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FOCUS Fall 2006 on the Insurance Industry A quarterly publication of the Foley & Lardner LLP Insurance Industry Team The Financial Accounting Standards Board In this issue… Proposes Bifurcation of Insurance Contracts By Wm. Carlisle Herbert The Financial Standards Accounting Board (FASB) recently invited Page 1 The Financial Accounting Standards public comments on a proposal to bifurcate many insurance and Board Proposes Bifurcation of reinsurance contracts for financial reporting purposes.i Under the Insurance Contracts FASB proposal, certain insurance and reinsurance contracts would Page 2 Regulators Consider New Rating be divided into an “insurance” component and a financing component called a “deposit.” Approach to Reinsurance Collateral Requirements While the FASB says it has not reached even a tentative conclusion on this proposal, it has solicited comments because some have suggested Page 3 Foley Sponsors Conference on Business that bifurcation would provide users of financial statements with better Method Patents for the Financial information about the economic substance of insurance arrangements. Services Industry Under current accounting practice, a contract is treated as a whole either as insurance or as a deposit depending on whether the contract transfers a significant insurance risk. Under Page 4 NAIC Amends Reinsurance Intermediary the bifurcation proposal, a contract would be bifurcated where the contract may be divided Model Act to Require Compliance With into a component reflecting claims payments that are likely to occur and a component reflecting Discovery Orders claims payments that are possible but not likely to occur. The former component would be treated as a deposit made to fund the expected claims payments, and the latter would be Page 5 Florida Creates Joint Underwriting treated as insurance. Association for Commercial Property Insurance Under the FASB proposal, several kinds of contracts would be excluded from bifurcation. These would include contracts such as loans that do not meet a specific definition of “insurance Page 6 Proposed Federal Regulation: A Bird’s contract.” Generally Accepted Accounting Principles (GAAP) currently do not define an insurance Eye View of the Battle contract, and part of the current FASB project is to collect comments on a proper definition. A second kind of excluded contract would be the “unequivocal insurance contract,” one that has Page 8 Announcements “negligible noninsurance features.” A typical contract of this kind would be a single-risk contract (e.g., single life, single asset or single event), where the premium is appropriately low, the contract has no risk-limiting features and the contract is not likely to produce in any claims during Foley has expanded the Insurance Practice Group to its term. This type of contract would be treated entirely as insurance. create our cross-departmental Insurance Industry A third kind of excluded contract would be the contract that does not transfer “significant insurance risk.” A contract that did not transfer significant risk would be treated entirely as a Team, chaired by Kevin G. Fitzgerald. The team deposit. For identifying such a contract, the FASB proposes to incorporate the guidance provided counsels clients in the following areas: mergers by GAAP (Statement 113) to determine whether a reinsurance contract transfers significant insurance risk. The FASB has invited comments specifically on whether it would be appropriate to and acquisitions/transactional, regulatory, insurance apply the Statement 113 guidance to insurance contracts as well as reinsurance contracts. taxation, financial products, reinsurance The FASB has suggested that bifurcation might be limited to those kinds of insurance contracts that have been described as “finite risk arrangements.” Under this approach, a fourth exclusion transactions and dispute resolution, insurance would preserve for bifurcation only contracts that meet tests designed to identify these specific dispute resolution, insolvency/guaranty fund, arrangements. The tests would look for risk-limiting terms or features in a contract, such as a matching of anticipated income and disbursements or provisions for profit or loss sharing distribution, captives, and public affairs. between insurer and insured, that produce “a significant financing component or an insignificant insurance component.” To subscribe to Focus, please send an e-mail to Alternatively, the FASB has suggested that bifurcation might be employed for all contracts Foley&LardnerInsuranceIndustryGroup@foley.com remaining after the first three exclusions have been applied. This approach would be designed to provide “consistent accounting across all remaining insurance and reinsurance contracts or visit us on the Web at Foley.com/insurance. regardless of the form, products, or features included in the contract.” The FASB has described three possible methods for bifurcating contracts. One, called the “expected payout method,” would identify a level of likely claims payments for a contract and FOCUS on the Insurance Industry Fall 2006 2 would treat a portion of the premiums paid under the contract as a Regulators Consider financing of these expected payments. This approach has also been described as a “dollar-trading method” of identifying the New Rating deposit component of insurance and reinsurance contracts. Approach A second method, the “proportional method,” would determine what portion of the entire risk addressed by a contract has been to Reinsurance retained by the policyholder. The ratio of the retained risk to the Collateral entire risk would then be applied to the contract’s cash flows to determine the deposit component of the contract. Requirements A third method, the “cash flow yield method,” would undertake to By Brian S. Kass identify a portion of an insurance contract’s cash flows that After years of discussion, the National Association of Insurance provides a return equivalent to the interest rate on a loan. This Commissioners (NAIC) has moved one step closer to a substantial portion would be treated as financing, while cash flows in excess revision of collateral requirements for reinsurers. In a move that of the interest rate would be treated as insurance. The FASB has caught many by surprise, regulators at the NAIC Summer Meeting specifically noted that more research is necessary to determine took measures to advance a new, rating-based proposal designed to the feasibility of this approach. ease collateral requirements for non-U.S. reinsurers. Unlike existing The FASB has acknowledged that there is a wide divergence of collateral rules, the NAIC proposal calls for collateral obligations to opinion on many aspects of the bifurcation proposal. While be tied to a reinsurer’s financial strength and would apply to all advocates of bifurcation believe that the user of a financial reinsurers, regardless of their licensing or accreditation status. statement “would be able to determine better the risk that a Current Collateral Requirements company bears and its strategy to limit that risk,” some opponents believe that insurance contracts are “essentially indivisible,” and Current reinsurer collateral requirements are imposed under some believe that bifurcation would not permit readers of financial state credit for reinsurance regulations. Generally speaking, these statements to evaluate “what the bifurcated components imply regulations require U.S. insurers to obtain acceptable forms of about future cash flows.” collateral from non-licensed or non-accredited reinsurers in order to take financial statement credit for reinsurance ceded to these The FASB proposal leaves many questions unanswered. For reinsurers. In these situations, credit for reinsurance is permitted example, the proposal suggests that group contracts, such as only in an amount equal to collateral posted by the reinsurer. group health or life insurance, would be bifurcated because a Conversely, ceding companies that cede risks to reinsurers that portion of the premium for such contracts compensates the are licensed or accredited in the ceding company’s state of insurer for the likely payment of expected claim losses. A portfolio domicile are permitted to take full financial statement credit of “unequivocal insurance contracts,” on the other hand, would be without obtaining any collateral from the reinsurer. In other words, treated entirely as insurance even though a portion of the premium existing regulations focus exclusively on a reinsurer’s licensing or received on the portfolio as a whole similarly compensates the accreditation status with no consideration given to the reinsurer’s insurer for the payment of expected claim losses. For the purpose financial strength or stability. of evaluating the financial condition of the insurer as a whole, it is not clear why a group contract and a portfolio of individual Proposed Collateral Requirements contracts should produce such disparate accounting results. The collateral requirements contemplated under the NAIC The FASB has noted that the International Accounting Standards proposal take the opposite approach and focus on the Board (IASB) is planning in the near future to solicit comments financial strength of a reinsurer rather than its licensing or on a paper containing its own tentative decisions on the accreditation status. These requirements would apply to accounting treatment of insurance contracts. The FASB has domestic and non-domestic reinsurers alike. stated that it will decide whether to join the IASB in a project to Under the proposal, procedures would be established for develop a comprehensive standard for such accounting after evaluating the credit risk of reinsurers through a rating-based receiving comments from its own constituents on the IASB system. Reinsurers placed into the highest rating category would paper. The IASB has reported that its paper will likely be be exempt from posting any collateral whereas reinsurers falling published near the end of 2006. into the lowest rating category would be required to secure 75% of their liabilities. Reinsurers that do not receive a rating would be i Financial Accounting Standards Board, Invitation to Comment, Bifurcation of Insurance and required to secure their obligations in order for U.S. ceding Reinsurance Contracts for Financial Reporting, Financial Accounting Series No. 1325-100 (May companies to take financial statement credit. 26, 2006) (the FASB requested that comments be submitted by August 24, 2006). The proposal calls for the NAIC Reinsurance Task Force (or its successor) to have primary jurisdiction to implement the rating FOCUS on the Insurance Industry Fall 2006 3 process. The Task Force would also be responsible for two Foley Sponsors important semi-annual assessments that would serve in part to determine a reinsurer’s rating. First, the Task Force would be Conference on responsible for publishing a list of those countries and states that they view as adequately regulating domestic reinsurers. Reinsurers Business Method domiciled in those jurisdictions identified as adequately regulating Patents for the reinsurers could potentially receive a higher rating than a similarly Financial Services situated reinsurer domiciled in a jurisdiction that does not make the list. Second, the Task Force would publish a list of those reinsurers Industry who, in its judgment, fail to engage in the prompt settlement of undisputed reinsurance claims. Reinsurers appearing on this By David G. Luettgen “slow-pay” list would automatically drop one rating category. For the third year in a row, Foley was the leading sponsor of the A reinsurer’s rating would be determined based on its Standard & annual conference on Patenting Business Methods in the Financial Poor’s rating or an equivalent rating from another nationally Services Industry, which was held July 25-27 in New York City. recognized rating organization. This rating would then be subject The conference this year explored what leading companies in the to adjustment depending on whether a reinsurer appears on the financial services industry are doing to build their defensive patent “slow-pay” list or is domiciled in a recognized regulatory jurisdiction. portfolios, protect their business method processes, gain freedom The proposal calls for the new collateral requirements to be to operate and, ultimately, develop a competitive edge. It also imposed on a prospective basis (i.e., only to reinsurance contracts explored the steps a few innovative companies have taken to that incept after the rules become effective). The proposal also monetize and leverage their IP assets. The conference featured addresses the consequences of a change in or revocation of a speakers from insurance companies, including Swiss Re and reinsurer’s rating after a reinsurance agreement goes into effect. Nationwide Mutual Insurance Company, as well as speakers from other financial services companies such as American Express, Industry Reaction to Collateral Proposal Citigroup Global Investment Bank, Goldman Sachs & Co., Fannie The collateral proposal has received strong, mixed reactions within Mae and Lehman Brothers. the insurance industry. Proponents of the proposed collateral Insurance Companies have been increasingly active in building requirements assert that the new rules will eliminate unnecessary their intellectual property portfolios. Currently, there are about 270 costs and disincentives for non-domestic reinsurers to write U.S. issued patents which the U.S. Patent Office classifies as insurance business by eliminating collateral requirements where they are not patents. This number is up dramatically from ten years ago, when reasonably required. They also claim that the new rules are there were fewer than 50 such patents. All signs are that this trend necessary to ensure that U.S. credit-for-reinsurance requirements is likely to continue. There are currently about 735 published patent are consistent with developments in international reinsurance applications relating to insurance, and an unknown additional number standards. Not surprisingly, most non-U.S. reinsurers favor the of unpublished patent applications. Because publication is optional, proposed ratings approach, which they view as leveling the playing the total number of pending patent applications related to insurance field with their U.S. competitors. is unknown. It is estimated, however, that the number of pending Most insurers and reinsurers based in the U.S., on the other hand, insurance-related patent applications is between 3,000 and 5,000. have opposed the proposed rules. Some claim the collateral It can take several years or more for a patent application to wend its proposal would undermine the financial security of U.S. ceding way through the process at the Patent Office and issue as a patent. companies and diminish the incentive of non-U.S. reinsurers to As the number of insurance patents grows, so too does the amount become licensed in the U.S. Others assert that the new collateral of patent litigation over insurance patents. Earlier this month, requirements would put U.S. reinsurers at a disadvantage because Transamerica Life Insurance Company and Lincoln National Life they would be required to comply with the collateral obligations at Insurance Company became embroiled in patent litigation over U.S. the same time they are subject to U.S. licensing requirements. Pat. No. 7,089,201. The patent, which issued to Lincoln National on Opponents favor maintaining the current collateral requirements or August 8, relates to a method of administering an annuity product. exploring different alternatives. Insurance companies also need to be careful to avoid overstepping At this time, the new collateral requirements remain in the proposal other types of intellectual property. In 2002, Hartford Insurance stage. The NAIC’s leadership, however, has requested that a formal settled a trade secret claim with Bancorp Services for $118 million. proposal be presented to the membership by the winter quarterly meeting. Given the strong opinions voiced on both sides of this Foley’s intellectual property department has been a long-term player issue, the collateral proposal is certain to be the subject of lively in advising companies on business method patents and other discussion at the NAIC Fall Meeting. intellectual property issues that are of major concern to insurance companies. Foley drafted the brief for the software industry in the seminal State Street Bank case in 1998. The judicial stamp of FOCUS on the Insurance Industry Fall 2006 4 approval given to business method patents in State Street Bank is document, or paper which may be deemed material as evidence widely seen as triggering the current flood of business method in the case.”5 Courts are split on the meaning of this provision. patent filings by insurance companies and others. Some hold that it authorizes arbitrators to order discovery from third parties.6 Others have ruled that it affords no pre-hearing discovery from third parties.7 A number of courts have staked out interpretations between the two extremes.8 NAIC Amends If an intermediary refuses to cooperate and cannot be Reinsurance compelled to participate in pre-hearing discovery, the result can be a lack of proof to establish or rebut, among other Intermediary elements, a misrepresentation at placement, an interpretation Model Act to of a critical contract provision, or a definition of a key term. Several solutions have been suggested to deal with the problem Require of the non-compliant reinsurance intermediary. These include Compliance With amending the FAA,9 seeking to compel intermediaries to participate in discovery based upon an argument that they Discovery Orders are third-party beneficiaries of the reinsurance contract,10 and requiring intermediaries to sign on as a party to the contract.11 By Eric L. Maassen and These proposed solutions today remain largely untested. Linda M. Annoye The NAIC recently implemented its own solution by adding the The National Association of Insurance following provision to the Model Act:12 Commissioners (NAIC) in June Section 11: Compliance with Orders adopted an amendment to the A. A RB or RM shall comply with any order of a court of Reinsurance Intermediary Model Act competent jurisdiction or a duly constituted arbitration (the Model Act) that would require panel requiring the production of non-privileged documents intermediaries to participate in pre- by the RB or RM, or the testimony of an employee or other hearing discovery if ordered to do so.1 individual otherwise under the control of the RB or RM with If adopted in several key states, the respect to any reinsurance transaction for which it acted as amendment could serve as a tool for gaining access to crucial a RB or RM. evidence in reinsurance arbitrations. B. Compliance shall be subject to the right of the RB or RM, Intermediaries are instrumental participants in many reinsurance and the parties to the reinsurance transaction, to object transactions and relationships. A reinsurance broker (RB), among to the court or arbitration panel concerning the nature or other functions, typically sets up a reinsurance program and scope of the documents or testimony or the time within then solicits, negotiates, and places the reinsurance cessions or which it must comply with the order. Failure to comply with retrocessions.2 Reinsurance managers (RM), for their part, generally the order shall be deemed to be a material non-compliance have authority to bind and manage the reinsurer’s assumed with this Act. However, in no event shall this section be reinsurance business.3 Intermediaries also frequently serve premium construed to require more than one appearance by the and claims processing and reporting functions. Intermediaries thus same witness in a single action or arbitration. are often important witnesses in reinsurance dispute proceedings, particularly in cases where a reinsurer seeks to rescind a contract Section 11 concededly is a mere model act; as such, it has no of reinsurance based on some alleged misrepresentation by the independent force or effect. But most states have laws similar to ceding company through its broker. Intermediaries also frequently the Model Act which govern the licensure and discipline of maintain documentary evidence of pre-contractual representations intermediaries.13 Although no state has yet adopted the new and understandings and contractual documentation. Section 11, insurance consultant, arbitrator and mediator Robert Hall, who participated in the negotiations that led to Section 11, Recent anecdotal evidence suggests that intermediaries are, with notes in a recent report on the amendment of the Model Act, increasing frequency, refusing to comply voluntarily with requests “several prominent states have indicated an interest in adopting the for documents and testimony in reinsurance disputes.4 The refusal amendments …”14 If Section 11 becomes law in a few key states, of intermediaries to participate voluntarily is chiefly a problem in it could go a long way toward solving the current rash of problems private arbitrations. Whereas courts have broad powers to require caused by uncooperative intermediaries. third parties to give evidence pursuant to subpoena, arbitration panels have only limited subpoena powers. Under the Federal Arbitration Act (FAA), “[t]he arbitrators … may summon in writing 1 Robert M. Hall, Discovery from Intermediaries: Interim Report on Developments in any person to attend before them or any of them as a witness and Regulation and Case Law, ARIAS U.S., Second Quarter 2006, at 3; in a proper case to bring with him or them any book, record, http://www.naic.org/committees_models.htm. 2 Reinsurance Intermediary Model Act § 790-1(2)(F) (NAIC 2004). FOCUS on the Insurance Industry Fall 2006 5 3 Reinsurance Intermediary Model Act § 790-1(2)(G) (NAIC 2004). property risks. 4 Hall, supra note 1, at 2; Michele L. Jacobson, Robert Lewin, Royce F. Cohen & Andrew S. Lewner, Commentary, Obtaining Discovery From Reinsurance Intermediaries and Other For individual risks, the “initial” policy limits will be $1 million or Non-Parties – Updated Case Law and Commentary, Mealey’s Litigation Report: less, with a 5% deductible. The Board of Governors may, subject Reinsurance, Nov. 17, 2005, at 1. to the approval of the Office of Insurance Regulation (OIR), amend 5 9 U.S.C. § 7. its plan of operation to change the limits or deductibles. 6 See, e.g., In re Sec. Life Ins. Co. of Am., 228 F.3d 865, 870-71 (8th Cir. 2000) (holding The rule creating the PCJUA does not elaborate on how that arbitration panel had the power to order non-party to produce documents prior to the hearing); Am. Fed’n of Television & Radio Artists, AFL-CIO v. WJBK-TV (New World reinsurance might be structured. Early drafts of the rule allowed Commc’ns of Detroit, Inc.), 164 F.3d 1004, 1009 (6th Cir. 1999) (stating that FAA’s only for excess-of-loss reinsurance contracts. The more general provision authorizing an arbitrator to compel production of documents from third parties language in the rule as adopted may indicate an intent to offer for an arbitration hearing has been held to implicitly include the authority to compel other kinds of reinsurance, such as quota share arrangements. production of documents prior to the hearing). 7 While there is express statutory authority for direct insurance, the See, e.g., Hay Group, Inc. v. E.B.S. Acquisition Corp., 360 F.3d 404, 406-11 (3d Cir. statute authorizing creation of the PCJUA does not explicitly either 2004) (holding that the FAA does not authorize an arbitration panel to issue pre-hearing discovery subpoena to a non-party). authorize or prohibit the writing of reinsurance. The Reinsurance 8 See, e.g., COMSAT Corp. v. Nat’l Sci. Found., 190 F.3d 269, 275-76, 278 (4th Cir. 1999) Association of America has stated that, in its view, the PCJUA has (holding that the FAA does not authorize an arbitrator to subpoena third parties during pre- no statutory authority to write reinsurance and that it would also hearing discovery, absent a showing of special need or hardship); Integrity Ins. Co., in have no authority to provide excess coverage on an individual Liquidation, v. Am. Centennial Ins. Co., 885 F. Supp. 69, 73 (S.D.N.Y. 1995) (allowing pre- basis if the excess coverage is provided in a manner that hearing document production but not depositions). constitutes a form of reinsurance.4 9 Robert M. Hall, Intermediaries and Discovery in Reinsurance Arbitrations, Mealey’s Litigation Report: Reinsurance, Dec. 2, 2002; Jacobson et al., supra note 4, at 12. Eligibility 10 Jacobson et al., supra note 4, at 10-11. A risk is eligible for PCJUA coverage only if the applicant has been unable to obtain an adequate level of coverage after a diligent 11 Id. at 12-13; Hall, supra note 9. 12 Reinsurance Intermediary Model Act § 790 (NAIC, Draft Dec. 3, 2005); Hall, supra note 1, search, including good faith applications to at least three admitted at 1. 13 insurers and one surplus lines insurer and a search through the Hall, supra note 1, at 2. 14 Florida Market Assistance Plan. An applicant will not be disqualified Id. at 3. for PCJUA coverage, however, by any offer of coverage for a premium cost higher than a specified level. For an offer from an admitted insurer, the level is the insurer’s filed rate or the PCJUA premium, whichever is greater, and, for a surplus lines insurer, the Florida Creates level is 125% of the PCJUA premium. Joint Underwriting The emergency rule offers no guidance on eligibility for excess Association for coverage or reinsurance. Commercial Rates, Forms, and Underwriting Rules The rates may be used only after they are approved by OIR. Property Insurance PCJUA rates must be actuarially sound and otherwise in compliance with the Rating Law. There is no requirement, By Leonard Schulte however, either in the PCJUA statute or in the rule, that prevents In recent months, many Florida businesses have been unable PCJUA rates from being competitive with the voluntary market. to obtain property insurance coverage or have been able to There is no indication in the rule of what means the PCJUA will obtain coverage only with lower limits, increased deductibles use to price reinsurance coverage, nor is there any established or significantly higher premiums.1 On August 15, 2006, the methodology under which OIR will review reinsurance rates. Florida Governor and Cabinet, sitting as the Financial Services The PCJUA must file forms and underwriting rules, which are Commission, responded by creating a residual market entity for subject to prior approval by OIR. commercial property insurance, the Property and Casualty Joint Underwriting Association (PCJUA).2 Assessments The PCJUA will operate under a 13-member Board of Governors All insurers writing commercial property coverage will be subject to appointed by the State Chief Financial Officer, including four assessments to fund PCJUA deficits in proportion to their market members representing insurance trade associations and two shares. Assessments are levied by OIR upon a request from the members representing insurance agents. PCJUA. Premiums for residential coverage and liability coverage will not be included in the assessment base. Coverage Provided The aggregate amount of an assessment with respect to a The PCJUA will write commercial property insurance covering particular year’s deficit may not exceed 10% of that year’s non-residential risks.3 The coverage may include direct insurance, aggregate voluntary market net direct premium for commercial excess coverage for individual risks, or reinsurance for commercial FOCUS on the Insurance Industry Fall 2006 6 property insurance. If the 10% assessment is not sufficient to cover the deficit, the PCJUA may issue bonds backed by further annual Proposed Federal assessments until the bonds are retired. The aggregate amount of Regulation: A these further assessments is capped at 10% of the prior year’s aggregate voluntary market net direct premium for commercial Bird’s Eye View of property insurance or 10% of the deficit, whichever is greater. the Battle The rule also gives the PCJUA the authority to request assessments to fund its start-up. No caps are specified for By Ethan D. Lenz and the startup assessments. Joseph J. Lotus An insurer subject to assessment may recoup assessments from The current state-based insurance its policyholders under Florida Statutes Section 627.3512. That regulatory system is being challenged provision authorizes an insurer to apply a uniform percentage factor by the National Insurance Act of to the premiums of all of its policyholders for the lines of business 2006 (NIA), which, if passed, would subject to assessment. The insurer then must make a recoupment create a uniform federal system of filing with OIR at least 15 days prior to applying the recoupment regulation for insurers and insurance factor. OIR’s review of the recoupment filing is limited to verification producers. The NIA attempts to of the insurer’s arithmetic calculations. address the claims of some life Startup insurers and some property and casualty insurers that the current The Governor and Cabinet, in discussions of the PCJUA, have state-based insurance regulatory instructed OIR to make every effort to have the facility in place as framework is inefficient, stifles the soon as possible. The first policies could be issued as early as development of new and creative products and imposes September, 2006. unnecessary compliance costs on state-licensed insurers and The emergency rule creating the PCJUA remains in effect for only insurance producers. 90 days. The preamble to the rule, however, indicates an intention The NIA would establish an “optional federal charter” so that to replace the emergency rule with a rule adopted through the insurers and insurance producers could choose to operate regular rulemaking process. nationwide under a single federal regulator rather than under the current state-based system. The NIA would create a central Office 1 An unscientific Internet survey conducted by the Florida Office of Insurance Regulation of National Insurance within the Department of the Treasury. The found that, of 1501 respondents, 17% were unable to find any coverage, 15% found only Office of National Insurance would be headed by a National some of the coverage they needed, 10% found coverage with higher deductibles, and 39% Commissioner, appointed by the President, who would be found coverage with premiums that seemed unreasonable. The survey results are available responsible for issuing regulations and for overseeing the online at http://www.floir.com/pdf/CommercialPropertySurvey.pdf. operation of the newly created federal regulatory system. 2 The PCJUA was established by Emergency Rule 69OER06-03, available online at http://www.floir.com/pdf/ER-69OER06-3.pdf, under the authority of Florida Statutes The NIA would allow insurers and insurance agencies to be Section 627.351(5). organized under federal law and would permit existing insurers 3 Commercial residential coverage is currently provided by another residual market entity, and agencies to replace their state charters and licenses with Citizens Property Insurance Corp., under Florida Statutes Section 627.351(6). federal charters. The NIA would regulate and license these insurers 4 Letter from Marsha A. Cohen and Dennis C. Burke, RAA, to Kevin McCarty, Insurance (National Insurers) and agencies (National Agencies) as well as Commissioner, August 14, 2006. other individual producers that qualify and elect to do business under federal law. (The NIA refers to National Agencies and the other qualifying producers collectively as National Producers.) The Relationship Between Federal and State Regulation Under the NIA The federal regulatory system proposed by the NIA would not replace the regulatory systems of the individual states. The states would continue to regulate insurers and insurance producers that retain state charters and licenses. Nonetheless, there is concern within the insurance industry and among state regulators of the industry that the NIA would undermine the state regulatory system by granting the National Commissioner broad rulemaking power, coupled with federal authority to preempt conflicting state law. FOCUS on the Insurance Industry Fall 2006 7 National Insurers and National Producers would be regulated insurers and insurance producers, who currently compete with exclusively under federal law. Critics of the NIA argue that, as banks and investment firms that now have lower compliance costs. a result of federal preemption, states may be prevented from For these reasons, the life insurance industry has been the regulating state-licensed producers in their dealings with National strongest supporter of the NIA. Insurers, as well as state-chartered insurers in their dealings with Major opposition to the NIA comes from state insurance National Producers. An example commonly used to illustrate regulators, state governments, and certain insurance industry the issue is a state’s prohibition on the payment of contingent trade groups. Those opposed include the National Governors’ commissions by a state-licensed insurer. If the NIA were held to Association, the National Association of Insurance Commissioners have broad preemptive effect, a state might be precluded from (NAIC), the National Conference of Insurance Legislators (NCOIL), enforcing such a prohibition as it applies to business placed by the National Conference of State Legislators (NCSL), the National Producers with state-licensed insurers. Independent Insurance Agents and Brokers of America, the Some parts of the state regulatory system would continue to apply National Association of Mutual Insurance Companies (NAMIC), the to National Insurers. For example, National Insurers would still have National Association of Professional Insurance Agents (PIA), the to pay state premium taxes. They also would have to participate in National Association of Professional Surplus Lines Offices and the residual market plans and state insurance guaranty associations, Property Casualty Insurers Association of America (PCI). Some subject to restrictions. Furthermore, the NIA does not provide for opponents believe that passage of the NIA would eventually lead a surplus lines marketplace, and that marketplace would continue to federal insurance regulation to the exclusion of any meaningful to be governed by state law. role for the states. The NIA versus the SMART Act Moreover, although the NIA establishes a Division of Consumer The NIA differs substantially from the State Modernization and Protection within the Office of National Insurance, consumer Regulatory Transparency Act (SMART Act). The SMART Act also groups have expressed concern that the NIA will weaken consumer would involve the federal government in insurance regulation, but protection by reducing regulatory limitations on insurance rates, on a more limited basis than the NIA. Representative Oxley (R-OH) forms, and market behavior, currently enforced by state regulatory and Representative Baker (R-LA) released a draft of the SMART Act systems. The consumer groups also argue that the dual regulatory in August 2004, but the draft has not yet been introduced as a bill. system will lead to policyholder confusion, market uncertainty and unintended consequences that will hurt consumers and taxpayers. The draft SMART ACT would require states to comply with uniform standards and resolve disputes, speed up the process of getting Opponents of the NIA argue that state regulation is better tailored new products to the market and move toward a system of market- to the needs of many insurance consumers. They say that based rates without creating a federal regulator to monitor many insurance products, such as auto, farm and homeowners’ compliance. The SMART Act would establish a seven-member insurance, are tailored to specific state and regional needs that do panel consisting of insurance commissioners and appointees not relate to interstate activities. These opponents believe that state from several federal agencies, including the Securities and regulators have a better understanding of the local insurance Exchange Commission. The panel would have no regulatory markets and, if regulatory changes are needed for these specific authority per se, but it would assess compliance with the statute markets, state regulators are more likely to act quickly and produce and mediate and resolve conflicts over uniformity requirements. better results in response to local insurance market needs. The SMART Act would also require states to adopt flex rating, Finally, opponents of the NIA have argued that the legislation which allows insurers to raise rates as long as they are kept would leave many of the details of the new federal regulatory within a certain percentage range for the year. It would call for scheme, such as procedures for policy approval by the National states to develop and implement procedures on market conduct Commissioner, open to future regulation and rule-making by the and standards. With regard to licensing, the SMART Act would National Commissioner. This broad delegation of regulatory power, require states to adopt a “single point-of-entry” system, whereby vested in the new position of a National Commissioner, could leave an insurance company in good standing in one state could submit the insurance industry susceptible to political shifts and create a uniform application to do business in other states. uncertainty in the industry. The Battlefield: Who’s For the NIA and Who’s Against It Current Status of the NIA Those supporting adoption of the NIA include the American Council Senators John Sununu (R-NH) and Tim Johnson (D-SD) introduced of Life Insurers (ACLI), the American Insurance Association (AIA), the the NIA into the US Congress on April 4, 2006. Adverse reactions, Council of Insurance Agents and Brokers, the American Bankers however, have slowed its passage. The legislation is currently in Insurance Association (ABIA) and the Financial Services Roundtable. the Senate Committee on Banking, Housing, and Urban Affairs Supporters argue that the legislation will create a more efficient without a scheduled vote or hearing and without additional regulatory system and encourage new and creative products. They sponsorship in the Senate. also argue that it will lower compliance costs for state-licensed FOCUS on the Insurance Industry Fall 2006 8 LEGEND Insolvency/Guranty Fund = IG Public Affairs = PA Risk Management/ Intellectual Property = IP Regulatory = RG Captives = RM Agency/Distribution = AD Litigation = LT Reinsurance/Commutation/ Tax = TX Financial Products/ Runoff = RE Announcements Variable Insurance = FP M&A/Transactional = MA Successes Annoye, Linda M. Harrell, Michael P. Luettgen, David G. Reuter, Bartholomew F. Partner Wm. Carlisle Herbert wrote the article, “Keeping the Equity in ERISA: Limiting Associate, RE Public Affairs Director, PA Partner, IP Senior Counsel, LT/RE Judicial Relief to What is ‘Appropriate’,” published in the June issue of the University of 414.319.7301 850.513.3379 414.297.5769 414.297.5826 Hanover’s Journal of Academic Legal Studies. firstname.lastname@example.org email@example.com firstname.lastname@example.org email@example.com Insurance Industry Team members Lisa S. Neubauer, Anne E. Ross, and Michael B. Aprahamian, Michael J. Heffernan, Michael S. Maassen, Eric L. Ridley, Eileen R. Van Sicklen were named 2006 Wisconsin Super Lawyers. Attorneys Paul S. Hunter, Partner, LT Special Counsel, RE Partner, LT/RE Partner, IP/LT/RE/RM Ethan D. Lenz, Brett H. Ludwig, and Bartholomew F. Reuter were deemed 2006 414.297.5516 608.258.4298 414.297.5585 415.438.6469 Wisconsin Risings Stars. In Illinois, the 2006 Super Lawyers named from the team were firstname.lastname@example.org email@example.com firstname.lastname@example.org email@example.com Richard Bromley and Wm. Carlisle Herbert. Bishop, Martin J. Herbert, W. Carlisle Mahe, Henry E. Riley, Leigh C. Foley has been named to the 2006 BTI “Power Elite” list, a ranking of the top 21 law firms Senior Counsel, IP/LT/RE Partner, IG/LT/RE Strategic Counselor, PA Partner, RG with the strongest market positions based upon the quality of their client relationships. 312.832.5154 312.832.4551 202.295.4106 414.297.5846 Foley ranks fifth, which represents the firm’s highest ranking in the survey and an firstname.lastname@example.org email@example.com firstname.lastname@example.org email@example.com improvement of three positions from BTI’s 2005 list. Foley also is one of only 14 law firms nationwide to appear on the list in consecutive years. Bolden, Kenyatta Hosay, Robert H. Maida, Thomas J. Ross, Anne E. Associate, MA/RG Special Counsel, PA Partner, MA/PA/RG/RE Partner, MA/RG In addition, Foley has been named to the 2006 BTI Market Movers list, a ranking of law 414.297.5541 850.513.3382 850.513.3377 608.258.4218 firms identified by corporate counsel as leaders implementing a strategic approach to firstname.lastname@example.org email@example.com firstname.lastname@example.org email@example.com delivering legal services. Foley is recognized as one of four Market Trailblazers, along with DLA Piper, Jones Day and Skadden, identified by corporate counsel for their unique ability Branch, Joseph C. Hrdlick, Thomas R. Martire, Mary Kay Schroeder, Jennifer K. to leverage client-focused strategies with bold approaches to the market. Partner, MA/RG/RE Partner, IG/MA/RG/RE Partner, IG/LT Associate, AD/MA/RG/RE/RM 414.297.5837 414.297.5812 312.832.4560 414.297.5647 Upcoming Presentations firstname.lastname@example.org email@example.com firstname.lastname@example.org email@example.com On September 9, 2006, Foley will be organizing the International Association of Insurance Bromley, Richard Hunter, Paul S. Monsees, Paul R. Schulte, Leonard Receivers (IAIR) Roundtable in St. Louis. Partner Richard Bromley will serve as the host. Partner, IG/TX Senior Counsel, IP Partner, RE Public Affairs Advisor, PA Partner John N. Gavin will discuss the Insurer Receivership Model Act (IRMA) and issues 312.832.4517 608.258.4292 202.672.5342 850.513.3380 relating to fraudulent conveyance and voidable preference. Senior Counsel Brian Kaas will firstname.lastname@example.org email@example.com firstname.lastname@example.org email@example.com present on IRMA and reinsurance, while Partners Mary Kay Martire and Wm. Carlisle Herbert will moderate on panels during the roundtable. Chester, Maksim Kaas, Brian S. Morgan, Belinda S. Soble, Jeff Associate, RE Senior Counsel, MA/RG/RE/RM Associate, IG/TX Partner, LT Partner Richard Bromley is scheduled to speak on a federal income tax panel on the topic 414.297.5573 414.297.5847 312.832.4562 312.832.5170 of loss reserves a seminar hosted by the Casualty Actuarial Society on September 12, firstname.lastname@example.org email@example.com firstname.lastname@example.org email@example.com 2006 in Atlanta, GA. On October 17, 2006, Partner Tracy D. Williams will give a tax update at the Illinois CPA Christie, R. Lee Kanwit, Glen H. Moser, Gregory V. Strickland, Nate Wesley Partner, IG/RM/TX Partner, RE Partner, RM Senior Counsel, MA/RG Society Insurance Seminar. 312.832.4525 312.832.4380 619.685.6426 850.513.3369 Partner R. Lee Christie will be speaking at the Insurance Tax Conference (to be held firstname.lastname@example.org email@example.com firstname.lastname@example.org email@example.com November 2 – 3, 2006, in Chicago) on the topic “Risk Transfer and the Emerging Definitions of Insurance.” Richard Bromley, partner, will chair a panel on developments with respect to Davenport III, Gordon Keller, George Neal, Austin B. Van Sicklen, Michael B. the FASB proposal regarding bifurcation of insurance contacts, finite risk reinsurance and Partner, AD/LT Partner, LT Partner, MA/RG Partner, RE 608.258.4208 415.438.6415 850.513.3363 608.258.4206 captive insurance. In addition, Partner Tracy D. Williams will be presenting “IRS Audit, firstname.lastname@example.org email@example.com firstname.lastname@example.org email@example.com Appeals & Litigation — Current Issues.” Partner Foley Partner Tracy D. Williams will speak on “Constitutional Issues in State Tax Fitzgerald, Kevin G. Kuhlmann, Patrick M. Neubauer, Lisa S. Wang, Peter N. Litigation.” Partner, AD/MA/RG/RE/RM Associate, RE Partner, LT Partner, LT 414.297.5841 414.297.5614 414.297.5507 212.682.7474 Foley Partners Tracy D. Williams, R. Lee Christie and Richard Bromley also are firstname.lastname@example.org email@example.com firstname.lastname@example.org email@example.com presenting at the Blue Cross & Blue Shield Association conference on November 30, 2006. Gavin, John N. Lee, Ladonna Y. Oberdeck, Andrew A. Williams, Tracy D. Recent Speaking Engagements Partner, IG/MA/RG/RE/RM Strategic Counselor, PA Associate, AD/MA/RG/RE Partner, TX Partner Gordon Davenport, III presented “Director & Officer Liability Update: Current 312.832.4544 202.295.4107 414.297.5598 312.832.4593 Liability Trends and D&O Insurance Strategies” at the August 16, 2006 InsideCounsel Web firstname.lastname@example.org email@example.com firstname.lastname@example.org email@example.com conference. Also, on May 17, 2006 in New York, Mr. Davenport presented “D&O Insurance: Current Hot Button Issues” at the D&O Insurance ExecuSummit. Goodman, George R. Lenz, Ethan D. Ossyra, James D. Zinkgraf, Gary M. Partner, IG/TX Partner, AD/MA/RG/RM Partner, LT/RE Partner, RE Foley sponsored the “Patenting Business Methods in the Financial Services Industry” 312.832.4545 414.297.5835 312.832.4565 202.672.5303 conference from July 25 – 27, 2006 in New York City. Senior Counsel Paul S. Hunter firstname.lastname@example.org email@example.com firstname.lastname@example.org email@example.com spoke on improving patent prosecution. Grane, Karen M. Leventhal, Robert C. Pasulka-Brown, Kathleen R. Partners Kevin G. Fitzgerald and John N. Gavin spoke on state and federal regulation Special Counsel, RE Partner, RE Partner, LT of managed care at the Friday Focus Web conference hosted by Foley on July 21, 2006. 202.672.5506 310.975.7734 312.832.5164 Recent Events firstname.lastname@example.org email@example.com firstname.lastname@example.org Foley’s Jacksonville office and the Insurance Industry Team hosted a fundraising reception for Gustafson, Christine A. Lotus, Joseph J. Patel, Jamshed J. Alex Sink, candidate for Chief Financial Officer for the State of Florida on August 22, 2006. Special Counsel, RM/TX Associate, PA Partner, RM/TX Foley’s Insurance Industry Team also proudly sponsored the Property Casualty Insurers 312.832.4529 312.832.5171 414.297.5742 email@example.com firstname.lastname@example.org email@example.com Association of America’s (PCI) Legislative Action Day in Washington, D.C. on June 22, 2006. The one-day event provided insurance company executives with a forum to discuss important Hakim, Anat Ludwig, Brett H. Pontrelli, Michael R. issues with their congressional representatives. Partner, IP Partner, RE Partner, LT/RE On June 11, 2006, Foley’s Insurance Industry Team hosted a reception for attendees of the 202.295.4046 414.297.5524 617.342.4074 firstname.lastname@example.org email@example.com firstname.lastname@example.org National Association of Insurance Commissioners (NAIC) Summer Meeting in Washington, D.C.
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