THIRD ANNUAL FINANCING, GROWTH & COMPETITIVE STRATEGIES FOR MUTUAL INSURANCE COMPANIES
FINANCIAL MODERNIZATION LEGISLATION:
IMPACT ON THE FINANCIAL SERVICES INDUSTRY
Douglas P. Faucette, Esq.
Muldoon, Murphy & Faucette LLP
5101 Wisconsin Avenue, N.W.
Washington, D.C. 20016
March 17-19, 1999
DOUGLAS P. FAUCETTE is a partner in the Washington, D.C. law firm of Muldoon, Murphy & Faucette LLP and heads up the firm's Banking and Financial Services Practice Group. His practice involves the representation of financial services companies, including insurance, investment banking and real estate companies, commercial banks, savings associations and credit unions before the U.S. Securities and Exchange Commission, the federal and state regulatory agencies and the U.S. Congress.
Muldoon, Murphy & Faucette LLP has worked with insurance companies over the years on a variety of legal matters, including companies such as Manulife, Liberty Mutual, The Principal Group and The Franklin Life Insurance Company. Mr. Faucette's representation of financial services companies spans a wide variety of matters including public and private securities offerings, mergers and acquisitions, executive compensation and employee benefits and governmental relations. Mr. Faucette has been involved in the passage of all major financial institution legislation in the past decade, including FIRREA and FDICIA, and over the years the firm has ranked among the top lobbying firms for financial institutions. In recent years, Mr. Faucette has devoted a substantial amount of his time to structuring demutualization plans for financial services companies, including mutual to stock conversions and mutual holding company reorganizations. Muldoon, Murphy & Faucette LLP has a reputation for innovation and has been responsible for almost every major precedent set in conversion and mutual holding company transactions during the last decade. Mr. Faucettes expertise and experience in advising clients on the demutualization process has been instrumental in the firm achieving the number one ranking of law firms in the aggregate amount of proceeds raised in conversion transactions. Muldoon, Murphy & Faucette LLP attorneys have served as counsel in more than one hundred and fifty mutual-to-stock conversions and mutual holding company reorganizations and during the last decade the firm has assisted its clients in raising more than $5.0 billion in proceeds. Mr. Faucette has been involved in the demutualization of almost every savings institution in the country with assets in excess of $1 billion.
Prior to joining the firm, Mr. Faucette was the director of the securities division and senior associate general counsel for a federal government agency that is now a bureau of the U. S. Department of Treasury. In such capacity, Mr. Faucette was responsible for developing the legislation and regulations that established the basis for the demutualization of thrift institutions. He also exercised legal oversight responsibilities for all merger and acquisition transactions and all corporate operational matters, including proxy issues.
Mr. Faucette has spoken on a broad spectrum of financial institution topics at hundreds of conferences and seminars and has authored numerous articles about financial services companies.He is also a nationally recognized expert in the field of financial institutions law, is frequently quoted in the national media and has appeared on such television programs as the CBS Evening News with Dan Rather and the MacNeil-Lehrer Report.
Mr. Faucette received his law degree from Suffolk University Law School and served as an editor of the Suffolk University Law Review. He received his undergraduate degree from the University of Massachusetts (Amherst) where he played varsity football.
Financial Modernization Legislation:
Impact on the Financial Services Industry
Where We Are and How We Got There
"As recently as thirty years ago, Americans lived in a financial world that today seems a bygone era. Investment choices were meager. If you valued safety above all else, you could invest in a government savings bond or in a federally insured savings account that could pay no more annual interest than the mandated ceiling rate of just over 5 percent. If you wanted to take a little more risk, you could buy "whole life" insurance, with a cash surrender value that would increase over time; you could buy mutual fund shares, but only a few funds were available; you could buy stock, but only from a brokerage firm that charged high commissions at fixed rates. If you had a pension plan, you probably did not control its investments, and when you retired you hoped that the company you worked for was still around to honor its commitments. Even so, you probably stored much of your wealth in your house Eits value and that of its furnishings.
When Americans borrowed money, they also faced what today seems a stark poverty of choices. Shopping for credit, for most people, was virtually synonymous with shopping for a bank. And when you did borrow from the bank, you probably filled out lots of forms, pledging as collateral whatever assets you may have owned Eif, that is, you were lucky enough to get the loan at all.
Or take the most basic financial service of all, making payments. If you paid in cash for the goods and services you bought, you almost certainly filled your wallet only after standing in line at a bank and waiting for a teller to cash your check (or, in some cases, waiting for the supermarket clerk to do it for you). You probably made most of your payments by check, drawn on accounts that, by federal dictate, could not pay interest. You may have used a credit card Eif, that is, you were one of the relatively few people who qualified for one Ebut probably just for a few purchases. Millions of Americans who today use credit cards just as readily as they use cash are old enough to remember when "charge it" was a phrase for special occasions."
This quote appeared in a report that the Department of Treasury prepared and issued in 1997 to study and consider the anticipated changes in the financial services industry over the next several years and review the adequacy of existing laws and regulations. As the quote recognizes, the financial services industry has experienced remarkable changes in the last three decades, changes that have had profound consequences for all companies that provide financial products and services. Perhaps the most significant consequence has been the dramatic expansion of the competitive landscape. Insurance companies no longer compete solely, or even principally, with other insurance companies, just as banks no longer compete solely with other banks. With the increase in the types of financial products available and the technological advancements in the means of distributing those products, as well as changes in the attitudes, preferences and needs of consumers, the competitive boundaries separating insurance companies, banks, securities firms, mutual funds, finance companies, etc., have all but disappeared.
One of the byproducts of this increased competition is the consolidation and homogenization of the financial services industry. In recognition of the changed financial services landscape, larger financial institutions, including banks, insurance companies and securities firms, have made competitive efforts to enhance market share by offering a complete range of financial services and products on a national, and even global, basis. This was dramatically underscored by last years merger of Citicorp and Travelers, which created the largest financial services company in the world. Although there has been much talk in recent years about the creation of the one-stop-shopEfinancial center, Citigroup represents the first attempt to put this concept into action.
Despite these dramatic and dynamic changes, the financial services industry remains largely governed by the same legal and regulatory structure that has been in place since the 1930s. Legislators and regulators, however, are slowly but surely recognizing that this structure can no longer accommodate or control the economic and market realities of today. For instance, in recent years, Federal bank regulators, principally the Office of the Comptroller of the Currency (OCCE, have aggressively interpreted the statutes governing the powers of national banks to expand the ability of banks and their affiliates to sell insurance products.In addition, the Board of Governors of the Federal Reserve System (Federal Reserve BoardEor FRBE has gradually whittled away the barriers between banks and other financial companies by expanding the scope of permissible securities underwriting activities for bank holding companies and by approving the Citicorp/Travelers merger. Perhaps most significantly, Congress is closer than ever to enacting broad based financial modernization legislation.
Financial Modernization Legislation: Crisis or Fate Accompli?
Congress typically enacts significant legislation regulating commerce in two scenarios: (1) in response to a crisis or (2) when economic or market forces have already rendered the change in policy a fate accompli. The current legal system governing the financial services industry was created in response to a crisis: the Great Depression. The current attempt to modernize that system, on the other hand, is more accurately described as an attempt to ratify what in many respects is already a fate accompli.
In response to the thousands of bank failures during the Great Depression, Congress and Federal regulators identified several objectives in restoring the health of the financial industry, one of which was to prevent future bank failures. One of the major policy linchpins for preventing bank failures was to limit competitive pressures on depository institutions; thus, beginning with Depression-era legislation such as the Glass-Steagall Act of 1933 and continuing with the Bank Holding Company Act of 1956, Congress placed ceilings on the interest that depository institutions could pay their depositors, limited the ability of banks to branch across state lines and limited banks in their ability to engage in nonbank financial activities, including securities and insurance underwriting. Over the years, many of these restrictions have been weakened or eliminated, largely because they proved ineffective at shielding depository institutions from the economic and technological advances that have unleashed an ever increasing array of financial products and financial intermediaries. Thus, in order to give depository institutions greater flexibility to respond to these competitive pressures, Congress has eliminated many of the limits on the rates institutions can pay on deposits and the restrictions on interstate branching, while Federal regulators have eviscerated many of the restrictions on the ability of banks or their affiliates to engage in insurance, securities and other nonbank financial activities, culminating in the approval of the Citicorp/Travelers merger.
The effort to modernize the laws governing the financial industry by eliminating the restrictions on affiliations between banks and other financial companies has been ongoing for many years, but the enactment of legislation has only become a realistic possibility in the last year. Traditionally, the concern of the various industry groups with protecting their competitive advantages under the current system has been the greatest obstacle to legislation. Last year, however, the House of Representatives passed H.R. 10 by one vote after much debate and compromise. Additional compromises were made in the Senate Banking Committee, but Republicans on the Committee, led by Senator Phil Gramm (R-TX), raised objections about certain provisions in the bill that they believed expanded the scope of the Community Reinvestment Act (CRAE and the Session ended before a vote was taken in the full Senate.
Status of Current Proposals
Representative James A. Leach (R-IA), Chairman of the House Banking and Financial Services Committee, reintroduced H.R. 10, which was based largely on the Senate compromise bill drafted prior to the conclusion of last years Session:
Last fall we came close to achieving consensus and the bill before us reflects compromises hammered out over four years of consideration.E/P>
The House Banking Committee held hearings on the bill in early February 1999, at which federal and state regulators, representatives of the insurance, banking and securities industries, and representatives of consumer groups testified. Chairman Leach agreed to some revisions to the bill that gained the support of several Committee Democrats, as well as the Treasury Department. The Banking Committee completed its markup and passed by a bipartisan 51-8 vote on March 11, 1999. Treasury Secretary Robert Rubin has expressed the Clinton Administrations strong supportEfor the House bill. The entire House of Representatives is expected to consider the bill in late Spring 1999.
In the Senate, Senator Gramm, who assumed the chairmanship of the Senate banking Committee this year as a result of former Senator DAmatos defeat in last Novembers elections, introduced a financial reform bill and then held hearings in late February 1999. Senator Gramms bill was much more scaled down than H.R. 10 and Senator Gramm has stated his preference for a bill that is simpler than H.R. 10:
H.R. 10 is 318 pages long. You can knock down the barriers that separate the insurance, banking and securities industries in about 65 pages.E/P>
The initial version of Senator Gramms bill drew significant criticism from various representatives of insurance companies and agents on the grounds that it did not include sufficient detail on such matters as the definition of insuranceEand protection from federal preemption for various state consumer protection laws directed at insurance sales by banks. Their primary concern was that the lack of detail would hinder the ability of state regulators to regulate insurance activities free from interference by federal bank regulators. After consultation with insurance groups, Senator Gramm included the definition of insuranceEset forth in H.R. 10 to his bill and during markup, the Committee voted in favor of an amendment to the bill to include safe harbor protections for certain state consumer protection laws.
The Senate Banking Committee completed its markup and passed the bill by an 11-9 vote on March 4, 1999. The vote was along partisan lines, with Republicans supporting the bill and Democrats opposed. The full Senate is expected to take up the bill in late Spring 1999.
Although there are significant differences in the House and Senate bills that must be worked out, each bill provides for the following:
Prospects for Enacting Legislation This Year
Several factors suggest that there is a better chance to enact legislation this year than at any previous time since serious attempts at financial modernization legislation began.
Although many of the necessary pieces for enacting a bill this year are in place, significant hurdles remain, including serious disagreements between Senator Gramm and the Clinton Administration.
The Citicorp/Travelers Merger and its Impact on Financial Modernization Legislation
The merger of Citicorp and Travelers provides the clearest indication yet that the world envisioned by the financial modernization proposals before Congress is already here. Citigroup, Inc. is the first global financial supermarket, with assets of approximately $700 billion and more than 100 million customers in 100 countries, and offers a complete array of financial services, including commercial and consumer banking, insurance underwriting and sales, securities brokerage and underwriting, investment services and consumer finance. There were at least three principal objectives for the merger:
It remains to be seen whether Citigroup will be able to successfully integrate the large, varied and complex businesses of Citicorp and Travelers, not to mention the different cultures of the two companies. Further, to date, the merger has not unleashed a wave of other banks, insurers and securities firms looking to establish global financial supermarkets. Nonetheless, Citigroups stated goal of becoming the premier financial services provider for retail customers and the resources it commands to achieve this goal unquestionably presents a significant competitive challenge for all financial companies, large and small. Further, the creation of Citigroup is likely to have a significant impact on the effort to reform the antiquated laws governing the financial services industry, although what shape that impact takes remains to be seen.
Current Model for Bank/Nonbank Affiliations
Pending the enactment of financial modernization legislation that permits affiliations between banks and nonbank financial companies, the Federal Reserve Boards order approving the Citicorp/Travelers merger (Citigroup OrderEor OrderE serves as the model for future mergers between banks and nonbanks. As a review of the Citigroup Order reveals, much of what the reform legislation seeks to accomplish is already permissible under the current legal and regulatory regime. Although Citigroup will have to eventually divest its insurance business if legislation is not enacted, almost all of the other activities conducted by Citigroup, which constitute a substantial majority of its business, are permissible under current law.
Although, the proposed creation of Citigroup engendered much controversy and debate about whether the merger was permissible under Glass-Steagall and the Bank Holding Company Act (BHC ActE, the FRB found that a substantial majority of TravelersEbusiness is permissible for a bank holding company. Indeed, the Citigroup Order noted that activities conducted by Travelers that do not conform to current law represented, on a pro forma basis, less than 15% of Citigroups total assets and less than 20% of its revenues. Central to the Order was the FRBs discussion of TravelersEpermissible activities, in particular, its securities underwriting and brokerage activities.
The Citigroup Order imposes few specific conditions and provides Citigroup with time and flexibility to conform its business to current law. Under the BHC Act, Citigroup has up to two years to comply with the Act and can apply to the FRB for an extension of up to an additional three years. Significantly, the Citigroup Order does require Citigroup to develop a specific plan for divesting its insurance business and permits cross-marketing between its insurance and banking businesses during the two (possibly five) year grace period for conforming its activities to the BHC Act. Specifically, the order requires that Citigroup:
Operation of Citigroup
Under the FRBs Order, Citigroup can continue to operate as much as 75% of its business indefinitely without significant limitation. Clearly, enactment of reform legislation that removes the barrier between commercial banking and insurance would best facilitate Citigroups ability to recognize its primary objective: cross-marketing of its banking and insurance products. Nonetheless, even if legislative efforts fail, Citigroup has other options to continue its insurance underwriting business:
Thus, regardless of what happens in Washington, Citigroup will likely be able to accomplish 100% of what it intends from the merger.
Impact on Efforts to Enact Modernization Legislation
Initially, at least, the conventional wisdom was that the Citicorp/Travelers merger would serve as a catalyst for Congress to enact modernization legislation. Upon the announcement of the merger, proponents of financial modernization legislation argued that it was necessary to give providers, both big and small, . . . the same opportunitiesEas Citigroup. However, the merger has not produced a groundswell of additional support for legislation and may actually have dampened some of the urgency for legislation. The Citigroup Order establishes that bank holding companies can offer a full range of bank, securities, and other financial products and services under current law. As one bank lobbyist stated after the announcement of the merger, but prior to the Federal Reserve Boards approval, if this deal is legal under current laws it shows the market can go forward.E/P>
Although the Citigroup Order probably has not changed the minds of most bankers and insurers who have expressed a desire for modernization legislation, it almost certainly has changed the dynamics underlying the reform effort, particularly for bankers, in at least two respects. First, the Citigroup Order provides banks with a model of nonbank affiliation to compare to the ultimate legislative product. For many banks, the Order is likely sufficient to accommodate product and service expansion goals. Few banks, large or small, have indicated much interest to date in expanding their business to include insurance underwriting. Large banks have shown more interest in expanding their securities dealing and underwriting activities, while smaller banks are generally more focused on pursuing the insurance agency powers that many already possess. Therefore, even though reform legislation will provide greater flexibility than the Citigroup Order to affiliate with nonbanks, because banks are able to accomplish much of what they want under the legal and regulatory framework clarified and set forth in the Order, they may be more emboldened to oppose the final legislation if it includes provisions they do not like, such as the continuation of the unitary thrift charter.
The second respect in which the Citigroup Order has altered the dynamics of the legislative effort is that it has undermined the sense of urgency to get a bill. Although many, if not most bankers still favor legislation, the Order makes clear that the legislation is not essential in order to expand their menu of nonbank products and services. As a result, while the banking industry may not actively oppose the final bill, it may be less willing to expend political muscle and capital to fight for a bill, which could prove critical if differences between the Administration and congressional Republicans on issues like the CRA bog down the legislative process.
Impact of Legislative Proposals on the Insurance Industry
The bills before the House and Senate present significant opportunities and challenges for insurance companies. Each bill would permit banks, insurance companies and securities firms to affiliate with one another. The ability to affiliate is perhaps less important to insurance companies because they have generally been permitted to affiliate with securities firms and since the late 1960s have been able to affiliate with thrift depository institutions. Consequently, the primary concern for the insurance industry with respect to the mixing of banking and insurance activities under the various reform proposals has been ensuring that all entities engaged in the insurance business compete on a level playing field. Specifically, the insurance industry is focused on the following areas:
While the competitive impacts of financial reform legislation are of significant concern to mutual and stock insurers alike, certain provisions under consideration are of particular importance to mutual insurance companies. Because of limitations inherent in the mutual form of organization, mutual insurers may have less flexibility to take advantage of the opportunities presented under the reform proposals to affiliate with depository institutions. Certain provisions in the bills under consideration alleviate these limitations:
However, neither the House nor the Senate bills under consideration permit redomestication of mutual insurers to states that provide for mutual holding companies. This is perhaps the most significant issue for mutual insurers and has been identified by the American Council of Life Insurance as one of the key conditions of support of the insurance industry for a final bill.
In order to maintain the support of the insurance industry, financial modernization legislation must provide for viable functional regulation; that is, state insurance regulators must have the primary responsibility for regulating all insurance business, regardless of the nature of the entity conducting such business. Although the states have traditionally been primarily responsible for supervising the insurance business, in recent years the Office of the Comptroller of the Currency has aggressively expanded the permissible insurance activities of national banks and their subsidiaries, including by means of preempting state laws.
Although the OCC has recognized the primary role of state regulators in the regulation of the insurance business, it has indicated that it will closely scrutinize and perhaps attempt to preempt state laws that it believes discriminate against national banks and significantly interfere with the exercise of their Section 92 powers. There is concern among many in the insurance industry, especially insurance agents, that the OCCs aggressive approach to protecting and expanding the powers of national banks to engage, directly and indirectly, in insurance activities may eventually result in a dual regulatory structure and that national banks will be subject to less stringent supervision under such a dual structure.
Preemption of State Laws
The House and Senate bills each reaffirm McCarran-Ferguson, but provide for the preemption of state laws that directly or indirectly prevent a depository institution or affiliate from engaging in any activity permitted under the bill.
Generally, H.R. 10 is closer than the Senate bill to the position of the insurance industry because it expressly adopts the Barnett standard. Nonetheless, the Senate Banking Committee amended the bill to be much closer to the House version, in particular by amending the bill to include the 13 safe harbors for certain state laws.
Insurance agents do not like the standards for preemption contained in H.R. 10 and the Senate bill. They prefer a standard that provides for the preemption of state laws that actually or constructively precludeEany depository institution from engaging in permissible insurance activities. Their concern is that without this more restrictive standard, the OCC will have more flexibility to preempt state laws that it believes disadvantage national banks. Agents also want to eliminate the non-discrimination provisions in the bills. Still, the agents are not likely to oppose either bill on the basis of the preemption provisions in their current form. The provisions in H.R. 10 were taken from last years final compromise bill and both the agents and the bakers have indicated that they can live with these provisions even if they are not completely satisfied with them. Also, the final bill voted out of the Senate Banking Committee was much more palatable to the agents than the bill Senator Gramm initially introduced, principally because the final bill included the 13 safe harbors.
Definition of Insurance
Insurance lobbyists have indicated that including a specific definition of what constitutes insuranceEin the legislation is essential to ensuring meaningful functional regulation. Absent a clear definition, federal banking regulators will have greater flexibility to determine that certain products and activities are incidental to banking and such determinations will be entitled to the Chevron standard of judicial deference. Further, failure to establish a clear definition of insurance might provide banks and federal bank regulators with greater flexibility to assert that a particular product is not insurance and can therefore be underwritten by a bank or bank subsidiary.
(i) Any product regulated as insurance as of January 1, 1999, in accordance with the relevant State insurance law, in the State in which the product is provided;
(ii) Any product first offered after January 1, 1999, which (a) the appropriate State insurance regulator determines shall be regulated as insurance and (b) is not a specified bank product, or includes an insurance component that would subject the product to insurance tax treatment under the Internal Revenue Code; or
(iii) any annuity contract, the income on which is subject to tax treatment under Section 72 of the Code.
Standard of Judicial Review
Both the House and Senate bills provide a process and standard of judicial review for resolving disputes between federal bank regulators and state insurance regulators over the classification of new products. Under the Chevron standard, courts typically accord great deference to interpretations of federal statutes by federal regulators responsible for administering such statues. Both H.R. 10 and the Senate bill provide that a court shall not afford greater weight to the views of federal regulators over those of State insurance regulators in resolving disputes about the proper classification of a product or about whether a State law, regulation, action, etc. should be preempted. This provision is crucial to the support of the insurance industry.
Prohibiting Insurance Underwriting in Bank Operating Subsidiaries
One of the more contentious areas of debate over the legislation concerns where certain insurance activities will be conducted in the holding company structure.
· Views of the Federal regulators on the powers of operating subsidiaries:
· The FRB is concerned that allowing operating subsidiaries to engage in expanded financial activities (i.e. insurance and securities underwriting) will increase the exposure of and risk to the deposit insurance fund and potentially impact the safety and soundness of banks.
· The Treasury Department argues that allowing operating subsidiaries to engage in such activities will provide banks with greater flexibility to determine the appropriate operating structure and will strengthen safety and soundness by providing for diversification of revenue sources and allowing the bank to retain ultimate control over the assets distributed to its subsidiaries. Also, if these activities were required to be conducted in holding company affiliates rather than operating subsidiaries, the ability of the executive branch to influence banking policy would be weakened because the OCC would not have oversight authority.
Bank/Insurer Affiliations and UmbrellaERegulator
At the heart of the legislative proposals under consideration is the removal of current legal restrictions on the affiliation of banks and other financial companies, including insurance companies. At the hearings before the House Banking Committee, a representative of the American Council of Life Insurance testified that insurers are more concerned with ensuring a level playing field than affiliating with banks, in part because insurance companies are already able to affiliate with
thrifts. Nonetheless, the dramatic increase in the number of applications by insurance companies to acquire thrift charters indicates that many insurers view affiliations with depository institutions as an important tool for competing in todays marketplace. Moreover, the final bill, if enacted, is likely to prohibit new unitary thrift holding companies. Therefore, it is important to understand the proposed regulatory framework under the bills being considered for holding companies that control banks and insurance companies.
The bills under consideration provide that persons or entities that provide insurance in a state as principal or agent must comply with the licensing requirements of that state and otherwise preserve the authority of the states to regulate the insurance business, subject to the nondiscrimination provisions contained in Section 104 of each bill, and otherwise. However, the Federal Reserve Board would serve as the umbrellaEregulator of the parent holding company.
As the umbrella regulator, the FRB is given the sole authority to approve the affiliation of an insured depository institution or affiliate and an insurance provider and the bills preempt state laws that directly or indirectly prevent or restrict such affiliations, subject to the following exceptions:
Unlike the Office of Thrift Supervision, which regulates unitary thrift holding companies, the FRB imposes capital requirements on the parent holding company. Although the bills under consideration provide that the FRB could not impose capital standards on the insurer, it would still be able to regulate the capital levels, as well as the other operating features, of the parent holding company.
Impact of Legislation on Mutual Insurers
The version of H.R. 10 that Chairman Leach introduced in January included a provision for redomestication. Under that provision, a mutual insurer domiciled in a state that does not permit mutual holding companies (MHCE would be permitted to transfer its domicile to a state that does permit MHCs in connection with an MHC reorganization conducted in accordance with the laws of the transferee domicile. The redomestication provision was removed from H.R.10, however, prior to the Banking Committees markup. The Senate bill also does not provide for redomestication.
The primary attraction of the MHC over the traditional form of mutual organization is that it provides greater flexibility to raise capital and pursue strategic business opportunities, such as mergers and acquisitions. Insurers have experienced limited growth in the sales of core insurance products due in large part to increased competition for individual savings from mutual fund companies, brokerage houses, commercial banks and other financial services companies. In response to these competitive pressures, insurance companies have recognized the need to raise capital to increase business and compete more aggressively by developing new distribution channels for insurance products and acquiring other companies. Mutual insurers are at a disadvantage in this environment because unlike stock insurance companies, which have the ability to use their own stock as acquisition currency and access capital markets through the sale of equity securities, mutual insurers are primarily limited to expanding their capital base by generating and retaining earnings.
The provision for redomestication is designed to facilitate the ability of mutual insurers to organize MHCs. Redomestication is important in the context of the legislative proposals under consideration because without the MHC structure, a mutual insurer would have to hold a bank as a downstream subsidiary, which presents significant disadvantages. For instance, the subsidiary bank would be subject to capital requirements imposed by state insurance regulators and statutory accounting rules. Consequently, for practical purposes, a mutual insurer can effectively affiliate with a depository institution only at the holding company level. Failure to include redomestication in the final bill, therefore, would disadvantage mutual insurers located in states that do not permit MHCs.
Many insurance industry groups, including the National Association of Mutual Insurance Companies and the American Council of Life Insurance have indicated that redomestication is an essential condition for the industrys support of a final bill. The provision was removed from the House bill with little fanfare, however, and the issue does not appear to be on the radar screen at the moment. For instance, no amendments on redomestication were offered in either the House or Senate Banking Committee markups. Therefore, at present it is difficult to accurately measure the impact that failure to include this provision in the bills will have on the likelihood of enacting a final bill.
Preemption of Certain State laws
Both the House and Senate bills specifically preempt state laws that would prohibit or restrict mutual insurers from affiliating with depository institutions. Specifically, the bills provide that:
The House bill specifically provides that it does not preempt state laws restricting a change in ownership of stock in an insurance company or its holding company for up to three years beginning on the date of conversion of such company from mutual to stock form. (H.R. 10, Section 104(a)(2)(D)). This provision is significant because it validates the objective of such laws in allowing recently converted companies to adjust to being publicly held without fear of a takeover.
Both the House and Senate bills include a provision that would facilitate mutual-to-stock conversions and MHC reorganization of mutual insurers by limiting the ability of a state insurance regulator to review demutualization and MHC plans of insurers not domiciled in that state. Specifically, the bills provide that:
This provision is significant because insurance regulators in some states have been active in reviewing demutualization plans of insurers not domiciled in the state, particularly plans involving the formation of an MHC. For instance, Principal Mutual had to address certain concerns raised by the New York Insurance Department in connection with Principals MHC reorganization. The above provision would therefore facilitate the ability of insurers with business in multiple states to pursue an MHC reorganization.
Prospects for Enacting Legislation
History: Many of the Tough Compromises Have Been Made
Several factors suggest that there is better chance to enact legislation this year than at any previous time since serious attempts at financial modernization legislation began, largely because of the progress made before this Session of Congress even began. As Chairman Leach indicated in his opening statement at the House Banking Committees hearings in February, many of the tough decisions and compromises have already been made over the course of the last few years. As a result, the various industry groups affected by the legislation appear to be relatively content with the bills produced by the House and Senate Committees. Although none of the industry groups are completely satisfied with the bills, no group has publicly announced its opposition to the proposals under consideration and sources on Capital Hill indicate that all of the significant industry players can live with either the House or the Senate bill. Indeed, most of the noise is coming from the politicians on Capital Hill and in the Clinton Administration.
Another factor that bodes well for enactment is that the House and Senate are proceeding at the same time. Last year, the House acted first on the legislation and did not pass H.R. 10 until late Spring. Thus, the Senate did not begin serious consideration of the bill until last Fall, just a few weeks before Congress was scheduled to adjourn for the elections. Because the Senate and House and proceeding simultaneously and at a quicker pace than last year and because this is not an election year time considerations are much less likely to prevent enactment of a bill.
Finally, there is near unanimous agreement among the regulators and all of the industry groups that the current legal system is outdated. Witnesses at both committee hearings repeatedly stressed the need to enact reform legislation that is more in tune with todays marketplace. Whether or not this expressed desire for legislation is genuinely felt by each group, it at least suggests that all of the important parties are committed to seeing legislation enacted this year.
Clinton Administration v. Congress: Potential Roadblocks
Although many of the necessary pieces for enacting a bill this year are in place, significant hurdles remain, including serious disagreements between Senator Gramm and the Clinton Administration. After the Senate Banking Committees vote on the Gramm bill, the President threatened a veto, based principally on concerns about the bills impact on consumers and the community investment obligations of banks under the CRA. After the Senate Committees vote, Senator Kerry (D-Mass.) stated, were at an impasse before we even start.E Senator Gramm responded that he was increasingly convinced that the president doesnt want a bill.E/P>
Other concerns that may impede passage of a bill this year include differences over the permissible activities of bank operating subsidiaries and questions about Senator Gramms desire for legislation.
Senator Gramm opposed last years version of H.R. 10 because of concerns that it would expand CRA obligations for banks. The bill adopted by the Senate Banking Committee includes provisions that would make it more difficult to challenge the CRA performance of certain financial institutions in connection with applications for mergers, branch openings and other activities and exempt small banks with less than $100 million in assets from the requirements of the CRA. These provisions are almost certain to draw a Presidential veto if included in the final bill. Although most banks likely favor these provisions, the banking industry did not lobby for their inclusion in the bill. Sources on Capital Hill have indicated that the CRA issue may be the most difficult to resolve if legislation is going to be enacted this year.
Another potential hurdle is determining what activities operating subsidiaries of national banks will be able to conduct. The House bill permits bank subsidiaries to engage in all financial activities except for insurance underwriting and real estate development. The Senate bill permits subsidiaries to engage in financial activities, including insurance underwriting, if the national bank parent has total consolidated assets of less than $1 billion and is not affiliated with a bank holding company. The Treasury Department, which has indicated its support for the provisions in the House bill, favors allowing operating subsidiaries to engage directly in financial activities while the Federal Reserve Board has taken the position that such activities should be conducted only by non-subsidiary affiliates of a national bank. Treasury and the FRB have moved closer to a compromise on this issue and the differences in the House and Senate bills will likely be resolved.
Senator DAmato, Senator Gramms predecessor as Chairman of the Senate Banking Committee was a leading proponent of the effort to enact modernization legislation. The intensity of Senator Gramms interest in enacting a bill, however, has been more difficult to discern. The Senator led the successful effort to derail H.R. 10 last year and stated that [i]f there was anyone in my state who was deeply concerned about that, I never really heard from them.E Further, although Senator Gramm has publicly stated his desire to enact a bill, he has indicated that he would prefer no bill to the bill in the House and he has shown little inclination to compromise on the CRA issue.
Positions of Major Constituencies
Although the important constituent groups, including insurers and bankers, have not publicly expressed serious objections to the proposals currently before Congress, support for enacting legislation in its current form may be lukewarm at best, particularly among bankers.
The testimony of Mark A. Pope, Lincoln National Corporation, before the House Banking Committee on behalf of the American Council of Life Insurance articulates a principal concern of the insurance industry with modernization legislation:
Our principal reason for supporting modernization legislation is to assure that an increasingly integrated and complex financial services industry is regulated fairly and effectively. Our goal has not been to secure any special treatment or advantage for insurers, but rather to make certain that if banks choose to enter the insurance business they will be subject to the same statutes and regulations that insurers not affiliated with banks must observe.E/P>
This concern is largely addressed in both the House and Senate bills, which reaffirm the primary role of the states in regulating insurance, define the term insuranceEin order to provide clear guidance to federal and state regulators and provides for judicial review of disputes between federal bank regulators and state insurance regulators that does not permit special deference to the views of the federal regulators. Further, any final bill is likely to prohibit or at least substantially circumscribe the ability of operating subsidiaries of banks to engage in insurance underwriting. Nonetheless, the failure to include mutual redomestication may engender significant opposition from the insurance industry.
The primary concern of insurance agents is ensuring that state insurance regulators will be solely responsible for regulating insurance sales by banks and bank subsidiaries. Agents achieved significant progress in the Senate Banking Committees markup, principally, the addition of the safe harbors for certain state laws that regulate bank insurance sales. Nonetheless, agent groups are not completely satisfied and will attempt to shape the final bill more to their liking:
Although banks have not raised any serious objections to the current versions of the bills before the House and Senate that might jeopardize their support for a final bill, the support of the banking industry can be characterized as lukewarm at best.
The only major issue for thrifts in the proposed legislation is preserving the unitary thrift holding company.
Consumer groups are opposed to the bills under consideration principally because of concerns that the proposals do not protect consumers and undermine community investment obligations of financial institutions. These groups fiercely oppose the CRA provisions in the Senate bill and their opposition may limit the ability of the Administration and key congressional Democrats to compromise on the CRA provisions.
Generally, the securities industry groups seem satisfied with the bills in their current form and are primarily concerned that a bill be enacted this year.
Areas for Compromise and Potential Deal Beakers
Compromises on many of the difficult issues, including the scope of permissible affiliations and the regulation of insurance sales and other insurance activities by banks, are already built into the bills in their present form, particularly the House bill. The differences between the Administration and certain congressional Republicans on CRA is the most serious hurdle at this time. Further, as various interest groups maneuver to shape the final bill as it moves through the full House and Senate and the conference process, many of the delicate compromises in the bills could unravel, particularly on issues like bank insurance sales, bank operating subsidiaries, affiliations with commercial entities and the unitary thrift.
At this time, neither the Clinton Administration nor Senator Gramm has indicated any willingness to budge on their differences over CRA. Further, the House bill contains certain provisions that strengthen the CRA and other community and consumer obligations of financial institutions and these provisions, if they survive a vote in the full House, will be difficult to reconcile with the Senate bill in conference. A representative of the American Council of Life Insurance has stated that although the CRA issue is a significant obstacle, it can be overcome, and that the group expected a significant amount of cooperation between Senators Lott (R-Miss.) and Daschle (D-SD) to get an acceptable bill through the Senate. Nonetheless, it remains to be seen whether the Administration and congressional Republicans are willing to compromise on this issue for the sake of getting a bill.
Even if the CRA issue can be resolved, the support of insurance companies, agents and banks for many of the crucial provisions is fragile. Any one of the following issues could derail legislation if provisions in the current versions of the bills are altered:
With the possible exception of the securities industry, none of the key industry constituencies appear concerned with getting a bill at the expense of undermining the delicate compromises that have been reached. This was raised by James Ericson, President and CEO of Northwestern Mutual Life, in his testimony before the Senate Banking Committee:
We believe the insurance provisions worked out with the banking industry last year embody the balance that is necessary to pass legislation affecting the competitive balance among competing industries. While we are not rigidly wedded to the exact language agreed to last year, we again caution that significant departures from that language or its principles risk alienating major segments of the financial services industry whose support is necessary for a bills passage. We are concerned that the enthusiasm of insurers for financial modernization may be waning as they begin to doubt that Congress will come up with a fair and balanced bill at the present time.E/P>
What Does the Future Look Like?
Although much significance has been attached to financial modernization legislation, whether or not legislation is enacted this year will have little practical impact on the challenges faced by insurance and other financial services companies, or even the strategies they will employ in responding to those challenges. The market is dictating the challenges and strategies, without regard to what the politicians in Washington are doing.
Enactment of Legislation
Impact on Financial Services Industry
The Citicorp/Travelers merger underscores that much of what financial modernization legislation would permit can already be accomplished under current law, so long as certain regulatory limitations are observed. Thus, enacting a bill would facilitate affiliations between banks and other financial services companies by removing the regulatory limitations in place under the current system and would allow certain affiliations that cannot easily be accommodated under current law, such as the mixing of commercial banking and insurance underwriting, but would not represent a dramatic departure from what is already happening in the marketplace, with the acquiescence of federal and state regulators.
Impact on Insurance Industry
For practical purposes, enactment of financial modernization legislation would offer insurance companies few new opportunities that are unavailable under current law. Insurers are already able to affiliate with securities firms and thrift depository institutions and for the most part have not indicated much interest in pursuing affiliations with commercial banks. Therefore, for most insurance companies, the primary significance of legislation will be its impact on insurance activities by banks.
Failure to Enact Legislation
Continuation of Citigroup Model for Affiliations
Failure to enact legislation this year is unlikely to have any significant impact on the business strategies of financial services companies. To date, the has been no rush by financial services companies to follow Citigroup down the path of establishing a giant financial supermarket,Eand to the extent companies intend to expand their menu of financial products, they can accomplish most if not all of their objectives under current law:
The Changes Have Already Been Set in Motion
The present course of the financial services industry is irreversible. Technological advancements and the growing sophistication of customer attitudes and diversification of financial needs will continue to produce new investment options. Thus, the traditional providers of financial products and services--insurance companies, banks, securities firms--will have to continue to diversify the types of products they offer in order to remain competitive and the usefulness of cross-industry consolidation as a tool for achieving diversification will no doubt continue to grow. The push to enact financial modernization legislation after decades of inaction and the regulatory approval of the Citicorp/Travelers merger underscores that the politicians and regulators recognize that either they can reform the antiquated laws governing the financial industry or the market will do it for them.