T H U R S D A Y ,  N O V E M B E R  3 0 ,  2 0 0 6

Big “I” National News

Producer Compensation Issue Update

Spitzer Tells ACE, AIG, St. Paul Travelers, Zurich that Contingents Are Out 

Attorneys general determine 65% tipping point reached in key lines.

New York Attorney General Eliot Spitzer will soon be sworn in as the Empire State’s new governor, but he had one last parting shot today for the insurance industry. As a result, four of the nation’s largest insurance companies will likely be barred from paying contingent commissions in six insurance lines for business written starting Jan. 1, 2007.

Earlier this year, the attorneys general of Connecticut, Illinois and New York entered into settlement agreements with ACE, AIG, St. Paul Travelers and Zurich that resolved charges and investigations resulting from the now famous Marsh bid-rigging scandal. Under these nearly identical settlements, each of the four insurance companies agreed to discontinue the payment of contingent commissions to producers in any line of insurance where more than 65% of the national market share is written by (1) insurers who do not pay contingent commissions (a category that, under the agreement's terms, includes direct writers and captive agency companies) and (2) insurers who have entered into settlements with the three AGs that preclude such payments.

Earlier today, Spitzer notified the four companies that the 65% "tipping point" had been reached in six lines of insurance: homeowners multi peril; private passenger automobile physical damage; private passenger automobile no-fault; other private passenger automobile liability; boiler and machinery and financial guaranty. The official letters to the companies did not disclose the precise methodology and reasoning used in reaching the determination, but the decision was made after reviewing the A.M. Best market share information for calendar year 2005.

The newly triggered ban only applies to ACE, AIG, St. Paul Travelers and Zurich, and Spitzer informed the four companies that they must stop paying contingent compensation for the affected insurance lines beginning Jan. 1, 2007. The affected companies are expressly permitted to pay any contingent compensation "accrued or accruing" until the end of 2006, and there is also a provision in the settlements that states that the companies are not required to "take any action that would cause [them] to be in breach of an agreement" in force at the time the settlement was completed.

Today’s announcement did not come as a complete surprise, especially in the area of personal lines. Many of the very largest personal lines insurers are direct writers, largely captive or had entered into these settlements, and there has been some speculation that the combined market shares of those entities would exceed the 65% threshold.  It is not yet known if any of the affected carriers will challenge the calculations. For a variety of reasons (including its more competitive nature and the relative lack of direct and captive market share), most commercial lines appear less susceptible to meeting the 65% test. However, the fact that the impact of the new ban on contingent commissions will be most heavily felt in personal lines is particularly ironic considering that the wrongdoing uncovered in the wake of Marsh scandal involved both commercial lines and the country’s largest mega-brokers.

The three attorneys general have been criticized for using these and similar settlement agreements to bypass the lawmaking process and impose their world view and policy perspective on the insurance industry. Although the insurance company settlements with Spitzer and the other attorneys general were intended to resolve and remedy the alleged wrongdoing of the four insurers, it is the independent agent and broker community that will likely feel the impact of this determination. The payment of incentive compensation is appropriate, legal in every state and beneficial to all parties in an insurance transaction, yet the settlement agreements have now interfered with the private marketplace in unprecedented ways.

There are many questions that remain unanswerable in the immediate wake of today’s announcement. Some of the companies involved have already begun to move away from the payment of contingent commissions, but how might the compensation practices of the affected insurers change in the coming weeks and months? Jay Fishman, CEO of St. Paul Travelers, confirmed with IIABA today that, “In the end, producers expect us to pay a competitive, market-driven commission that differentiates for the performance of their business. And we will.”

At press time, comments were not available from the other affected carriers. Will one or more of the four companies elect to challenge this determination? How will this announcement and the new ban affect independent agencies that rely on this important and legal form of compensation? For answers and more information on this and related issues, stay tuned to IN&V in the weeks to come.

Wes Bissett (wes.bissett@iiaba.net) is Big “I” senior vice president, government affairs and state relations.

 

Legal Advocacy

Homeowners Obtain Favorable Ruling in Katrina Canal Breach Case

On Nov. 28 the United States District Court for the Eastern District of Louisiana issued an Order in the consolidated case “In re: Katrina Canal Breaches Consolidated Litigation.” The Order referred to the case as “the umbrella for all cases which concern damages caused by flooding as a result of breaches or overtopping in the areas of the 17th Street Canal, the London Avenue Canal, the Industrial Canal, and the Mississippi Gulf River Outlet.” Plaintiffs are homeowners in New Orleans who claim that their property sustained damage from a levee breach during Hurricane Katrina. Defendants are the insurance companies which wrote the insurance policies on plaintiffs’ properties.

Plaintiffs claimed that the “water damage inflicted on the [plaintiffs’] homes and property was not the result of flood, surface water, waves, [tidal] water, tsunami, seiche, overflow of a body of water, seepage under or over the outfall canal wall or spray from any of the above but was water intrusion, caused simply from a broken levee wall.” They also said the water damage to their homes was not an excluded loss and that the defendants were at fault for failing to pay for the water damage to their homes.

In examining the different policies of insurance applicable in the case, as well as existing case law, the court said that “As a general rule, insurance policies should be construed to effect, not deny coverage.” The court stated that in “all-risk” homeowner policies, any exclusion must be clear and unambiguous. The court noted that insurers can write clear exclusions if they choose to do so.

One of the homeowner policies discussed in the court’s order is the ISO form issued by defendants Standard Fire, Hartford, Hanover and Unitrin, all of which contain the same language:

Coverage A – dwelling and coverage B – other structures: We insure against risk of direct loss to property described in coverages A and B only if that loss is a physical loss to property.

The exclusion below to that coverage appears later in the policy:

1) We do not insure for loss caused directly or indirectly by any of the following. Such loss is excluded regardless of any other cause or event contributing concurrently or in any sequence to the loss.

(c) Water Damage, meaning:

Flood, surface water, waves, tidal water, overflow of a body of water,
or spray from any of these, whether or not driven by wind.

The Court found the Water Damage Exclusion on the ISO form was ambiguous and that “(W)hen the ambiguity relates to an exclusionary clause, the law requires that the contract be interpreted liberally in favor of coverage.” The Court stated that “(T)o find that the ISO language clearly excludes negligent acts would be to reward and encourage the use of vague language.  This determination is underscored by the fact that the tension between natural flooding and flooding caused by negligent or intentional acts has existed for decades; obviously, some insurers made efforts to be clear in their intentions.”

According to the Court, “(A)n insured may reasonably expect overtopping of a levee, but on the other hand an insured may not reasonably expect that levees designed and certified by the United States Corps of Engineers would fail as a result of negligent design and construction as has been alleged.”  Based on the Court’s analysis,  motions to dismiss brought by defendant insurers using the ISO form were denied.

Conversely, the Court found that the State Farm policies contained a lead-in whose specificity removes the ambiguity concerning whether the flood was natural or man-made.

The State Farm policies provide:

Section I – Losses Not Insured

2.  We do not insure under any coverage for loss which would not have occurred in the absence of one or more of the following excluded events.  We do not insure for such loss regardless of: (a) the cause of the excluded event; or (b) other causes of the loss; or (c) whether other causes acted concurrently or in any sequence with the excluded event to produce the loss; or (d) whether the event occurs suddenly or gradually, involves isolated or widespread damage, arises from natural or external forces, or occurs as a result of any combination of these:

c. (1) flood, surface water, waves, tidal water, overflow of a body of water, or spray from any of these all whether driven by wind or not:”

The Court found that the State Farm policy does exactly what the Water Damage Exclusion on the ISO form failed to do:  it makes it clear that no coverage will be provided for flooding “regardless of the cause.”  The Court found that it was the clear intent of this language to exclude coverage for all flooding.  As a result, State Farm’s motion to dismiss was granted.

The Court distinguished this case from previous Hurricane Katrina cases by noting that “(T)he allegations before the Court are not analogous to those which the Mississippi federal courts are facing in Buente v. Allstate Ins. Co…” in that “(T)his case does not present a combination of forces that caused damage such as wind versus water as was present in the natural disaster which the Mississippi Gulf coast experienced as a result of Hurricane Katrina.”

The parties will have 10 days from the entry of the Court’s Order to decide whether to appeal the Court’s decision to the 5th Circuit Court of Appeals.  Both Allstate and St. Paul Travelers have been cited in the press as saying that they will appeal the ruling.

The Office of the General Counsel will provide updates as significant developments in the case occur.

For more information, contact IIABA Assistant General Counsel Amy Hendricks at (800) 221-7917; amy.henricks@iiaba.net.



Legal Advocacy

Supreme Court Hears Important Federal Preemption Case 

On Nov. 29 the United States Supreme Court heard oral arguments in the case of Watters v. Wachovia Bank, N.A. The case specifically pits state regulation of mortgage lending against federal preemption by the Office of the Comptroller of the Currency (OCC) and more generally addresses when federal regulations can preempt state law.

The case stems from a reorganization of Wachovia Bank.  In the reorganization, Wachovia Mortgage became a “nonbank operating subsidiary” of Wachovia Bank, a national bank. Wachovia Mortgage is a state-chartered subsidiary of Wachovia Bank and is a mortgage lender, but not a national bank. Wachovia Bank, by virtue of its national charter under the National Bank Act (NBA), is regulated exclusively by the OCC. Since national banks are federally regulated, states have no authority to supervise or regulate them unless expressly permitted by federal law. However, in 2001 the OCC enacted a regulation extending the NBA and OCC exclusive oversight to state-chartered nonbank operating subsidiaries of national banks. The effect of this was to preempt state regulatory power over those entities.

The question now before the Supreme Court is whether the OCC properly extended its authority to regulate nonbank subsidiaries of national banks. If so, state laws and regulations in this area would be preempted and states would be prohibited from exercising supervision, examination and enforcement authority over nonbank operating subsidiaries of national banks.

By way of background, Watters is the Commissioner of the Michigan Office of Financial and Insurance Services, the Michigan governmental entity that regulates mortgage activities. Wachovia initially brought this action in federal district court seeking a ruling that Michigan statutes as applied to Wachovia Mortgage were preempted by the NBA and OCC regulation. Wachovia has prevailed at both the federal district court and on appeal to the federal Circuit Court.

It is noteworthy that all federal court decisions that have been reported on this issue have ruled in favor of OCC preemption of state law.  So, it was surprising to some that the Supreme Court agreed to hear this case because the Supreme Court usually does not accept cases like this unless there is a split in the federal circuit courts.

Watters Arguments
In briefs to the Supreme Court, Watters makes four primary arguments:

•First, the lack of authority by states over national banks is limited only to national banks, not their nonbank operating subsidiaries. If Congress wanted to extend the exclusive powers of the OCC to nonbank operating subsidiaries, it could have and would have done so, but it did not. Absent such congressional authority, the OCC had no power to enact a regulation preempting state authority over nonbank operating subsidiaries of national banks.

•Second, because the ability of the federal government to preempt state law is an extraordinary power, there is a presumption against preemption unless the intent to preempt is express. Here, since consumer protection involving mortgages has largely been regulated by states, Watters asserts that the court should not conclude that the OCC has authority to preempt state law.

•Third, the OCC regulation ignores basic corporate law principles that provide that a parent corporation is a separate legal entity from its subsidiaries. Unless there is explicit language in federal law permitting this approach, Watters argues that state corporate law should prevail. The argument then explains that as a subsidiary, Wachovia Mortgage is a separate and distinct entity from Wachovia Bank, so Wachovia Mortgage should not be treated as a national bank simply because its parent is a national bank.

•Fourth, Watters argues that the OCC regulation violates the 10th Amendment of the United States Constitution, which states that “the powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.” The essence of this argument by Watters is that the OCC regulation transforms the state-chartered corporation into “(a) creature of the federal government” in violation of the 10th Amendment. In other words, Watters maintains that the OCC’s regulation unconstitutionally encroaches on a power not delegated to the federal government, and thus it should be left to the states.

Wachovia Arguments
In its brief, Wachovia Bank argues that Michigan law is preempted by the NBA, based on the following points:

•First, the NBA grants national banks both specific enumerated powers and “incidental powers” to carry on the business of banking. This allows the OCC to  determine how broadly to interpret those “incidental powers,” including to apply them to include mortgage lending done by a subsidiary of a national bank.

•Second, Congress, through the Gramm-Leach-Bliley Act, has determined that subsidiaries of national banks are subject to the same “terms and conditions” that apply to national banks, and therefore, state statutes are preempted by federal law on topics covered by federal law. Wachovia Bank also asserts that while the NBA does not specifically say that nonbank operating subsidiaries are subject to the OCC’s exclusive authority, that it is implicit in the law.

•Third, the OCC regulation is a valid exercise of rulemaking authority by a federal agency. As such, the OCC regulation is entitled to deference in the courts, and thus should be upheld.

•Fourth, only the banking activities conducted through a subsidiary of a bank are subject to OCC regulation, so state corporate laws are not affected.

•Fifth, Wachovia Bank argues that the Tenth Amendment of the United States Constitution is not violated because Congress has the power to regulate commercial lending, which is the only thing covered by the OCC regulation. Wachovia Bank argues that this means that the states maintain their power under state corporate law.

Amicus Curiae Briefs
Interest in this case by the financial services industry is high, demonstrated in part by the fact that 14 amicus curiae (friend of the court) briefs were filed. The purpose of these briefs and value of them to the Court is to present information and context on the policy impact of the issue before the Court, rather than to make legal arguments for the parties based on the facts of a specific case.

For Wachovia Bank, eight amicus briefs were filed. They came from banking associations (including the American Bankers Association, Financial Service Roundtable, Mortgage Bankers Association and other state and national banking associations), the United States, the Chamber of Commerce, law professors from George Washington University and two other universities and economists from universities and think tanks (including Stanford University, University of Chicago, American Enterprise Institute and the Brookings Institution). Generally, the majority of these briefs focus on the need for consistent regulation of financial services. They argue that such consistency can only be obtained through federal regulation and not through regulation by the states. The United States and the law professors maintain that the OCC regulation is a reasonable interpretation of the NBA and entitled to deference. The economists argue that state regulation could have an anti-consumer effect of making home loans more expensive.

On behalf of Watters, six amicus briefs were filed. These briefs were filed by the National Association of Realtors, various associations and law professors focused on consumer issues (including AARP, Consumer Federation of America, Public Citizen, Trial Lawyers for Public Justice, and law professors from Yale and other universities), the state attorneys general for the other 49 states plus Puerto Rico and the District of Columbia and some other groups representing state and local governments (including the National Governors Association, National League of Cities, National Conference of State Legislatures, U.S. Conference of Mayors, Conference of Bank Supervisors and others). These briefs generally follow one of two themes. First, state law should not be preempted merely because a federal agency determines itself that it can preempt state law. Absent a clear intent by Congress to allow state law to be preempted, there should be a presumption against preemption. Second, the OCC does not do a vigilant job of consumer protection, and the states are in a better position to protect consumers from abuses like predatory lending, so state law should not be preempted.

Oral Arguments
The Supreme Court justices heard oral arguments on this case yesterday.

When questioning Watters’ counsel, the justices asked why a subsidiary of a national bank should be subject to state regulation when the national bank itself could conduct the same activity and be regulated by the OCC, not the state. The justices questioned the logic of Congress allowing national banks to engage in banking activities through a subsidiary, when the national bank is regulated by federal law and the subsidiary is regulated by state law. Watters’ argued that banks are trying to “have their cake and eat it too” because banks want the subsidiary to be treated as a separate entity for liability purposes but treated as a national bank in order to get immunity from state regulation.

During the argument on behalf of Wachovia Bank, the justices followed up on the idea of the banks “having their cake and eating it, too.” They asked if national bank subsidiaries, by being treated as a national bank to get immunity from state regulation, would be in a better competitive position than other mortgage lenders subject to state regulation. Counsel for Wachovia responded that the NBA was enacted before nonbank subsidiaries were permitted, so Congress could not have intended to address how they would be regulated. He added that Gramm-Leach-Bliley was enacted after nonbank subsidiaries were permitted, so Congress had the ability to determine if they should be subject to the same “terms and conditions” as national banks, and did so. He also stated that the extension of OCC exclusive authority over subsidiaries of national banks is supported by the overall federal banking scheme.

Impact on the Insurance Industry
This decision will be important for the insurance and financial services industries, and potentially could have application to the many other industries regulated at both the federal and state levels.

If the OCC position is upheld allowing it to preempt state regulation of a national bank operating subsidiary, many think that the OCC will feel empowered to expand its reach further in order to regulate the insurance activities of national banks. If this happens and state insurance laws are preempted for insurance affiliates of national banks, the result will be a dual system of regulation –a federal system for national bank affiliates and a state system for insurance carriers and agencies not affiliated with a national bank. In addition to the general confusion this would cause consumers about whether state or federal laws govern their transactions and what regulator oversees abuses or problems, it also will add fuel to the arguments advanced by supporters of Optional Federal Charters because they will argue that a federal charter is needed to level the regulatory playing field by circumventing requirements to comply with varying state laws.

The broader issue posed by this case is how far the federal government can go generally  in preempting state laws. It is likely that any precedent set by the new Roberts court will be used as a sword by whichever side is successful. If the OCC’s preemption of state law is upheld, it may open the door to preemption arguments on a wide range of other issues where states have consumer protection laws in place and the federal government also has a regulatory scheme work. This could arise in areas as divergent as environmental protection, civil rights, labor practices, health and safety issues and so on.

The decision in this case is not expected for several months. When it is issued, IIABA will provide an update.

For more information, please contact Debra Perkins, Big “I” executive vice president and general, at (703)706-5426; debra.perkins@iiaba.net or Kathleen Graber, IIABA associate general counsel at (703) 706-5432; kathleen.graber@iiaba.net.

P-C Trends

Banking on Insurance 

Study gauges health of nation’s top banks in insurance.

Commercial p-c is the dominant insurance category among the nation’s top banks in insurance, according to the 2006 edition of “Who’s Who in Bank Insurance.”

The study, written by Andrew Singer of the Bank Insurance & Securities Association, examines the top 100 banks and thrifts in the insurance brokerage business. The study was conducted to determine the status of the industry by focusing on the top banking insurance brokerages exclusive of annuities and credit-related insurance, according to the Bank Insurance Market Research Group, which publishes the study.

Citigroup, Inc. tops the list of the top 100 banking insurance brokerages, and eight of the top 10-ranked institutions achieved their positions through the acquisition of commercial p-c agencies, including Wells Fargo & Company (second), BB&T (third), Wachovia (fifth), Bank of America (sixth), Grater Bay Bancorp (seventh), UnionBanCal Corp. (eighth), Commerce Bancorp, Inc. (ninth) and Regions Financial Corporation (10^th). JPMorgan Chase & Co. rounds out the list as the fourth-ranked institution.

According to the study, this year commercial lines will account for 73% of bank insurance programs, down from 79% in 2005. While the drop is not dramatic, it may be an indication of a trend in the industry.

“The drop in commercial lines to from 79% to 73% is not very steep, and it may not even be statistically significant,” Singer says. “However, there is no question that more banks are interested in employee benefits, and there has been some movement in the last few years toward banks acquiring employee benefits agencies rather than commercial lines agencies.”

According to the study, insurance underwriting has also dropped among some U.S. depository institutions---evident by Citigroup and JPMorgan Chase’s departure from the market---yet depository institutions continue to grow their insurance brokerage businesses.

Bank brokerage revenues are expected to total nearly $4.2 billion in 2006 and the study forecasts that, if the growth trend continues, bank-owned insurance operations will account for 10% of the total net written p-c premiums by 2008. However, profitability among these institutions is still relatively low.

Insurance contributions to net earnings lagged behind the contribution to non-interest income or revenues. Of the 23 institutions that reported net income numbers, the median contribution to the parent company’s net income was a menial 4.4%, meaning that for every $100 of profits the bank generated, only $4.40 were generated by insurance.

“The profit margins are low relative to some other bank income sources,” Singer says. “Commercial lines firms pay relatively hefty commissions to their brokers, for instance. By contrast, a bank that is drawing most revenues from low-touch credit insurance, like Doral Financial, has higher profit margins. Doral’s ratio of insurance net income to insurance revenues was 68%, much higher than the other 22 banks for which we have net income insurance data. That’s because they sell primarily credit-related insurance. For most commercial-lines-dominated bank insurance operations, that ratio is about 15%.”

The study also polled the top 100 institutions on cross-selling insurance and, of the 31 institutions that shared cross-selling ratios, the median rate was 14%. This means that 14% of new insurance business in 2006 was expected to come from bank customers or bank referrals, but Singer says most institutions are aiming slightly higher.

“Most banks would prefer to get their cross-selling ratios into the 20% range or higher,” Singer says. “Recently, a few bank agencies have stated that they don’t want this ratio to rise much beyond 25%, however, because they don’t want their producers to be simply ‘referral handlers.’ Most banks, however, wouldn’t mind a higher ratio. Robert D. Davis, CEO at Leesport Financial, told us that a high cross-selling ratio means more customers are buying multiple services from his institution, which means they are less likely to bolt Leesport for another bank or financial intermediary.”

For more information or for a copy of the study,  click here.

Michelle Payne (michelle.payne@iiaba.net) is a Big “I” writer/editor.

L&H Trends

Mixed Messages on Setting Financial Priorities

Common postscripts to the Thanksgiving holiday are reports on the amount of consumer spending that took place on Black Friday and the following weekend. Economy watchers scan the data to discern whether consumer confidence is on the rise or decline. In fact, the feedback almost portrays consumer spending as a patriotic act since it helps stimulate the economy. So what's the problem? The problem is that the emphasis on consumer purchases permeates the media and influences the attitudes of Americans. In essence, the message is that buying the latest video game or big screen television actually helps everyone else. 

The issue is really one of priorities. First, installment debt is at an all-time high, leading to high credit card balances and correspondingly high-interest charges, particularly among young people. Give the typical person a choice between having a long-term care policy or buying a plasma television and immediate gratification tends to win out with the purchase of the TV.

The role of the independent agent becomes all the more challenging in motivating customers into taking a long-term view of the world. Instead of citing statistics and other related information, the best thing for an agent to do is to remind customers of Aesop’s fable about the grasshopper and the ant. The grasshopper spent an entire summer playing while the ant prepared for the upcoming winter season. Then when winter came the grasshopper was dying of starvation while the ant had plenty of food. The moral of the story: it’s best to prepare ahead of time.

In Aesop's day, people understood they were on their own. Today, many Americans believe the government has a program to take care of them. For example, studies point out that many people believe Medicare covers nursing home costs. Yet, the reality is that Medicare pays limited benefits towards nursing home care, typically following a period of hospitalization. In fact, according to the results of a study commissioned by the New York Life Long-Term Care Division, the average cost for nursing home care in the United States climbed significantly in 2006. This study indicates that the costs for both private and semi-private care are 6% higher than in 2005. The average cost of a private room with a single occupant climbed to $204 dollars a day, or $74,445 a year. Non-private rooms, based on double occupancy, rose to an average of $180 dollars a day, or $65,700 a year. Nationwide, the average private room rate increased by $11 per day, or $4,015 per year. The average semi-private room rate rose by $10 per day, or $3,650 per year.

The only weapon to combat ignorance is education. Agents need to reinforce the exposure of this huge risk to a person's financial independence by having information on their Web sites, in pamphlets in their offices and in occasional mailings. You'll be doing society a favor by having one or two more people who will be in a position to pay for their own expenses in the event they need long-term care.

Dave Evans (dave.evans@iiaba.net) is a certified financial planner and an IA l-h contributing editor.



Carrier News

Fireman’s Fund Names New CEO 

Fireman’s Fund will soon have a new chief executive officer. The company’s board of directors recently appointed Joseph Beneducci to the position, effective Jan. 1, 2007.

He succeeds Charles Kavitsky, who was promoted to president of Allianz of America, a holding company for Allianz AG Insurance Group, which bought Fireman's Fund in 1991.

Beneducci has served as Fireman’s Fund’s president and chief operating officer since February 2006. He joined Fireman’s Fund in 1998 after a 10-year career at Chubb, according to a company release.

“The appointments reflect Allianz’s ongoing commitment to the U.S. market,” Allianz of America spokeswoman Sabia Schwarzer told the Marin Independent Journal.

Fireman's Fund's premium volume so far this year is $5.6 billion, according to the San Francisco Business Times.