The Office of General Counsel issued the following informal opinion on February 20, 2002, representing the position of the New York State Insurance Department.
Re: Unearned Premium Reserve Requirement for Bail Bond Insurers
Does an insurer have to establish an unearned premium reserve for bail bond premiums even though there is never a return premium due on a bail bond?
Yes. The purpose of the unearned premium reserve requirement in N.Y. Ins. Law § 1305(a) (McKinney 2000) goes beyond simply providing a reserve for the payment of return premiums when due.
The insurer functions as a surety for the appearance of the defendant in court on a specific return date. Once the court accepts the bond upon which the defendant is released, there is no circumstance under which the insured (defendant) has a claim of entitlement to a refund of any portion of the premium. If the defendant appears on the return date, the court has the option of allowing the defendant to remain free until the next scheduled appearance, based upon the original bond or altering the conditions of the bail including revocation. The inquirer asserts that the distinct operation of bail bonds results in the premium being fully earned at the time the bond is issued, thereby, making N.Y. Ins. Law § 1305(a) (McKinney 2000) inapplicable to the bail bond business.
N.Y. Ins. Law § 1305(a) (McKinney 2000), which requires the establishment of an unearned premium reserve, provides:
Every authorized insurer shall, except as to reserves required under section one thousand three hundred four of this article and subject to paragraph fourteen of subsection (a) of section one thousand three hundred one of this article and other specific provisions of this chapter, maintain reserves equal to the unearned portions of the gross premiums charged on unexpired or unterminated risks and policies.
In the past, after an extensive study of the bail bond business, this Office opined that an insurer is obligated to establish an unearned premium reserve on its bail bond business on a pro-rata basis. This is done by assigning an arbitrary one year policy period to each bond written and pro-rating the premium for each bond accordingly. 1In reaching this decision, the Department relied on several fundamental principles, which still remain applicable today.
The bail bond charge, like every insurance premium, is the consideration for which the insurer assumes a stated obligation. The premium on the bail bond cannot be earned until the obligation is discharged, either by the prisoners appearance in court or by payment of the stipulated forfeit. Until such time as the obligation is discharged, this remains an unexpired or unterminated risk, despite the fact that the insured is never entitled to a refund of premium.
The decision is also supported by a fundamental principal of accounting that income and costs incurred in its production should be reported in a manner that reasonably relates one to the other. This is related to the concept of "matching" and is recognized by the NAIC in its Accounting Practices and Procedures Manual (Vol. 1, March 2001). The Preamble states that "Revenue should be recognized only as the earnings process of the underlying underwriting or investment business is completed. Failure to adhere to this principle can lead to distortion in financial reporting and can result in a false picture of the companys financial condition."
The unearned premium reserve is often referred to as the reinsurance reserve because it provides a fund for the reinsurance of outstanding policies and bonds, whether voluntarily by the insurer or mandatorily by the Superintendent in the event of rehabilitation or insolvency. 43 Am. Jur. 2d Insurance § 28 (1962). Without an unearned premium reserve, the monies need to reinsure outstanding bail bonds, should that be necessary, would have to come out of either capital or surplus. This would further aggravate an impaired insurers financial conditional and could, in fact, push it into insolvency. Moreover, it could result in there being no monies available for the purchase of reinsurance.
For the above stated reasons, it remains the Departments position that insurers must maintain an unearned premium reserve for their bail bond business on a pro rata basis.
For further information, you may contact Supervising Attorney Joan Siegel at the New York City Office.
1 This was a liberalization of an earlier requirement that the company reserve for 100% of all undischarged bonds without pro-rating the premium.