On October 3, 2008, following a week of intense negotiations, the House of Representatives gathered enough votes to finally approve landmark legislation, H.R. 1424, that includes the “Emergency Economic Stabilization Act of 2008” (the “Stabilization Act” or “Act”).1 The Act was originally proposed by the Administration, working with U.S. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke, to enable the U.S. government to purchase $700 billion of illiquid mortgages and mortgage-related financial instruments currently held by U.S. financial institutions.
Leading up to the House vote, Congressional leaders had expressed concern about the bill’s passage since the House had unexpectedly voted down a prior version of the Act on Monday, September 29.2 After the unexpected defeat, Congressional leaders employed the unusual procedural move of including the Act in a larger piece of legislation characterized as a tax bill that was then introduced in the Senate. The Act itself was amended primarily by adding a provision raising the limits of the FDIC guarantee on bank deposits from $100,000 to $250,000. However, the new legislation also included an extensive set of new measures, primarily tax incentives, designed to increase the odds of the revised legislation passing the House. On October 1, the Senate approved the legislation by a vote of 74-25.3
Once approved by the Senate, the legislation was brought back to the House. Opposition to the bill remained for a variety of reasons, including the cost of the bailout and the fact that several of the new tax incentives added to the legislation would not be offset by other budget cuts. Notwithstanding the continued opposition of some House members, the House approved the legislation on October 3. Immediately after passage in the House, the President signed this landmark bill.
The Stabilization Act authorizes $700 billion for the Treasury Department (“Treasury”) to acquire and manage “troubled assets” from financial institutions through a newly created Office of Financial Stability. In addition to this asset relief program, the Act creates a Financial Stability Oversight Board; requires Treasury to implement a plan for mortgages and mortgage-backed securities it acquires to mitigate foreclosures and to encourage servicers of mortgages to modify loans through Hope for Homeowners and other programs; and places executive compensation limits on financial institutions that sell troubled assets to Treasury.4
As noted, we have provided legal alerts to our clients at the critical junctures of the Stabilization Act’s progress through the House and Senate. We are taking this opportunity to highlight how the Stabilization Act and certain related developments may impact our insurance company clients.
Impact of the Stabilization Act on Insurance Companies
The Stabilization Act could provide important benefits to insurance companies. However, we believe there will be significant questions regarding the corresponding trade-offs. Specific issues and questions germane to the insurance industry may include the following:
- Can insurance companies move “troubled” mortgages and mortgage-related securities off their books by selling them to Treasury under the “Troubled Asset Relief Program”?
Section 101 of the Act authorizes Treasury to establish the “Troubled Asset Relief Program” (“TARP”) to purchase “troubled assets” from financial institutions. Section 3 of the Act defines “financial institution” to mean “any institution, including, but not limited to, any bank, savings association, credit union, security broker or dealer, or insurance company (emphasis added),” so insurance companies are specifically included as financial institutions eligible to participate in the TARP program. “Troubled assets” include “residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes financial market stability.” Read together, these two provisions confirm that insurance companies will be eligible to sell troubled mortgages and mortgage-related securities to the Treasury.
Another source of assistance to insurers with troubled assets likely will be provided by a guarantee program to be established by Treasury. Section 102 of the Stabilization Act requires the Treasury, once the TARP program is established, to also establish a program to guarantee the timely payment of principal of, and interest on, troubled assets. Obtaining an insurance guarantee would require payment of associated premiums.
- What are the trade-offs of the TARP program for insurance companies?
As expected, purchases of troubled assets by Treasury under the TARP program will be heavily conditioned. However, the provisions of the Act specifying the conditions are general in nature, and the exact scope of the conditions will therefore have to be specified by Treasury. Regardless of the exact nature of the conditions, though, there are two conditions that will likely raise significant concerns for insurers: the Act’s executive compensation provisions and warrant provisions.
Executive Compensation Limits. Section 111 of the Act imposes executive compensation limits on companies that engage in significant sales of troubled assets to Treasury. According to a published summary of the House bill, the executive compensation provisions reflect a determination that “executives who made bad decisions should not be allowed to dump their bad assets on the government, and then walk away with millions of dollars in bonuses.” The Act stipulates that companies that participate in the TARP program will lose certain tax benefits and, in some cases, must limit executive pay. The Act also limits “golden parachutes” and requires that unearned bonuses be returned.
It is not certain exactly how the executive compensation provisions of the Act would apply to the senior executives of insurance companies under a corporate umbrella. Section 111 defines “senior executive officer” as an “individual who is one of the top five highly paid executives of a public company, whose compensation is required to be disclosed pursuant to the Securities Exchange Act of 1934, and any regulations issued thereunder, and non-public company counterparts.” It is unclear how this definition would apply in the context of an insurance company complex where only the parent was a public company; nor is it clear how it would apply to a mutual life insurance company. However, given the enormous public backlash that led Congress to include these provisions in the Act, Treasury will likely be guided by what it views as a clear Congressional mandate to apply the provisions liberally. Accordingly, the executive compensation limits could be a significant variable in an insurer’s determination of whether to sell securities to the Treasury under the TARP program. 5
Warrants. In order to cover losses and administrative costs and to allow taxpayers to be compensated for providing federal assistance to financial institutions, the Stabilization Act requires Treasury to obtain warrants to receive securities from financial institutions participating in the TARP program. Such warrants, with de minimis exceptions, will be required to give Treasury the right to receive non-voting common stock or preferred stock in, or debt securities of, the financial institution. The Act does not, however, specify the requisite terms of the warrants, other than it is required to “provide for reasonable participation by the Secretary, for the benefit of taxpayers, in equity appreciation . . . or a reasonable interest rate premium . . . .” The open-ended nature of these provisions may have a chilling effect on insurers’ decisions as to whether to participate in the TARP program.
- Asset Management and Other Service Provider Opportunities
The Act authorizes the Secretary of the Treasury to manage troubled assets purchased under the TARP program. Treasury is further authorized by the Act to waive specific provisions of the Federal Acquisition Regulation in retaining asset managers, servicers, project managers and other service providers. This aspect of the Stabilization Act could be seen as an opportunity for insurers to manage portions of troubled assets acquired by Treasury and provide other securities. Yesterday, the Treasury announced solicitations for financial agents under the Act to provide these services; interested parties must apply by no later than 5 p.m. EDT, Wednesday, October 8. 6
Other Related Developments that May Impact Insurance Companies
As noted, the Stabilization Act may present significant opportunities for insurance companies. However, there are other developments related to the continuing market turmoil that may impact insurance companies. Some of the more significant developments are noted below.
- Mark-to-Market Accounting Developments
In response to the turmoil in the credit market and suggestions that fair value accounting rules have been a contributing factor to the current financial crisis, on September 30 the Securities and Exchange Commission (“SEC”) and the Financial Accounting Standards Board jointly issued guidance on determining the fair value of securities under Statement of Financial Accounting Standards No. 157 (“SFAS No. 157”).7 This interpretive guidance may provide additional flexibility in connection with mark-to-market valuations of mortgage-backed and other securities, which may relieve some of the current financial pressure on financial institutions and the general market, free up capital, and encourage lending.
In addition, a somewhat more aggressive approach has been urged upon Congress. As a result, the Stabilization Act authorizes the SEC to suspend applicable mark-to-market accounting rules. There is reportedly considerable interest in pursuing this alternative over the more moderate course suggested by the new interpretive guidance under SFAS No. 157.
- Treasury Money Market Fund Guarantee Program
The current market turmoil has resulted in other new regulations and administrative procedures – the application of which to insurance companies is not completely clear at this point. Among other things, questions have been raised concerning the applicability of the Treasury’s money market fund guarantee program to some money market funds, including those offered as investment options under variable insurance contracts.
- Optional Federal Chartering
The prospects for and need for an optional federal charter (“OFC”) for insurance companies has been the subject of considerable debate for the past decade or more. Given the tumult in the financial markets, and the recent federal financial assistance and the equity position Treasury has taken in AIG, there has been considerable posturing related to the OFC in the past several weeks, and there will likely be continued developments in that arena in the coming months.
By way of background, in May 2007, Senator Sununu (R-NH) and Senator Johnson (D-SD) introduced S. 40 entitled “The National Insurance Act of 2007” (“S. 40”). The provisions of S. 40 are very similar to previous OFC bills Congress has considered dating back to 2001. Under S. 40, and a companion bill in the House (H.R. 3200), there would be an OFC and insurance would be overseen at the federal level by the National Insurance Commissioner, who would be appointed by the President for a five-year term. Under S. 40, a dual regulatory structure would be created under which insurance companies could determine whether to be chartered under federal or state law. An Office of National Insurance would be created within Treasury to support the regulation of insurers.
More recently, the Treasury Department’s Blueprint for a Modernized Financial Regulatory Structure (“Blueprint”) also developed a structure for an OFC and federal regulation of insurance.8 While the Blueprint was careful not to suggest that it concurred with all aspects of S. 40, instead setting forth general guiding principles for federal insurance regulation, the general structure recommended followed the major principles of S. 40. Under the Blueprint, Treasury recommended as “intermediate steps” (1) the establishment of a federal structure to allow for an OFC; and (2) the creation of an Office of National Insurance within Treasury. In addition, the Blueprint called for Congress to create an “Office of Insurance Oversight” within Treasury as an interim step to establish a federal presence on regulatory and international insurance issues.9
Insurance trade associations and state insurance regulators have been trading barbs over the potential impact and consequences of the federal assistance provided to AIG and the financial markets turmoil. Several insurance trade associations have suggested that the financial markets events of the last 6 weeks provide a better reason than ever to move forward as expeditiously as possible with OFC legislation. In addition, the insurance trade associations are also calling for, as quickly as possible, the establishment of the Office of Insurance Oversight within Treasury to develop and maintain some federal expertise on insurance and create an international voice for the U.S. insurance markets. At the same time, state insurance regulatory organizations such as the NAIC are pushing back on the idea that recent events indicate a need for an OFC and federal involvement in the U.S. insurance business. The NAIC is pointing to the AIG developments described above as an object lesson in why state insurance regulation works. In their view, the financial solvency of AIG’s insurance company subsidiaries, as compared to the financial state of the other AIG companies, including its holding company, indicate that state regulation (at least solvency regulation) is working. While it is unclear where and how this debate will end, it appears that the next year will be critical in determining the role of the federal government in regulating insurance operations in the U.S. for decades to come.
To view a related legal alert entitled, “House Financial Services Subcommittee Approves the Insurance Information Act of 2008 to Create an Office of Insurance Information,” please click here.