BILL ANALYSIS                                                                                                                                                                                                    



                                                                  AB 1837
                                                                  Page  1

          Date of Hearing:   April 21, 2010

                           ASSEMBLY COMMITTEE ON INSURANCE
                                 Jose Solorio, Chair
                    AB 1837 (Gaines) - As Amended:  April 5, 2010
           
          SUBJECT  :   Unlicensed insurers: transaction of insurance

           SUMMARY  :   Authorizes a nonadmitted (unlicensed) insurer that is  
          affiliated with a domestic admitted insurer to receive  
          administrative services performed in California by the domestic  
          admitted affiliate.  Specifically,  this bill  :  

          1)Authorizes a nonadmitted insurer that is affiliated with a  
            California domestic insurer to receive (undefined)  
            administrative services rendered in California by its domestic  
            affiliate. 

          2)Requires the nonadmitted insurer to provide the Insurance  
            Commissioner (IC) with a description of the administrative  
            services to be rendered in California by the domestic  
            affiliate.

          3)Provides that none of these administrative services may  
            constitute the transaction of insurance, nor constitute a  
            violation of the statute that prohibits a surplus lines broker  
            from acting as an agent of or advertising in the state for a  
            nonadmitted insurer.

          4)Authorizes a nonadmitted insurer and its domestic affiliate to  
            have common officers and directors, provided that the  
            nonadmitted insurer maintains a resident operating manager in  
            its home state who is responsible for and carries out all  
            management functions in its home state.

           EXISTING LAW  :

          1)Requires insurers that "transact" insurance in California to  
            be "admitted" to transact in the state.  "Admitted" is the  
            Insurance Code terminology for being licensed to transact  
            insurance in this state.

          2)Provides that "transact" as it applies to insurance includes  
            solicitation, negotiations preliminary to the execution of an  
            insurance contract, execution of the contract, and transaction  








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            of matters subsequent to the execution of, and arising out of,  
            the insurance contract.

          3)Authorizes "nonadmitted" insurers to sell insurance to  
            Californians on a limited basis, through specially licensed  
            "surplus lines brokers."  

          4)Provides broadly that nonadmitted insurers may sell insurance  
            to Californians when the insurance is needed by the  
            policyholder, but generally not available from admitted  
            insurers.

          5)Requires that, before selling insurance on a nonadmitted basis  
            in California, the nonadmitted insurer must apply to be placed  
            on the list of eligible surplus lines insurers (LESLI list),  
            and the Insurance Commissioner (IC) must approve the  
            application based on statutory criteria before placing the  
            nonadmitted insurer on the list.

          6)Prohibits in virtually all circumstances a nonadmitted insurer  
            from selling insurance in California except though a surplus  
            lines broker, who reaches out and places the California  
            insurance with the nonadmitted insurer outside of the state.   
            In this sense, the nonadmitted insurer is not "transacting"  
            insurance in California.

          7)Places a series of duties on the surplus lines broker to  
            ensure that these requirements are met.

          8)Recognizes the role of the Surplus Lines Association (SLA), a  
            nongovernmental entity, as an administrative agent of the IC  
            for carrying out certain functions, including a role in tax  
            collection and a role in pre-screening applicants for  
            placement on the LESLI list.

          9)Establishes the California Insurance Guarantee Association  
            (CIGA) as the guarantor for the payment of covered claims in  
            the event an admitted insurer becomes insolvent.  There is no  
            comparable entity for nonadmitted insurers.

          10)Defines a "domestic" insurer as one that is organized under  
            the laws of California.

          11)Defines "nonadmitted" as an entity that is not entitled to  
            transact the insurance business in California.








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           FISCAL EFFECT  :   Undetermined.

           COMMENTS  :   

           1)Purpose  .  According to the author and the sponsor, the Pacific  
            Association of Domestic Insurance Companies (PADIC),  
            California domestic insurers face a competitive disadvantage  
            in comparison to non-domestic admitted insurers with respect  
            to the operations of affiliated nonadmitted insurers.   
            Specifically, the author and PADIC argue that a non-domestic  
            admitted insurer can share a range of services and cost-saving  
            activities with a nonadmitted affiliate that is selling  
            insurance in California, but a domestic insurer cannot provide  
            those same services to its nonadmitted affiliate without  
            violating the laws that bar a nonadmitted insurer from  
            transacting insurance in the state.  The bill is intended to  
            level this playing field among nonadmitted insurers.

           2)Why have nonadmitted insurance  ?  The general rule in  
            California, as in every state, is that an insurance company  
            must be licensed (admitted) in order to do business in the  
            state.  There are sound reasons for this rule, notably the  
            ability of the IC to ensure the solvency of these companies to  
            ensure they can keep their promises to pay future benefits to  
            Californians, and to ensure that the insurers treat  
            policyholders and claimants in a fair and reasonable manner.   
            In addition, in California admitted property-casualty insurers  
            are subject to a rate regulation law that was enacted by the  
            voters (Proposition 103 of 1988).

          However, despite these sound reasons to require all insurers to  
            be admitted, the law recognizes that there are reasons to  
            allow the sale of insurance by nonadmitted insurers.  If there  
            is an insurance need by a California resident, and that need  
            is not being filled by admitted insurers, it is logical that  
            the law allow that need to be filled.  Thus, for unusual  
            risks, or for very large risks, the nonadmitted market plays a  
            crucial role in providing commercial insurance in California.   
            There is a small amount of personal homeowners insurance sold  
            by nonadmitted insurers in California, but virtually all  
            nonadmitted insurance is in the commercial lines.

           3)Problems with nonadmitted insurance  .  In the 1980s and early  
            1990s, the surplus lines market was far less regulated than it  








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            is today.  As a result, extremely poorly capitalized insurers  
            would start writing business to unsuspecting consumers, and  
            all too frequently these insurers would default on their  
            obligations.  The automobile insurance crisis was at the point  
            where hundreds of thousands of Californians were purchasing  
            basic automobile insurance from nonadmitted insurers.  At that  
            time, the law did not require nonadmitted insurers to apply  
            for and be placed on an eligibility list.  Indeed, there were  
            not even financial filing requirements.  The DOI attempted to  
            deal with this problem by adopting a regulation that mandated  
            a contemporaneous financial filing at the time when a  
            nonadmitted insurer first sold a policy to a Californian.   
            However, even this approach proved inadequate, as the courts  
            made it extremely difficult for DOI to shut down financially  
            unsound nonadmitted insurers, because these insurers had  
            established a "property right" in the business that they were  
            conducting.
          The Legislature responded to this problem by enacting laws that  
            in most circumstances prohibit private passenger automobile  
            insurance to be sold by nonadmitted insurers, and by creating  
            the LESLI list to ensure no nonadmitted insurer could  
            establish the foothold "property interest" unless the IC had  
            affirmatively approved the nonadmitted insurer's status as  
            financially sound.  These changes have improved the market,  
            but also highlight the fact that selling insurance on a  
            nonadmitted basis is a privilege granted by the state, to be  
            authorized only where there is a clear need to fill a void.   
            Without a need to fill a void, insurance should be sold by  
            licensed companies only.

           4)Support  .  PADIC writes in support that the bill recognizes  
            that the nonadmitted regulatory process is fundamentally  
            unfair to small and medium sized domestic insurers due to the  
            ability of nonadmitted affiliates of nondomestic insurers to  
            save costs more effectively with respect to competing for  
            California business.  PADIC also makes the case that  
            California should be encouraging insurers to locate their  
            primary offices within the state, and that this bill will  
            enhance the ability of insurers that do locate here to better  
            compete.

           5)Competitive disadvantage  ?  Proponents suggest that nonadmitted  
            affiliates of a domestic insurer are at a competitive  
            disadvantage with nonadmitted affiliates of nondomestic  
            insurers.  In a certain sense, the observation is valid.   








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            However, it misses the mark at two levels.  First, a  
            nonadmitted affiliate of a United States based insurer will  
            always have one state where there is this appearance of  
            disadvantage - the state where its affiliate is domesticated.   
            Thus, just as a nonadmitted affiliate of a California domestic  
            faces issues when selling insurance in California, a  
            nonadmitted affiliate of a Nevada domestic faces issues when  
            selling insurance in Nevada, and the California-affiliated  
            nonadmitted has a competitive advantage over that insurer in  
            Nevada.  Second, the notion of level playing field competition  
            in the context of nonadmitted insurance in the absence of any  
            showing of a market void ignores the fact that, under  
            California law, if a company wants to compete and exercise its  
            rights under the law, it should become admitted.

           6)Would a nonadmitted insurer under the bill be a real company  ?   
            A nonadmitted insurer that is selling insurance in California  
            should be a real company, with its own assets, offices,  
            management and staff.  Under the proposal currently in the  
            bill, it could be argued that a California domestic insurer  
            could establish a nonadmitted affiliate and operate it out of  
            California, contrary to the principles of current law.  While  
            the bill does require there to be a resident operating  
            manager, it authorizes every senior management officer, from  
            CEO, to CFO, to General Counsel, to Vice-President of  
            Underwriting or Vice President of Investments, to operate out  
            of its California offices.  This could render the distinction  
            between admitted and nonadmitted insurers virtually  
            nonexistent, and encourage other insurers to attempt to avoid  
            the requirements in the law that require obtaining a license  
            to transact insurance in California.

           7)Discussions between DOI and sponsors  .  DOI and the sponsors  
            have been discussing alternatives to the current language in  
            the bill.  The discussions have focused on identifying  
            specific activities that are unrelated to the transaction of  
            insurance, but would be potential cost-saving services in  
            operating a business.  PADIC has proposed a list of activities  
            and operations that it argues would not inappropriately  
            constitute transacting insurance in California.  DOI believes  
            the listing to be far too broad.  PADIC's proposal includes  
            authorizing common officers and directors, as provided in the  
            bill, and would further allow the following activities to be  
            performed in California by the domestic affiliate: computer  
            operations, clerical and staffing support, human resources,  








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            arranging or placing treaty reinsurance, managing investments,  
            and claims adjusting, provided that notices, decisions, and  
            payments be from the nonadmitted affiliate.  As a condition of  
            moving the bill forward, absent an agreement between DOI and  
            the sponsors, it is recommended that the bill be amended as  
            follows:

             a)   Delete reference to common officers between the domestic  
               and the nonadmitted affiliate.

             b)   Delete the reference (page 2, line 37-38) that  
               authorizes the nonadmitted affiliate to "receive  
               administrative services rendered in California" and replace  
               that phrase with a listing of the most acceptable of the  
               proposed services.  These would be computer operations that  
               are unrelated to the underwriting process, clerical and  
               staffing support, human resources, and claims adjusting,  
               provided that notices, decisions and payments be from the  
               nonadmitted affiliate, and further provided that the claims  
               adjusting services be pursuant to a written contract  
               executed between the domestic and the nonadmitted affiliate  
               and filed with the IC.  The purpose of filing the contract  
               is to allow the IC to ensure that an inappropriate  
               delegation of management discretion is not transferred from  
               the nonadmitted insurer to its domestic affiliate.

           REGISTERED SUPPORT / OPPOSITION  :   

           Support 
          
          Pacific Association of Domestic Insurance Companies

           Opposition 
           
          None received.
           
          Analysis Prepared by  :    Mark Rakich / INS. / (916) 319-2086