BILL ANALYSIS Ó SENATE INSURANCE COMMITTEE Senator Ronald Calderon, Chair SB 1448 (Calderon) Hearing Date: April 25, 2012 As Amended:April 16, 2012 Fiscal: Yes Urgency: No SUMMARY: Conforms California law to the recently revised Insurance Company System Regulatory Act ("Model Act") drafted by National Association of Insurance Commissioners (NAIC). DIGEST Existing law 1. Governs the business of insurance and authorizes the Insurance Commissioner to provide oversight over the insurance industry, including conducting investigations and bringing enforcement actions; a. Provides that any officer, director, or employee of an insurance holding company who willfully and knowingly subscribes to, makes, or causes to be made materially false statements, reports, or filings, as specified, that involves the deliberate perpetration of a fraud upon the commissioner is guilty of a misdemeanor or a felony; b. Prohibits a person from making a tender offer for, or a request or invitation for tenders of, or from entering into an agreement to exchange securities for or acquire in the open market, any voting security, or any security convertible into a voting security, of a domestic insurer or of any other person controlling a domestic insurer, if the other person is not substantially engaged either directly or through its affiliates in any businesses other than that of insurance, if, as a result of the consummation thereof, the person would, directly or indirectly, acquire control of the insurer; c. Prohibits a person from entering into an agreement to merge with or otherwise acquire control of a domestic SB 1448 (Calderon), Page 2 insurer, unless, at the time copies of the offer, purchase, request, or invitation are first published, sent, or given to security holders or the agreement or transaction is entered into, the person has filed with the commissioner, and has sent to the insurer, a statement containing the specified information, including, among other things, information regarding the background and identity of all persons by whom or on whose behalf the purchases or the exchange, merger, or other acquisition of control are to be effected, and any additional information as the commissioner may by rule or regulation prescribe as necessary or appropriate in the public interest or for the protection of policyholders or shareholders; 2. Prohibits purchases, exchanges, mergers, or other acquisitions of control from being made until the commissioner approves those acquisitions, and requires the commissioner to approve or disapprove the transaction within 60 days after the filing of that statement; 3. Requires every insurer authorized to do business in this state to register with the commissioner and to file a registration statement containing specified information, including the identity and relationship of every member of the IHC system; 4. Authorizes domestic insurers and commercially domiciled insurers to enter into specified transactions, including sales, loans, and reinsurance agreements, only if the insurer has notified the commissioner in writing of its intention to enter into the transactions at least 30 days prior thereto, or a shorter period as the commissioner may permit, and the commissioner has not disapproved it within that period; 5. Requires that information reported to the commissioner in the registration statement, and information disclosed in the course of an examination or investigation of the registration statement, be exempt from subpoena or public disclosure, except as specified. This bill 1. Would authorize the commissioner to hold a noticed public hearing after a statement containing specified information regarding the acquisition of a domestic insurer is filed and SB 1448 (Calderon), Page 3 would provide the person filing the statement with the right to present evidence, to examine witnesses, and to offer oral and written arguments; Would also provide for a consolidated hearing before the commissioner and commissioners from other states, as specified; 2. Would require any controlling person of a domestic insurer seeking to divest its controlling interest in the domestic insurer to file with the commissioner a confidential notice of its proposed divestiture at least 30 days prior to the cessation of control; 3. Would require the commissioner to determine those instances in which an insurer under those circumstances would be required to file for and obtain approval of the transaction; 4. Would require the information submitted to the commissioner to remain confidential unless the commissioner makes a specified determination; 5. Would require that the ultimate controlling person of every insurer subject to registration file an annual enterprise risk report; 6. Would define "enterprise risk" for purposes of these provisions to mean any activity, circumstance, or event or series of events involving directly or indirectly one or more affiliates of an insurer that, if not remedied promptly, is likely to have a material adverse effect upon the financial condition or liquidity of the insurer or its IHC system as a whole; 7. Would authorize the commissioner to ascertain the enterprise risk to which an insurer is subjected by the ultimate controlling party or by any entity or combination of entities within the IHC system, or by the IHC system on a consolidated basis, and to order an insurer to produce an enterprise risk report; 8. Would provide that whenever it appears to the commissioner that any person has committed a violation of the registration requirements that prevents the full understanding of the enterprise risk to the insurer by affiliates of the insurance company holding system, the violation may serve as an independent basis for disapproving dividends or distribution or placing the insurer under an order of supervision; SB 1448 (Calderon), Page 4 9. Would require the commissioner to approve or disapprove an acquisition of control on or before the latter of 60 days after the statement has been filed with the commissioner or 30 days after the close of the hearing; 10.Would require the registration statement to specify that the insurer's board of directors is responsible for overseeing corporate governance and internal controls, and that the insurer's officers or senior management have approved, implemented, and continue to maintain and monitor corporate governance and internal control procedures; 11.Would require the insurer to include in the registration statement, if requested by the commissioner, financial statements, as described, of or within an IHC system, including all affiliates; 12.Would authorize the commissioner to participate in a supervisory college for any domestic insurer that is part of an IHC system with international operations in order to determine compliance with specified provisions and would require the insurer to pay for the reasonable expenses of the commissioner's participation; 13.Would also authorize the commissioner to establish the supervisory college, clarify its membership, and establish a crisis management plan; 14.Would clarify that information disclosed in the course of an examination or investigation of specified transactions between registered insurers and their affiliates is exempt from subpoena or public disclosure; 15.Would specify that information disclosed in the course of an examination or investigation of specified transactions between registered insurers and their affiliates and the registration statement information is not subject to disclosure pursuant to the California Public Records Act, but would authorize the commissioner to share the information with other state, federal, and international regulatory and enforcement entities if specified requirements are met; 16.Would authorize the commissioner to receive documents from the National Association of Insurance Commissioners (NAIC) and regulatory and enforcement entities and to enter into SB 1448 (Calderon), Page 5 agreements with the NAIC governing the sharing and use of that information, as specified. 17.Would revise the required content of statements, filings, and reports, and require additional statements and reports, and because it would be a crime for an officer, director, or employee of an IHC to willfully or knowingly engage in specified acts relative to those statements, filings, and reports, the bill would impose a state-mandated local program. This bill would provide that no reimbursement is required by this act for a specified reason. COMMENTS 1. Purpose of the bill . According to the author, this bill conforms California law to the Model Law prepared by the NAIC. 2. Background a. History of the Model Act. According to the Insurance Commissioner ("Commissioner"), the National Association of Insurance Commissioners ("NAIC") is an organization of state insurance regulators for all 50 states, Washington D.C., and five U.S. territories. Its primary mission is to promote uniform practices in regulating multi-state insurers. To support this effort, the NAIC maintains an insurance regulator accreditation program and develops uniform standards known as model laws. Commonality in regulating insurers is critical toward maintaining effective state-based consumer protections. The Commissioner explains that in December 2010, the NAIC adopted significant revisions to the Model Act in response to concerns that insurance regulators lacked the necessary authority to adequately understand the risks and activities of non-insurance entities within a holding company system that could pose a risk to an insurer. The argument for new tools to evaluate risks within insurance groups was intensified by the financial difficulties experienced by certain affiliates of the AIG insurance holding company system during the 2008 financial crisis. The NAIC designed these models to provide SB 1448 (Calderon), Page 6 inter-jurisdictional uniformity and cooperation among regulators in a manner that builds in quality control. This approach should allow one jurisdiction to comfortably rely on another NAIC accredited jurisdiction since, by statute, the regulatory processes and standards applied would be substantially similar. b. Insurance Holding Company Systems. SB 1448 conforms California law to recent revisions the NAIC made to its model Insurance Holding Company System Regulatory Act. An insurance holding company system ("IHC system") consists of two or more affiliated persons, one or more of which is an insurer. But these systems can be far more complex than that and involve transactions that shift control and apparent accountability from the actor to a remote person. In this context, person includes business entities such as a corporation or partnership, as well as individuals (Ins. Code § 1215); SB 1448 would also add limited liability companies to that list. From a top-down perspective, an entity within a holding company system may be likened to a remote-controlled car, both may be controlled by someone far removed. But the remote-control may be held by another remote-controlled instrument, and so on and so forth. But the analogy changes when viewed horizontally in that the controlling authority in a business entity may be spread around and decisions are ultimately made by the person or persons who have the controlling interest, not just a person who owns an interest - several remotes might share control of the same instrument or car. The person with, or persons sharing, the most powerful remote-control drives the car. An IHC system can become a vast network of drones, remotes and decision-makers; the problem is identifying who is what. SB 1448 would give regulators tools designed to provide the information necessary to track down the ultimate controlling person or persons - who has the most powerful remote and what are they doing with it. The Act and SB 1449 would create or provide enhancements to mechanisms that help to monitor IHC systems: Registration of Insurers Enterprise Risk Examinations Acquisition of Insurers Examinations SB 1448 (Calderon), Page 7 Transactions within Holding Company Systems Examinations Supervisory Colleges a. Registration. Currently, every insurer authorized to do business in this state, that is also a member of an IHC system, must file an initial registration statement and every year thereafter on a form prescribed by the NAIC (with narrow exception for certain foreign insurers). (Ins. Code § 1415.4.) Registration requires disclosure of pertinent information regarding the operations and governance of the holding company system. (Ins. Code § 1415.4(b).) SB 1448 expands the financial statements requirements, if requested by the Commissioner, to include annual audited financial statements filed with the U.S. Securities and Exchange Commission (SEC) or the most recently filed parent corporation financial statements filed with the SEC. Additionally, the bill would require statements that the insurer's board of directors is responsible for overseeing corporate governance and internal controls and that the insurer's officers or senior management have approved, implemented, and continue to maintain and monitor corporate governance and internal control procedures. i. Disclaimer. Existing law allows a person to disclaim affiliation with any authorized insurer to relieve an insurer of any duty to register or report based on that relationship. The disclaimer is effective unless and until the Commissioner disallows it. SB 1448 grants the Commissioner the power to disallow the disclaimer at any time if the Commissioner determines that the information disclosed in the disclaimer is incomplete or inacurate. ii. New Cause for Sanctions. This bill also provides that acts that violate the registration provisions preventing the full understanding of the enterprise risk to the insurer by affiliates or the holding company system may serve as an independent basis for discipline. That means that acts or omissions, taken as a whole, designed to evade scrutiny, constitute a reason for discipline against the actor separate and apart from the individual acts SB 1448 (Calderon), Page 8 or omissions (for instance, submitting an incomplete report may constitute a violation of Section 1215.4 relating to disclosure, but under SB 1448, may also constitute a separate cause for interference with the monitoring of an insurance holding company). b. Enterprise Risk Examinations. SB 1448 defines an enterprise risk as any activity, circumstance, or event or series of events that could adversely impact the financial condition or liquidity of the insurer or its IHC system as a whole. The bill also incorporates the concept into the regulatory scheme. i. Reporting. This bill would require the ultimate controlling person (the person holding the most powerful remote) of every insurer to file an annual enterprise risk report with the insurance commissioner of the lead state of the IHC system that identifies the potential enterprise risks to the insurer. (The lead state is determined by procedures established in the Financial Analysis Handbook adopted by the NAIC.) If the IHS system has an insurer domiciled in California but has a lead state elsewhere, its respective holding company must file a copy of that report with the Commissioner as well. The first enterprise risk report would be filed with the insurer's registration statement, but would not be due until after July 1, 2013, although the Commissioner would be able to extend the date. ii. Examination. The Commissioner already has the authority to examine the financial condition of insurers and must do so at least every five years. (Ins. Code § 730 et seq.) Under SB 1448, if the Commissioner performs an examination that proves inadequate, or determines the policyholders are being adversely affected, he or she would have additional investigative powers. These new powers allow the Commissioner to evaluate enterprise risks related to the entities within and ultimately the controlling parties of the holding company system. The Commissioner may require the ultimate controlling party or entity to produce records in the possession of the insurer or its affiliates, as well as retain advisory professional assistance such attorneys, SB 1448 (Calderon), Page 9 actuaries, accountants, etc., to assist the Commissioner at the registered insurer's expense. e. Acquisition of Insurers. Acquisition of insurers requires disclosure statements regarding the parties and the sale. (Ins. Code § 1215.2(g).) The Commissioner may only disapprove an acquisition for specified reasons. (Ins. Code § 1215.2(d).) SB 1448 adds provisions related to i. Public Hearings. Under SB 1448, the Commissioner may hold to hold a public hearing subject to the Administrative Procedure Act (Govt. Code § 11500 et seq.). At the hearing, the filer, insurer, persons designated by the Commissioner, and any other person whose interest may be affected, may present evidence and arguments. ii. Consolidated Hearings. SB 1448 would allow for consolidated hearings at the request of the filer, when two or more commissioners must approve the transaction. A commissioner may opt out or attend by telecommunication. iii. Divestment. This bill also requires disclosure when a controlling person seeks to divest its controlling interest in a domestic insurer, unless a statement is filed under Section 1215.2, at least 30 days prior to the cessation of control. Information provided would remain confidential until the conclusion of the transaction, unless the Commissioner determines that otherwise. a. Transactions within a Holding Company System. Existing law provides that the Commissioner will review certain transactions (such as sales, purchases, exchanges, loans, extensions of credit, management agreement, etc.) within an IHC system to determine whether the terms are fair and reasonable and to monitor a one-sided gift of assets - the transaction should not be a way of transferring profits. (Ins. Code § 1215.5.) The insurer must notify the Commissioner within 30 days prior to entering into the transaction. SB 1448 would require that insurers notify and seek approval for amendments and modification to any affiliate SB 1448 (Calderon), Page 10 agreements previously filed, with an explanation for the change and the financial impact on the domestic or commercially domiciled insurer. It also would require that, along with reinsurance agreements, insurers disclose pooling agreements and modifications and changes in the insurer's reinsurance premium or liabilities projected with the following three years. b. Supervisory Colleges. Holding companies with an international presence pose additional challenges to regulators. SB 1448 codifies the authority for the Commissioner to participate in supervisory colleges that provide for cooperation among regulatory jurisdictions in order to examine a domestic insurer that is part of an IHC system with international operations. Under the bill, supervisory colleges may be convened on a temporary or permanent bases and used to assess the business strategy, financial position, legal and regulatory position, risk exposure, risk management, and governance processes. Other regulators may participate as well if charged with supervision of the insurer or its affiliates (such as regulators from other states, the federal government, and international regulatory agencies). The Commissioner may enter into agreements providing the basis for cooperation between college participants so long the confidentiality and evidentiary privilege provisions are also respected. i. Expenses. SB 1448 provides that the Commissioner may charge the insurer for reasonable expenses of the Commissioner's participation in a supervisory college related to the regulation of the insurer's business. ii. Confidentiality of Materials Examined. Under existing law, materials provided to the Commissioner and other regulators must remain confidential unless otherwise provided. (Ins. Code § 1215.7) SB 1448 would expressly exempt these materials from the Public Records Act and subpoena. SB 1448 provides that the Commissioner may receive or share confidential materials with other agencies so long as the commissioners of other states are subject to statutes or regulation similar to California and recipients verify that he or she has the legal authority to maintain confidentiality and agree in writing to do SB 1448 (Calderon), Page 11 so. SB 1448 also permits the Commissioner to enter into written agreements with the NAIC that govern sharing and use of information, and requires NAIC to consent to intervention by an insurer in a proceeding where confidential information may be required to be disclosed (intervention would allow the insurer to defend against disclosure or subpoena in that proceeding). a. Authorizes the Commissioner to Issue Rules and Regulations Relative to the Provisions of the Bill. b. Exception for Home Protection Companies. SB 1448 exempts specified home protection companies (that sell home warranties) as insurers for the purposes of the revised Act if the IHC system invested in the home protection companies on or before December 31, 1978. 1. Summary of Arguments in Support a. The Commissioner explains that adoption of the Model Act's revisions is pivotal in providing uniform standards for corporate governance and holding company supervision. It is anticipated that the Act's revisions will be an NAIC accreditation issue; consequently, enactment of SB 1448 is critical for California to retain its accreditation status. b. The Commissioner supports SB 1448 because it provides for an enterprise risk filing with CDI when California is not the lead state of the holding company, but the holding company system includes an insurer domiciled in California. This ensures that if CDI is examining the enterprise risk of an insurer, which is permitted under current law, then CDI is entitled to a copy of the enterprise risk report prepared by the controlling party of the holding company system. c. The Commissioner also supports SB 1448 provision that avoid the automatic granting of a disclaimer of SB 1448 (Calderon), Page 12 affiliation filing in 30 days when no action is taken by the commissioner, and provides for the disclaimer to be withdrawn if the commissioner determines that it is no longer factually accurate. 1. Summary of Arguments in Opposition None received (as of April 22, 2012) 2. Questions a. The NAIC is comprised of insurance commissioners and the Model Act, and SB 1448, provides the Commissioner with a discretion on several key points. i. Are the decisions of the commissioners subject to judicial review or some type of oversight? ii. How might an insurer or entity in a holding company challenge a decision of the Commissioner on questions such as disallowed disclaimers, sanctions for registration requirements, release of confidential information, etc.? a. "Enterprise risk" means any activity, circumstance, or event or series of events involving directly or indirectly one or more affiliates of an insurer that, if not remedied promptly, is likely to have a material adverse effect upon the financial condition or liquidity of the insurer or its insurance holding company system as a whole. How would the department determine which enterprise risks are threatening enough to require reporting under the directly or indirectly standard? 1. Suggested Amendments Amend page 21, lines 27 - 34, to read: (c) An insurer registered under Section 1215.4 that is SB 1448 (Calderon), Page 13 subject to this section shall be liable for and shall pay the reasonable expenses of the commissioner's participation in a supervisory college pursuant to this section, including reasonable travel expenses, limited to those expenses reasonably related to the regulation of the insurer's business in this state.The commissioner may establish a regular assessment on the insurer for the payment of these expenses.SB 1448 (Calderon), Page 14 2. Prior and Related Legislation AB 299 (Committee on Insurance) (enacted as Chapter 234, Statutes of 2009) created filing and notice requirements for specified transactions involving holding company systems and persons therein. AB 109 (Committee on Budget) (enacted as Chapter 15, Statutes of 2011) created civil and criminal penalties for directors or officers of insurance holding company systems that engage in transactions or make investments which have not been properly reported or submitted. POSITIONS Support California Department of Insurance/Sponsor Opposition None received (as of April 22, 2012) Consultant: Hugh Slayden, (916) 651-4773