An issue important to the insurance industry is percolating in the U.S. Treasury Department. That issue is whether the insurance industry should participate in the TARP Capital Purchase Program (“CPP”) authorized by the Emergency Economic Stabilization Act of 2008 (“EESA”). It has been the focus of numerous news reports over the last several days.

As discussed in this Client Alert, expanding the existing framework of the CPP to insurance entities not only would pose challenges to Treasury but also may raise regulatory issues for the insurance industry. The critical challenge for Treasury, if the CPP is extended to insurers on an industry sector basis, is two-pronged. Treasury must decide (i) which of the various types of insurers not already eligible as bank or thrift holding companies for TARP participation should be permitted to participate in TARP, and (ii) how and when such participation should be implemented under the CPP.

Treasury’s thinking has not yet crystallized. An atmospheric factor which may influence Treasury’s deliberations is that the insurance industry is not unified over the need for TARP participation. The Chairman of the American Insurance Association (“AIA”), a trade association representing 350 major property and casualty insurers which together write more than $123 billion in annual property and casualty premiums, has been quoted in news reports as stating that the AIA does not support inclusion of property and casualty insurers in the CPP and that a substantial majority of its members would not participate. The American Council of Life Insurers, a trade association comprised of 353 major life insurers which together write more than 93 percent of annual life premiums, is actively lobbying Treasury for TARP participation. Reports attributed to Treasury sources disclosed that negotiations between Treasury and representatives of the life insurance industry are ongoing.

Treasury is being pressed to swiftly extend TARP participation to the insurance industry. Although the scope and implementation of a possible expanded CPP framework is unclear at present, we urge our insurance industry clients to monitor these developments closely to evaluate their own participation in the process. Those companies which are Qualified Financial Institutions (“QFIs”) or affiliates of QFIs must be very careful to create an adequate fiduciary record as to their choice of particpation.

TARP’s Existing Capital Purchase Program

The Treasury’s existing framework for CPP participation extends the program to QFIs, including “bank holding companies, financial holding companies, insured depository institutions and savings and loan holding companies that engage solely or predominately in activities that are permissible for financial holding companies” under Section 4(k) of the Banking Holding Company Act. Such institutions must be established and regulated under the laws of the United States or any State, territory, or possession of the United States, the District of Columbia, Commonwealth of Puerto Rico, Commonwealth of Northern Mariana Islands, Guam, American Samoa, or the United States Virgin Islands. Banking institutions controlled by a foreign bank or company are excluded from the CPP.

The benefits of capital infusions under the CPP are not directed to specific institutions controlled by QFIs. Although Section 3(5) of the EESA listed insurance companies as eligible to participate in the TARP program, the existing CPP does not expressly include insurance entities in the published categories of QFIs. CPP participation is already available to insurers and insurance holding companies which are bank-related QFIs or affiliates of bankrelated QFIs.

At present, Treasury is making investments only in publicly-traded holding companies of banks or thrifts, banks and thrifts. However, Treasury announced yesterday that it is considering methods to extend CPP participation to privately or closely held banking institutions, and mutual banks or savings and loan and mutual bank or savings and loan holding companies.

Challenges of Expanding the Capital Purchase Program Framework to Insurance Entities

Expansion of the current CPP framework poses significant challenges to Treasury and raises regulatory issues for the insurance industry:

  • Any expansion of the CPP to insurers would need to include mutual insurers and mutual insurance holding companies. It is reasonable to assume that if the CPP were to be extended to the insurance industry, any program to accommodate mutual banking or savings and loan institutions would need to make similar provisions for mutual insurers and mutual insurance holding companies.
  • Assuming that CPP participation would be made available to mutual insurers and mutual insurance holding companies, capital infusions would have to be effected by Treasury purchasing equity contribution certificates or other equity-like securities of the mutual entity.
  • Corporate structural issues aside, some news reports suggest that Treasury may be uncomfortable with investing in insurers without clear evidence that such investments would promote market stability and not merely shore up the balance sheets of insurers that have suffered declines in equity investments due to market downturns.
  • Under the current CPP framework, Treasury may invest in senior preferred shares of a QFI equal to not less than 1 percent of the institution’s “risk-weighted assets” and not more than the lesser of (i) $25 billion and (ii) 3 percent of such assets. “Risk-weighted assets”, which are assets weighted for credit risk as prescribed by applicable banking law, are corollaries to risk-based capital tests under the insurance laws of the various states. The diverse types of insurers that may be eligible for expanded CPP participation, including direct property and casualty insurers, direct life insurers, property and casualty reinsurers, life reinsurers, accident and health insurers, workers compensation insurers, financial guaranty or mortgage guaranty insurers, have differing capital and investment requirements. Treasury would need to address these differences when considering the investment parameters of an expanded CPP applicable to insurers.
  • All QFIs eligible for CPP participation as banking or savings and loan institutions under the current framework are regulated at the federal level. Treasury and the other federal banking regulators have extensive expertise in the regulation of these institutions, whether they are federally or state chartered. The vast majority of U.S. insurance holding companies and all U.S. insurance companies which may benefit from an expanded CPP framework, however, are state regulated. Treasury sources quoted in published sources have acknowledged their concern that federal regulators do not have the expertise to evaluate the financial strength of insurance institutions. Our sources suggest that if the CPP were to be extended to the insurance industry, Treasury would chose the Federal Reserve to act as the monitoring agency for CPP participating insurance entities.
  • It cannot be lost on the insurance industry, whether proponents or opponents of CPP participation, that centralizing the monitoring function for insurance in the federal government, albeit for this limited purpose, may hasten the enactment of an optional federal charter law for insurers.