PLAYER’S POINT
The Federal/State Minuet
By Thomas A. Player
With each news day comes another story of the urgent and growing puzzle of the regulation of the insurance industry. At this time, any effort to pull together into a cogent theme seems like a waste of time. Therefore, with apologies for lack of analysis, what follows is a stream of recent news releases and some comments concerning their consequences.
- Treasury says six major life insurers have been approved to participate in the next round of TARP funding. As of this writing, two of the companies have declined to participate, two have accepted and two are evaluating whether to take the plunge.
- It is the intention of Treasury to convert preferred shares taken in exchange for TARP money into common stock. Further, Treasury has signaled it will convert the preferred shares it now holds in other large banks into common stock if the banks cannot raise sufficient private capital to satisfy the “stress tests” recently concluded by government regulators.
- Therefore, with TARP funding for insurers, comes the possibility of government control and representation on the recipient’s board of directors.
- The Federal government effectively controls AIG through the trust established last fall by Treasury and the Federal Reserve Bank of New York which holds 77.9 percent of the voting stock of AIG. The Trustees controlling the AIG common shares just endorsed six new independent directors named to the AIG Board.
- As was covered by Tony Roehl’s article in the Winter 2008 Insurance Newsletter, there was no Change of Control filing for the infusion of TARP money into AIG, nor any specific exemption.1
- Twenty-nine states have statutes limiting the right of state controlled insurers from doing business in their state. These statutes were designed to blunt the ability of foreign state controlled insurers from having a competitive advantage.2 Does TARP create such a competitive advantage? What about using the government subsidy to compete unfairly in the market? Recently, PCI made that point by saying “its members are concerned that those [companies who receive TARP money] could potentially win an unfair competitive advantage.”
- While Board members endorsed by Treasury enjoy the indemnity provided by company by-laws (to the extent allowed by state law) and directors and officers liability coverage (to the extent their insurer remains solvent), we are not aware of Federal indemnity nor immunity for their actions.3
- What are the duties of Board members vis-a-vis the government and shareholders when the government’s interests may conflict with those of other shareholders?
- A May 14, 2009 GAO Report on the effectiveness of state regulation of insurance sounds like a broken record. That is, states are striving for uniformity and efficiency in regulation but continue to fall short. This has been going on for some time.
- The major trade associations are split on Federal regulation with the major life association favoring an Optional Federal Charter and most property and casualty associations (excluding AIA) favoring state regulation with some Federal coordination.
It is tempting to predict the outcome of all of this. A safe prediction would be that Congress will tidy up the laws allowing Treasury to effectively fund and control insurers, that some form of Federal oversight of systemic risk will emerge, and that state regulation of insurance will continue to be the primary regulator.
Thomas Player is a Senior Partner in the Insurance and Reinsurance Practice. His areas of expertise include insurance and reinsurance, mergers and acquisitions, complex regulatory issues and dispute resolution. Tom received his bachelor’s degree from Furman University and his law degree from the University of Virginia.
1 The point here is not that Treasury doesn’t have the power to take control of insurers under emergency situations; it is that Congress did not specifically address the issue of Federal control of insurers (which has traditionally been an area of exclusive state control).
2 Thirteen of these states’ statutes would appear to include control by the federal government, leading to the curious conclusion that a state could withdraw the Certificate of Authority of an insurer accepting TARP money and presumably controlled by the Feds.
3 A board of directors of an insurance company owes those fiduciary duties that are required by any corporation to its shareholders, including the duty of care and the duty of loyalty. If the board of directors fulfills its fiduciary duties, its decision will be protected by the business judgment rule, which is a presumption that the board of directors’ business decision was made in good faith, made on an informed basis, and based on an honest belief that the decision was in the best interest of the corporation. However, if the board of directors does not fulfill its fiduciary duties to the shareholders, the board will not get the protection of the business judgment rule and will be held to the more onerous entire fairness standard.
In addition to the duty of care, a board of directors owes a duty of loyalty. The duty of loyalty prohibits a director from self-dealing and requires that the director must act with the utmost good faith. In order to avoid self-dealing, directors should not appear on both sides of the transaction or expect to gain a personal financial benefit from the transaction. The presence of a directorial interest will not be fatal, however, if the interested director abstains from voting and notifies the board of the conflict of interest.
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