International insurers and reinsurers are halting coverage of and investments in companies that do business in Iran, as U.S. regulators and lawmakers seek harsher penalties against companies that have contacts with what they fear may soon be a nuclear-armed nation.

In late February, Allianz S.E. and Munich Reinsurance Co. announced they would voluntarily suspend business in Iran, which has built a nuclear enrichment program that the International Atomic Energy Agency says could be used to create nuclear weapons. Various international officials have called for more stringent sanctions against the country. As a result of the decision to forgo business in Iran, Allianz said it would lose a negligible amount of premiums, and Munich Re said it would lose about e10 million ($13.6 million).

“Due to the political situation in Iran, Munich Re has decided to not renew existing business or write any new business with insurance companies there,” the company said in the statement.

Many of the calls for more stringent sanctions against Iran have come from the U.S., where federal lawmakers and state regulators have increased the pressure on insurers and reinsurers to drop indirect investments in Iran. It already is illegal for U.S. companies to invest directly in Iran, but the proposed Iran Refined Petroleum Sanctions Act of 2009 would impose tougher economic sanctions on U.S. or foreign companies that conduct business with companies that do business with Iran's energy sector.

The legislation, which has passed the House and Senate in different forms and now must be reconciled in conference, would apply to an insurer that, for example, covers a shipowner's entire fleet for worldwide transits, if one of the ships brought refined petroleum to Iran. Despite being the world's fourth largest oil producer, Iran reportedly imports 40% of its gasoline because of problems with its oil industry infrastructure.

Meanwhile, California Insurance Commissioner Steve Poizner has asked 340 insurers licensed in that state to divest from companies that do business with sensitive business sectors in Iran. Mr. Poizner, who is running for governor, also has declared that California will not count investments in such companies toward reserve requirements. The insurance department has identified 50 companies that do business in Iran, including Siemens A.G., Royal Dutch Shell P.L.C. and Hyundai E&C Co. Ltd., and says California-licensed insurers have invested about $6 billion in those companies.

All these actions are prompting many insurers to stop renewing or writing new business in Iran, observers say.

“The big players in the field are getting out or (are) in the process of getting out,” said Pieter Van Tol, a New York-based partner with law firm Lovells L.L.P.

Jon Biasetti, a Chicago-based partner at Locke Lord Bissell & Liddell L.L.P., said insurers and reinsurers licensed in California but domiciled elsewhere are “befuddled” by demands for data and actions that their home state regulators do not require.

“But clearly it's something they're paying attention to,” he said. “Because no one wants to suffer the reputational damage of being called out by any regulator, be it federal or the California Commissioner of Insurance, for not complying with disclosure requirements or requirements to divest” from companies doing business in Iran.

Pennsylvania Insurance Commissioner Joel Ario and Florida Insurance Commissioner Kevin McCarty have expressed support for Mr. Poizner's actions. Mr. McCarty, who is vp of the Kansas City, Mo.-based National Assn. of Insurance Commissioners, said he has talked to other state commissioners and is evaluating the feasibility of developing a national divestment initiative modeled on California's.

California's efforts likely will spread to other states and prompt many insurers and reinsurers to divest voluntarily, Mr. Biasetti said.

“People responsible for investment portfolios of insurance companies may voluntarily take a look at permitted investments they had and say, "We don't want to be called out and have it said we're supporting companies in Iran, regardless of whether their state of domicile adopts similar regulations,' “ Mr. Biasetti said. “Fear of reputational damage in this area is something not to be toyed with.”

Mr. Biasetti said the federal legislation is important because the Senate version would permit state regulators to impose penalties on companies for these kinds of investments, a role traditionally reserved for the federal government.

Legal dilemma

Even if an insurer or reinsurer opts not to renew or write new business with companies that do business in Iran, it is unclear whether long-tail insurance policies written in previous years would be subject to the new economic sanctions proposed in federal legislation, legal observers say. If they did apply, an insurer or reinsurer could encounter a dilemma: continue to cover a ship traveling to Iran and risk becoming the target of U.S. sanctions, or discontinue coverage and risk being sued for breach of contract, said Hal Eren, a Washington-based partner in Eren Law Firm who formerly worked in the Treasury Department office that enforces U.S. trade sanctions.

The argument that providing insurance would break an applicable law often is an acceptable defense for an insurer accused of breach of contract with a policyholder, Mr. Eren said. But he said the proposed legislation would create sanctions, which penalize a company, and not an applicable law, which prohibits a company's behavior. Sanctions would not necessarily hold up as legal justification if the insurer discontinued coverage with a company involved in business in Iran, he said.

Messrs. Eren and Van Tol said some insurers and reinsurers have begun to insert exclusions into policies and treaties that excuse the insurer from covering any business transaction that would be subject to trade sanctions.

Mr. Eren said he did not expect the federal legislation to be reconciled and signed into law soon, because the Obama administration is working to achieve multilateral sanctions against Iran through the United Nations.