Many insurance products are easy to distinguish as insurance; if one pays a fee to a company, and the company pays for damages when one gets into a car accident, most would recognize the contract as insurance. Surprisingly, in most states, "insurance" is not defined, so that more nuanced situations are left up to state interpretation. This can lead to situations where a contract is considered insurance in one state and not in another. This has been apparent for years in the varied regulation of warranties, service contracts, and related products. Most of these contracts exist in the world of consumer products, but there is another marketplace which makes this issue even murkier.
Take for example a seller of commercial products who wants to sell an extended warranty/service contract on the product. This warranty/service contract takes over when the manufacturer's warranty expires, providing for repair or replacement of equipment due to defect, to keep the equipment operational. In this case, the warranty would not seem to qualify as insurance, and in most cases the seller would not hold an insurance license. However, you might be surprised to find that a state-by-state analysis is required to determine whether any state requires licensure or registration of the seller.
Analysis:
Our analysis starts, as a point of reference, with making a distinction between a consumer product and a commercial product. Most warranty/service contract statutes are intended to protect private consumers from being taken advantage of by more sophisticated sellers. However, a commercial transaction is distinguishable from this situation, and the warranty and the statutes regulating service contracts and warranties may not be applicable in this instance.
Federal Law
The Federal Magnuson-Moss Act1 is the authority on warranties to which some states have reported that they turn when they have gaps in their own laws and Departmental positions. The federal Act defines warranties and service contracts in terms of consumer products, as in many states. However, the federal Act goes on to define consumer product as:
The term "consumer product" means any tangible personal property which is distributed in commerce and which is normally used for personal, family, or household purposes (including any such property intended to be attached to or installed in any real property without regard to whether it is so attached or installed).2
Therefore, a dealer selling warranties/service contracts to commercial purchasers of commercial products would not be regulated by this federal Act. In states where the definitions were not clear, it makes logical sense to argue that the warranty/service contract laws do not apply to the current "commercial" situation.
NAIC Model Act
The NAIC issued a Service Contracts Model Act, which defines a "service contract" as:
"Service contract" means a contract or agreement for a separately stated consideration or for a specific duration to perform the repair, replacement or maintenance of property or indemnification for repair, replacement or maintenance, for the operational or structural failure due to a defect in materials, workmanship or normal wear and tear, with or without additional provision for incidental payment of indemnity under limited circumstances, including, but not limited to, towing, rental and emergency road service, but does not include mechanical breakdown insurance or maintenance agreements.3
The drafting notes for the Model Act state that the Model Act assumes a service contract is exempt from the Insurance Code. Many states have also written express exemptions for service contracts into their Insurance Code.4
The NAIC Service Contract Model Act provides that the administrator of a service contract must register with the State in order to issue, sell, or offer for sale a service contract.5 The Model Act defines an administrator as a person responsible for the administration of the service contract and who is responsible for any filings required by the Act.6 In this situation, the seller would be considered the administrator of the service contract.
Only seven states have adopted the Model Act; however, many other states have adopted similar service contract legislation. The NAIC Model Act is silent on exemptions from the service contract administrator registration requirement, so whether a retailer selling a service contract to a commercial purchaser as incidental to the sale of a commercial product is required to be registered requires a state by state analysis.
Most state Insurance Departments have not addressed this situation in their statutes and regulations, so we contacted those states to obtain their position. We found that New York, the only state which has addressed dealers in the context of service contract administrator registration, had a very complete and sophisticated analysis, which we used in our questions and discussions with the other states.
New York
New York does not consider warranties/service contracts to be insurance, because they define insurance to guard against fortuitous events, and a warranty from a dealer guarding against defects in the product the dealer sells does not guard against fortuitous events.7 New York has adopted the NAIC Service Contracts Model Act.8 The New York Insurance Department Office of General Counsel later issued an opinion that an extended warranty sold for an additional fee is not considered a service contract or subject to the Service Contract Act when made by the manufacturer or seller.9 Under New York's interpretation, the mere charging of a fee does not convert a warranty into a service contract. If the contract is a warranty, and the warrantor makes warranties merely as incidental to another legitimate business or activity, not as the warrantor's vocation, the warranty does not qualify as a service contract.10 Therefore, because the retailer is selling extended warranties as incidental to the sale of his commercial products, his true vocation, the warranties are not considered service contracts in New York, and New York will not require the seller to register as a service contract provider.
The Other Jurisdictions
Most of the other jurisdictions reach the same ultimate conclusion as New York, but with different and in most cases more simplistic reasoning. However, many jurisdictions do not address warranties or service contracts in their statutes and regulations, so these areas are largely governed by individual Department position. Whether statutory or Departmental position, the rationale for exempting dealers from licensure or registration can be broken down into six distinct categories.
Eighteen Insurance Departments reported that they do not regulate warranties and/or service contracts. A few reported that the Attorney General regulates warranties and/or service contracts in their jurisdictions, but upon follow up, the Attorneys General reported that the only regulation is under the general unfair trade practices. Other jurisdictions reported that the only regulation of warranties and/or service contracts lies in their unfair trade practice acts.
Six jurisdictions exempt the dealer from licensure/registration because the warranty is incidental to a commercial transaction. Because the general intent of warranty/service contract law is to protect consumers, this set of jurisdictions reasons that commercial transactions do not appear to conform to the intent of the law.
Another set of three jurisdictions exempt the seller from licensure/registration because he sells a commercial product. In these jurisdictions, warranty and/or service contract statutes apply only to consumer products, generally defined as tangible property used for personal, family, or household use. Because the product in question is intended for commercial use, the warranty and/or service contract regulations do not apply.
Eight jurisdictions reason that the seller does not need a license/registration because the retailer is selling to a person other than a consumer. Similar to the reasoning exempting commercial transactions, these jurisdictions believe that the warranty/service contract regulations protect consumers, and since consumers are not involved in the purchase of the commercial product and warranty, their regulations do not apply.
Three other jurisdictions exempt the seller from licensure/registration because he is a retail seller or supplier of the product. These jurisdictions have exemptions from warranty/service contract regulations for manufacturers or sellers of products. These parties are warranting the service of their own products and promising to repair or replace them if they do not work as intended. These jurisdictions do not require parties warranting their own products to register or license.
Two jurisdictions, including New York, do not require license or registration of a seller who sells warranties as incidental to his primary business. Because the retailer's primary business is selling commercial products, and the warranties on such products are incidental to the sale, the seller does not need to obtain a license or register.
There are a few jurisdictions who have decided to regulate warranties and service contracts in this commercial situation. There are three jurisdictions which consider the seller to be engaging in the business of insurance, and will require some type of insurance license. There are also five jurisdictions which do not consider the seller to be engaging in the business of insurance, but will require the seller to register as a service contract provider or service warranty association. Three jurisdictions are unclear on the subject.
Dealer Insurance Coverage
Because of the expense of repairs and replacement of some commercial products, many sellers choose to obtain an insurance policy to reimburse any expenses they incur in the repair and/or replacement of these products. Generally speaking, this warranty reimbursement policy may be written by an admitted or nonadmitted insurance carrier, provided all nonadmitted insurance requirements are fulfilled. However, states which require the seller to register as a service contract provider also impose strict financial responsibility requirements on registered service contract providers. One of these requirements is a contractual liability insurance policy written through an admitted carrier. This policy cannot simply reimburse the seller for its expenses in repair and/or replacement; it must provide that the insurance carrier would step in for the seller in the event of a default by the seller under the warranty. This is an extra step of liability that an ordinary warranty reimbursement policy does not take. Therefore, to offer an extended warranty in a state requiring registration, a seller must both complete registration and obtain a separate insurance policy fulfilling financial responsibility requirements, from an admitted carrier.
Conclusion:
The question "what is insurance?" seems to be a simple one. However, each state is charged with defining insurance for itself. Therefore, an extended warranty/service contract sold by a retailer to a commercial purchaser incidental to the sale of a commercial product may not be regulated in one state, but in a neighboring state a retailer doing the same duties would need an insurance license. Even where states come to the same conclusion, the reasoning differs widely. Forty-five jurisdictions do not consider the warranty in question to be insurance, but for varying reasons. Three jurisdictions do consider it to be insurance, and three other jurisdictions continue to be unclear on the issue. Of the forty-five jurisdictions who do not consider this situation to be insurance, five require that the seller register as a service contract provider/service warranty association, and forty jurisdictions do not require any licensure or registration. Even among the forty jurisdictions who do not require licensure/registration of the seller, the reasoning for this decision is based on six differing theories. States who require registration add an extra complication to the seller's business because financial responsibility requirements necessitate a contractual liability insurance policy from an admitted carrier, rather than a simple warranty reimbursement policy which can be written by an admitted or nonadmitted carrier.
As one can see, the simple question, "what is insurance?" in the world of warranties and service contracts is actually not a simple question. Despite there being an NAIC Model Act and Federal Act with which jurisdictions could align their statutes, jurisdictions have taken to defining for themselves whether warranties and service contracts are considered insurance, and whether they will require any licensure or registration.