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American Deposit Corp. v. Schacht

May 13, 1996






Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 95 C 207 Edward A. Bobrick, Magistrate Judge.

Before CUMMINGS, FLAUM, and DIANE P. WOOD, Circuit Judges.

CUMMINGS, Circuit Judge.


DECIDED MAY 13, 1996

The National Bank Act ("Bank Act") arguably permits a national bank to sell an innovative investment product known as the "Retirement CD." The Illinois Insurance Code ("Insurance Code"), however, prohibits selling this product without a certificate of authority from the Director of Insurance. Defendant Blackfeet National Bank ("Blackfeet") has no such certificate and sued for a declaration that the Illinois Insurance Code cannot stand in the face of the National Bank Act. The district court concluded that the sale of the Retirement CD was the "business of insurance" within the meaning of the McCarran-Ferguson Act, which reverses the rule of federal preemption, and thus held that the Illinois Insurance Code applied regardless of whether the sale of the Retirement CD was authorized by the National Bank Act. For the following reasons, we affirm that decision.


The following facts are undisputed. Plaintiff American Deposit Corporation, of Pine, Colorado ("ADC") owns and licenses to banks an investment vehicle known as the Retirement CD. The Retirement CD is structured such that the purchaser qualifies for special tax treatment by the Internal Revenue Service. A customer first deposits money with an individual bank and selects a maturity date in the future (usually the customer's anticipated retirement date). Interest then accumulates on the deposits until the maturity date, at which time the depositor may withdraw in a lump sum up to two-thirds of the account balance, including the accrued interest. Thereafter, the customer receives the remainder of the account in periodic payments for the rest of his life -- essentially a lifetime annuity. The amount of each payment is determined according to mortality tables and a guaranteed interest rate. The customer is assured of receiving the entire amount of the account balance regardless of his lifespan; if he dies prior to receiving that amount in monthly payments, the remainder of the account is paid in a lump sum to his estate or designated beneficiary.

Blackfeet is a small national bank located on the Blackfeet Indian Reservation in Browning, Montana and is a licensee of the Retirement CD. By late 1994, Blackfeet was offering the Retirement CD to investors across the country, although it had yet to accept a deposit from an Illinois resident. Defendant Schacht, on behalf of the State of Illinois, issued an order on December 9, 1994, directing Blackfeet to "immediately cease and desist any and all practices which purport to offer [the Retirement CD] to residents of the State of Illinois." The basis for the order was that Blackfeet was engaging in the business of insurance without a certificate of authority to do so in violation of 215 ILCS 5/24. Plaintiffs concede that because of its lifetime monthly payments feature, the Retirement CD is essentially an annuity and that the Insurance Code includes "granting, purchasing or disposing of annuities" within the "life insurance" classification of the business of insurance. 215 ILCS 5/4(a). Section 5/24 of the Insurance Code dictates that "[n]o company shall transact any business of insurance until it has received a certificate of authority" from the Director of Insurance, which plaintiffs concede they do not have.

The Director of Insurance issues certificates of authority only to domestic, foreign, or alien companies. "Domestic companies" are those organized under the laws of the State of Illinois, 215 ILCS 5/2(f), "foreign companies" are those organized under the laws of any other state or territory of the United States, or the District of Columbia, 215 ILCS 5/2(g), and "alien companies" are those organized under the laws of a country other than the United States, 215 ILCS 5/2(h). Because Blackfeet is a national bank organized under the Bank Act, it does not qualify for certification as any of the above. *fn1 Additionally, 215 ILCS 5/111(c) dictates that companies which engage in other business in addition to the life insurance business -- which, as a bank, Blackfeet obviously does -- may not be certified. Therefore, Blackfeet is not permitted under the Insurance Code to sell and underwrite the Retirement CD in Illinois. The only way it could accomplish the sale in compliance with the Insurance Code would be to set up a subsidiary specifically for that purpose, which could then be issued a certificate of authority.

Blackfeet brought suit against Schacht for a declaration that the sale of the Retirement CD is not subject to regulation by the State of Illinois. Blackfeet argues that the Bank Act, through the express authority to receive deposits, 12 U.S.C. sec. 24 (Seventh), and to enter into contracts, 12 U.S.C. sec. 24 (Third), authorizes the sale of the Retirement CD. We will assume, arguendo, that it does. *fn2 Magistrate Judge Bobrick granted summary judgment to Schacht, concluding that "the nature of the Retirement CD makes it an appropriate subject for regulation as an insurance product because it entails an insurance or mortality risk and a guaranteed return."


We review the grant of a motion for summary judgment de novo, drawing all reasonable inferences in favor of the non-moving party. Smith v. Shawnee Library Sys., 60 F.3d 317, 320 (7th Cir. 1995).

The tension in this case comes from an apparent overlap between activities arguably authorized by the Bank Act and activities that individual states have a legitimate interest in regulating. If we assume that Blackfeet is authorized to sell the Retirement CD under the Bank Act, the pertinent question is whether the Insurance Code can nonetheless prohibit the sale. It is well settled that a federal law preempts a conflicting state law under the Supremacy Clause of Article VI of the Constitution, and the Bank Act is no exception. See, e.g., Barnett Bank of Marion County, N.A. v. Nelson, 116 S. Ct. 1103 (holding that a provision of the Bank Act which allows national banks located in towns with populations of fewer than 5000 people to act as insurance agents preempts contrary state law); Franklin Nat'l Bank v. New York, 347 U.S. 373 (striking down an effort to apply state Saturday closing laws to national banks); Easton v. Iowa, 188 U.S. 220 (striking down state regulation of the circumstances in which a national bank can accept deposits). Thus under ordinary preemption rules, the provisions of the Bank Act would trump contrary Illinois law.

However, with regard to the "business of insurance," the McCarran-Ferguson Act "overturn[ed] the normal legal rules of preemption" by imposing a rule "that state laws enacted for the purpose of regulating the business of insurance do not yield to conflicting federal statutes unless the federal statute specifically provides otherwise." U.S. Dep't of Treasury v. Fabe, 113 S. Ct. 2202, 2211. Specifically, Section 1012 of the McCarran-Ferguson Act provides:

(a) The business of insurance, and every person engaged therein, shall be subject to the laws of the several States which relate to the regulation or taxation of such business.

(b) No Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance . . . unless such Act specifically relates to the business of insurance . . . .

Thus to decide whether the Insurance Code may stand in the face of the Bank Act we must resolve three issues: (1) whether the pertinent sections of the Insurance Code were enacted "for the purpose of regulating the business of insurance"; (2) whether the Retirement CD is properly considered "the business of insurance"; and (3) whether the pertinent provisions of the Bank Act "specifically relate to the business of insurance." Id.


In SEC v. National Sec., Inc., 393 U.S. 453, the Court held that "statutes aimed at protecting or regulating th[e] relationship [between insurer and insured], directly or indirectly, are laws regulating the 'business of insurance.' " Id. at 460. The opinion emphasized that the focus of the McCarran-Ferguson Act is upon the relationship between insurance companies and their customers:

The relationship between insurer and insured, the type of policy which could be issued, its reliability, interpretation, and enforcement -- these were the core of the "business of insurance." Undoubtedly, other activities of insurance companies relate so closely to their status as reliable insurers that they too must be placed in the same class. But whatever the exact scope of the statutory term, it is clear where the focus was -- it was on the relationship between the insurance company and the policyholder. Id.

The Court stated that the "broad category of laws enacted 'for the purpose of regulating the business of insurance' consists of laws that possess the 'end, intention, or aim' of adjusting, managing, or controlling the business of insurance." Id. (citing Black's Law Dictionary 1236, 1286 (6th ed. 1990)). Section 5/24 of the Insurance Code prohibits companies from selling any type of insurance without gaining prior approval of the Department of Insurance. The approval requirement is necessary for the State of Illinois to monitor and regulate the relationship between insurer and insured; without it, regulations that more directly concern the actual relationship between insurer and insured would be impossible to enforce. Furthermore, 215 ILCS 5/121-1 expressly states that the Illinois General Assembly enacted the certification requirement because it was "concerned with protection of residents of [Illinois] against acts by insurers not authorized to do an insurance business in [Illinois]." We conclude that Section 5/24 possesses the " 'end, intention, and aim' of adjusting, managing, or controlling the business of insurance," and was therefore enacted "for the purposes of regulating the business of insurance." Id. Thus the first prong of the test is satisfied.


Having concluded that Section 5/24 was "enacted for the purpose of regulating the business of insurance," we must determine whether the sale of the Retirement CD is properly considered the "business of insurance." Section 5/4(a) expressly includes annuities in its definition of "life insurance," but we may not simply defer to that definition. SEC v. Variable Annuity Life Ins. Co., 359 U.S. 65, 69 ("The meaning of 'insurance' . . . under the [McCarran-Ferguson Act] is a federal question."). Thus we must go further and examine whether the specific practice to which the Code would be applied -- the sale of the Retirement CD -- is properly considered the "business of insurance." See Fabe, 113 S. Ct. at 2212 (noting that an Ohio priority statute was the "business of insurance" to the extent that it regulated policyholders, but not to the extent that it furthered the interests of other creditors); Merchants Home Delivery Serv., Inc. v. Reliance Group Holdings, Inc., 50 F.3d 1486, 1489 (9th Cir. 1995) ("The proper inquiry is whether . . . the specific practice being challenged under federal law is a part of the 'business of insurance.' ").

Plaintiffs initially cite NationsBank of N.C. v. Variable Annuities Life Ins. Co., 115 S. Ct. 810, in claiming that the Supreme Court has already held that the Retirement CD, as an annuity, is not the "business of insurance." We think plaintiffs read too much into that case. In Nations-Bank, the Comptroller of the Currency had authorized a national bank to broker annuities as "an incidental powe[r] . . . necessary to carry on the business of banking." Id. at 814. In addition, the Comptroller had concluded that annuities were not "insurance" within the meaning of 15 U.S.C. sec. 92, which allows national banks doing business in towns of 5000 people or less to act as an agent for an insurance company. The Court held that the Comptroller's interpretations of the Bank Act were reasonable and thus were given controlling weight. Id. However, NationsBank is distinguishable from our situation. First, the holding was limited to the brokering, not underwriting, of annuities. Id. at 815 n.4 ("Assuring that the brokerage in question would not deviate from traditional bank practices, the Comptroller specified that NationsBank 'will act only as agent, . . . will not have a principal stake in annuity contracts and therefore will incur no interest rate or actuarial risks.' "). Second, the holding was limited to whether federal law precluded a national bank from brokering annuities, not whether a bank doing so -- much less a bank underwriting annuities -- would be subject to state regulation. *fn3 In fact, the Supreme Court expressly noted that "States generally classify annuities as insurance when defining the powers of . . . state insurance regulators." Id. at 815. Thus, NationsBank did not answer the question as plaintiffs suggest.

However, the Supreme Court has spoken on this issue and articulated a tripartite standard in Union Labor Life Ins. Co. v. Pireno, 458 U.S. 119, and Group Life & Health Ins. Co. v. Royal Drug Co., 440 U.S. 205, to determine what constitutes the "business of insurance" for purposes of Section 1012(b) of the McCarran-Ferguson Act. Those criteria are: (1) whether the practice has the effect of transferring or spreading a policyholder's risk; (2) whether the practice is an integral part of the policy relationship between the insurer and the insured; and (3) whether the practice is limited to entities within the insurance industry. Pireno, 458 U.S. at 129.

We are aware that the Supreme Court, in distinguishing the state law at issue in U.S. Dep't of Treasury v. Fabe from those at issue in Royal Drug and Pireno, recently noted that those cases involved determinations of whether certain activities were the "business of insurance" for purposes of the second clause of Section 1012(b), which exempts the "business of insurance" from antitrust laws, not determinations of whether laws were "enacted for the purposes of regulating the business of insurance" for purposes of the first clause of Section 1012(b):

Both Royal Drug and Pireno, moreover, involved the scope of the antitrust immunity located in the second clause of sec. [101]2(b). We deal here with the first clause, which is not so narrowly circumscribed. The language of sec. [101]2(b) is unambiguous: the first clause commits laws "enacted . . . for the purpose of regulating the business of insurance" to the States, while the second clause exempts only "the business of insurance" itself from antitrust laws. To equate laws "enacted . . . for the purpose of regulating the business of insurance" with "the business of insurance" itself, as petitioner urges us to do, would be to read words out of the statute. This we refuse to do. Fabe, 113 S. Ct. at 2209-2210.

However, we do not interpret this language to mean that it is inappropriate to utilize the criteria announced in Royal Drug and Pireno in cases involving the first clause of Section 1012(b). Rather, the Court merely noted that one cannot answer the question of whether a state law was "enacted for the purposes of regulating the business of insurance" merely by reference to the Royal Drug and Pireno criteria. As the Sixth Circuit recently recognized,

If . . . the issue arises of whether a particular activity is part of the "business of insurance," the Pireno criteria apply. See Fabe, 113 S. Ct. at 2208 (noting, in considering claim that arose under first clause of sec. 1012(b), that Pireno "identified the three criteria . . . that are relevant in determining what activities constitute the 'business of insurance.' ") (emphasis added). In short, the Fabe Court merely noted that the scope of the respective immunities created by the first and second clauses of sec. 1012(b) are different; it assuredly did not give "business of insurance" one meaning in the first clause and a different meaning in the second. Owensboro Nat. Bank v. Stephens, 44 F.3d 388 (6th Cir. 1994), certiorari denied, 116 S. Ct. 1350.

Because the situation facing us involves a determination of whether the sale of the Retirement CD is to be included within the "business of insurance," we shall apply the criteria announced in Royal Drug and Pireno.

The first and most important factor in determining whether a practice is the "business of insurance" is whether it spreads policyholder risk. The spreading and underwriting of a policyholder's risk are "indispensable characteristic[s] of insurance," Pireno, 458 U.S. at 127; Royal Drug, 440 U.S. at 212, and the legislative history of the McCarran-Ferguson Act "strongly suggest[s] that Congress understood the business of insurance to be the underwriting and spreading of risk." Royal Drug, 440 U.S. at 221; H.R. Rep. No. 873, 78th Cong., 1st Sess., 8-9 (1943) ("Insurance is the distribution of risk according to hazard, experience, and the law of averages."). Essentially, lifetime annuities such as the Retirement CD are the "mirror image" of life insurance policies. *fn4 With life insurance, the issuing company gambles that the purchaser of the policy will not pass away sooner than predicted such that the company does not receive enough in premiums and interest to cover the policy's payout obligation; with lifetime annuities, the position is reversed and the company gambles that the annuitant will not survive longer than predicted such that the company will have to pay more than the amount invested by the annuitant (plus interest). The element of mortality risk, however, is the same in both:

Each issuer [of an annuity] assumes the risk of mortality from the moment the contract is issued. That risk is an actuarial prognostication that a certain number of annuitants will survive to specific ages. Even if a substantial number live beyond their predicted demise, the company issuing the annuity -- whether it be fixed or variable -- is obligated to make the annuity payments on the basis of the mortality prediction reflected in the contract. This is the mortality risk assumed [by the issuer]. SEC v. Variable Annuity Life Ins. Co., 359 U.S. 65, 70. See also Associates In Adolescent Psychiatry v. Home Life, 941 F.2d 561, 565 (7th Cir. 1991) ("Annuities sometimes contain an element of insurance: they may, for example, promise a monthly payment from retirement until death . . . [t]he seller then bears both investment and insurance risks.").

That typical life insurance involves payment "upon" a death, while lifetime annuities involve payment "until" a death is a distinction without a difference: a company selling either the typical insurance policy or the lifetime annuity uses exactly the same actuarial tables to calculate its mortality risk and to set the price of its product.

Not all annuities have insurance characteristics, however. The Supreme Court has noted that " 'insurance' involves a guarantee that at least some fraction of the benefits will be payable in fixed amounts," Variable Annuity Life Ins. Co., 359 U.S. at 71, and thus has held that variable annuities are not "insurance" for purposes of the Securities Act of 1933. Id. at 71-73. The Retirement CD is not a variable annuity. It offers a guaranteed payment to the annuitant for the rest of his life in a predetermined amount and also provides a guaranteed return of the total balance. Thus it involves both fundamental characteristics of insurance: a mortality risk and a guaranteed return. Id. at 71.

Plaintiffs argue that the Retirement CD does not satisfy the first criterion -- spreading risk -- by emphasizing that the spreading and the underwriting of risk refer to "the transfer of risk characteristic of insurance." Pireno, 458 U.S. at 130 (emphasis added). They contend that "risk characteristic of insurance" is "risk of loss resulting from the happening of a contingent event, such as the loss of a house by fire . . . or of a breadwinner by death." [Pl. Br. 24]. The Retirement CD, they argue, does not spread this type of risk, but spreads only an "investment risk," which they define as "the hazard of having insufficient investment acumen to outlive an asset." Id.

We are unpersuaded by plaintiffs' argument. First, describing the purchase of the Retirement CD as "hedging against faulty investment acumen," [Pl. Br. 18], does little to distinguish it from typical insurance; purchasing fire insurance can just as easily be described as "hedging against faulty fire prevention acumen." [Brief of Amicus Curiae American Council of Life Insurance p.6]. Second, the purpose of purchasing a life insurance policy on a family's breadwinner and of purchasing a lifetime annuity is essentially the same. The individual who purchases the life insurance policy insures against no longer having the money produced by the breadwinner, and the person who purchases a lifetime annuity insures against no longer having sufficient money produced by his assets. Finally, plaintiffs' attempt to distinguish insurance by claiming that it involves a loss caused by a single, contingent event overlooks an important aspect of the Retirement CD: By providing a guaranteed minimum return on investment, the Retirement CD insures the purchaser against a decline in the market -- a single, contingent event. The purchaser is given the comfort that should a depression occur in the market, causing rates of interest to fall significantly, he will not suffer a "loss" of future income, but will continue to receive the rate of interest guaranteed in his Retirement CD contract. Furthermore, insurance policies do not always insure against circumstances that occur as a sudden event. For example, one is currently able to purchase an insurance policy that will provide nursing home care to an individual when he finally reaches an age where he is no longer able to care for himself. In short, we conclude that the Retirement CD spreads policyholder risk in a manner similar to typical insurance and thus satisfies the first criterion of the Pireno test.

The Retirement CD satisfies the second and third Pireno factors as well. It is not only an "integral part" of the policy relationship between the insurer and the insured, it is the very document that evidences that relationship. It dictates the rights and obligations of both parties and sets forth the amount of deposit, date of first withdrawal, rate of interest, and the guaranteed amount of monthly payments. The third factor is met because the Retirement CD is an annuity, virtually all of which are issued by insurance companies. See Barron's, Oct. 3, 1994, at 23 (noting that nearly all of the $1 trillion worth of annuities currently in effect in the United States are issued by regulated insurance companies). Furthermore, forty-two state legislatures currently consider annuities to be an insurance industry activity and regulate them as such. [Brief of Amicus Curiae Council of Life Insurance, Ex. D (listing statutes)]; see also SEC v. Variable Annuity Co., 359 U.S. at 69 ("All states regulate 'annuities' under 'insurance' laws."). They do so because a state's interests in regulating the sale of annuities are virtually identical to its interests in regulating the sale of typical insurance. States attempt to ensure that companies remain sufficiently solvent to meet their obligations to customers, which often do not arise until years after the customer purchases his policy. To do this, they require those companies frequently to submit financial statements and actuarial opinions to insurance regulators and to maintain minimal capital reserves. *fn5 Consumer protection concerns motivated states to enact insurance regulations in the first place, and are the reason they include annuities within those regulations.

Our determination that the Retirement CD is the "business of insurance" is further supported by the legislative history of the McCarran-Ferguson Act. While the legislative history contains no explicit debate on whether annuities were intended to be either included or excluded, both the House and Senate incorporated in their deliberations on the Act an August 29, 1944 report by the National Association of Insurance Commissioners ("NAIC"), the voice of state insurance regulators. The NAIC's opinion was important to the debate of the Act, as evidenced by the fact that the statute was a "modification of a measure which was originally drafted by the legislative committee of the [NAIC]." 91 Cong. Rec. 483 (Jan. 25, 1945) (Sen. O'Mahoney). As printed in the Congressional Record, that report seems to suggest that annuities were considered to be part of the "business of insurance":

The insurance business has been alert to keep abreast with the ever-changing and expanding developments of American social and economic life. . . . Some idea of the complexity of the business may be gleaned from the fact that the insurance law of New York makes provision for 22 major kinds of insurance; namely, life, annuity, accident and health, fire, miscellaneous property, water damage, burglary and theft . . . . 90 Cong. Rec. A3975-77 (NAIC report introduced by Rep. Anderson) (emphasis added) (Aug. 29, 1944). *fn6

Because the sale of the Retirement CD satisfies each of the Supreme Court's Pireno criteria, we conclude that the Retirement CD is properly considered the "business of ...

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