The Office of General Counsel issued the following opinion on January 23, 2002, representing the position of the New York State Insurance Department.

Re: Issuance of Mandatorily Exchangeable Preferred Stock

Question Presented:

Would the preferred stock issuance arrangement described below be permissible under the New York Insurance Law?


The arrangement would be permissible under the New York Insurance Law.


An organization has proposed a preferred stock investment that could be issued by an insurance company subsidiary, and inquired about its permissibility under the New York Insurance Law.

Based upon the facts described in the term sheet, the proposed arrangement involves the creation of a wholly owned real estate investment corporation subsidiary ("REIT") by an insurance company ("Company"). The Company will contribute real estate assets to the REIT. The REIT will issue two classes of perpetual preferred shares (Series A and Series B) to a subsidiary of the Company ("Subsidiary").

The Series B preferred shares will be securities of the REIT, and will be sold by the Subsidiary to third party investors. Should there occur a "Mandatory Exchange Event"1 , the Series B shares will be mandatorily exchangeable into shares of the Company. Thus, upon the occurrence of a Mandatory Exchange Event, the investors’ Series B preferred shares of the REIT would be exchanged for the preferred stock of the Company ("Company Series B shares"). If delivered pursuant to the Mandatory Exchange Event, the Company Series B shares would have the same dividend rate, liquidation preference, and other attributes relative to the Company as the Series B preferred shares had to the REIT.

Finally, under the terms of the arrangement, the Company, pursuant to a "Dividend Restriction Agreement" would agree not to pay dividends to its own preferred or common shareholders unless the current dividend is being paid to the shareholders of the Series B preferred shares.


Life Insurance Companies

The proposed arrangement involves the establishment of an investment subsidiary of the Company. Such a subsidiary is defined by N.Y. Ins. Law § 1702 2 (McKinney 2000) as follows:

[A] subsidiary… engaged or organized to engage exclusively in the ownership and management of assets (other than equity securities of subsidiaries) authorized as investments for the parent corporation and other investment subsidiaries…

In the proposed structure, the REIT constitutes an investment subsidiary of the Company in that it functions solely as the holder of investment assets transferred to it by the Company.

N.Y. Ins. Law § 1704 (d) (McKinney 2000) sets forth the characterization of investment subsidiary as simply an "alter-ego", or pass-through entity, for purpose of insurance regulation. That section provides as follows:

Investments made or acquired by investment subsidiaries shall be deemed, for the purposes of this chapter, to be made or acquired directly by the parent corporation (pro rata, in the case of a subsidiary less than all of whose voting securities are owned by the parent corporation, in accordance with the parent corporation's investment in such subsidiary), and shall (to such extent) be subject to all the provisions and limitations (including quantitative limits) on the making thereof specified in this chapter with respect to investments by the parent corporation.

Under N.Y. Ins. Law § 1704 (d), assets held by the investment subsidiary are attributed to the parent insurance company. In effect, the existence of the subsidiary is disregarded.3 Thus, there would be no restriction in the New York Insurance Law on the use of a structure such as the one proposed.

With respect to the Dividend Restriction Agreement, the New York Insurance Law would not expressly prevent the use of such an agreement. N.Y. Ins. Law § 4207 (McKinney 2000) sets forth specific guidelines governing the payment of dividends by a stock life insurer.However, these guidelines are intended to protect the solvency of the insurer, and do not conflict with the terms of the Dividend Restriction Agreement described above.

Nothing in the N.Y. Insurance Law prohibits the arrangement described in the inquirer’s letter and accompanying term sheet. However, certain of the elements of the proposed structure may constitute transactions between a "controlled insurer" and other entities within a "holding company system" as those terms are defined in N.Y. Ins. Law § 1501(a) (McKinney 2000). If such is the case, the provisions of Article 15 of the Insurance Law would apply, and the arrangement could trigger the reporting or approval requirements contained therein.

Property/Casualty Insurance Companies

As indicated above, Article 17 of the New York Insurance Law concerns only the subsidiaries of life insurers. The rules governing the subsidiaries of property/casualty insurers are contained in N. Y. Ins. Law Article 16 (§§ 1601 – 1612) (McKinney Interim Supp 2001-02). The provisions of Article 16 differ from those of Article 17. For example, Article 16 does not contain the concept of an "investment subsidiary". However, this does not present any impediment to the use of the proposed structure. N.Y. Ins. Law § 1601 (McKinney Interim Supp. 2001-02) grants property/casualty companies broad authority to invest in subsidiaries and provides as follows:

(a) (1) A domestic insurer authorized to make investments by subsection (c) of section one thousand four hundred three of this chapter may, subject to section one thousand two hundred eighteen of this chapter invest in, or otherwise acquire, subsidiaries engaged or organized to engage in any business lawful under the laws of the jurisdiction in which such subsidiaries are organized.

(2) Notwithstanding the provisions of paragraph one of this subsection, no assessment corporation, as defined in subsection (b) of section six thousand six hundred two of this chapter, shall invest in or otherwise acquire, directly or indirectly, an insurance company if such investment or acquisition results in the control of such insurance company by the assessment corporation.

(b) Except as prohibited by paragraph two of subsection (a) of this section, subsidiaries engaged or organized to engage exclusively in owning or investing in insurers, directly or indirectly, are subject to the limitations set forth in sections one thousand two hundred eighteen and one thousand four hundred eight of this chapter.

In addition, N.Y. Ins. Law § 1404(a)(9) (McKinney 2000) expressly permits a property/casualty insurer to use a subsidiary as a conduit for real estate investments. That section provides as follows:

[T]he reserve investments of a domestic insurer authorized to make investments under the authority of this section shall consist of the following:

(9) Investments made by subsidiaries. The net investment in real property and loans secured by real property made by subsidiaries engaged or organized to engage exclusively in the acquisition, ownership and management of such investments. Such loans and real property must qualify as a reserve investment under paragraph four or five of this subsection. The subsidiary’s net investment in such real property and loans shall be included under such paragraph when computing any limitations applicable to such real property and loans and excluded when computing the limitations applicable to equity interests under paragraph eight of this subsection. In order to qualify, a subsidiary must be wholly-owned either by the insurer or by two or more insurance companies domiciled in the United States who are members of the same holding company system, as such term is defined in article fifteen of this chapter, and each individual insurer`s share of the net investments made by such subsidiary shall be computed in proportion to its equity interest in such subsidiary.

As in the case of investment subsidiaries of life insurance companies, the real estate investments of a subsidiary of a property/casualty insurer are accounted for as those of the parent for purposes of applying the relevant investment limitations. Thus, the subsidiary structure proposed for the transaction should be allowed irrespective of whether a life or a property/casualty insurer is involved.

Similarly, the Dividend Restriction Agreement does not pose a regulatory issue. In the case of a property/casualty insurer, the granting of dividends is governed by N.Y. Ins. Law § 4105 (McKinney 2000), which essentially provides that dividends may not be declared or distributed except out of earned surplus. No provision of the N.Y. Insurance Law prohibits the limiting of dividends as is proposed in the instant transaction.

Finally, as was discussed in connection with life companies, the holding company provisions are applicable and could impact the transaction. In light of the above, the proposed structure could be employed by a life or a property/casualty insurer.

For further information you may contact Supervising Attorney Michael Campanelli at the New York City Office.

1  A "Mandatory Exchange Event" will be deemed to occur for purpose of the proposed structure, if any of the following happen:
      (A) The Company’s Risk Based Capital (RBC) ratio falls below 200% of Authorized Control Level Risk Based Capital;
      (B) Any state insurance regulator requires corrective action by the Company to improve its capitalization or RBC Ratio; or
      (C) The Company enters into rehabilitation under the control of the insurance commissioner of its state of domicile.

2 Article 17 (§§ 1701 – 1716) of the New York Insurance Law concerns only Life companies.   You have indicated that it is likely that chiefly Life companies will be interested in the structure proposed herein.   However, you have not precluded the possibility of offering this structure to Property/Casualty companies.   The applicability of the structure to Property/Casualty insurers is discussed in the final section of this letter.

3 The fact that an investment subsidiary is not viewed as an entity distinct from the parent insurer is further evidenced by the fact that investment subsidiaries are exempted from: (1) the quantitative limitations placed upon insurers under N.Y. Ins. Law § 1705 (a); and (2) the superintendent's power to order disposition of a subsidiary pursuant to N.Y. Ins. Law § 1710.  In addition, Regulation 115 requires that the annual and quarterly statements of insurers with investment subsidiaries must include exhibits setting forth descriptions of the assets held by such subsidiaries.  These exhibits must be in the same degree of detail as if the assets were held by the insurer directly.   N.Y. Comp. Codes R & Reg. tit. 11, § 81-2.8 (1995).