BILL ANALYSIS                                                                                                                                                                                                    

                                    AND INSURANCE
                           Senator Ronald Calderon, Chair

          AB 1837 (Gaines)    Hearing Date:  June 30, 2010  

          As Amended: May 20, 2010
          Fiscal:             No
          Urgency:       No

          VOTES:              Asm. Floor(05/28/10)58-01/Pass
                         Asm. Ins.                (04/21/10)10-02/Pass

           SUMMARY    Would permit a California domestic insurer to provide  
          designated administrative services to an affiliated non-admitted  
          insurer which is approved by the California Department of  
          Insurance for accepting surplus lines placements in California.
           Existing law
           1.  Requires insurers that "transact" insurance in California  
              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 of matters subsequent to the  
              execution of, and arising out of, the insurance contract;

           3.  Authorizes licensed "surplus lines brokers", when a risk  
              cannot be placed with an admitted insurer,  to place the  
              risk with an insurer that is not fully licensed in  
              California, subject to rules and financial requirements  
              designed to strengthen the public's confidence when dealing  
              with such entities;

           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  


                                               AB 1837 (Gaines), Page 2


           5.  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;

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

           7.  Imposes various duties on surplus lines broker to ensure  
              compliance with the Surplus Lines law;

           8.  Recognizes the role of the Surplus Lines Association (SLA),  
              a nongovernmental entity, as an administrative agent of the  
              Commissioner 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 essentially the guarantor for the payment of  
              covered claims in the event an admitted insurer becomes  
              insolvent. There is no comparable entity for nonadmitted  

           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.

           This bill

             1.  Would authorize a nonadmitted insurer that is affiliated  
              with a California domestic insurer to have common directors,  
              provided that the directors do not perform management  
              functions for the nonadmitted affiliate, and provided that  
              the common directors do not constitute a majority of the  
              nonadmitted affiliate's board.


                                               AB 1837 (Gaines), Page 3

            2.  Would authorize a California domiciled insurer to provide  
              the following administrative services to its nonadmitted  

               a.     Computer operations, as specified, that are  
                 unrelated to the underwriting process;

               b.     Clerical and administrative staffing support,  
                 provided that the staff providing these services to not  
                 have contact or interaction with policyholders of the  
                 nonadmitted affiliate;

               c.        Human resources, provided that hiring and firing  
                 decisions, employee discipline, and compensation  
                 decisions are handled directly by the nonadmitted  

               d.     Claims adjusting, as described in a specified  
                 Insurance Code section, provided that the notices,  
                 decisions, and payments are made directly by the  
                 nonadmitted insurer; and,

               e.     Investing services, provided that decisions on  
                 investment goals, risk assumptions, diversification and  
                 liquidity needs are made directly by the nonadmitted  

          3.Would state that nothing in the above provisions permits the  
            nonadmitted insurer to conduct activity that constitutes the  
            "transaction" of insurance, or a violation of specified  
            sections of the Insurance Code.


          1.  Purpose of the bill  To permit a California domestic insurer  
              to provide designated administrative services to an  
               affiliated  non-admitted insurer which is approved by the  
              California Department of Insurance for accepting surplus  
              lines placements in California.

          2.  The approach adopted in this bill as of the May 20th amended  
              version is in large part consistent with the approach  
              authorized under the laws governing admitted and nonadmitted  
              insurer operations in the key regulatory state of New York.   
              On many matters of insurance regulation, the policies of New  


                                               AB 1837 (Gaines), Page 4

              York are seen as setting a touchstone of validity.  The  
              approach embodied in AB 1837, and concurred in by the  
              California Department of Insurance, is generally consistent  
              with a New York State Office of General Counsel opinion  
              letter dated on November 29, 2007 and issued on behalf of  
              the New York State Insurance Department.

          3.  The bill (Page 15, Line 38 to Page 16, line 2) contains  
              language to preclude the two entities to have interlocking  
              directorates of a type where the same persons are actively  
              managing both entities.
          4.  Background   According to the author and the sponsor, the  
              Pacific Association of Domestic Insurance Companies (PADIC),  
              since foreign insurers and their non-admitted insurer  
              affiliates reside outside of California, administrative  
              services for the non-admitted insurer can be provided by or  
              shared with the admitted insurer in its home state to save  
              costs.  However, this is not the case for many California  
              domestic insurers.  If domestic insurers wish to write  
              business on a non-admitted basis, they are required by the  
              Department of Insurance to offer coverage through a separate  
              company located out of the state which cannot be supported  
              administratively by the California domestic insurer.

          5.  According to PADIC, AB 1837 recognizes that the non-admitted  
              regulatory process is fundamentally unfair to small and  
              medium size domestics.  As stated by PADIC,  the solution to  
              this problem is to permit California domestic insurers to  
              provide certain administrative services to their DOI  
              approved affiliated non-admitted insurer.  PADIC argues the  
              services being considered by AB 1837 would not constitute  
              transacting insurance but would permit the California  
              domiciled insurer to protect California jobs by providing  
              administrative services that do not include any direct  
              contact with the policyholder or claimants to the  
              non-admitted insurer.

          6.  As explained above, the general rule in California and  
              elsewhere is that an insurance company must be licensed  
              (admitted) to do business in the state.  This requirement  
              empowers the Insurance Commissioner to regulate company  
              solvency, a vital consumer function. In California, a  
              further dimension of this oversight is that admitted  
              property-casualty insurers are subject to rate regulation  
              law under Proposition 103 of 1988.


                                               AB 1837 (Gaines), Page 5

          7.  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.

           8.  Shared Investment Plan Execution Function  Surplus lines  
              insurers are not subject to protection under the California  
              Insurance Guaranty Act, so that their basic financial  
              "promise" and what backs it up is based upon their capital  
              and surplus. This bill will allow an affiliated admitted  
              company to administer the investment management program of  
              the surplus lines company pursuant to Subdivision (o)(E) of  
              Section 1765.1.  The surplus lines company could, as a  
              matter of common business practice, retain a third party  
              investment manager to administer its investment strategy.  
              This bill will permit it to use the services of its  
              affiliated admitted company to perform this function. 

              A possible objection to this arrangement is that if there  
              are significant market losses, a surplus line company  
              insured faceing a significant loss might attempt to "pierce  
              the corporate veil" and pull in the admitted company's  
              assets to cover their surplus lines losses, asserting  
              "culpability" exists since the admitted affiliate company  
              was managing both investment portfolios. While this  
              possibility does exist, it would appear to be highly remote.  
               Furthermore, if an affiliated entity is administering the  
              investments rather than a 3rd party, the affiliated entity  
              actually has a greater stake in the investment program's  
              success, i.e. more "skin-in-the-gam"e. 

              For this reason the authority for a California admitted  
              affiliate of a surplus lines company, where 1) the boards  
              are independent of one another and 2) the investment program  
              for the surplus lines company is directed by the surplus  
              lines company, appears to be reasonable. 


                                               AB 1837 (Gaines), Page 6

           9.  Questions  None

           10. Suggested Amendments  None are suggested in committee but the  
              measure will need to amended on advice of Legislative  
              Counsel to eliminate a conflict with AB 1708 (Villines). 

           11. Prior and Related Legislation  AB 1708 (Villines) is pending  
              on the Senate Floor and will raise the required capital and  
              surplus of this type of nonadmitted insurer from 15 to 45  
              million dollars. 

          Pacific Association of Domestic Insurance Companies (PADIC)  

          Consultant:   Kenneth Cooley (916) 651-4102