of insurance companies by non-insurers may not always be as benign from the viewpoint of the policyholder and the public as it appears to have been thus far.

A number of factors contribute to our concern. While holding companies are not themselves new, the dominant motives for their formation may be changing from a desire to facilitate the conduct of the insurance business to a desire to shift away from the insurance business and to subordinate insurance to other business objectives. This change in motive will increase the strain on the established regulatory system.

Further, the opportunities for pyramiding and excessive accumulation of economic power through the use of holding companies are real and potentially contrary to the public interest. When a non-insurance holding company system includes an insurance company within it, its potential for specific harm becomes greater since tempting reservoirs of liquid assets become accessible to persons without an appreciation of the security needs of the insurance enterprise, and the interests of the policyholders thus become vulnerable. Moreover, the interests of the controlling persons are potentially in conflict not only with those of the policyholders and the public but with those of any other shareholders of the insurance company. There is something anomalous in an insurance business, which is fiduciary in nature, affected with the public interest and intensively regulated, being controlled by persons neither charged with such fiduciary-like responsibilities nor regulated to assure their adherence to appropriate standards of conduct.

The potential costs of conflict between the social purposes served by insurance and the self-interest of those who may control an insurer are substantial. Both the inclination to profit at the expense of the policyholder, and the means by which to do it, are far more likely in a control situation than where ownership is widely distributed among many policyholders or shareholders who do not in fact act in pre-arranged concert.

A catalogue of the potential abuses latent in non-insurance control of insurance companies is not necessary for the purposes of this report. It is sufficient to note that such a list (1) would include all of the devices for "milking" that have been ingeniously exploited in other contexts; (2) would encompass the full range of preferential or less than arm's-length transactions that benefit the parent or its affiliates at the expense of the subsidiary; (3) would contain all the evasions of the insurance laws and regulations open to a parent that has an opportunity (through payments to insurance agents and employees, for example) to do what would be. prohibited to its insurance subsidiary; (4) would list all of the ways in which management judgment could be subverted to the detriment of the insurance enterprise. In short, a catalogue would comprehend the diverse

Accordingly, we have given considerable thought to whether we should urge that, apart from limited or technical exceptions, no person other than an insurer licensed in New York should be permitted to control a New York licensed insurance company. Such a prohibition would, as a matter of principle, be a drastic remedy for it would crode the freedom business enterprises should enjoy except when that freedom endangers the public interest. Such a prohibition becomes even more drastic when, as would now be the case, it would require divestment of insurance holdings of considerable magnitude. Especially serious does such a remedy appear when it has not yet been firmly established that concerned and comprehensive state regulation, alertly pursued, cannot adequately protect both the policyholders' and the public interest.

While reasonable persons may question whether state regulation can muster the muscle required effectively to protect the public's and policyholders' interests in the presence of a proliferation in non-insurance control of insurance companies, we think it should be tried. Nevertheless, we urge upon those who now control, or hereafter may seek to control insurance companies, that, in analyzing the courses of action open to them, they weigh most carefully the possibility that total divestment of insurers from non-insurance control may ultimately be found, by state or federal legislators, to be, not only the most feasible and effective method, but the necessary method, for protecting all of the diverse interests involved.

Any New York legislation designed to inhibit and minimize the potential abuses of holding companies, and prevent the interests of the policyholders and the public from being subordinated to those of the controlling persons, must be bold if it is to be effective. While the Superintendent already has, in considerable part, the necessary powers, we believe the issue to be so crucial that those powers should be clarified, systematized and expanded. As we visualize it there are certain essentials.

First, of course, there is a need for full disclosure subject to verification by examination. The power to make inquiry of, require reports from, and to examine any company in the holding company system, about any activities affecting a licensed insurance company, is so vital that it should be plainly stated and made fully effective.

Any person who controls a domestic or foreign New York licensed insurer (or an insurer seeking a license) or any affiliate of such a person,

1Such as where the control is temporary, or the insurer essentially confines its business to the insurance of the parent, or the control is technical and nominal only, or even perhaps where the holding company is engaged solely in holding the stocks of licensed insurers.

should be required to make all relevant material, as well as its appropriate officers, directors and employees, available for examination by the Insurance Department at such times as and to the extent that the Superintendent deems necessary to determine the condition of the insurance company and the manner in which it conducts its business. Further, all members of the controlling interest group should file with the Insurance Department various documents such as their charters, by-laws, financial statements, and biographical data on directors, officers, principal shareholders and controlling persons.

Regular reporting should also be required in potentially sensitive, areas such as, for example, the nature of, and the affiliation within, the controlling group, the intercorporate transactions between the insurer and the controlling interest or any affiliate, any changes in the structure of the controlling group, the financial transactions among members of the group, and all management changes. Indeed, certain specified activities of the entire controlling group, such as securities offerings, changes in control of the controlling interest and personnel changes in the management of the parent charged with particular responsibility for the insurance subsidiary, should be subject to immediate and full reporting by the parent.

Some of these disclosure requirements could be met through a "registration statement" at the time of licensing, others could be met. through periodic reports, and the most sensitive areas could be made the subject of special reports either in advance of, or at the time of, the transaction in question.

Second, neither dividends nor other distributions should be permitted to weaken the financial soundness of the controlled insurer. Thus, no stockholder or policyholder dividend or other distribution should be paid by any controlled insurer unless the insurer will retain sufficient assets to support its writings and promote its continued growth. To permit surveillance over distributions, no controlled insurer licensed in New York should make a distribution to shareholders until a reasonable period has elapsed after notice and supporting financial data have been given to the Superintendent. The Superintendent in turn should be able to disapprove the distribution if in his judgment it would reduce the insurer's surplus to policyholders below that required to support its writings and promote its necessary growth.

This control by the Superintendent over distributions is of crucial importance. The freeing of surplus for transfer to a controlling parent and its use in other enterprises is an important objective of some holding company formations. Indeed, some managements will wish to free the maximum amount of money. One insurance spokesman has recently said: "Stripping the transaction [formation of a holding company and transfer of its assets] to its essentials, it is merely an exercise in leverage whereby the true value of the insurance company's assets are [sic] freed to be

the motivation reflected in this quotation, but it is clear that action so motivated must be controlled by the Superintendent so that the funds left to support the insurance operation will suffice without anticipation of aid from, or rescue by, any parent or affiliate.

The risk that a controlling parent of insurance subsidiaries may draw too much from the assets of the subsidiaries is not a fancied danger. Despite existing legal prohibitions, the New York Insurance Department reports some experience with the problem. Moreover, milking is reported as the cause of much regulatory difficulty in the analogous savings and loan field. There, inadequately capitalized holding companies top-heavy with debt and over-extended in their operations are said to have pressed their subsidiaries for unreasonably large cash dividends, forcing the subsidiaries to dangerous expedients to make the payments. This problem has led the Federal Home Loan Bank Board to press for a strong federal holding company bill. Thus, the fact that the holding company structure will facilitate financing of expanded insurance operations, although quite true, is only part of the picture, for transfer of assets is a two-way street.

Third, in addition to disclosure and the opportunity to disapprove distributions, we recommend that transactions between a domestic or foreign New York licensed insurance company and a non-licensed controlling person or any affiliate of such a person, or at least some classes of transactions to be specified by Departmental regulation, be prohibited unless they are, pursuant to Departmental regulation, either specifically approved by the Superintendent, or not disapproved within specified period of time following notice prior to action, or exempted from a requirement of approval.

a

Among the criteria to be applied by the Superintendent of Insurance in determining whether approval should be required either for a specific transaction or for a general class of transactions, or whether they should be exempt, are these:

1. the transaction should be on a reasonable arms's-length basis with strict cost accounting;

2. no services should be performed by the holding company or the insurer for the other (or for or by an affiliate) except at a cost that is reasonable to the insurer;

3. there should be an equitable allocation of all expenses incurred jointly, or incurred by either party for the other, and a similar equitable allocation of receipts;

1 Insurance Advocate, Nov. 4, 1967.

2 Purchases and exchanges of securities or significant assets, or services; loans and other investments; material transactions not in the ordinary course of business; transactions resulting in an actual or contingent liability of insurance assets; and re-insurance transactions are prime candidates for Departmental scrutiny and appres when undertaken between an insurer licensed in New York and its parent or any liate of its parent.

4. books, accounts and records of each party to any intercorporate transaction should be kept in a manner which clearly and accurately discloses the nature and details of the transaction; and

5. the terms are fair and equitable.

It is a corollary of the foregoing that the Superintendent of Insurance have power to prescribe by regulation such uniform standards for reporting, allocation and record-keeping as may be necessary to enable him to review the transactions and apply the requisite standards.

Fourth, the approval of the Superintendent should be required for the acquisition of control of any domestic insurer, including any change in the control of the controlling parent. In the case of acquisition of control over a foreign insurer licensed in New York it may be sufficient to require advance notice of a proposed acquisition with a sufficient opportunity to disapprove. In either case, the Superintendent should be given power to compel divestment of acquisitions of which he disapproves on the basis of standards comparable to those discussed in Part II of this report in connection with the formation or acquisition of subsidiaries.

Review of a proposed acquisition should also encompass such matters as the financial condition of the acquiring entity, the trustworthi ness and competence of its officers, directors and controlling persons, the submission of a satisfactory plan of operations for the proper and effective continuation of the insurer's business, potential conflicts of interest and any anticompetitive effects upon the insurance business arising out of the acquiring entity's other enterprises.

Such review and prior approval should be applicable regardless of what method of acquisition or change of control is utilized.

Where exchange offers or tender offers are to be made for the stock of domestic insurers, the acquiring entity should also be required to meet minimum standards of disclosure to existing shareholders as to the identity and plans of those seeking such acquisition.

In keeping with the foregoing, where non-licensees now control either domestic insurers or foreign insurers doing business in New York, acquiescence in the continuance of that control should be subject to the same conditions, and the Superintendent should be empowered to require divestiture of control in situations which could not be approved under such standards.

The acquisition by a non-insurer, without the approval of the Superintendent, of control over a domestic or foreign insurer licensed in New York (or the failure of such a controlling person to divest control when ordered to do so), should be grounds for revocation or non-renewal of the insurer's license, or for liquidation or other proceedings under Article XVI of the Insurance Law.

Fifth, we think it appropriate to require that a controlled insurance company be operated by its own personnel actually engaged in the