BILL ANALYSIS Ó AB 2354 Page 1 Date of Hearing: May 4, 2016 ASSEMBLY COMMITTEE ON INSURANCE Tom Daly, Chair AB 2354 (Calderon) - As Amended April 11, 2016 SUBJECT: Vehicle service contracts SUMMARY: Expands and clarifies the law governing automobile and watercraft service contracts. Specifically, this bill: 1)Repeals the statute that allows sellers of certain motor lubricants to provide a warranty that covers all damages to the vehicle drive train under a presumption that any mechanical failures are caused by a failure of the lubricant. 2)Adds lubricant-based repair commitment programs to the vehicle service contract law. 3)Requires a vehicle service contract provider that offers incidental indemnity benefits to certify that the indemnity benefits are substantially less than the primary service contract benefits. 4)Authorizes service contracts of at least one year duration to provide for routine maintenance of the covered vehicle(s). AB 2354 Page 2 5)Authorizes vehicle service contracts to provide for the replacement of a vehicle key or fob in the event the key or fob is lost, stolen, or becomes inoperable. 6)Exempts from the vehicle service contract law service arrangements whereby an employer contracts with a third party to provide basic vehicle service reimbursements to employees of the employer who use their own personal vehicle for business purposes on behalf of the employer. 7)Clarifies that the vehicle service contract law covers watercraft or motor vehicles. 8)Defines "road hazard" for purposes of the vehicle service contract law that authorizes limited wheel and tire repair coverage by a vehicle service contract. 9)Specifies that the new services authorized to be provided via the service contract law do not make the seller of those services subject to the Motor Club law. EXISTING LAW: 1)Requires that contractual arrangements whereby one party accepts a payment from another party, and agrees to provide a service or pay indemnification upon the occurrence of a future contingent event be regulated as insurance. 2)Authorizes the seller of a motor lubricant to provide a warranty for the product that guarantees the repair and replacement of mechanical components of the vehicle based on a AB 2354 Page 3 presumption that the damage was due to the failure of the lubricant, and declares that this warranty does not constitute insurance. 3)Establishes a separate but insurance-like regulatory system for vehicle service contracts, which are contractual promises made by a third-party obligor (i.e., not the manufacturer or seller of the vehicle) to repair or replace damaged or worn out vehicles in exchange for a premium or charge. 4)Establishes a separate but insurance-like regulatory structure for Motor Clubs, which generally provide towing and emergency roadside assistance programs. FISCAL EFFECT: Undetermined. The bill is tagged non-fiscal. Minor changes in the rules governing vehicle service contracts should have little effect on the regulatory program administered by the Department of Insurance (DOI). COMMENTS: 1)Purpose . According to the author, current law governing service contracts is out of date, and fails to provide consumers with desirable coverage, such as coverage for lost, stolen or damaged keys and fobs - increasingly expensive necessities for operating a vehicle. The bill clarifies and updates the law and creates better options for consumers. The author also points to the elements in the bill intended to remedy loopholes in the law that have been exploited to the detriment of consumers. 2)Warranty, service contract, or insurance . In general, whenever a business sells a contract to a consumer that AB 2354 Page 4 promises to pay a claim or provide a service in the future, based on some uncertain or contingent event, the contract is a contract of insurance, and the elaborate regulatory structure governing insurance applies. However, there are a number of products that meet the general definition of insurance, but for a range of policy reasons are subject to formal but different regulation by the DOI. Typically these products cover relatively small risks, and the financial requirements of full insurance regulation would be too burdensome. Motor Clubs and vehicle service contracts are two examples. Warranties are different. Warranties are governed by federal law, and the promises being made to the consumer are from either the manufacturer or seller of the underlying product. For example, an automobile manufacturer or an automobile dealer can warrant the car you buy. But if some third-party wants to sell you an extended service contract, even if offered by the dealer, it is not a warranty, but rather a service contract regulated by the DOI. Typically automobile dealers do not offer their own warranties because they want the responsibility for performance on the service contract to be the duty of the third party seller. Warranties also differ from insurance or service contracts in the scope of what is promised. A warranty typically covers the product that the consumer purchased in the event of defects or prematurely wearing out. Service contracts can provide a broader scope of coverage, but that scope is detailed in the vehicle service contract law. In order for a service contract provider to offer broader coverage, the statute must be amended to authorize these new coverages. Several of the amendments in this bill provide the statutory authorization for vehicle service contract providers to offer broader coverage to consumers. 3)Lubricant warranties . The Insurance Code has, as noted above, some exceptions to the rule that insurance-like transactions be regulated as insurance. One of those exceptions states AB 2354 Page 5 that vehicle lubricant warranties (masquerading as vehicle service contracts) are "not insurance." The effect of this exception is that these "warranties" are neither regulated as service contracts nor insurance. This bill cures this regulatory hole by changing the characterization of these products from "warranty" to "vehicle service contract." According to the Department of Insurance, lubricant warranty scams have cost consumers in California and across the country hundreds of millions of dollars - one case alone involved over $100,000,000 of fraudulent activity. The Department has obtained cease and desist orders and pursued other enforcement efforts against individuals and businesses that have attempted illegally to circumvent the vehicle service contract law via the warranty exception. The bill takes a moderate approach to curing the problem. Merely repealing the Insurance Code provision that declares these products not to be insurance would result in any business desiring to sell such a product having to comply with full insurance company regulation. The bill, instead, would treat lubricant warranty programs the same as other vehicle service contracts. 4)Incidental indemnity coverage . The bill proposes several expansions of what may be covered by a vehicle service contract. Most of the changes are self-explanatory and detailed, above. One issue that requires more explanation is the proposed requirement that a vehicle service contract provider certify that indemnity benefits are substantially smaller benefits than the primary service contract benefits. The law that allows indemnity benefits already requires that they be "incidental." The new certification is designed to provide more specific guidance about what the word "incidental" means. The "incidental" requirement is important. Vehicle service contracts are already in a category of contracts that are exempt from the standard rules that regulate insurance. The purpose of a vehicle service contract is to cover the repair of the vehicle. The Legislature in the past has judged that it is appropriate to AB 2354 Page 6 allow some insurance-like indemnity benefits, such as reimbursement for towing or rental cars that arise due to a covered breakdown. However, a problem could arise if these indemnity benefits constituted the overwhelming value of the contract - in that case, the contract could start to look like a full-fledged insurance policy masquerading as a vehicle service contract. As a result, only "incidental" indemnity benefits have been authorized. The bill adds clarity that these benefits may only be a small portion of the value of the contract. 5)Employee reimbursements . Some vehicle service providers provide services to businesses that do not trigger application of the law. For example, businesses often contract with third party providers to help in the management of their vehicle fleets, and this may involve repairs, routine maintenance, among other services. These activities do not come within the vehicle service contract law. However, the question has arisen whether or not the vehicle service contract law would be triggered if these same fleet management activities are performed for a business that has its employees use their own vehicles and the employer reimburses the employees for that use. The bill provides that it does not trigger application of the vehicle service contract law when a service provider contracts with a business to help manage employee-owned business use vehicles. REGISTERED SUPPORT / OPPOSITION: Support None received AB 2354 Page 7 Opposition None received Analysis Prepared by:Mark Rakich / INS. / (916) 319-2086