Insurers that are interested in entering the California insurance market should be aware that in at least five important respects, insurance is regulated in California differently than in most other U.S. states. Insurers that enter the California insurance market without being familiar with California’s distinctive insurance regulatory requirements could encounter unanticipated problems.
Following are five often lesser known regulatory issues that ought to be considered before an insurer seeks to transact an insurance business in California, either by becoming licensed or by seeking to make use of an available exception to licensing:
California Commercially Domiciled Insurers
California is one of a handful of states that regulates foreign insurers that are deemed to be “commercially domiciled” in the state as if they are, in many respects, domestic insurers. Generally, a foreign insurer is deemed to be commercially domiciled in California based upon the volume of insurance premiums written by the foreign insurer in California as compared to premiums written by the insurer in its state of domicile and nationally. California Insurance Code § 1215.14 provides that a foreign insurer that is licensed in California will be deemed to be a California commercially domiciled insurer if, in the past three years (or lesser period if it is licensed in California for less than three years) it (i) has written more direct premiums in California than it has written in its state of domicile during the same period, and (ii) has written direct premium in California that equals or exceeds 33% of its total U.S. direct written premium for that three-year or lesser period.
A foreign insurer that is deemed to be a California commercially domiciled insurer will, if it is also a controlled insurer, need to comply with many aspects of California’s Holding Company System Regulatory Act as if it were a California domestic controlled insurer.1For example, in addition to complying with its domestic state’s holding company act requirements, a foreign insurer that is deemed to be commercially domiciled in California will be subject to the holding company registration and filing requirements of California Insurance Code §§ 1215.4(a), (b), (c), (d) and (e), as well as the ordinary dividend reporting requirements that apply to domestic controlled insurers under § 1215.4(f). Additionally, such a foreign insurer will also be subject to the standards contained in § 1215.5 regarding intercompany transactions, including the applicable notice and non-disapproval requirements (except for those dealing with reinsurance agreements among affiliated insurers as set forth in § 1215.5(b)(3)).
Among the more significant aspects of being deemed to be commercially domiciled in California is that a party seeking to acquire such an insurer will need to file a Form A with and obtain approval from both the insurer’s actual state of domicile as well as the California Department of Insurance (the “CDI”).
Accordingly, a foreign insurer considering becoming licensed in California should be aware that it could be treated as a California domestic insurer if it writes significant business in California.
California’s Limited Rebating Exception
All U.S. states (except, in limited circumstances, California and Florida) prohibit the practice of “rebating” in connection with the sale of insurance. The rebating statutes generally prohibit paying, giving or offering the policyholder or the insured anything of value that is not specified in the policy.
Until November 1988, Article 5 of the California Insurance Code (then titled “Unlawful Rebates, Profits and Commissions”) contained a general rebating prohibition. Specifically, § 750 of Article 5 prohibited insurance rebating by providing:
An insurer, insurance agent, broker, or solicitor, personally or by any other party, shall not offer or pay, directly or indirectly, as an inducement to insurance on any subject-matter in this State, any rebate of the whole or part of the premium payable on an insurance contract, or of the agent’s or broker’s commission thereon, and such rebate is an unlawful rebate.
In November 1988, California voters repealed Article 5’s then existing rebating prohibitions by passing Proposition 103. For this reason, many insurers believe that rebating is permissible under California law. However, notwithstanding Proposition 103, rebating is not permissible in all circumstances in California. For example, rebating is explicitly prohibited in California in connection with title insurance (pursuant to §12404), mortgage guaranty insurance (pursuant to § 12640.14) and financial guaranty insurance (pursuant to § 12122). It is also unlawful to offer or distribute any “bonus or gratuity” to potential or existing subscribers to induce enrollment, or induce the continuation of enrollment, in health care services plans, pursuant to California Code of Regulations § 1300.46. Moreover, the CDI interprets the repeal of § 750 as only permitting rebating of insurance commissions by insurance agents (i.e., rebating of insurance premiums by insurers remains unlawful).
Additionally, an otherwise permissible rebate would be prohibited to the extent it violates California’s antitrust statutes. In response to Proposition 103, in March 1990, the California Department of Justice issued “Antitrust Guidelines for the Insurance Industry.” The Guidelines provide that “anticompetitive rebating is still prohibited, notwithstanding the repeal of Insurance Code § 750 et seq.” Among the anticompetitive rebates that remain prohibited are those described in §§ 17040 through 17051 of California’s Business and Professions Code. For example, § 17043 makes it unlawful for a person to “sell any article or product at less than the cost thereof to such vendor, or to give away any article or product, for the purpose of injuring competitors or destroying competition.” Similarly, § 17045 prohibits “secret” rebates that are “not extended to all purchasers purchasing upon like terms and conditions, to the injury of a competitor and where such payment or allowance tends to destroy competition . . . .”
Foreign insurers seeking to pay rebates in California should be aware that rebating by insurers remains prohibited.
California’s Limited Industrial Insured Exception
Many U.S. states allow unauthorized insurers to provide within the state certain kinds of insurance to “industrial insureds.” An industrial insured exception commonly permits unauthorized insurers to provide insurance to large companies that generally (a) have a specified number of employees, (b) use a risk manager or broker to purchase their insurance, and (c) pay at least $25,000 to $50,000 per year for all of their insurance coverage.
The California Insurance Code does not include a “standard” industrial insured exception (whereby an insurer that is not licensed in California may transact insurance in the state so long as the insured qualifies as an industrial insured). Instead, California’s industrial insured exception merely exempts unauthorized insurers and surplus line brokers seeking to place unauthorized business in California from certain of the surplus line notice requirements and insured signature requirements described in § 1764.1.
A separate definition of commercial insured, set forth in § 1760.1, exempts surplus line brokers who place business for commercial insureds from the diligent search requirements if the commercial insured has received a disclosure in writing that surplus insurance may or may not be available from the admitted market (which may provide greater regulatory protections) and the commercial insured has subsequently requested in writing that the business be placed on a surplus line basis.2
Accordingly, foreign and alien insurers that are not licensed in California should be aware that California law provides only a limited exception to surplus line requirements when dealing with industrial insureds and commercial insureds.
California’s “Relicensing Application” Requirement
California Insurance Code § 700(c) in relevant part provides that, after a California certificate of authority to transact insurance has been issued, the insurer must continue to comply with the requirements set forth in the California Insurance Code and in the other laws of California.
Section 700(c)’s implementing regulation, California Code of Regulations § 2303.15(q), provides that when a licensed insurer is sold as a corporate shell, or when a sale of the insurer or other circumstance results in a significant change in the insurer’s operations so that all or a majority of the documents previously submitted to the CDI by the insurer concerning its operations are no longer valid, the insurer must, within 60 days, submit to the CDI all documents the CDI deems necessary to determine compliance with § 700(c). Pursuant to California Code of Regulations § 2303.22, those documents include all supporting documents required for an initial license application.
The NAIC’s Uniform Certificate of Authority Application’s State chart entitled “Change in Control of Foreign (Non-Domestic) Insurers” provides guidance with respect to the requirements of § 700(c) by providing, in relevant part, that with respect to the change of control of a California licensed foreign insurer:
Foreign insurers are required to submit new Biographical Affidavits and fingerprint cards and may also be required to file Form 700(c).
For this reason, one seeking to transact an insurance business in California by purchasing a California licensed shell insurer should be aware that they will likely be required to file for CDI approval what is essentially a California license application for the insurer to maintain its California license and to continue to transact insurance in California.
The Section 1011(c) Transfer of Business Filing Requirement
California Insurance Code § 1011(c) provides significant regulatory sanctions (essentially, the issuance of a conservation order) for failing to obtain the consent of the California Commissioner of Insurance prior to transferring 75% or more of an insurer’s business.
California Insurance Code § 1011(c) in relevant part provides that upon the filing of a verified application by the California Commissioner of Insurance that a California licensed insurer “has transferred, or attempted to transfer, substantially its entire property or business” or “has entered into any transaction the effect of which is to merge, consolidate, or reinsure substantially its entire property or business in or with the property or business of any other person” without first obtaining the Commissioner’s consent, the California Superior Court must issue an order (i) vesting title to all assets of the insurer in the Commissioner (in his official capacity), (ii) directing the Commissioner to take possession of the insurer, (iii) directing the Commissioner to conduct the business of the insurer, and (iv) enjoining the insurer and its officers, directors, agents, etc., from the transaction of the insurer’s business or the disposition of its property until the further order of the Court.
California Code of Regulations § 2303.15(d) provides the meaning of “substantially its entire property or business” as follows:
As used in Code Section 1011(c), the term “substantially its entire property or business” means an amount of business such that the sale, cession, assumption or purchase thereof has the potential to render a company insolvent or create a hazard to its policyholders or creditors. A sale, cession, assumption or purchase that equals or exceeds either 75% of an insurer’s total premium or 75% of its total liabilities, calculated before the subject transaction, shall constitute “substantially its entire property or business” for purposes of Code Section 1011(c). This subdivision shall not be construed as limiting the type of transactions within the scope of Code Section 1011(c).
All California licensed insurers are subject to § 1011(c), except as it applies to reinsurance (for which non-domestic licensees are exempt pursuant to California Insurance Bulletin 2011-2). Therefore, while only California domestic insurers are required to obtain the consent of the California Commissioner of Insurance prior to entering into indemnity reinsurance transactions meeting the 75% threshold, all California licensed insurers must obtain the consent of the California Commissioner of Insurance prior to entering into any transaction that directly or indirectly results in the sale, transfer or assumption of the insurer’s business (including mergers), even if the insurer has already obtained the prior consent of its domiciliary regulator (and even if the prior consent of its domiciliary regulator is not required).
Accordingly, to avoid the significant regulatory sanctions associated with failing to obtain the prior consent of the California Commissioner of Insurance, any person seeking to enter into such a transaction would be wise to comply with the requirements of § 1011(c).