BILL NUMBER: SB 1528 CHAPTERED 07/21/00 CHAPTER 170 FILED WITH SECRETARY OF STATE JULY 21, 2000 APPROVED BY GOVERNOR JULY 21, 2000 PASSED THE SENATE JULY 6, 2000 PASSED THE ASSEMBLY JUNE 29, 2000 AMENDED IN ASSEMBLY JUNE 1, 2000 AMENDED IN SENATE APRIL 10, 2000 INTRODUCED BY Senator Hughes FEBRUARY 17, 2000 An act to amend Sections 1215.1 and 1215.5 of the Insurance Code, relating to insurers. LEGISLATIVE COUNSEL'S DIGEST SB 1528, Hughes. Insurance. (1) The Insurance Holding Company System Regulatory Act sets forth certain limitations with respect to the acquisition of subsidiaries by a domestic insurer. Under existing law, a domestic insurer is authorized to invest in the securities of one or more subsidiaries amounts that do not exceed the lesser of 5% of the insurer's assets or 50% of the insurer's surplus as regards policyholders as long as it retains a reasonable surplus, as specified, after making these investments. Existing law requires in calculating the amount of these investments, that the total net moneys or other consideration expended and obligations assumed in the acquisition or formation of a subsidiary, as specified, be included as well as all amounts expended in acquiring additional securities and all contributions to the capital or surplus of a subsidiary after its acquisition or formation. This bill would increase, from 5% to 10%, the percentage of the insurer's assets used as one of the bases to measure the amount a domestic insurer is authorized to invest in subsidiaries, and in calculating the amount of these investments, would exclude investments made by a domestic insurer in insurance subsidiaries. (2) The Insurance Holding Company System Regulatory Act also requires that certain transactions involving a domestic insurer or commercially domiciled insurer, as defined, and any person in its holding company system, may be entered into only if the insurer notifies the Insurance Commissioner, and the commissioner does not disapprove the transaction within a certain period of time. The transactions subject to this provision include management agreements, service contracts, and cost-sharing arrangements. Existing law also makes transactions by registered insurers with their affiliates subject to specified standards, including each of the following: the fees charged for services and the terms of the transactions are reasonable; expenses and payments are allocated to the insurer in conformity with standard insurance accounting practices; the records of each party clearly and accurately disclose the precise nature and details of the transaction, including the requisite accounting information to support the reasonableness of the charges and fees; and the insurer's policyholder surplus, following any dividends or distributions to shareholder affiliates, is reasonable in relation to the insurer's outstanding liabilities and is adequate to its financial needs. This bill would provide that a domestic insurer is not precluded by any provision in the Insurance Holding Company System Regulatory Act from having or sharing a common management or cooperative or joint use of personnel, property, or services with one or more other persons under arrangements that meet the above-described standards governing transactions by registered insurers with their affiliates. This bill would also provide that notwithstanding the control of a domestic insurer by any person, the officers and directors of the insurer remain liable for any obligation to which they would otherwise be subject to by law and would require that the insurer be managed to maintain its separate operating identity. THE PEOPLE OF THE STATE OF CALIFORNIA DO ENACT AS FOLLOWS: SECTION 1. Section 1215.1 of the Insurance Code is amended to read: 1215.1. (a) Any domestic insurer, either by itself or in cooperation with one or more persons, may organize or acquire one or more subsidiaries subject to the limitations of this section. (b) In addition to investments in common stock, preferred stock, debt obligations, and other securities permitted under all other sections of this chapter, a domestic insurer may also do one or more of the following: (1) Invest in common stock, preferred stock, debt obligations, and other securities of one or more subsidiaries, amounts that do not exceed the lesser of 10 percent of the insurer's assets or 50 percent of the insurer's surplus as regards policyholders. However, after these investments, the insurer's surplus as regards policyholders shall be reasonable in relation to the insurer's outstanding liabilities and adequate to its financial needs. In calculating the amount of these investments, there shall be excluded investments in insurance subsidiaries, and there shall be included (A) total net moneys or other consideration expended and obligations assumed in the acquisition or formation of a subsidiary, including all organizational expenses and contributions to capital and surplus of the subsidiary whether or not represented by the purchase of capital stock or issuance of other securities, and (B) all amounts expended in acquiring additional common stock, preferred stock, debt obligations, and other securities and all contributions to the capital or surplus, of a subsidiary subsequent to its acquisition or formation. "Insurance subsidiary" is an insurer that is organized within the United States and is controlled, directly or indirectly, by a reporting insurer subject to this article. For purposes of this paragraph, "investments in insurance subsidiaries" shall include the following: (A) Any direct investment in an insurance subsidiary. (B) The insurer's proportionate share of any investment in an insurance subsidiary held by any subsidiary of the insurer. This shall be calculated by multiplying the amount of the subsidiary's investment in the insurance subsidiary by the insurer's percentage of ownership of the subsidiary. (2) If the insurer's total liabilities, as calculated for National Association of Insurance Commissioners' annual statement purposes, are less than 10 percent of assets, invest any amount in common stock, preferred stock, debt obligations, and other securities of one or more subsidiaries. However, after this investment the insurer's surplus as regards policyholders, considering this investment as if it were a disallowed asset, shall be reasonable in relation to the insurer's outstanding liabilities and adequate to its financial needs. (3) Invest any amount in common stock, preferred stock, debt obligations, and other securities of one or more subsidiaries, provided, that each subsidiary agrees to limit its investments in any asset so that these investments will not cause the amount of the total investment of the insurer to exceed any of the investment limitations specified in paragraph (1) of this subdivision or in this chapter applicable to the insurer. For the purpose of this paragraph, "the total investment of the insurer" shall include (i) any direct investment by the insurer in an asset, and (ii) the insurer's proportionate share of any investment of an asset by any subsidiary of the insurer, which shall be calculated by multiplying the amount of the subsidiary's investment by the percentage of the insurer's ownership of that subsidiary. (4) With the approval of the commissioner, invest any amount in common stock, preferred stock, debt obligations, or other securities of one or more subsidiaries, provided that after this investment the insurer's surplus as regards policyholders shall be reasonable in relation to the insurer's outstanding liabilities and adequate to its financial needs. (5) Invest any amount in the common stock, preferred stock, debt obligations, or other securities of any subsidiary exclusively engaged in holding title to or holding title to and managing or developing real or personal property, if after considering as a disallowed asset so much of the investment as is represented by subsidiary assets which if held directly by the insurer would be considered as a disallowed asset, the insurer's surplus as regards policyholders shall be reasonable in relation to the insurer's outstanding liabilities and adequate to its financial needs. (c) Investments in common stock, preferred stock, debt obligations, or other securities of subsidiaries made pursuant to subdivision (b) of this section shall neither limit nor be subject to any of the otherwise applicable authorizations, restrictions, or prohibitions contained in this part applicable to such investments of insurers. (d) Whether any investment pursuant to subdivision (b) of this section meets the applicable requirements thereof is to be determined immediately after such investment is made, taking into account the then outstanding principal balance on all previous investments in debt obligations, and the value of all previous investments in equity securities as of the date they were made. (e) If an insurer ceases to control a subsidiary, it shall dispose of any investment therein made pursuant to this section within three years from the time of the cessation of control, or within such further time as the commissioner may prescribe, unless at any time after such investment shall have been made, such investment shall have met the requirements for investment under any other section of this part. SEC. 2. Section 1215.5 of the Insurance Code is amended to read: 1215.5. (a) Transactions by registered insurers with their affiliates are subject to the following standards: (1) The terms shall be fair and reasonable. (2) Charges or fees for services performed shall be reasonable. (3) Expenses incurred and payment received shall be allocated to the insurer in conformity with customary insurance accounting practices consistently applied. (4) The books, accounts, and records of each party to all transactions shall be so maintained as to clearly and accurately disclose the precise nature and details of the transactions, including accounting information that is necessary to support the reasonableness of the charges or fees to the parties. (5) The insurer's policyholder's surplus following any dividends or distributions to shareholder affiliates shall be reasonable in relation to the insurer's outstanding liabilities and adequate to its financial needs. (b) The following transactions involving a domestic insurer or commercially domiciled insurer, as defined in Section 1215.13, and any person in its holding company system, may be entered into only if the insurer has notified the commissioner in writing of its intention to enter into the transaction 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. The commissioner shall require the payment of one thousand eight hundred eighty-nine dollars ($1,889) as a fee for filings under this subdivision. The payment shall accompany the filing. (1) Sales, purchases, exchanges, loans, extensions of credit, or investments, if the transactions are equal to or exceed: (A) For a nonlife insurer, the lessor of 3 percent of the insurer' s admitted assets or 25 percent of the policyholder's surplus as of the preceding December 31st. (B) For a life insurer, 3 percent of the insurer's admitted assets as of the preceding December 31st. (2) Loans or extensions of credit to a person who is not an affiliate, if made with the agreement or understanding that the proceeds of the transactions, in whole or in substantial part, are to be used to make loans or extensions of credit to, to purchase assets of, or to make investments in, any affiliate of the insurer, if the transactions are equal to or exceed: (A) For a nonlife insurer, the lesser of 3 percent of the insurer' s admitted assets or 25 percent of the policyholder's surplus as of the preceding December 31st. (B) For a life insurer, 3 percent of the insurer's admitted assets as of the preceding December 31st. (3) Reinsurance agreements or modifications thereto in which the reinsurance premium or a change in the insurer's liabilities equals or exceeds 5 percent of the insurer's policyholder's surplus, as of the preceding December 31st, including those agreements that may require as consideration the transfer of assets from an insurer to a nonaffiliate, if an agreement or understanding exists between the insurer and nonaffiliate that any portion of the assets will be transferred to one or more affiliates of the insurer. (4) All management agreements, service contracts, and cost-sharing arrangements. However, subscription agreements or powers of attorney executed by subscribers of a reciprocal or interinsurance exchange are not required to be reported pursuant to this section if the form of the agreement was in use before 1943 and was not amended in any way to modify payments, fees, or waivers of fees or otherwise substantially amended after 1943. Payment or waiver of fees or other amounts due under subscription agreements or powers of attorney forms that were in use before 1943 and that have not been amended in any way to modify payments, fees, or waiver of fees, or otherwise substantially amended after 1943 shall not be subject to regulation pursuant to paragraph (2) of subdivision (a). (5) Guarantees when initiated or made by a domestic or commercially domiciled insurer; provided, however, that a guarantee that is quantifiable as to amount is not subject to the notice requirements of this paragraph unless it exceeds the lesser of one-half of 1 percent of the insurer's admitted assets or 10 percent of surplus as regards policyholders as of the 31st day of December next preceding. Further, all guarantees that are not quantifiable as to amount are subject to the notice requirements of this paragraph. (6) Direct or indirect acquisitions or investments in a person that controls the insurer or in an affiliate of the insurer in an amount that, together with its present holdings in those investments, exceeds 2.5 percent of the insurer's policyholder's surplus. Direct or indirect acquisitions or investments in subsidiaries acquired under Section 1215.1, or in nonsubsidiary insurance affiliates that are subject to the provisions of this article, or in subsidiaries acquired pursuant to Section 1199, are exempt from this requirement. (7) Any material transactions, specified by regulation, that the commissioner determines may adversely affect the interests of the insurer's policyholders. (c) A domestic insurer may not enter into transactions that are part of a plan or series of transactions with persons within the holding company system if the purpose of those transactions is to avoid the statutory threshold amount and thus avoid review. If the commissioner determines that separate transactions were entered into over any 12-month period to avoid review, the commissioner may exercise his or her authority under Section 1215.10. (d) The commissioner, in reviewing transactions under subdivision (b), shall consider whether the transactions comply with the standards set forth in subdivision (a) and whether they may adversely affect the interests of policyholders. (e) The commissioner shall be notified within 30 days of any investment by the insurer in any one corporation if the total investment in the corporation by the insurance holding company system exceeds 10 percent of the corporation's voting securities. (f) For purposes of this article, in determining whether an insurer's policyholder's surplus is reasonable in relation to the insurer's outstanding liabilities and adequate to its financial needs, the following factors, among others, shall be considered: (1) The size of the insurer, as measured by its assets, capital and surplus, reserves, premium writings, insurance in force, and other appropriate criteria. (2) The extent to which the insurer's business is diversified among the several lines of insurance. (3) The number and size of risks insured in each line of business. (4) The extent of the geographical dispersion of the insurer's insured risks. (5) The nature and extent of the insurer's reinsurance program. (6) The quality, diversification, and liquidity of the insurer's investment portfolio. (7) The recent past and projected future trend in the size of the insurer's investment portfolio. (8) The recent past and projected future trend in the size of the insurer's surplus, and the policyholder's surplus maintained by other comparable insurers. (9) The adequacy of the insurer's reserves. (10) The quality and liquidity of investments in subsidiaries made under Section 1215.1. The commissioner may treat any such investment as a disallowed asset for purposes of determining the adequacy of the policyholder's surplus whenever, in his or her judgment, the investment so warrants. (11) The quality of the company's earnings and the extent to which the reported earnings include extraordinary accounting items. (g) No insurer subject to registration under Section 1215.4 shall pay any extraordinary dividend or make any other extraordinary distribution to its stockholders until 30 days after the commissioner has received notice of the declaration thereof and has approved the payment or has not, within the 30-day period, disapproved the payment. For purposes of this section, an extraordinary dividend or distribution is any dividend or distribution which, together with other dividends or distributions made within the preceding 12 months, exceeds the greater of (1) 10 percent of the insurer's policyholder' s surplus as of the preceding December 31st, or (2) the net gain from operations of the insurer, if the insurer is a life insurer, or the net income, if the insurer is not a life insurer, for the 12-month period ending the preceding December 31st. Notwithstanding any other provision of law, an insurer may declare an extraordinary dividend or distribution that is conditional upon the commissioner's approval. The declaration confers no rights upon stockholders until the commissioner has approved the payment of the dividend or distribution or until the commissioner has not disapproved the payment within the 30-day period referred to in this subdivision. (h) Notwithstanding the control of a domestic insurer by any person, the officers and directors of the insurer shall not thereby be relieved of any obligation or liability to which they would otherwise be subject to by law, and the insurer shall be managed to ensure its separate operating identity consistent with the provisions of this article. However, nothing in this article shall preclude a domestic insurer from having or sharing a common management or cooperative or joint use of personnel, property, or services with one or more other persons under arrangements meeting the standards of subdivision (a). (i) The provisions of this section do not apply to any insurer, information, or transaction exempted by the commissioner.