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2. S. 1710 would not allow assets supporting policy holders obligations to be invested in 21 categories of investments which are now permitted under state law as reserve investments :

(a) Noncorporate net leases,
(b) Trustee and receiver obligations,
(c) Equipment trust obligations,
(d) Production payments,
(e) Acceptances and bills of exchange,
(f) Mortgage loans,
(g) Real estate
(h) Foreign investments,

(i) Stock and debt of housing companies and corporations acquiring income producing property,

(j) Obligations issued or guaranteed by the International Bank for Reconstruction & Development, the Inter-American Development Bank, or the Asian Development Bank,

(k) Obligations guaranteed by the community facilities project guarantee fund, (1) Stock and obligations of mortgage companies, (m) Transportation equipment, (n) Personal property, (0) Real estate corporation stock, (p) Stock in subsidiaries,

(q) obligations. of Canadian municipalities and agencies (S. 1710 mentions only the Dominion of Canada and its Provinces),

(r) Securities traded in the United States and issued by foreign corporations, e.g., Schlumberger, Royal Dutch/Shell.

(s) Securities traded over-the-counter,

(t) Hospital revenue, industrial revenue, and pollution control obligations. It is unclear whether they would be deemed “issued, assumed, or guaranteed by any county, city, town or district of any such State" in subsection 8(c) (8), and

(u) Municipal obligations payable from conditional sales or lease payments.

Each of the above categories is specifically allowed by New York insurance law for reserves. The New York statute is regarded as the most restrictive state law governing insurance investments. It also can apply extraterritoriality to investments held by any company licensed to sell insurance in New York State, regardless of where the company may be domiciled.

The potential which S. 1710 may have for disrupting the investment practices of insurance companies, and the implication this could have for the ability of each category of issuer named above to obtain debt or equity capital cannot be underestimated. This possibility is particularly alarming because of the power which S. 1710 would grant the Federal Insurance Commission to regulate indirectly investments of state chartered insurers which seek Federal insolvency protection.

3. S. 1710 would introduce an untested, vague standard by which insurance investments could be disallowed.

Assets supporting policyholder obligations plus minimum capital and surplus shall be invested according to a standard of "integrity and stability" in S. 1710. This standard, as well as the entirety of Section 205, is a copy of Section 37–195 of the South Carolina Insurance Code, as amended in 1971. As far as we can determine there have been no subsequent interpretations or case law in South Carolina to shed light on what those words mean. The standard of “integrity and stability" exists nowhere else in state regulation of insurance investments, to our knowledge. The Federal Insurance Commission would seem free to give those words any meaning it wishes in deciding to disallow any specific investment which supports policyholders obligations plus minimum capital and surplus. This standard might prevent purchasing any bond except one rated triple A. The word "stability" could imply investments would be allowed only in short-term obligations.

The problems which a new standard for judging investment management can create are shown by modification of the prudent man rule in ERISA. S. 1710 could create larger problems than ERISA because ERISA retains to a considerable extent language interpreted by courts for decades in deciding cases under the "prudent man" concept.

Contemporary portfolio theory, however, has a more complex view of the riskiness of an investment portfolio than traditional trust law, which has a virtually exclusive focus on the possibility of capital loss. This change in the view of risk has been accompanied by the realization that each investment should be evaluated in the context of the entire portfolio, rather than on an individual basis, as was the rule at common law. The statutes, however, do not reflect this change. Rather than clearing the air, ERISA requires fiduciaries to discharge their duties "with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.” Neither ERISA nor its legislative history clearly indicates how any of the other standards which might be implied in the statute are to be interpreted in conjunction with the prudent man standard above. When evaluating trustees' investment decisions under the prudent man rubric, most courts focus on the possibility of capital loss as the sole measure of the riskiness of an investment. Moreover, each investment is evaluated in isolation from the portfolio of which it is a part. The portfolio is considered as a whole only in the requirement that it be sufficiently diversified to minimize the risk of loss. Through all of its stages of development, the common law has been shaped by the need to resolve the basic tension between the interests of the income beneficiary and the remainderman of a trust, giving greater weight to the remainderman's interest by valuing safety of the corpus over generation of income.

In the view of Senator Lloyd Bentsen and other members of the Senate Finance Committee, the adoption of the prudent man rule in ERISA has made pension fund managers afraid to purchase any stocks for their managed portfolios except those of the highest rated Fortune 500 companies. As a consequence, many smaller corporations believe they have been foreclosed from equity markets because of ERISA's adoption of the prudent man rule. Senator Charles Mathias has introduced legislation to amend the prudence requirement in ERISA so as to permit sound investment strategies designed to take into account the impact of such economic forces as inflation, and the soundness and growth potential of total investments rather than on an investment-by-investment basis.

4. The "basket” provision in S. 1710, intended to give flexibility beyond the standard of "integrity and stability" for insurance investments, is drafted in such a way that its actual effect upon investment portfolios cannot be determined.

Under the most favorable interpretation, section 205 in S. 1710 may contain a more liberal "basket" provision allowing investment discretion than New York State law. Your legislation provides :

“[E]very federally chartered insurer shall have and maintain investments of the classes described ... to the extent of policyholder obligations and minimum capital and surplus . less an amount equal to 30 percent of its surplus as re gards policyholders, but in no event shall such insurer have and maintain investments of the amount described less than in an amount equal to the sum of 70 percent of such policyholder obligations ... and 100 percent of the minimum re quired capital and surplus, except that the investments referred to in this subsection shall be subject to the limitations provided by subsection (d).".

We are told the intent is for "less an amount equal to 30 percent of its surplus as regards policyholders" to be a basket for any type of investment not allowed in subsection 8(d). Under that approach, the specific categories enumerated in section two of this report could fall within the basket. If a figure equal to the sum of 70 percent of policyholder obligations and 100 percent of minimum capital and surplus is greater than 30 percent of policyholders surplus, then an insurer would have full use of the basket. If that same figure is less than 30 percent of policyholders surplus, then something less than the full basket would be available. The chart below illustrates how this concept would work for three companies :

[blocks in formation]

Policyholders obligations.
Policyholders surplus
Basket, 30 percent of policyholders surplus..
70 percent of policyholders obligations
100 percent of minimum capital and surplus (assuming maximum
under sub. 4(a)(2)).

$500,000,000 $1,000,000,000
400,000,000 350,000,000
120,000,000 105,000,000
350,000,000 700,000,000

$500,000,000 1, 300,000,000


7,500,000 7,500,000 357, 500,000 707, 500,000

390,000,000 350,000,000

7,500,000 357, 500,000

In the case of Company “C”, unlike the other two, the “basket” of 30% policyholders surplus would not be available because the total of 70% policyholders obligations and 100% minimum capital and surplus is less than 30% policyholders surplus. In this case, the "basket” would become the difference between policyholders obligations and 70% policyholders obligations, or 150,000,000.

The language employed in S. 1710 is so vague we cannot safely assume the statute would work this way if enacted. It is possible to construe subsections 8(c) and 8(d) so that their restrictions apply to more than policyholders obligations plus minimum capital and surplus. If the restrictions do not apply to more than these categories, why is the basket written in terms of policyholders surplus?

5. The Federal Insurance Commission would be given power to review and approve certain proposed portfolio transactions, and to block entry into related businesses.

The Commission would be able to prescribe rules and regulations "in order to insure the financial stability of federally guaranteed insurers” [$ 107 (a) ]. Such rules and regulations must require, among other things, that:

“Each insurer shall not sell, transfer, assign, pledge, or otherwise dispose of or relinquish control over more than 25 per centum of its funds, assets or investments within any twelve month period except as provided by regulation unless at least thirty days prior notice has been provided to the Commission and it has not disapproved.”

This would be particularly troublesome in periods of high portfolio activity. During the first quarter of 1976, the SEC recorded the portfolio activity rate for property-casualty insurers was 37.8 percent. [Activity rate is the average of gross purchases and sales (annualized) divided by the average market value of holdings.]

The Commission would have broader powers over federally chartered companies. In addition to the provision quoted above, the federally chartered company must have Commission approval :

"[t]o conduct any other business which is complementary or incidental to the insurance business . . . subject to such limitations the Commission may prescribe for the protection of the interest of policyholders... after taking into account the effect of any such other business on the insurer's existing business and its surplus, the proposed allocation of the estimated cost of any such business and the risks inherent in any such business as well as the relative advan. tages to the insurer and its policyholders of conducting such business directly instead of through a subsidiary [8 202(e) (8)]."

This would be bothersome to insurers which have expanded into financial services beyond insurance. A recent study by Stanford Research Institute predicts competition between financial institutions-insurers, banks, broker-dealers, investment advisors—will become more intense than in the past over efforts to provide one-stop financial services to high and middle income individuals.

6. The provisions in S. 1710 may leave the door open for development of a Federal annual statement for insurers.

The Commission would be empowered to make examinations of and to require information and reports from all federally guaranteed insurers, or applicants for a guaranty or charter ($ 101 (a) (7)]. Each federally guaranteed insurer would also be required to furnish financial reports or records at such times and in such detail as the Commission may prescribe [8 107 (a)). Every federally chartered insurer and every affiliated or controlling person shall comply with the Commission's rules and regulations, and shall make periodic reports in such form and detail as the Commission shall prescribe [§ 202 (f) ). Nowhere in S. 1710 are the issues addressed of the NAIC Annual Convention Statement's fate and whether statutory accounting principles would be followed by federally chartered insurers.

7. S. 1710 could materially alter the existing NAIC standards for valuing securities held by insurers.

The bill provides :

“(8) For the purposes of the limitations contained in this section (d), the property and securities enumerated in subsection (c) shall be valued at market value or at cost, less depreciation except that the Commission may, by regulation, authorize valuation of securities in accordance with stated values established for such securities in writing or as published by the Committee on Valuation of Securities of the National Association of Insurance Commissioners (205(d)(8)].”

This phraseology implies NAIC values will be used only as a last resort. Due to the language's vagueness, the Commission might be able to value stocks at cost, and bonds at market. The disruption this could cause our companies needs no further emphasis.

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Our members hope these comments on S. 1710 as a "working document to be studied and criticized" are responsive and helpful to your concerns. Please let me know if any further information might be useful. Sincerely yours,

WALTER D. VINYARD, Jr., Counsel.





Washington, D.C. The committee met at 9:40 a.m. in room 5302, Dirksen Senate Office Building, Senator William Proxmire, chairman of the committee, presiding.

Present: Senators Proxmire, Brooke, and Tower.

Senator BROOKE (presiding). The committee will come to order. Senator Proxmire, our chairman, is unavoidably detained, but will be in the hearing room as soon as possible.

Our first witness this morning will be Robert L. Dillard, Jr., executive vice president, general counsel, and secretary, Southland Life Insurance Co. of Dallas, Tex.

And with us today is our senior Republican member of this committee, my distinguished colleague, the Honorable John Tower, who will introduce Mr. Dillard.

Senator TOWER. Thank you, Mr. Chairman, I will be very brief.

I would only like to note that Bob Dillard is not only a leader in his professional field, but is highly regarded as a civic leader, a public spirited man in Dallas, and I think he will be a witness whose testimony we should give great weight to.

I welcome him here on behalf of the committee, and I will listen to what he has to say with interest. Thank you, Mr. Chairman.

Senator BROOKE. Thank you, Senator Tower. We are very pleased to have you, Mr. Dillard. After that sendoff, you may proceed. If you wish to summarize your statement, we do have questions we would like to ask you, and the full text of your statement will be printed in the record. But you may proceed.



Mr. DILLARD. Fine. I will try to shorten it as I go. I am Robert L. Dillard, Jr., executive vice president, general counsel and secretary of the Southland Life Insurance Co., Dallas, Tex., and I am making this statement of S. 1710 on behalf of the American Council of Life Insurance and the Health Insurance Association of America.


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