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NAIC considers efficacy of anti-fronting bill.

The National Association of Insurance Commissioners continues to consider a model act that would restrict the ability of licensed insurers to reinsure with unlicensed reinsurers. The latest draft of the Limitations on Reinsurance Activities of Insurers Model Act contains several exceptions, including one intended to apply to business reinsured to captives:

"The policyholder whose business is ceded under the reinsurance agreement controls or is affiliated with the unlicensed assuming insurer ... is a corporation that has and maintains a net worth of more than $50 million as evidenced by a financial statement certified by an independent certified public accountant, which statement shall be submitted on an annual basis to the licensed insurer; and such corporation [i.e., the insured] agrees, in writing, that it will indemnify the licensed insurer or its estate for any losses resulting from failure of the unlicensed assuming insurer to meet its obligations under the agreement..."

The exception does not sufficiently deal with captive situations for several reasons. First, many entities that form wholly owned captives or participate in group captives do not have $50 million in net worth. Thus, this requirement will prevent many smaller businesses from participating in captives.

Second, the indemnification requirement may eliminate insureds' ability to deduct premiums paid to captives regardless of such recent decisions as Humana, Inc. v. Commissioner and The Harper Group, et al. v. Commissioner. If an insured must guarantee the risk payment it has insured with the fronting company, the Internal Revenue Service will probably argue that no transfer existed and, consequently, no premium deduction will be afforded.' Instead, losses will be deductible when paid. Third, the requirement will also cause many corporations to seek waivers of loan indentures and other contract provisions that preclude such guarantees.

The 'Regulatory' Exclusion

The 1991 Minnesota case of St. Paul Fire and Marine Insurance Co. v. FDIC considered whether the "insured vs. insured" exclusion or the regulatory" exclusion in a directors' and officers' liability policy purchased by a financial institution precludes recovery against the insurer. The issues have been considered in other cases with varying results.

In this case, however, St. Paul initiated an action against the Federal Deposit Insurance Corp. seeking a determination that it is not obligated to insure either the former State Bank of Greenwald, MN, or certain former officers and directors.

Regarding the insured vs. insured exclusion, the FDIC argued that the clause was ambiguous because it did not clearly explain whether a receiver or purchaser of the bank would be treated as an insured. The court agreed that the clause could be interpreted more than one way and construed the policy against the insurer, finding that the exclusion did not preclude coverage for suits by the FDIC.

The FDIC made a similar claim concerning the regulatory exclusion, which specifically stated that no coverage was provided for suits brought by the FDIC. The court found that the "intent to preclude all suits brought by the FDIC could not be stated in more explicit language" and held that suits brought by the FDIC would be excluded by virtue of this exclusion.

The FDIC then argued that the regulatory exclusion should not be enforced as a matter of public policy. Indeed, the exclusion as interpreted by the court would hamper the FDIC's ability to discharge its statutory duties. The court rejected this argument, stating: "There is no evidence that enforcement of the Regulatory Endorsement will in any way contravene statutory law. There is no statute that expressly invalidates the regulatory exclusions in directors' and officers' liability policies. In addition, directors' and officers' liability insurance is optional under all the rules and regulations promulgated by the various regulatory agencies that oversee the bank."

The FDIC then argued that the exclusion would "bargain away" its right to "marshal and collect assets." The court rejected this argument, stating that the bank had not purchased a policy with an endorsement providing coverage in the event of a suit by the FDIC and, therefore, had no asset to marshal.

Finally, the FDIC, joined by the directors and officers, argued that the regulatory exclusion is not enforceable because it violates the directors', officers' and bank's "reasonable expectation" of coverage. The court concluded, however, that the reasonable expectation doctrine did not apply in Minnesota unless the policy provision is a "hidden major exclusion" and "unconscionable as a result of unequal bargaining power where the insured may have been misled." In the St. Paul case, the court stated that there is no basis for applying this doctrine.
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Title Annotation:Legal Considerations; National Association of Insurance Commissioners
Author:Wright, Bruce
Publication:Risk Management
Date:Aug 1, 1991
Words:750
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