While the financial crisis has postponed attention from the debate over an optional federal charter for insurers, we may have already witnessed the states ceding regulatory grounds to the federal government. I am speaking, of course, of the unprecedented federal bailout of AIG.
In addition to the initial $85 billion loan by the Federal Reserve Bank of New York to AIG at confiscatory rates, collateralized, in part, by the stock of substantially all of AIG’s insurance subsidiaries, the Treasury, through a trust, also acquired a new series of non-redeemable, convertible participating serial preferred stock (the “Preferred Stock”) for $500,000. The Preferred Stock is entitled to participate in any dividends paid on AIG common stock and is convertible into a number of shares of common stock equal to 79.9% of the outstanding common stock when converted. In addition to being convertible into a supermajority of the outstanding common stock of AIG, the Preferred Stock has the right to vote with the common stock on all matters submitted to AIG shareholders and is entitled to an aggregate number of votes equal to its equity share as converted (79.9%). AIG renegotiated the terms in early November but the government’s total equity stake remained largely unchanged. Thus, the federal government currently enjoys complete control of AIG.
Interestingly, from an insurance regulatory perspective, to our knowledge, the federal takeover of AIG and subsequent investments were accomplished without any requests for approval with the twenty-state Departments of Insurance that have jurisdiction over an AIG domestic insurer. Control is presumed to exist when any person holds with the power to vote 10.0% or more of the voting securities of an insurer’s ultimate controlling person. While the presumption of control can be rebutted, a finding that a 79.9% shareholder doesn’t have control would be unprecedented. No hearings were held despite the fact that the federal government now has 79.9% voting control in the AIG domestic insurers’ ultimate controlling person. Nor did the federal government seek approval for AIG’s $37.8 billion “loan” of securities from its insurance company subsidiaries to the Federal Reserve Bank of New York1.
In fact, under existing state law any transaction between the federal government and an AIG regulated entity should be subject to Department of Insurance approval as a transaction between affiliated parties. Moreover, there should be no deference for the federal government acquiring AIG. The lack of state approval contradicts the McCarran-Ferguson Act, which states in relevant part “No act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance…unless such Act specifically relates to the business of insurance.” 15 U.S.C. § 1012(b) (emphasis added).
State laws dealing with the business of insurance, therefore, apply over generally applicable federal laws - which is the case with the federal takeover of AIG. This requirement for federal laws to specifically state that they apply to the business of insurance is called “express preemption.”
The government proceeded under Section 13(3) of the Federal Reserve Act, which states that:
In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal Reserve bank, during such periods as the said Board may determine…to discount for any individual, partnership or corporation notes, drafts and bills of exchange when such notes, drafts and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve Bank.
12 U.S.C. § 343.
Section 13(3) of the Federal Reserve Act (and the Federal Reserve Act itself generally) clearly does not specifically relate to the business of insurance and therefore would not be the express preemption required for federal law to supersede a state law under McCarran-Ferguson. Because the Treasury now has super majority control of AIG, and through AIG effective control of its insurance subsidiaries, it would appear that there should have been state Departments of Insurance change of control hearings to approve the government’s actions.
States will, presumably, require change of control hearings to review and approve any transaction whereby AIG sells an insurance subsidiary to another entity. However, the case for state oversight and regulation of that subsequent transaction is weakened by states’ inaction on the previous change of control.
1One notable exception from the requirements for prior approval would be New York, which exempts the federal government from its holding company law.
Anthony C. Roehl is an Associate in the firm’s Insurance and Reinsurance and Corporate Practices. Mr. Roehl’s principle areas of concentration are insurance regulation and corporate matters involving entities within the insurance industry. Mr. Roehl received his bachelor’s degree from the University of Florida and his law degree from the University of Michigan.