Letter states that it is permissible for national banks to participate in a group to self-insure group members' workers' compensation obligations.

O

Comptroller of the Currency

Administrator of National Banks

Washington, DC 20219

Interpretive Letter #1022

February 15, 2005 March 2005

12 USC 24(7)

Subject:

Group Self Insurance Program

Dear [ ]:

This is in response to your request for a legal opinion from the OCC concerning your

organization’s proposal to form a group self insurance program (“GSIP”) in California that

would provide worker’s compensation insurance to members of the group. You have requested

confirmation that it would be permissible for national banks to participate in this program. For

the reasons discussed below, we conclude that such participation is permissible.

DESCRIPTION OF PROPOSAL

[ ] (“ ”) is a trade association of approximately 250 community

banks and bank holding companies in nine western states. It is proposing to sponsor, through its

subsidiary, [ Corp. ], a GSIP in California that will make available a workers’

compensation self insurance program to its member banks in that state. The following

description of the program is based on materials that you have submitted to the OCC as well as

representations that have been made by your organization during meetings and telephone calls

with OCC staff.

You represent that it has become increasingly difficult for smaller banks in California to meet

their workers’ compensation insurance obligations. California banks have three ways to obtain

insurance for potential workers’ compensation claims, but each has drawbacks. The first is to

purchase a traditional workers’ compensation policy from an insurance company. However, you

state that the insurance market has been in a state of extreme volatility since the early 1990s,

when workers’ compensation insurance rates were deregulated

ations. California banks have three ways to obtain

insurance for potential workers’ compensation claims, but each has drawbacks. The first is to

purchase a traditional workers’ compensation policy from an insurance company. However, you

state that the insurance market has been in a state of extreme volatility since the early 1990s,

when workers’ compensation insurance rates were deregulated. In 2000, many insurance

companies began to charge significantly higher premiums in order to recoup losses they

sustained after deregulation, while others simply left the market. Individual banks may also self-

insure themselves, but this is only practical for larger banks.

- -

2

Finally, the State of California operates the Self-Insurers’ Security Fund.1 Employers may cover

their workers’ compensation obligations by becoming members of this fund. However, some

have questioned the long-term financial stability of the fund.

Consequently, [ ] has investigated other alternatives for its members and has concluded that a

group self-insurance plan — a GSIP — is the best option. You represent that GSIPs have

operated successfully in California and other states for nearly 25 years. The GSIP would be a

nonprofit, mutual benefit corporation organized under section 7110 et seq. of the California

Corporations Code. Such a corporation has members and membership certificates rather than

shareholders and stock certificates. Normally, each member has only one membership. There is

a board of trustees that is selected by the members and is responsible for managing the

corporation’s assets and approving new members. In the present case, the board would be drawn

from the presidents or CEOs of the founding banks. However, as sponsor of the GSIP, [ ]

intends to maintain control of two of the five proposed seats. Membership in [ ] would be

required for membership in the GSIP

stees that is selected by the members and is responsible for managing the

corporation’s assets and approving new members. In the present case, the board would be drawn

from the presidents or CEOs of the founding banks. However, as sponsor of the GSIP, [ ]

intends to maintain control of two of the five proposed seats. Membership in [ ] would be

required for membership in the GSIP.

California law allows two or more private employers to form a nonprofit, mutual benefit

corporation for the sole purpose of operating a group workers’ compensation self-insurance fund

to pool their compensation liabilities, i.e., form a GSIP.2 The GSIP retains a group plan

administrator to run the day-to-day operations (including actuarial oversight and recommending

premium rate adjustments) and a third-party claims administrator to manage claims

administration. [ ] plans to use [ Co. ], of [ City, State ],

a specialist in workers’ compensation group self-insurance, as its group plan administrator.

GSIPs are comprehensively regulated by the California Department of Industrial Relations

(“DIR”).

You represent that the advantage of a homogeneous group of employers such as banks forming a

GSIP versus purchasing individual coverage from an insurance company is that in a GSIP,

premiums can be based on the claims experience of the banking industry (“common risks”). In

contrast, a bank purchasing traditional coverage from an insurance company will be paying,

through its premiums, to cover the risks of other, more dangerous industries (“diversified risks”).

For this reason, [ ] estimates that the GSIP would save its members 25% to 35% a year over

comparable private insurance carrier rates.

In a GSIP, each prospective member is individually underwritten and premiums are priced

accordingly

overage from an insurance company will be paying,

through its premiums, to cover the risks of other, more dangerous industries (“diversified risks”).

For this reason, [ ] estimates that the GSIP would save its members 25% to 35% a year over

comparable private insurance carrier rates.

In a GSIP, each prospective member is individually underwritten and premiums are priced

accordingly. Prospective members are screened by the GSIP and may be rejected for

membership, for example, if they present a high risk or are financially unstable. Members make

premium contributions to fund payment of claims and administrative expenses. Under California

law, after the third year of operations any surplus, including interest income, may be returned to

1 California Labor Code § 3701.8 (West 2003).

2 Cal. Code Regs. tit. 8, § 15470 et seq.

- -

3

the members in the form of a dividend. Members may withdraw for any reason, although they

may be subject to a penalty if certain conditions apply.3

The [ ] GSIP would provide coverage for individual claims up to $500,000 for each

occurrence. Under California DIR regulations, each member of a GSIP must assume joint and

several liability for the group’s obligations.4 Moreover, a withdrawing member remains liable

for claims against the GSIP arising from years in which it was a member.5 Should the assets of

the group be insufficient to cover the GSIP’s obligations, each member theoretically would be

subject to an assessment in order to fund the shortage. Therefore, the proposed GSIP

incorporates a number of measures to address the possibility of claims exceeding the $500,000

limit or the fund otherwise becoming exhausted:

• Excess insurance. The GSIP will obtain excess insurance from an “A”-rated carrier that

will provide unlimited funds for individual claims that exceed $500,000. This will

eliminate catastrophic claim assessment exposure

Therefore, the proposed GSIP

incorporates a number of measures to address the possibility of claims exceeding the $500,000

limit or the fund otherwise becoming exhausted:

• Excess insurance. The GSIP will obtain excess insurance from an “A”-rated carrier that

will provide unlimited funds for individual claims that exceed $500,000. This will

eliminate catastrophic claim assessment exposure. Excess insurance is required by DIR

regulations.6

• Aggregate insurance. The GSIP also will obtain aggregate insurance coverage from an

“A”-rated carrier. This coverage is optional under DIR regulations. Id. § 15478(b). If

claims payout reaches 90% of the claims fund, the aggregate insurance carrier would

provide an additional $2 million to pay claims falling within the $500,000 limit. In other

words, this would be a backup source of liquidity for the payment of ordinary claims.

According to WIB’s actuary, the likelihood of losses exceeding the $2 million of

aggregate coverage is less than 1%.

• Conservative premium rates. The premium level will be set at more than double what the

actuary has estimated will be needed to cover claims and expenses. The actuary has

estimated that premiums of $0.94 per $100 of payroll will be sufficient to cover expected

claims, while the actual premium the GSIP intends to charge will be $1.99. In addition,

60% of all premiums will be held as a reserve for future claims, while the industry norm

for self-insured groups is 50%. These measures are intended to generate a surplus

funding position that will reduce the risk of deficiency assessments on members and

permit a premium reduction in later years.

• Prepayment of first year’s premium. Members will pay all first-year premiums in full at

the inception of the GSIP. This will eliminate “uncollected premium exposure,” that is,

3 Members withdrawing during their first year of membership would forfeit 35% of their premium payment

that will reduce the risk of deficiency assessments on members and

permit a premium reduction in later years.

• Prepayment of first year’s premium. Members will pay all first-year premiums in full at

the inception of the GSIP. This will eliminate “uncollected premium exposure,” that is,

3 Members withdrawing during their first year of membership would forfeit 35% of their premium payment. After

the first year, withdrawing members would pay a 15% of premium penalty, but only if they fail to give 60 days

notice of their intent to withdraw.

4 California Code of Regulations tit. 8, § 15479.

5 Id. § 15480.

6 Id. § 15478(a).

- -

4

the risk that large claims might be sustained at the inception of the GSIP before it is fully

funded.

In the event (which you characterize as unlikely) that the board of trustees of the GSIP concludes

that additional funds will be needed to cover claims liability, the board would simply declare a

pro rata increase in premiums. You maintain that this is the same thing a private insurance

company would do, so a bank that obtained traditional workers’ compensation insurance would

face the same risk. In fact, you believe there will be less risk of this happening with the GSIP

because of the program features outlined above.

[ ] further represents that any premium increases would be declared well in advance of any

projected payment of claims so there will be, at all times, sufficient reserves to pay all projected

claims. In an extreme case, a high-risk member that is driving up costs can be terminated from

the group, just as an insurance company could cancel the policy of such a company. You believe

there will never be a time when the GSIP’s reserves are depleted, and therefore the risk of joint

and several liability actually occurring is statistically insignificant, i.e., less than 1%

all projected

claims. In an extreme case, a high-risk member that is driving up costs can be terminated from

the group, just as an insurance company could cancel the policy of such a company. You believe

there will never be a time when the GSIP’s reserves are depleted, and therefore the risk of joint

and several liability actually occurring is statistically insignificant, i.e., less than 1%.

In sum, [ ] believes that a GSIP is a superior alternative to either private insurance or the state

fund because:

• It can charge lower premiums because it has common risks rather than diversified risks;

• Since it will be started de novo, it will not have embedded losses from prior years;

• Excess funds can be returned to the members.

LEGAL ANALYSIS

There is no doubt that national banks have the authority, under 12 U.S.C. § 24(Seventh), to

purchase insurance to meet their business needs.7 The OCC also has approved, on a number of

occasions, national bank ownership of or investment in captive insurance companies to provide

for the insurance needs of the owning banks.8

However, the OCC has not previously approved national bank participation in a self-insurance

group such as you propose, primarily because of the possible liability for obligations of other

members of the group. Nevertheless, we conclude that your proposal is permissible for national

banks. The OCC recognized long ago that issues of structure or organization do not control

whether an activity is permissible. For example, we once considered whether national banks

7 See, e.g., 12 C.F.R. § 7.2013 (fidelity bonds); OCC Bulletin 2004-56, December 7, 2004 (life insurance); former

Interpretive Ruling 7.7115, 12 C.F.R. § 7.7115, removed as unnecessary in 1996 (key person insurance);

Interpretive Letter No. 965, Feb. 24, 2003 (liability insurance for a national bank operating subsidiary).

8 See, e.g., Corporate Decision No. 99-3, Dec

7 See, e.g., 12 C.F.R. § 7.2013 (fidelity bonds); OCC Bulletin 2004-56, December 7, 2004 (life insurance); former

Interpretive Ruling 7.7115, 12 C.F.R. § 7.7115, removed as unnecessary in 1996 (key person insurance);

Interpretive Letter No. 965, Feb. 24, 2003 (liability insurance for a national bank operating subsidiary).

8 See, e.g., Corporate Decision No. 99-3, Dec. 21, 1998 (operating risks of parent bank and its affiliates);

Interpretive Letter No. 845, Oct. 20, 1998 (same); Corporate Decision No. 97-92, Oct. 17, 1997 (safe deposit box

liability insurance for parent bank and its bank affiliates); Letter of Richard V. Fitzgerald, Chief Counsel, Oct. 22,

1986 (unpublished) (directors’ and officers’ liability insurance for member banks).

- -

5

could become members of a mutual insurance company in order to obtain directors’ and officers’

liability insurance. Since mutual insurance companies are owned by their policyholders, the

issue that confronted the OCC was whether a national bank could be part owner of an insurance

company. We concluded that there was no reason to limit national banks to stock insurance

companies in obtaining insurance coverage. In substance, the banks were simply purchasing

needed insurance coverage and so, ignoring the form and looking to the substance of the

transaction, the proposal was approved.9

The same holds true here. The GSIP form is somewhat novel and has not been approved

before. However, looking to the substance of your proposal rather than the form, it is

simply a way for banks to obtain necessary workers’ compensation insurance for

themselves. This activity is clearly permissible.

The cross-liability aspect of your proposal can be viewed as a permissible guarantee

.9

The same holds true here. The GSIP form is somewhat novel and has not been approved

before. However, looking to the substance of your proposal rather than the form, it is

simply a way for banks to obtain necessary workers’ compensation insurance for

themselves. This activity is clearly permissible.

The cross-liability aspect of your proposal can be viewed as a permissible guarantee. Although

courts have held that national banks lack authority to assume unlimited liability for the acts of

others as a general partner,10 and have no power to issue guarantees solely for the benefit of

another party,11 the courts have recognized that national banks do have implied power to issue a

9 Letter of Richard V. Fitzgerald, supra note 8.

10 In Merchants National Bank v. Wehrmann, 202 U.S. 295 (1906), the Supreme Court held that the national bank

did not have the power to assume unlimited liability for the acts of others and thus could not be a member of the

general partnership firm. Because of this precedent, the OCC has taken the position that national banks cannot

assume joint and several liability for the acts of others. See Interpretive Letter No. 544, Feb. 14, 1991; Interpretive

Letter No. 589, June 16, 1992 (affirming previous decision).

This proposal is distinguishable from the situation in Wehrmann. The plan incorporates so many safeguards

(discussed on pages 3 and 4, supra) that the possibility of a bank actually sustaining joint and several liability

appears to be de minimis. In addition, as you have pointed out, if the GSIP were to experience a shortfall in its

claims fund, it would simply raise members’ premiums the following year, the same as a commercial insurance

company would do.

Most importantly, this is not a partnership; the theoretical joint and several liability here is limited to workers’

compensation claims. There is no general liability for any and all acts of the other members of the GSIP as would

be the case in a general partnership

claims fund, it would simply raise members’ premiums the following year, the same as a commercial insurance

company would do.

Most importantly, this is not a partnership; the theoretical joint and several liability here is limited to workers’

compensation claims. There is no general liability for any and all acts of the other members of the GSIP as would

be the case in a general partnership. This is in sharp contrast to Wehrmann, in which the bank was a general partner

in a partnership, exposed to liability for any acts of the other partners, and where no safeguards that could protect the

bank from liability existed.

Although the unlimited liability rule and the guarantee rule both relate to banks assuming liability for the obligations

of others, the guarantee rule is not an exception to Wehrmann. They are separate concepts, arising from different

lines of case law. The Wehrmann rule relates to the unlimited personal liability that is an inherent aspect of a

general partnership, while a guarantor’s liability is based upon and limited to the obligations described in its

contract.

11 See, e.g., Border National Bank v. American National Bank, 282 F. 73 (5th Cir. 1922), cert. denied, 260 U.S. 701

(1922); Commercial National Bank v. Pirie, 82 F. 799 (8th Cir. 1897); First National Bank v. Crespi & Company,

217 S.W. 705 (Tex. Civ. App. 1920).

- -

6

guarantee that is not solely for the other party’s benefit, i.e., if the bank has a substantial interest

of its own in the transaction.12

These cases have been codified in the OCC’s regulation at 12 C.F.R. § 7.1017 on permissible

national bank guarantees which provides, in part:

A national bank may lend its credit, bind itself as a surety to indemnify another,

or otherwise become a guarantor . . . if:

s not solely for the other party’s benefit, i.e., if the bank has a substantial interest

of its own in the transaction.12

These cases have been codified in the OCC’s regulation at 12 C.F.R. § 7.1017 on permissible

national bank guarantees which provides, in part:

A national bank may lend its credit, bind itself as a surety to indemnify another,

or otherwise become a guarantor . . . if:

(a) The bank has a substantial interest in the performance of the transaction

involved . . . .

Your proposal satisfies this requirement. A “substantial interest” exists if the guarantee

provided by the bank is incidental to an authorized activity.13 To put it another way, the

nexus between the bank permissible transaction and the guarantee provides the

substantial interest for the bank.14 OCC precedents have found a substantial interest in a

guarantee to exist in a variety of circumstances.15

In particular, your proposal is similar to OCC precedents on national bank membership in

securities and commodities exchanges. The OCC has long permitted national banks (or

their operating subsidiaries) to be members of such exchanges even if membership

requires liability for defaults by other members of the exchange. As long ago as 1975,

the OCC approved membership by a national bank operating subsidiary in commodity

and mercantile exchanges which carried the possibility of liability for defaults by other

12 See, e.g., Dunn v. McCoy, 113 F.2d 587 (3d Cir. 1940) (guarantees entered into by banks for the furtherance of

their own rights or as an incident to the transaction of their own business will be enforced notwithstanding the

absence of an express grant of power); American National Bank v. National Wall Paper Co., 77 F. 85 (8th Cir.

1896) (a national bank may lend its credit where the bank was to receive and did receive benefit therefrom);

Southern Exchange Bank v. First National Bank, 141 S.E. 323 (Ga. App

eir own rights or as an incident to the transaction of their own business will be enforced notwithstanding the

absence of an express grant of power); American National Bank v. National Wall Paper Co., 77 F. 85 (8th Cir.

1896) (a national bank may lend its credit where the bank was to receive and did receive benefit therefrom);

Southern Exchange Bank v. First National Bank, 141 S.E. 323 (Ga. App. 1928) (national bank has implied power to

make a valid contract of guarantee for its own benefit).

13 Dunn v. McCoy, supra note 12; Interpretive Letter No. 929, Feb. 11, 2002; Interpretive Letter No. 376, Oct. 25,

1986.

14 Interpretive Letter No. 1010, Sep. 7, 2004; Interpretive Letter No. 929, supra note 13.

15 See, e.g., Interpretive Letter No. 1010, supra note 14 (“financial warranties” provided to mutual fund

advised by the bank); Interpretive Letter No. 542, Feb. 6, 1991 (guaranteeing loans made by bank’s foreign

subsidiary); Interpretive Letter No. 376, supra note 13 (guaranteeing owners of securities loaned by bank

against loss); Interpretive Letter No. 218, Sept. 18, 1981 (bill of lading guarantee; substantial interest in

facilitating liquidation of goods after previous issuance of a letter of credit); Interpretive Letter No. 177,

Jan. 14, 1981 (guarantee of reimbursement to payors of direct deposit pension payments in case recipient

not entitled to payment).

- -

7

exchange members. The OCC found this possible liability to be a permissible guarantee

because the subsidiary had a substantial interest in being a member of the exchanges.16

In 1986, the OCC approved the acquisition by a national bank of an operating subsidiary

that was a member of the clearing corporations or associations of several securities and

options exchanges

exchange members. The OCC found this possible liability to be a permissible guarantee

because the subsidiary had a substantial interest in being a member of the exchanges.16

In 1986, the OCC approved the acquisition by a national bank of an operating subsidiary

that was a member of the clearing corporations or associations of several securities and

options exchanges. For each of these entities, the operating subsidiary was required to

make deposits to a guarantee fund that would be used to satisfy the outstanding

obligations of any member that was unable to satisfy its debts. The OCC found that this

potential liability for the obligations of other members was not an impermissible

guarantee; rather, the subsidiary had a substantial interest in satisfying this guarantee

fund requirement in order to retain its ability to provide clearing services to its

customers.17

More recently, the OCC found that it was permissible for the foreign branch of a national

bank to become a member of a securities clearing exchange in order to engage in

permissible securities activities. Membership in the exchange required contribution to a

default fund to cover losses caused by any defaulting member of the group. The OCC

found that contributing to the default fund in order to guarantee the national bank’s own

obligations as well as those of other exchange members was consistent with the

“substantial interest” requirement of 12 C.F.R. § 7.1017.18

A similar conclusion can be drawn here. Like the members contributing to the securities

and commodities exchange default funds in the precedents discussed above, members of

the GSIP will contribute insurance premiums to establish a reserve fund that will be used

to pay claims against any member of the group

was consistent with the

“substantial interest” requirement of 12 C.F.R. § 7.1017.18

A similar conclusion can be drawn here. Like the members contributing to the securities

and commodities exchange default funds in the precedents discussed above, members of

the GSIP will contribute insurance premiums to establish a reserve fund that will be used

to pay claims against any member of the group. Contributing to this fund in order to

guarantee a national bank’s own obligations as well as those of other members of the

GSIP satisfies the “substantial interest” test because there is a nexus between the

guarantee — which is required for membership — and the permissible activity of

obtaining worker’s compensation coverage for the bank. Thus, the possible liability for

obligations of the GSIP constitutes a permissible guarantee.19 In addition, your proposal

16 Letter of J. T. Watson, Deputy Comptroller of the Currency, July 11, 1975 (unpublished). This letter discussed

membership in two exchanges. It appears that the subsidiary’s potential liability was limited in one case, but not in

the other.

17 Interpretive Letter No. 380, Dec. 29, 1986.

18 Interpretive Letter No. 929, supra note 13.

19 Although some guarantees that the OCC has found to be permissible involved specific dollar amounts, this is not a

requirement for a permissible guarantee. See, e.g., Interpretive Letter No. 1010, supra note 14 (financial

warranties); Interpretive Letter No. 376, supra note 13 (securities lending); Letter of J. T. Watson, supra note 16

(commodities exchange default fund).

pra note 13.

19 Although some guarantees that the OCC has found to be permissible involved specific dollar amounts, this is not a

requirement for a permissible guarantee. See, e.g., Interpretive Letter No. 1010, supra note 14 (financial

warranties); Interpretive Letter No. 376, supra note 13 (securities lending); Letter of J. T. Watson, supra note 16

(commodities exchange default fund).

- -

8

includes enough safeguards that the possibility of any liability under this guarantee

actually coming to pass appears de minimis.20

Accordingly, we conclude that participation in the workers’ compensation GSIP that you

describe is permissible for national banks. This conclusion is based on the information

and representations that you have provided. A significant change in the facts could

require a different conclusion.

I trust that this has been responsive to your inquiry. If you have any questions, please

contact Christopher Manthey, Special Counsel, Bank Activities and Structure Division, at

(202) 874-5300.

Sincerely,

/s/ Daniel P. Stipano

Daniel P. Stipano

Acting Chief Counsel

20 Interpretive Letter No. 376, supra note 13, noted that the guarantee found to be permissible in that case was only a

minor part of a much larger package of banking services. Similarly, the guarantee involved in GSIP membership is

a very minor part of a much larger program.