It is important that the concept of affiliation or control be

spelled out carefully because of the disallowance of securities in an affiliate or controlled corporation and the ineligibility of a bank affiliated or under common control to act as custodian for the insurer. In attempting to provide an appropriate definition for this concept, draftsmen have gone to a model holding company statute which was prepared several years ago by an industry advisory committee and approved by the NAIC. It is believed that this is the best definition extant and it is believed that it is extremely important for the concept in the holding company act to be consistent with concepts in the Policyholder Security Account statute.

"Custodian"

Commissioner or Treasurer as Custodian

It is appropriate to authorize an Insurance Commissioner

or a State Treasurer to act as Custodian. First of all, they do have funds deposited with them, and have the facilities to handle such procedure. More importantly, however, is the fact that certain special deposits are made with the Insurance Commissioner of the state or domicile and often with the Insurance Commissioner or the State Treasurer of other states. It is intended, and properly so, that special deposits should qualify as part of the custodial account. Inasmuch as the requirement applies to all admitted companies and covers the reserves for obligations in all states in which the company does business, it

is appropriate that the special deposits in any given state should qualify as part of the custodial account. In Section 5(B) there is a specific

provision allowing the use of such deposits for the Policyholder Security

Account.

Banks with Trust Powers

Either a state or national bank may qualify as a custodian, provided it has trust powers and agrees to the four procedures listed under (c). (These procedures will be discussed in conjunction with other provisions of the model bill.) It will be noted that the bank as custodian need not be a bank domiciled in the state of the depositor. Clearly this might be impractical for most any company and most definitely will be impractical for large companies domiciled in states which do not have substantial banking institutions capable of handling hundreds of millions of dollars of custodial deposits. Further, some companies choose to keep their securities in a financial center such as New York, San Francisco or Chicago. This should certainly be permitted, provided the four requirements set forth in (c) are met.

Requirements of the Bank

The four requirements are set forth in (c) and will be

discussed in detail in the comments under Section 5. It should be noted in passing that no well-run bank used to accepting deposits from insurance companies (and most insurance companies maintain their securities in one or more banks) should have any difficulty furnishing the information and the cooperation as required in (c).

It should be noted that the bank merely receives the securities

as a bailee or custodian. It is not a trustee, there is no implication that it is, and Section 8 specifically negatives the idea that there may be some such relationship. This is important in order to permit the company to have the appropriate

freedom to exchange its securities as needed, and also to avoid any substantial increase in fees because of the trust relationship. Fees of banks acting as custodians are quite reasonable, but if a trustee relationship is thrust upon them they necessarily must increase their fees substantially. Again, since no undue burden is intended for companies complying with this requirement, it is specifically determined in this model statute that such a trustee relationship is not established.

"Insurance Company"

Reference should be made to the code Section or Article setting

forth property and casualty lines.

"Marketable Securities"

Investment Article. It is impossible to provide in a model bill

provisions appropriate to the wide variation of state investment laws and the pattern which these laws follow. Therefore, it is suggested that each state's investment code be handled individually as appropriate.

It is intended that

basically cash, stocks, bonds and other "liquid" assets be used in such an

account.

Common Stock. Investment in common stock is generally permitted in this proposal with the exception of stock in affiliates and the overall limit that investment in the securities of any one corporation cannot exceed five percent of the total deposit required. The problem with stock is a problem of liquidity and valuation. However, in view of the difficulty by the Valuation of Securities Office of the NAIC in connection with the insolvency of Community National Life Insurance Company several years ago, the Valuation of Securities Office has tightened substantially its procedures and this tightening will enhance the use and value of the Policyholder Security Account proposal in connection with the use of common stock in such accounts.

Bonds and Other Obligations. Investments in bonds and other

obligations can be used in the account. There is a general limitation of 5% of the account in any one corporation, but this is increased to 25% if the obligation is guaranteed by the United States Government.

Real Estate. Investments in real estate and mortgages cannot

be used in the account.

Investments in Affiliated Entities. Almost invariably companies

which have run into difficulty in recent years have gone insolvent with a substantial portion of their assets invested in stock or other securities of affiliated companies. The room and ability to manipulate the value of these securities, the ability to exchange solid liquid assets for assets of questionable value involving subsidiary or affiliated corporations makes the potential for abuse almost unlimited. Accordingly, though the investment code of various states would, of course, continue to permit investment in such securities, the concept of the Policyholder Security Account proposal does not permit the inclusion of such investments within the definition of marketable security as applied to the Policyholder Security Account proposal.

This

Commissioner's Discretionary Authority. It is believed that some discretionary authority should be given to the Commissioner, and accordingly (D) provides in a rather controlled way for such discretionary authority. permits the Commissioner to allow certain investments to be eligible for coverage in the Policyholder Security Account even though they do not come within the definition of marketable securities as set forth in (A), (B), and (C) of this

definition.

One example of the need for this escape clause may suffice.

There is a company which has a fairly substantial investment in so-called private placement from municipalities from the state in question. The reason for these

private placements is two-fold, (1) to obtain reasonable interest rate in tax-free obligations, and (2) to furnish capital support to municipalities which may have some difficulty in obtaining funds in the bond market. Naturally, the solidity and liquidity of these private placements vary, but some undoubtedly are almost as solid an investment as are some municipal bonds purchased on the open bond market.

Lines of Insurance Covered. The same lines that are covered by the

Fire and Casualty Insolvency Funds are intended to be covered.

Alternate Measures for Amount of Policyholder Security Account. The basic purpose of the statute is to provide coverage for obligations to persons with claims against the company, either policy claims, third party claims, or claims for return of premium. Hence, one measuring stick involves the reserves for losses, loss adjustment expenses and unearned premium reserves.

In many insolvencies it has been found that reserves, particularly loss reserves have been understated. If there is a gross understatement of reserves then much of the protection of the Policyholder Security Account is lost. To guard against this possibility, an alternate measure is used, 75% of

written premium.

This latter approach is the sole measure in the present Illinois Statute (except the amount is 65%). In most cases the "reserve measure" should produce a greater

amount.

It should be noted that the reserve statutes in each individual state are unique to that state. Therefore, this provision of the model bill will have to be tailored to the specific requirements in each state. It is suggested that a specific reference be made to the sections of the code which

require the various reserves for losses and loss adjustment expenses and unearned