# O

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| ## Comptroller of the Currency                                        |
|                                                                       |
| > Administrator of National Banks                                     |
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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. 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.

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.

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. 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 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. 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, 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%.

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 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. 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 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:

(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 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. 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
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

[^1]: California Labor Code § 3701.8 (West 2003).

[^2]: Cal. Code Regs. tit. 8, § 15470 *et seq.*

[^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).

[^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)^.^

[^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. 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).

[^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. 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).

[^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).

[^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.