Regulate me, please, the opinion column written by Allstate CEO Tom Wilson, appeared in the April 15 NYT in the guise of Wilson’s on-going effort to garner support for national regulation of the insurance industry.
Calling it his CDS mea culpa, Option ARMageddon gave Wilson “kudos” for coming clean:
My company, Allstate, serves more than 17 million American households. While we played only a small role in unregulated insurance markets, we have a duty to help stabilize the financial system. It was, after all, an insurance product that contributed to the risk that almost brought down the global economy.
New York State’s Insurance Superintendent, Eric Dinallo, on the other hand, had no kudos to offer:
“While the credit default swap market is not regulated, insurance company use of credit default swaps is,” Mr. Dinallo said in a statement. “In New York, no insurance company can use credit default swaps except under very specific and limited ways and only with approval.”
Was Option ARMageddon spot on or was Wilson’s agenda to set up Dinallo and DOI to the advantage of his efforts to secure national regulation of the insurance industry? Dinallo’s press release suggests Wilson may have had another agenda – one that would lead to Hank Greenberg, AIG, and, perhaps, other insurers.
The Allstate opinion article argues for federal regulation of insurance based on a number of inaccurate and misleading statements: that credit default swaps are insurance; that A.I.G. sold credit default swaps as an insurer; and that insurance companies were unregulated in selling credit default swaps. In fact, most credit default swaps are not insurance because most buyers were not insuring something they owned, which is a requirement for insurance.
A.I.G. purposely sold huge numbers of credit default swaps through a federally-regulated non-insurance subsidiary because it would not have been allowed to sell swaps with no limits, no controls and no reserves through a state-regulated insurance company. Insurance company sales of credit default swaps are highly regulated and limited.
“I am also concerned that the Allstate opinion article makes a number of broad statements that could risk unnecessarily undermining consumer confidence in the insurance industry as a whole. It states that insurance companies wrote credit default swaps and were not regulated and their solvency was not protected. Wilson’s column does not name those companies, leaving consumers to wonder which companies. It says A.I.G. sold credit default swaps as an insurer, suggesting any insurer could do the same, which is not true.
It says Allstate itself was involved in unregulated insurance, without defining what that means. The column says insurance contributed to the market failure, but is not clear if it means only credit default swaps or insurance generally. Consumers should know that insurance companies are weathering this crisis better than the rest of financial services and that state regulators are focused on ensuring insurers are solvent and can pay claims. I welcome a principled debate about federal regulation of insurance, but the last thing an insurance executive should be doing now is undercutting consumer confidence,” Dinallo said.
There’s another player in CDS regulation – one with a history of involvement documented in correspondence and legislation – ISDA (the International Securities and Derivatives Association).
Following a June 16, 2000, opinion letter from the OCG of the NY Department of Insurance to Bertil Lundqvist, now General Counsel and Executive Vice President of C. V. Starr.ISDA began actively promoting its CDS agenda at the federal level.
From 1991 to 2006, Mr. Lundqvist was a partner at the New York law firm of Skadden, Arps, Slate, Meagher & Flom LLP, where he was responsible for international corporate transactions, insurance management and restructuring, and mergers and acquisitions.
A September 23, 2008 eAlert from Allen and Overy provides information about the content of the OCG’s opinion letter to Lundqvist:
…that [June 16, 2000] opinion did not grapple with whether, under the Insurance Law §1101, a CDS is an insurance contract when it is purchased by a party who, at the time at which the agreement is entered into, holds, or reasonably expects to hold, a “material interest” in the referenced obligation.
According to the Department’s June 16, 2000 opinion, a contract will not constitute an insurance contract if A’s obligation to make a payment to B “upon the happening of a fortuitous event” is “not dependent upon buyer having suffered a loss”. In other words, such a contract will not constitute an insurance contract so long as the contract does not require B to suffer a loss in order to get paid by A; the fact that B may suffer a loss will not automatically result in the contract being characterized as an insurance contract.
The next available correspondence related to CDS regulation is an October 24, 2002 letter from the International Securities and Derivatives Association (ISDA)
ISDA concurs in the suggestion, made in a letter, dated July 2, 2002, from Capitol Tax Partners, that the Internal Revenue Service (the IRS) issue guidance providing that there is no withholding tax (including any insurance or reinsurance excise taxes) on payments made to a non-U.S. counterparty on a CDS.
ISDA expressed other positions related to CDS and CDS transactions:
- Although the terms “seller” and “buyer” are used in the CDS market, both dealers and end users enter into both sides of CDS transactions and, therefore, can assume the role of either the “credit protection seller” or “credit protection buyer.” Thus, the revenue ruling should set forth facts whereby a taxpayer that is a “dealer in securities” within the meaning of section 475(c) enters into either side of a CDS (that is, as either a credit protection buyer or credit protection seller).
- Dealers often enter into a CDS either as a hedge of another CDS or as a hedge of a longposition in a debt instrument. Accordingly, as a practical matter, a protection buyer may have a loss on its offsetting position. The fact that a dealer or investor hedges or uses its CDS as a hedge should not affect whether payments made under such CDS are subject to withholding or insurance excise taxes. Thus, the second factual assertion on which Capitol Tax Partners asks guidance to be based should make clear that a loss is not required under the terms of the CDS.
- [W]we suggest setting forth a factual scenario whereby a CDS is defined as a contract pursuant to which, for valuable consideration, one party transfers credit risk to another party with respect to one or more reference obligations (or obligations of a reference obligor), which may be changed over the life of the contract, wherein: (1) at least one party to the contract is a “dealer in securities” within the meaning of section 475(c) that enters into a CDS, (2) the agreement is documented as an over-the-counter contract that is governed by an ISDA Master Agreement that does not by its terms require a loss on the part of the credit protection buyer as a condition to payment, and (3) the reference obligor(s) or the obligor(s) on any reference obligation are not the credit protection buyer or seller and are not related to either one under section 267(b) or section 707(b).
The October 2002 letter was included as an Exhibit in correspondence dated May 2, 2003 submitted to the IRS by ISDA.
As further described in a letter to the IRS dated October 24, 2002 and in a meeting on March 12, 2003, with, among others, Barbara Angus, International Tax Counsel, Department of Treasury, we respectfully request guidance that a credit default swap (CDS) is a financial instrument and that payments made thereunder are not subject either to withholding taxes under sections 1441 & 1442 of the Internal Revenue Code or to insurance excise taxes.
Both letters, as well as the OIG’s opinion letter to Lundquist were included as attachment to November 2003 correspondence from ISDA to Barbara Angus, International Tax Counsel, Department of Treasury. Also enclosed were these additional documents:
- A Queen’s Counsel opinion indicating that credit default swaps are not insurance in the United Kingdom.
- A document entitled, “Description of Credit Default Swaps,” setting out a suggested description of a credit default swap transaction for use in any guidance to be issued.
- Letter from Capitol Tax Partners to Department of Treasury (July 2, 2002).
The November 2003 letter was a follow-up to a meeting between ISDA and Barbara Angus, International Tax Counsel at Treasury.
to discuss our request for guidance that a credit default swap is a financial instrument and that payments made thereunder are not subject either to withholding taxes under Sections 1441 and 1442 of the Internal Revenue Code or to insurance excise taxes.
In addition to the six attachments to the letter, SDA noted: we will be sending under separate cover, information from U.K. counsel confirming that credit default swaps are not subject to U.K. withholding taxes .
The amendment redefined “asset-backed securities” to expressly permit policies on CDS referencing a pool of obligations or pools of CDS.
The amendment also added the following definition of CDS to Insurance Law § 6901(j-1): [A]n agreement referencing the credit derivative definitions published by the International Swap and Derivatives Association, Inc., pursuant to which a party agrees to compensate another party in the event of a payment default by, insolvency of, or other adverse credit event in respect of, an issuer of a specified security or other obligation; provided that such agreement does not constitute an insurance contract and the making of such credit default swap does not constitute the doing of an insurance business.
Thus, provided that the making of the CDS itself “does not constitute the doing of an insurance business,” Insurance Law § 6901(j-1) expressly permits FGIs to issue insurance policies that guarantee payments by transformers or other parties pursuant to such a CDS.
There are two key aspects of this legislation. One is that some CDS contracts do not constitute or amount to the creation of insurance as defined by the State of New York. These CDS transactions are not regulated by the insurance department as a matter of routine. However, when a CDS contract is written that does constitute the issuance of an insurance policy as defined by the State of New York Insurance Law than that transaction should be referred to the agency for a determination of its status as insurance
The tax issues were still not resolved in September 2005 when the Tax Section of the NY State Bar Association issued a Report on Credit Default Swaps several weeks after Hurricane Katrina.
The next mention of regulation was Circular 19 issued by NY Department of Insurance in September 2008, summarized briefly below.
An important part of the Circular Letter suggests that the Department is contemplating a fundamental shift in position with respect to credit derivatives that could have wide-reaching consequences, not only for the credit derivatives market, but for the derivatives industry as a whole.
What does all this mean? Ask the Institutional Risk Analyst.
…One of the first things we learned about the insurance world is that the concept of “shifting risk” for a variety of business and regulatory reasons has been ongoing in the insurance world for decades. Finite insurance and other scams have been at least visible to the investment community for years and have been documented in the media, but what is less understood is that firms like AIG took the risk shifting shell game to a whole new level long before the firm’s entry into the CDS market.
In fact, our investigation suggests that by the time AIG had entered the CDS fray in a serious way more than five years ago, the firm was already doomed. No longer able to prop up its earnings using reinsurance because of growing scrutiny from state insurance regulators and federal law enforcement agencies, AIG’s foray into CDS was really the grand finale. AIG was a Ponzi scheme plain and simple, yet the Obama Administration still thinks of AIG as a real company that simply took excessive risks. No, to us what the fraud Bernard Madoff is to individual investors, AIG is to the global financial community.
As with the phony reinsurance contracts that AIG and other insurers wrote for decades, when AIG wrote hundreds of billions of dollars in CDS contracts, neither AIG nor the counterparties believed that the CDS would ever be paid. Indeed, one source with personal knowledge of the matter suggests that there may be emails and actual side letters between AIG and its counterparties that could prove conclusively that AIG never intended to pay out on any of its CDS contracts…
After Greenberg stormed the media and appeared before Congress proclaiming he had absolutely nothing to do with the current Credit Default Swap-based economic meltdown, Ed Liddy cried foul and launched organized counter-media campaign.
In more than 30 media appearances since the beginning of the year and elsewhere, Mr. Greenberg and his lawyers have made false and misleading statements about AIG, including his role in creating AIG Financial Products and its credit default swap business, as well as the circumstances surrounding his forced departure from AIG during an accounting fraud investigation.
When Congressman Towns questioned the spending, Liddy replied:
This issue is not about AIG’s corporate public relations expenditures, which are down sharply since last year. It is about correcting Mr. Greenberg’s false and damaging statements.
Kudos for Tom Wilson? Not yet.