The Office of General Counsel issued the following informal opinion on November 27, 2002, representing the position of the New York State Insurance Department.
Re: Service Contracts
1) If a service contract is sold by a product dealer but another person is obligated to perform the services under the service contract (the service contract provider), does the person who purchased the service contract (the service contract holder) have any recourse under N.Y. Ins. Law Article 79 (McKinney 2000) against the product dealer should the service contract provider fail to honor its obligations under the service contract?
2) If a service contract provider elects to comply with the financial responsibility requirements of N.Y. Ins. Law Article 79 (McKinney 2000) by establishing a funded reserve account and financial security deposit under N.Y. Ins. Law § 7903(c)(2) (McKinney 2000) and the service contract provider thereafter fails to fulfill its obligations under its New York service contracts, what recourse does a service contract holder have?
3) If the service contract provider elects to comply with the financial responsibility requirements of N.Y. Ins. Law Article 79 (McKinney 2000) by establishing a funded reserve account and financial security deposit under N.Y. Ins. Law § 7903(c)(2) (McKinney 2000), may the service contract provider secure additional protection for itself under a separate insurance policy issued in another state by a risk retention group ("RRG") not domiciled in New York?
4) If neither the service contract provider or additional insurance is able to meet the provider's obligations under its New York service contracts, would the service contract holder then have any recourse against the product dealer?
1) No. Under the New York Insurance Law and regulations, if the service contract provider fails to fulfill its obligations, the service contract holder has no rights against the product dealer.
2) The service contract holder would have a cause of action against the service contract provider in a court of law. In addition, in certain circumstances under N.Y. Comp. Codes R. & Regs. tit. 11, Part 390 (2001) (Regulation 155), the service contract holder can make a service contract claim to the claims trustee named by the service contract provider under the providers default contingency plan agreement that was filed with the Department when it applied for registration as a service contract provider. Also, the service contract holder may apply to the Superintendent to share in any funds remaining in the funded reserve account and the financial security deposit to pay such claim.
3) The service contract provider is not prohibited by New York Law from securing insurance coverage for itself above and beyond its N.Y. service contract financial responsibility requirement. Whether the RRG may issue such a policy in another state is a question for the appropriate regulatory body in that jurisdiction.
4) No. Under the New York Insurance Law and regulations, the service contract holder has no rights against the product dealer.
ABC, Inc. is in the business of selling automobile service contracts under which it is obligated to provide the services specified. The service contracts are marketed to consumers by automobile dealers. ABC, Inc. is registered as a service contract provider in New York State. It elected to comply with the financial responsibility requirement contained in Article 79 of the Insurance Law by the method specified in N.Y. Ins. Law § 7903(c)(2) (McKinney Supp. 2002): maintaining a funded reserve account and placing in trust with the Superintendent a financial security deposit. The ABC, Inc. service contract states that, "Obligations of the Provider under this Contract are backed by the full faith and credit of the Provider." In addition to fulfilling the financial responsibility requirement as stated above, ABC, Inc. has secured additional protection for itself by purchasing a policy to be issued in another state by a RRG domiciled outside of New York.
Article 79 of the Insurance Law (Service Contracts) was enacted by Chapter 614 of the Laws of 1997. It became effective on January 15, 1998. Under Article 79, the marketing and selling of service contracts in New York does not constitute the doing of an insurance business. However, the law establishes a legal framework for the doing of a service contract business, which includes, among other things, the requirement that all service contract providers (persons obligated to provide services under a New York service contract) be registered with the Superintendent of Insurance. N.Y. Ins. Law § 7907 (McKinney 2000).
Before any service contract may be issued, sold or offered for sale in New York State, the service contract provider is required to demonstrate its financial responsibility by one of three methods specified in N.Y. Ins. Law § 7903(c) (McKinney Supp. 2002). ABC, Inc., when it applied for registration in New York, chose to establish a funded reserve account and make a financial security deposit. This method is specified in paragraph (2) of the foregoing statute as follows:
(2)(A) maintain a funded reserve account for its obligations under its service contracts issued and outstanding in this state, which reserve account (i) contains reserves in an amount not less than forty percent of the gross consideration received upon the sale of, less claims paid under, all its service contracts then in force, but not less than zero, and (ii) shall be subject to examination and review by the superintendent; and
(B) place in trust with the superintendent a financial security deposit, having a value of not less than five percent of the gross consideration received upon the sale of, less claims paid under, all service contracts issued and then in force, but not less than fifty thousand dollars, consisting of one or more of the following:
(i) a surety bond issued by an authorized surety;
(ii) securities of the type eligible for deposit by authorized insurers in this state;
(iii) cash; or
(iv) a letter of credit issued by a qualified United States financial institution.
The law requires that New York service contracts contain certain provisions and that they be sold in a certain manner, but it does not require that the service contracts be either prior approved by or filed with the Department. Pursuant to N.Y. Ins. Law § 7905(c) (McKinney 2000), service contracts not insured by service contract reimbursement insurance (another method of financial responsibility) are required to contain a statement, substantially as follows:
"Obligations or the provider under this service contract are backed by the full faith and credit of the provider."
The ABC, Inc. contract that was submitted to this Department for review contains the exact language as stated above. The statement places service contract holders on notice that their recourse is to the service contract provider who is responsible for and stands behind its obligations under the service contract. Under the language of the ABC, Inc. service contract there is no recourse available to the service contract holders against the automobile dealers who sold them the service contracts. Under the terms of the service contract the obligation is solely upon the service contract provider, ABC, Inc.
In addition, there is a statutory and regulatory structure in place that is intended to protect New York service contract holders in the event that the service contract provider is unable to, or otherwise fails, to pay on valid service contract claims. The Superintendent is authorized to take action that is necessary or appropriate to enforce the provisions of Article 79 (see Regulation 155) in order to protect service contract holders in New York State. N.Y. Ins. Law § 7910 (McKinney 2000) specifies how the provisions of Article 79 are to be enforced by the Superintendent. Under the statute, the Superintendent is authorized to conduct investigations or examinations of providers, administrators, insurers or others in order to enforce the law and protect New York service contract holders. Service contract providers are required, upon request, to provide the Superintendent with access to accounts, books and records. N.Y. Ins. Law § 7910(a) (McKinney 2000).
When a service contract provider has violated the law, the Superintendent may issue a cease and desist order against the provider, issue an order suspending the providers registration or prohibiting the provider from doing any element of a service contract business, or issue an order imposing a civil penalty. N.Y. Ins. Law § 7910(b) (McKinney 2000).
The Superintendent has promulgated N.Y. Comp. Codes R. & Regs. tit. 11, §§ 390.0 390.13 (2001) (Regulation 155), which implements the Article 79 of the Insurance Law. Section 390.10(a) of Regulation 155 requires a service contract provider that demonstrates its financial responsibility by the method chosen by ABC, Inc. to also file an audited financial statement with the Superintendent. Section 390.10(d) of Regulation 155 requires that such service contract providers, on or before June 30th of each year, or 180 days after the end of the providers fiscal year, whichever is later, file an audited financial statement for the prior calendar year with the Superintendent. The statement must include an opinion by an independent certified public accountant. The notes to the foregoing statement must show how the service contract provider meets the statutory reserve and trust requirements and how the assets in the account and trust meet these requirements. The audited financial statement is necessary for the Superintendent to evaluate whether the service provider has met the financial responsibility requirements.
Pursuant to Regulation 155 if, at any time, the certified public accountant or the service contract provider determines that the provider has materially misstated its financial condition as reported to the Superintendent or that the funded reserve account does not meet the requirements of the law, the provider is required to submit this information to the Superintendent in writing within fifteen days of the determination. The Superintendent may thereupon seek to suspend or revoke the service contract providers registration. If the registration is suspended for more than sixty days, revoked or otherwise terminated, and service contracts have been issued and are outstanding in New York State, the provider is required under the Regulation to immediately transfer the funded reserve account to the Superintendent for safekeeping and for the use and protection of contract holders and the administration of service contract claims.
Section 390.12 of Regulation 155 requires that every service contract provider registration application under which the provider elects to provide proof of its financial responsibility by means of a funded reserve account and financial security deposit, or by net worth qualification, must include a "default contingency plan agreement" that provides, in pertinent part, as follows:
(a) for the appointment of a claims trustee that is acceptable to the superintendent and who is registered as a provider, in the event of a providers default in performance as specified in sections 390.10(e) and 390.11(c) of this Part;
(b) that the appointment shall be made within 15 days of the providers default;
(c) that the superintendent may make the appointment in the event the provider fails to make an appointment within the time specified in subdivision (b) of this section or if the appointed trustee fails to serve or resigns;
(d) for the trustee to administer all claims outstanding and which may arise after the providers default;
(e) for the trustee to receive from the superintendent the funded reserve account, any securities deposited with the superintendent as financial security, ;
(f) for the trustee to apply all funds received pursuant to subdivision (e) of this section exclusively to the payment of claims arising from service contracts issued by the provider;
(g) for the trustee to have the power to bring actions or proceedings against the provider to obtain the funds provided for by subdivision (e) of this section and any additional funds that may be necessary for the payment of claims and expenses arising from service contracts issued by the provider; and
(h) that all funds received by the trustee pursuant to the default contingency plan shall be treated as trust funds and shall not be used for any purpose except as specified in subdivision (f) of this section.
Section 390.10(e) of Regulation 155 provides that if the service contract providers registration is suspended for more than sixty days, revoked, or otherwise terminated, and there are outstanding New York service contracts, the provider is required to immediately transfer to the Superintendent the funded reserve account for safekeeping and for the use and protection of New York service contract holders. The foregoing monies, and any securities deposited with the Superintendent under the financial security deposit, would go to the claims trustee to be administered in accordance with the default contingency plan.
The foregoing statutory provisions and Regulation 155 provide a structure for enforcing the Insurance Law for the benefit of New York service contract holders when the registration of the service contract provider has been suspended or revoked or if the service contract provider has failed to honor a valid service contract claim. The Superintendent, on behalf of New York service contract holders, can collect the funds held in the funded reserve account and the financial security deposit, and pay out valid service contract claims, to the extent the funds held to insure the provider's financial responsibility permit him to do so.
So long as the service contract provider had satisfied one of the statutory methods of establishing financial responsibility, it would be free to secure separate coverage for itself. If it obtains a policy to be issued and delivered in another state by a risk retention group domiciled outside of New York, such policy would not be subject to New York law. Whether the RRG may issue the policy in the other state is a question for the appropriate regulatory authority of that state.
The fact that the service contract provider secured additional protection for itself under the policy issued by a RRG not domiciled in New York would have no effect on the possible liability of the product dealer. Under the ABC, Inc. contract, for example, the service contract holder would not, in any event, be able to collect from the RRG in the event ABC, Inc. fails to satisfy its obligations under the service contract. The service contract holder could only benefit indirectly in the event the RRG was called upon to make payment to ABC, Inc., thus enabling the service contract provider to fulfill its obligations to the service contract holder. The RRG's failure to fulfill its obligations would not give rise to an obligation on the part of the product dealer to make payments to the service contract holder.
For further information you may contact Senior Attorney Sam Wachtel at the New York City Office.