a non-admitted insurer without the need to involve a surplus lines broker in seeking declinations from admitted carriers prior to placing the business.  The exemption is predicted on the alien (or other non-admitted) insurer refraining from doing business where it is not authorized to do so.  Alien insurers seeking to write business in states which have enacted the industrial insured exemption must otherwise abide by the rules restricting their activities.  In essence, the limitations imposed on non-admitted insurers by the direct procurement requirements also apply to industrial insured placements.  Industrial insured placements typically require that the insured:

1. Procure insurance by utilizing the services of either a full-time employee18  acting as an insurance manager or buyer or a regularly and continuously retained, qualified insurance consultant or risk manager;
2. Have an aggregate annual premium on all of its insurance totaling at least $25,000; and
3. Have at least 25 full-time employees.19

The rules prohibiting negotiation and delivery of a policy inside the state are less strict for industrial insured placements than they are for direct procurement placements.

Approximately 13 states allow the formation of industrial insured captives or industrial insured group captives or otherwise apply an industrial insured exemption to captives only.20

Finally, it is worthwhile noting that there is no prohibition on an eligible surplus lines insurer transacting business on a direct procurement (or industrial insured) basis as well, provided the strict rules as respects direct procurement business and/or industrial insured business are observed.

Enforceability of the Rules of Direct Procurement Outside the Insured’s Home State

As a practical matter, there would appear to be more of a risk for the New York broker in involving itself in direct procurement transactions (which generally presuppose the absence of a broker) than there is for the alien insurer which is not transacting U.S. surplus lines business. A New York broker’s license could be jeopardized if it were found to be violating New York law. With regard to an alien insurer which is not transacting U.S. surplus lines business, it would be difficult for insurance regulators to enforce the statute as against such a company, even if it is found to be violating New York law.21

Conclusion: Questions Arising From Nonadmitted and Reinsurance Reform Act 

As the NRRA takes center stage and marches toward its July 21, 2011 deadline for implementation by the fifty states, numerous questions surround the Act and perplex state legislators and insurance regulators.  Among those questions are the following:

1. Will the concept of an “exempt commercial purchaser” exception to the due diligence rule for placing business with non-admitted insurers pre-empt the “industrial insured exemptions” in states that have enacted them?
2. Will a state that did not adopt the “industrial insured exemption” now be obliged to abide by the “exempt commercial purchaser” exception to the due diligence rules for multistate surplus lines risks as set forth in the NRRA where that state is the “home state”? 
3. Will the approximately 14 states that have not (thus far) assessed a tax on independently procured insurance now be obliged to do so by reason of the NRRA’s pre-emption of regulation of non-admitted insurance?  Will all those states now codify the right of direct procurement?

Failure by the states to conform their insurance laws and regulations, in a uniform manner, to the mandates of the NRRA will likely result in legal challenges by private parties, state insurance regulators and insurance trade organizations. The most vexing problems may arise as various states enact different iterations of statutes, certain of which adopt some, or none, of the NRRA’s mandatory uniformity requirements in the areas of 1) taxation and allocation of taxes on premiums paid for policies covering multistate risks placed through surplus line producers or through direct procurement transactions, 2) declinations in advance of placements of risk by sophisticated commercial insureds based in states that have enacted an industrial insured exemption, and 3) broker licensing requirements.  In that case, some of the state laws will wind up being pre-empted by the NRRA and made totally irrelevant or subject to legal challenge.  In many states, brokers and/or insureds (the latter in direct procurement transactions) will have no clarity as to how to report and/or pay the taxes and may inadvertently end up in violation of state laws. 

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NOT IN MY BACKYARD: NAIC FILES AMICUS CURIAE BRIEF ARGUING FEDERAL COURT HAS NO PLACE IN INSURER LIQUIDATION PROCEEDINGS

Richard J. Fidei, Esq.
COLODNY, FASS, TALENFELD, KARLINSKY & ABATE, P.A.
(954) 492-4010

Fred E. Karlinsky, Esq.
COLODNY, FASS, TALENFELD, KARLINSKY & ABATE, P.A.
(954) 492-4010/(954) 332-1749

Every state within the United States has adopted a statutory scheme for the receivership and liquidation of insolvent insurance companies. In late 2010, the United States Department of Labor filed a complaint in a federal court seeking declaratory and injunctive relief with respect to the Department of Labor's rights and priority of payment owed under a federal workers' compensation law in an insurance company's pending state liquidation proceeding based upon theories including federal preemption of state law. One motion currently pending before the court is a motion to dismiss the federal court action filed by the New Hampshire Insurance Commissioner, as liquidator of the insolvent insurer, urging the federal court to abstain from considering the action based on an argument that issues related to insurer liquidation proceedings are a matter of state law, not federal law. The National Association of Insurance Commissioners filed an amicus curiae brief in this proceeding asserting that claims filed in insurer liquidation proceedings should be determined and prioritized in accordance with state insurer insolvency law.

I. Department of Labor's Complaint

The Home Insurance Company ("Home"), a New Hampshire domiciled property and casualty insurer, was declared insolvent and ordered into liquidation by the Superior Court of Merrimack County in 2003. In re Liquidation of the Home Ins. Co., No. 03-E-0106 (N.H. Sup. Ct. filed June 13, 2003). In June 2003, the Department of Labor ("DOL") filed its proof of claim, followed by amended proofs of claim in February and April 2005, with the New Hampshire Insurance Commissioner claiming $2,672,527 in unpaid assessments under the federal Longshore and Harbor Workers' Compensation Act ("LHWCA" or "Act") for the years 2000 through 2004. Subsequently, the liquidator issued a notice allowing the full amount of the claim and assigning the DOL's claim to priority Class III. The notice indicated that there would not be sufficient assets to make a distribution to creditors below Class II.

On December 9, 2010, the DOL filed a complaint in the United States District Court, District of New Hampshire arguing that its right to unpaid assessments under the LHWCA preempted New Hampshire's statutory liquidation scheme and the priorities set forth in the state law. U.S. Dept. of Labor v. the Home Ins. Co., No. 1:10-cv-572 (D.N.H. filed Dec. 9, 2010). Currently, any matters related to the DOL's proof of claim are stayed in the state court proceeding pending the outcome of the federal action.

A. Department of Labor's Claim Under the Longshore and Harbor Workers' Compensation Act

The DOL's claim is for unpaid assessments under the LHWCA, which is a federal workers' compensation program administered by the Office of Workers' Compensation Programs. The Act provides for compensation and medical care to employees disabled from injuries that occur on the navigable waters of the United States, or in adjoining areas used in loading, unloading, repairing, or building certain vessels.

The law applies to certain maritime workers, to employers who employ such workers "in whole or in part, upon the navigable waters of the United States," and to carriers authorized to provide the workers' compensation insurance required by the LHWCA. A "carrier" includes any person or fund authorized under 33 U.S.C. § 932 to insure under the Act. Employers are to secure payment of the compensation available under the LHWCA by contracting with an authorized insurance carrier or by obtaining authorization to self- insure. The DOL's complaint provides that Home was an authorized carrier under the LHWCA.

The benefits are paid directly by an authorized self-insured employer, by an authorized insurance carrier, or, in particular circumstances, by a special fund ("Special Fund") established in the Treasury of the United States in trust for injured workers and administered directly by the Division of Longshore and Harbor Workers' Compensation. The Special Fund is financed in part by the DOL's annual assessment of insurance carriers and self-insured employers according to a statutory formula. Carriers are required to pay these annual assessments in the amounts determined by the Secretary of the DOL. The DOL's complaint asserts that Home did not pay Special Fund annual assessments for the years at issue.

B. New Hampshire's Insurance Insolvency Laws

The New Hampshire insurance insolvency laws provide for a statutory framework regulating the rehabilitation and liquidation of insurers. This framework sets forth certain classes of claims of unsecured creditors and the order in which claims are to be paid in an insurer liquidation proceeding. Under New Hampshire law, Class I claims include costs and expenses of administration of the proceeding. Class II claims encompass policy related claims, which include guaranty associations and any other similar organizations in another state. Claims of the federal government are included in Class III. The law provides for other subordinate classes of claims and their priority of distribution.

C. The Department of Labor's Arguments

In its Complaint, the DOL argued that its claim under the LHWCA preempted the New Hampshire priority statute and is entitled to absolute priority. Essentially, the DOL reasoned that according to the Supremacy Clause of the United States Constitution, which provides that federal law is the supreme law of the land, the federal LHWCA preempts any state law with regard to the DOL's claim. Specifically, the DOL argued that the state law must yield to the federal law because it would be impossible for Home and the Liquidator to comply with the LHWCA if Class I and Class II claims were to be paid ahead of the DOL's claim. In addition, the DOL explained that the McCarran-Ferguson Act would not act to protect state laws from preemption because the LHWCA, an act of Congress, specifically relates to the business of insurance.

In the alternative, the DOL argued that its claim should be assigned to Class II because the Special Fund is similar to state guaranty associations, in that the Special Fund was established, in part, to pay claims of insolvent insurers. The DOL also argued, in the alternative, that its claim should be assigned to Class I because its claim represents a cost and expense of administration, such as the payment of federal taxes, which some courts have considered to be a cost and expense of administration.

II. New Hampshire Insurance Commissioner's Motion to Dismiss

On February 11, 2011, the New Hampshire Insurance Commissioner, Roger A Sevigny, as liquidator of Home, filed a motion dismiss the DOL's complaint in the federal court. Generally, the motion raised several abstention arguments and alleged that the DOL was forum shopping because its claim was assigned a lower priority in the state court. The Commissioner argued that the federal court should abstain from considering the action (1) under the principle that the court first assuming jurisdiction over property may maintain and exercise that jurisdiction to the exclusion of the other in accordance with United States v. Bank of New York & Trust Co., 296 U.S. 463 (1936), (2) in light of the discretion to avoid duplicate proceedings under Wilton v. Seven Falls Co., 515 U.S. 277 (1995) (related to Colo. River Water Conserv. Dist. v. United States, 424 U.S. 800 (1976)), and (3) in light of the principles of federalism and comity of Younger v. Harris, 401 U.S. 37 (1971).

As noted, the first argument made by the Commissioner relies upon Bank of New York, a case very similar to the one at hand. In Bank of New York, a federal district court dismissed suits brought by the United States seeking an accounting of assets held under order of the New York state courts. In each of these cases, the state proceedings had started as liquidations in which the New York Superintendent had been appointed as liquidator of insolvent U.S. branches of foreign insurers.

In Bank of New York, the United States Supreme Court affirmed the decrees of the district court based on a determination that the federal court interfered with the state court's in rem jurisdiction and rejected the position that the United States was entitled to a federal forum. The Court explained that the federal court's action sought to take property from the control of the state court and to vest the property in the United States to the exclusion of all other claimants, thereby interfering with the previously exercised court jurisdiction. In addition, the Court indicated that "[t]he fact that the complainant [in the federal court] is the United States does not justify a departure from the rule which would otherwise be applicable. . . . [T]he United States is free to invoke the jurisdiction of the state court for the determination of its claim, and the decision of the state court of any federal question which may be presented upon such an invocation, may be reviewed by this court, and thus all the questions which the government seeks to raise in these suits may be appropriately and finally decided."

Furthermore, the Commissioner argued in his motion that banking institutions and insurance companies are excluded from liquidation under the bankruptcy laws because they are bodies for which alternative provision is made for their liquidation, a principle which should apply equally to Home's liquidation proceeding. In addition, the Commissioner contended that the McCarran-Ferguson Act reflects federal policy to leave insurance matters to the states unless Congress has specifically provided otherwise. The Commissioner's motion to dismiss indicated that state insurer liquidation proceedings are included within such a purpose because states have traditionally been the preeminent regulators of insurance.

III. National Association of Insurance Commissioners' Amicus Curiae Brief

On March 16, 2011, the National Association of Insurance Commissioners ("NAIC") filed an amicus curiae brief in the pending federal court action urging the court to abstain from hearing the merits of the case. Essentially, the NAIC's brief re-alleges the New Hampshire Insurance Commissioner's motion to dismiss the federal court action, but provides further guidance with regard to a state's effective administration of the liquidation of insurers.

In summary, the NAIC argued that the federal court should abstain from hearing the complaint filed by the DOL because state liquidation proceedings are the exclusive jurisdiction and forum for resolving disputes related to the liquidation of an insolvent insurer, especially with respect to the priority of distribution of assets. A state court's exclusivity with regard to insurer receivership is a long-standing principle that contributes to the efficiency of estate administration and the strength of state-based insurance regulation.

The NAIC's brief discusses its Insolvency Models, which provide, among others, for the priority of distribution of claims in an insurer liquidation proceeding. Many of the states have adopted some version of the NAIC's Insolvency Models. The NAIC indicated that the New Hampshire liquidation chapter is taken directly from a series of NAIC Insolvency Models dating back to the original version adopted in 1969.

As explained in the NAIC's brief, the commentary to the Models illustrates the historical significance of regulatory and judicial attempts to fashion a comprehensive, equitable, and efficient system to handle insurer insolvencies at the state level. As a result, it would be impractical for a court to interfere on an issue so central to an insurer liquidation as the application of the priority of distribution of assets. If a federal court were not to abstain, but rather hear the merits of the DOL's complaint, the NAIC emphasized that this would introduce uncertainty into determinations properly before a liquidator.

The NAIC discussed another significant factor in that state insolvency laws are tied to the NAIC's Financial Regulation Standards and Accreditation Program. This Program promotes interstate reliance and ultimately saves money in duplicative examination costs. According to the NAIC's brief, fifty-one jurisdictions, including New Hampshire, are accredited under this Program. Should the federal court hear the DOL's complaint, it would call into question the stability and uniformity of New Hampshire's receivership scheme that the accreditation standard requires. In addition, should the federal court decide to entertain the case, it could affect the interpretation and application of the NAIC Insolvency Models and other state insolvency statutes because all states have adopted some version of the NAIC Insolvency Models. Courts have looked to other state courts for assistance in interpreting similar statutory provisions based onthe models. Essentially, this one federal case could cast doubt on the entire statutory scheme of insolvency and the web of interstate reliance fostered through the accreditation program.

IV. Conclusion

As of the date of this article, no decision has been made regarding whether the federal court will abstain from considering the case and defer jurisdiction to the state court. The potential effects of the federal court's decision are numerous and widespread. A decision to hear the merits of the case and determine claim priorities in a manner inconsistent with state law could raise serious concerns with state statutory liquidation schemes. In addition, a decision to hear the merits of the case in a federal court could create jurisdictional issues with regard to the proper forum to resolve disputes in an insurer liquidation proceeding. As is common, the legal ramifications of a seemingly isolated issue have the potential to create an environment of uncertainty.

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THE FEDERAL INSURANCE OFFICE

William J. Toman, Esq.
QUARLES & BRADY LLP
(608) 283-2434

The history of the federal role in the regulation of insurance is a story of fits and starts.  Presumably, there would have been no such story, and the federal government would have assumed a primary regulatory role (as it did in other areas of financial services), but for the historical anomaly of the Supreme Court declaring that insurance was not interstate commerce.  From that point until the Court reversed itself 75 years later, the states established a regulatory framework that would be difficult to displace.  That difficulty was first evidenced by the quick passage of the McCarran-Ferguson Act to restore the primacy of the states when the Supreme Court dumped insurance regulation in the lap of Congress.

When Congress first decided to take on some insurance issues in a major way with ERISA in 1974, it still left the regulation of insurance to the states with a complex system of preemption, saving, and deemer clauses.  With HIPAA in 1996, Congress enacted mandates for health insurance, but the federal government never made a serious effort to enforce those mandates, again leaving it to the states to monitor compliance via mini-HIPAA laws.  The Gramm-Leach-Bliley Act in 1999 brought federal recognition of insurance as one of the major sectors of the financial services industry, but the functional oversight system again left regulation to the states.  The health care reform law passed last year includes additional health insurance mandates, again with a preference for state enforcement, along with health insurance exchanges that the states have the first opportunity to create; the main federal obligation is to enforce the requirement for the purchase of health insurance, which is done through the IRS. 

During this period there were occasional calls for a complete federal takeover of insurance regulation, as well as for lesser federal forays into regulation such as the optional federal charter for certain insurers.  These calls resurfaced as the economic crisis deepened in 2008, especially with the prominent role played by AIG; but, in the end, the massive revision of the laws regulating financial services in the Dodd-Frank Act continued the tepid federal incursion into insurance:  Dodd-Frank only created a noncontroversial, uniform national approach to the regulation and taxation of non-admitted insurance and the regulation of credit for reinsurance and reinsurer solvency, and a Federal Insurance Office

The Office is part of the Treasury Department, and is headed by a Director appointed by the Treasury Secretary.1  The Secretary has named Illinois Insurance Director Michael McRaith to be the first Director of the Office, with his term beginning this June.  The Office has three basic functions:

• Monitor and report on the U.S. insurance industry, and consult with state regulators on national and international insurance matters.2
• Provide input on the insurance industry to the Financial Stability Oversight Council, the new systemic regulation body established by Dodd-Frank.3
• Coordinate federal efforts on international prudential insurance regulation, including determining whether any state laws are preempted by international agreements in that area.4

Generally, these functions apply only to lines of insurance other than health insurance (which, of course, is covered by the massive health care reform bill), long-term care insurance, and federal crop insurance.5

On May 9, 2011, Treasury announced that it was taking applications for membership on a new Federal Advisory Committee on Insurance to advise the Office and Treasury on insurance matters.  According to the announcement, “Recognizing the important role of state insurance regulators, half of the Committee’s membership [of up to 15 persons] has been reserved for state and tribal insurance regulators.  The remaining members of the Committee will represent a diverse range of perspectives from, for example, the property and casualty insurance industry, the life insurance industry, the reinsurance industry, the agent and broker community, public advocates, and academia.”

Monitor, Report, and Consult 

One charge given to the Office is “to monitor all aspects of the insurance industry,”6 with a specific mention given to monitoring the “extent to which traditionally underserved communities and consumers, minorities …, and low- and moderate-income persons have access to affordable insurance products regarding all lines of insurance.”7  In performing its functions, the Office “may require an insurer, or any affiliate of an insurer, to submit such data or information as the Office may reasonably require,”8 including by use of a subpoena.9  However, this authority does not extend to a small insurer as defined by the Office.10  In addition, this authority does not apply if the information is already available from state or federal regulators or public sources.11 

Presumably, the information obtained by the Office will allow it to fulfill its function of advising Treasury “on major domestic and prudential international insurance policy issues,”12 and assisting Treasury with managing the Terrorism Risk Insurance Program.13  The Office’s information gathering authority will also allow it to prepare the many reports it is obligated to provide: 

• An annual report to the President and Congress on the insurance industry is due by September 30, beginning this year.14
• A report to Congress on the “breadth and scope of the global reinsurance market and the critical role such market plays in supporting insurance in the United States” is due by September 30, 2012.15  Three months later, the Office must report to Congress on the impact of the Dodd-Frank Act provisions regarding the regulation of credit for reinsurance and reinsurer solvency on the ability of states to access reinsurance information for their domestic insurers.16  This report must be updated by January 1, 2015.
• A report to Congress on “how to modernize and improve the system of insurance regulation in the United States,” including recommendations, is due by January 21, 2012.17  This report must deal with several issues involving federal regulation of insurance, including the costs and benefits, the feasibility of dual authority with the states, the ability of federal regulation to “eliminate or minimize regulatory arbitrage,” the impact of insurance regulation outside the U.S., and the ability of a federal regulator “to provide robust consumer protection.”18

Finally, the Office will consult with the states and state regulators (1) “regarding insurance matters of national importance and prudential insurance matters of international importance,”19 and, (2) to the extent the Director deems it to be appropriate, regarding implementation of all functions of the Office.20   Just to make it clear, Dodd-Frank states that the Office does not have “general supervisory or regulatory authority over the business of insurance.”21

Systemic Regulation 

The Director serves in an advisory capacity as one of three insurance representatives on the Financial Stability Oversight Council.22  According to Treasury, “The Council is charged with identifying threats to the financial stability of the United States; promoting market discipline; and responding to emerging risks to the stability of the United States financial system.”23  To date, the Council’s main activity has been drafting rules, which are mainly focused on banks and other non-insurance financial institutions; of course, these rules could eventually include or affect insurers.

One of the Council’s high-profile obligations is to end the concept of an institution that is “too big to fail” by designating nonbank financial companies as requiring consolidated supervision.  The Office has authority to recommend to the Council that it so designate an insurer or its affiliates.24  Finally, one of the purposes of the Office’s obligation to monitor the insurance industry is to identify “issues or gaps in the regulation of insurers that could contribute to a systemic crisis in the insurance industry or the United States financial system.”25

International Prudential Insurance Regulation 

The Office is authorized “to coordinate Federal efforts and develop Federal policy on prudential aspects of international insurance matters.”26  While “prudential” is not defined here, one of the examples of what is included in this authority is “assisting the [Treasury] Secretary in negotiating covered agreements.”27  A “covered agreement” is an agreement between the United States and one or more foreign governments or regulators that “relates to the recognition of prudential measures with respect to the business of insurance or reinsurance that achieves a level of protection for insurance or reinsurance consumers that is substantially equivalent to the level of protection achieved under State insurance or reinsurance regulation.”28  While this definition leaves “prudential” undefined, it tells us that these prudential “aspects” or “measures” must provide at least the level of protection for consumers that is achieved under regulation by the states in the U.S.

Presumably, we can obtain guidance on the meaning of “prudential” from the “prudential standards” that Dodd-Frank requires the Fed to develop for nonbank financial companies that the Council designates as requiring consolidated supervision.  Those standards must include: 

• risk-based capital requirements and leverage limits;
• liquidity requirements;
• overall risk management requirements;
• resolution plan and credit exposure report requirements; and
• concentration limits.29

These prudential standards may also include contingent capital requirements, enhanced public disclosures, and short-term debt limits.30 

The meaning of “prudential measures with respect to the business of insurance” in the definition of covered agreements is not clear, but it bears on one of the most controversial powers of the Federal Insurance Office, that is, the authority “to determine … whether State insurance measures are preempted by covered agreements.”31  To preempt a state insurance measure, the Director must determine that the measure (1) results in less favorable treatment of a non-U.S. insurer that is subject to a covered agreement than a U.S. insurer would receive, and (2) is inconsistent with a covered agreement.32  Moreover, the Director may not preempt a state law that:

• governs an insurer’s rates, premiums, underwriting, or sales practices;
• imposes coverage requirements for insurance; or
• applies an antitrust law to the business of insurance.33

Finally, the Office must submit an annual report to the President and Congress on any actions it takes under its preemption authority.34

Conclusion 

The Federal Insurance Office is one of a long line of federal incursions into the business of insurance, but it is the first one to establish a bureau dedicated to that business.  It remains to be seen how the Office will use its existing authority, and how its authority might be expanded in the future.  However, the Office certainly could provide the foundation for a greater or even exclusive role for the federal government in the regulation of insurance.

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