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THE OPPORTUNITY TO CIRCUMVENT insurance regulation in the United States, through the marketing and distribution of insurance via the Internet, has yet to be tested.
Apart from ongoing study by the National Assn. of Insurance Commissioners, many state insurance departments have not formally confronted this problem. Many find comfort in their state's excessively broad jurisdictional laws, which, if enforced, could probably ensnare the legitimate offshore markets. Even if these laws overcome constitutional challenges, enforcement may still be problematic for the departments if the perpetrators operate from countries with no treaties with the United States.
The California Insurance Department, having an older and narrower law, has formally taken a position on part of the issue. Under California's Bulletin No. 96-4, issued on May 30, 1996, the solicitation of insurance via a Web site of a non-admitted insurer was analogized to be the equivalent of a non-admitted insurer advertising in a magazine of general circulation and including a pre-stamped, self-addressed return mailer for the prospective policyholder.
The California department's position is that if the Web site reasonably would be expected to reach, or is purposefully directed at prospective California policyholders, then the Web site must have a disclaimer of the insurer's unlicensed status in California. If these applicants can obtain an executed policy in California via the Web site, then the policy must be procured through a California surplus lines broker.
Given that this was outlined in a bulletin, the department recognizes that this is its viewpoint and did not cite any statutory authority for its position.
The analogy of a Web site to a magazine ad of general circulation is well-intentioned but inaccurate. Reliance upon the surplus lines laws is also misplaced.
Unlike a magazine that is physically in California, a Web site on a non-admitted insurer's server located outside the state is not soliciting in California. Like any direct placement initiated by the policyholder, it is there to be solicited.
It is the distinction that takes the Web site transaction outside the statutory predicate for the regulation of insurance. The "transaction of insurance," which is the basis for all state insurance regulation, requires, in part, solicitation, negotiation or procurement of insurance within the state.
If there is no solicitation of insurance by a non-admitted insurer because the applicant has dialed an out-of-state server, the next criterion for insurance regulation is negotiation of insurance within the state. If the Web site merely contains a program or template for the inputting of data from California, it would be questionable whether this would constitute negotiation of insurance. The insurer's underwriting and rate quote would be done outside the state and would be merely available to the prospective insured by again accessing the out-of-state server.
The California Insurance Department seems to have recognized this fact, as its focus is on the final criterion for insurance regulation: the procurement of the policy.
In this regard, California agrees that if the policy is delivered to a California resident who is not in the state, then a California surplus lines broker need not be used. The department does not address the issue of the policy being electronically delivered to an out-of-state location or computer, but I believe the result would be the same. It also does not address the possibility that the policy might be kept electronically by the insurer in a book entry format rather than delivered. This would permit a policyholder to access its policy through the Web site, at any time, via a policy number. While I do not believe any insurer has done this to date, the possibility exists that this could be done for standard forms and ultimately save insurers considerable expense. It also would offer the policyholder, who elected book entry when applying for the insurance, an opportunity for permanent record retention.
As it is feasible for a non-admitted insurer through its Web site not to solicit, negotiate or procure insurance in a state other than where its server is located, insurance regulation can be avoided in a state such as California. If the non-admitted insurer's server is offshore, then all U.S. insurance regulation conceivably could be avoided.
Although surplus lines business is exempt from certain licensing and other regulation, it is still within the definition of the "transaction of insurance." It is this distinction that undermines the California department's application of the surplus lines laws to electronic insurance.
Of broader implication is that because such electronic insurance would not be the "transaction of insurance" as currently defined in some state statutes, the independent procurement laws would not apply. This seems to be an incongruous result, as such transactions are clearly direct placements. The fact that most states do not have independent procurement laws is ill considered in light of electronic commerce.
Assuming that the definition of "transaction of insurance" is broadened to include direct placements through any medium-or, as in many other states, be premised upon the location or performance of the risk within the state, regardless of where the insurance transaction directly occurs-the most difficult question of all remains: How will insurance regulation be enforced and premium tax collected if a policyholder can directly obtain insurance electronically from an offshore insurer, bank or other institution?
Because large and middle-market commercial insurance buyers already have found numerous ways to legally circumvent the insurance laws, this is primarily an issue that will become the focus of the small commercial lines market, select specialty lines and personal lines that are based upon standardized product and price. State insurance departments do not have the resources to monitor or prevent such transactions, so enforcement ultimately may have to be through direct placement and financial responsibility laws and through criteria set by commercial participants in their business transactions.
While the industry is cognizant of the susceptibility of the insurance regulatory system to electronic commerce, it has not yet exploited the opportunity. This is partially due to the development of companies' own electronic marketing and internal systems, the incomplete development of electronic signature laws, the limitation on non-admitted insurer defense rights and good citizenship. Rogue insurance markets will not be as charitable.
Brooks White is associate general counsel with Reliance National Insurance Co. in New York. The views in this article are Mr. White's and do not reflect those of Reliance Group Holdings Inc. or any of its affiliates.