The Office of General Counsel issued the following informal opinion on March 26, 2002, representing the position of the New York State Insurance Department.
Re: Home Warranty Association
With regard to its home warranty program, would ABC Home Warranty Association ("ABCHWA") be subject to regulation by the Department?
Yes. Under ABCHWAs one/two year "warranty" agreements, ABCHWA would be acting as a surety or guarantor by guaranteeing performance in circumstances where the Builders are unwilling or unable to perform. Such assurance of performance requires ABCHWA to obtain a license, as an insurer, to write surety insurance. Under its ten-year major structural "warranty" agreement, ABCHWA would also be acting as an insurer without a license. However, to eliminate that violation, ABCHWA may register as a service contract provider in accordance with Article 79 of the Insurance Law.
ABCHWA, a licensed and regulated home warranty company in another state, would like to offer its program in New York. ABCHWA has a membership of homebuilders who have met rigorous technical competency and financial stability standards. The builders must sign an agreement that outlines their responsibilities. For a premium, paid by the builder, ABCHWA provides "warranties" to its members and to purchasers of the homes built by such members. The homeowner does not have to pay a separate fee for the warranties as such warranties are "an extra benefit included in the purchase price of the home."
Further, there are three (3) kinds of "warranties," the ABC-W400, ABC-W401 and ABC-W602. A builder who purchases both the ABC-W400 and ABC-W401 is responsible for defects in its workmanship, materials, electrical, plumbing, or mechanical systems (ABC-W401) for one year. Under the one-year "warranty" agreement, ABCHWA fulfills the builders obligation for a defect in its workmanship and materials if the builder is unwilling or unable to meet its obligations under the "warranty." ABCHWA may then subrogate the builder. Pursuant to ABC-W400, ABCHWA, not the builders, are responsible for the 10-year major structural defect "warranty." The ABC-W602 "warranty" is HUD approved for FHA/VA financing and includes the same first year coverage as above, a second year coverage for electrical, plumbing and mechanical systems, as well as a 10-year major structural defect "warranty".
We note that use of the term "warranty" is not consistent with the way such term is used in the Insurance Law. Moreover, how a maker of a contract characterizes a contract is irrelevant when determining whether such contract constitutes an "insurance contract" or not. Whether a particular contract constitutes insurance or a warranty depends on, among other things, the nature of the agreement, the scope of the obligations undertaken, the makers relationship to and control over the product, and the nature of the makers other activities. A particular contract constitutes insurance if it comes within the definition provided by N. Y. Ins. Law § 1101(a) (McKinney 2000), which provides:
In this article: (1) "Insurance contract" means any agreement or other transaction whereby one party, the "insurer", is obligated to confer benefit of pecuniary value upon another party, the "insured" or "beneficiary", dependent upon the happening of a fortuitous event in which the insured or beneficiary has, or is expected to have at the time of such happening, a material interest which will be adversely affected by the happening of such event.
(2) "Fortuitous event" means any occurrence or failure to occur which is, or is assumed by the parties to be, to a substantial extent beyond the control of either party.
(3) "Contract of warranty, guaranty or suretyship" means an insurance contract only if made by a warrantor, guarantor, or surety who or which, as such, is doing an insurance business.
(b)(1) Except as provided in paragraph two, three or three-a of this subsection, any of the following acts in this state, effected by mail from outside this state or otherwise, by any person, firm, association, corporation or joint-stock company shall constitute doing an insurance business in this state and shall constitute doing business in the state within the meaning of section three hundred two of the civil practice law and rules:
(A) making, or proposing to make, as insurer, any insurance contract, including either issuance or delivery of a policy or contract of insurance to a resident of this state or to any firm, association, or corporation authorized to do business herein, or solicitation of applications for any such policies or contracts;
(B) making, or proposing to make, as warrantor, guarantor or surety, any contract of warranty, guaranty or suretyship as vocation and not as merely incidental to any other legitimate business or activity of the warrantor, guarantor or surety.
Pursuant to N. Y. Ins. Law § 1101(b)(1)(B) (McKinney 2000), the making of, or proposing to make, a contract of warranty, guaranty or surety, constitutes the doing an insurance business where such warranty, guaranty or surety is the vocation of the warrantor, guarantor or surety and is not merely incidental to any other legitimate business or activity of the warrantor, guarantor or surety.
While the Insurance Law does not define "warranty", a warranty is an undertaking to cover a defect in the materials or workmanship of a product. For a contract to be a warranty, the maker of the warranty must exercise the requisite control over the property and have some relationship to the product or service, or do some act that imparts knowledge of the product or service, to the extent of minimizing, if not eliminating, the element of chance or risk contemplated by N.Y. Ins. Law § 1101(a). See,Ollendorf Watch Co., Inc. v. Pink, 279 N.Y. 32 (1938). Where there is no relationship to or control over the product, the maker of the contract undertakes an obligation involving a fortuitous risk, and the agreement is an insurance contract, constituting the doing of an insurance business. Pursuant to N. Y. Ins. Law § 1102(a) (McKinney 2000), unless exempt, a coverage provider that is doing an insurance business must be appropriately licensed. Even if the contract is a warranty, the provider must be licensed as an insurer if the business is done as a vocation (except for warranties in connection with the sale or supply of heating fuel).1
Guaranty or Surety
With respect to contracts of guaranty and surety, the Insurance Law generally does not make a distinction between the two terms. Both are undertakings to answer for the debt or obligation of another if such person fails to perform, or defaults. Usually, after the surety or guarantor performs, its recourse is to go after the person that is primarily responsible to perform, for reimbursement of the expenses it incurred in performance of the underlying obligation. See, Dictionary of Insurance Terms 497 (4th ed. 2000). As the case with a warranty, the making of contracts of guaranty or surety as a vocation constitutes the doing of an insurance business.
One/Two Year "Warranty" Agreement
The one/two year agreements involve the Builders, who have primary responsibility to perform the obligation; ABCHWA, the surety or guarantor (the entity with secondary responsibility to perform if the builders fail to do so); and the homeowner or obligee to whom the right of performance is owed. In other words, the agreements obligate ABCHWA to perform where the Builders fail to perform. This obligation is contained in both the ABC-W602 and ABC-W401 agreements, which contain similar language and provides, in pertinent part, that:
In consideration of the premium received and subject to provisions of this certificate, the Builder and the ABC Home Warranty Association agree to the terms and conditions that follow herein. ABCHWA is the warrantor under this limited warranty and will meet the Builder obligations to the Homeowner(s) for covered deficiencies if ABCHWA has established that the Builder is unable or unwilling to comply with the assurances, conditions and standards as set forth herein. (emphasis added).
The above assurance by ABCHWA constitutes a contract of surety or guaranty by virtue of the fact that ABCHWA, formed with the sole or principal purpose of providing "warranty" services to its builder members in return for a separate consideration, provides these "warranties" as its vocation. In addition, it does not appear that such "warranties" are incidental to any other legitimate business or activity that ABCHWA engages in. As a result, with regard to the one/two year "warranty" agreements, ABCHWA would be doing an insurance business without a license. Thus, it must obtain a license as an insurer to write surety insurance.
Ten-Year Major Structural Defect Agreement
Pursuant to the 10-year major structural defect "warranty", ABCHWA agrees to and is directly responsible for making all repairs for certain "major structural defects" of the homes for the first ten years. This agreement is not a warranty because, among other things, ABCHWA does not have the requisite control over and/or relationship with the product (the homes). Even if ABCHWA had the requisite control over and relationship to the product or service, or did some act that imparts knowledge of the product or service, to the extent of minimizing, if not eliminating, the element of chance or risk contemplated by N.Y. Ins. Law § 1101(a) (McKinney 2000), ABCHWA would be doing an insurance business without a license because, as mentioned above, the "warranties" are the vocation of ABCHWA and not merely incidental to any other legitimate business it has.
In order to provide such coverage in New York, ABCHWA must register as a service contract provider in accordance with Article 79 of the Insurance Law. Under N.Y. Ins. Law § 1101(b)(3-a) (McKinney 2000) the making of a service contract does not constitute the doing of an insurance business if made in accordance with Article 79 of the Insurance Law. N.Y. Ins. Law § 7902(k) (McKinney 2000) defines a "service contract" as:
(k) " Service contract" means a contract or agreement, for a separate or additional consideration, for a specific duration to perform the repair, replacement or maintenance of property, or indemnification for repair, replacement or maintenance, due to a defect in materials or workmanship or wear and tear, with or without additional provision for indemnity payments for incidental damages, provided any such indemnity payment per incident shall not exceed the purchase price of the property serviced .
Before a service contract provider (anyone who "markets, sells, offers for sale, issues, makes or proposes to make or administer a service contract, and who is contractually obligated to provide service under a service contract") may sell such contracts in New York, it must apply and obtain the Superintendents approval of a service contract provider registration and provide proof of financial responsibility. Therefore, in order to offer the 10-year "major structural warranty" coverage in New York, ABCHWA must be registered as a service contract provider and comply with Article 79 of the Insurance Law. Service contract providers must also comply with N.Y. Comp. Codes R. & Regs. tit. 11, §§390.0-390.13 (Regulation 155) (2001).
As a final matter, ABCHWAs argument that the contracts in question do not constitute service contracts because express or implied warranties are not service contracts does not excuse ABCHWA from regulation under the Insurance Law. As mentioned above, the making of such contracts would constitute the doing of an insurance business, thus requiring ABCHWA to obtain an insurers license.
ABCHWA also argued that the contracts are not service contracts because there is no separate or additional consideration. While, Section 7902(k) provides that a service contract exists where there is a separate or additional consideration for a specific duration to perform repair or maintenance, that section does not specify which party in an agreement must pay the separate or additional consideration. Thus, it is irrelevant that the homebuyer does not pay a separate fee, because it is clear that the Builders will pay ABCHWA a separate fee (in terms of premiums) for such "warranty", thus constituting a service contract. Accordingly, where an entity, like ABCHWA, that is not licensed as an insurer, makes a contract which is sold for a separate or additional consideration, such contract constitutes a service contract.
Please contact the Departments Licensing Bureau at Agency Building 1, Empire State Plaza, Albany, NY 12257 or call (518) 474-7159, to obtain the appropriate registrations/licenses.
For further information you may contact Senior Attorney D. Monica Marsh at the New York City Office.
1 See, N.Y. Ins. Law § 1101(b)(3-a) (McKinney 2000) and N.Y. Ins. Law § 7901(b)(4) (McKinney 2000) (warranties, service contracts or maintenance agreements conditioned upon or otherwise associated with the sale or supply of heating fuel do not constitute doing an insurance business in this State).