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on the Insurance Industry


  • pg 1
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.
        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
            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.
                                                                                    Reinsurance Intermediary Model Act § 790-1(2)(F) (NAIC 2004).
FOCUS        on the Insurance Industry                                                                                                                               Fall 2006        5

             Reinsurance Intermediary Model Act § 790-1(2)(G) (NAIC 2004).                                  property risks.
             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
             9 U.S.C. § 7.                                                                                  its plan of operation to change the limits or deductibles.
             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).
                                                                                                            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
             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
             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.
             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
             Id. at 12-13; Hall, supra note 9.
             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.
                                                                                                            insurers and one surplus lines insurer and a search through the
             Hall, supra note 1, at 2.
                                                                                                            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
            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.
            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
            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
            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.                                                     lannoye@foley.com           mharrell@foley.com             dluettgen@foley.com            breuter@foley.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            maprahamian@foley.com       mheffernan@foley.com           emaassen@foley.com             eridley@foley.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              mbishop@foley.com           wherbert@foley.com             emahe@foley.com                lriley@foley.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            kbolden@foley.com           rhosay@foley.com               tmaida@foley.com               aross@foley.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                                                                           jbranch@foley.com           thrdlick@foley.com             mmartire@foley.com             jkschroeder@foley.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        rbromley@foley.com          phunter@foley.com              pmonsees@foley.com             lschulte@foley.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,             mchester@foley.com          bkaas@foley.com                bmorgan@foley.com              jsoble@foley.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             lchristie@foley.com         gkanwit@foley.com              gmoser@foley.com               nstrickland@foley.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,
                                                                                                 gdavenport@foley.com        gkeller@foley.com              aneal@foley.com                mvansicklen@foley.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                   kfitzgerald@foley.com       pkuhlmann@foley.com            lneubauer@foley.com            pwang@foley.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          jgavin@foley.com            llee@foley.com                 aoberdeck@foley.com            twilliams@foley.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               ggoodman@foley.com          elenz@foley.com                jossyra@foley.com              gzinkgraf@foley.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                                                                                    kgrane@foley.com            rleventhal@foley.com           kpasulka-brown@foley.com

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
                                                                                                 cgustafson@foley.com        jlotus@foley.com               jpatel@foley.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
                                                                                                 ahakim@foley.com            bludwig@foley.com              mpontrelli@foley.com
National Association of Insurance Commissioners (NAIC) Summer Meeting in Washington, D.C.

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