BILL ANALYSIS SENATE COMMITTEE ON BANKING, FINANCE, 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. DIGEST 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 insurers; 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 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. 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 affiliate: 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 affiliate; 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 affiliate. 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. COMMENTS 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. POSITIONS Support Pacific Association of Domestic Insurance Companies (PADIC) (Sponsor) Oppose None Consultant: Kenneth Cooley (916) 651-4102