The Office of General Counsel issued the following opinion on October 30, 2002, representing the position of the New York State Insurance Department.

Re: N.Y. Ins. Law §§ 7903 and 5913 and Risk Retention Groups

Question Presented:

Does the Second Circuit Court of Appeals decision in Preferred Physicians Mutual Risk Retention Group v. Pataki, et al., 85 F.3d 913 (2d Cir. 1996) require the Superintendent to accept, for the purposes of meeting the financial responsibility requirements of N.Y. Insurance Law § 7903(c)(1) (McKinney 2000 & Supp. 2002), a policy of insurance issued by a risk retention group not domiciled in New York?

Conclusion:

No, the provisions of § 7903(c)(1) have not been preempted by the LRRA.

Facts:

The inquirer is the General Counsel to ABC Association, which is concerned about two recent opinions of this Department, dated October 20, 2000 and July 6, 2001 (00-10-09 and 01-07-03, respectively, on the Insurance Department’s website). Both of these opinions concluded that an insurance policy issued by a risk retention group does not satisfy the financial security requirements of N.Y. Ins. Law § 7903)(c)(1). The inquirer asserts that the Department’s position discriminates against risk retention groups, in violation of the provisions of the federal Liability Risk Retention Act 15 U.S.C. §§ 3901, et seq. ("LRRA"), specifically, 15 U.S.C. 3902(a). The inquirer asked the Department to again reconsider its position, and to address the Preferred Physicians case, cited above, which the inquirer believes is controlling.

Analysis:

Article 79 of the N.Y. Ins. Law governs the issuance of service contracts. No person or other entity who is obligated to provide service under a service contract may issue, sell or offer for sale a service contract in New York unless it first registers with the Superintendent of Insurance as a service contract provider, pursuant to N.Y. Insurance Law § 7907 (McKinney 2000). As a requirement of registration, a service contract provider must assure the faithful performance of the provider's obligations to its contract holders by complying with one of the three methods for demonstrating its financial responsibility as provided in N.Y. Ins. Law § 7903(c) (McKinney 2000). Section 7903(c)(1) contains the insurance policy method for demonstrating financial responsibility. It provides, in pertinent part, as follows:

(c) In order to assure the faithful performance of a provider's obligations to its contract holders, each provider who is contractually obligated to provide service under a service contract shall comply with one of the following three paragraphs of this subsection:

(1) insure the performance of all its obligations under all service contracts pursuant to a service contract reimbursement insurance policy issued by an insurer authorized to issue service contract reimbursement insurance in this state or procured by an excess line licensee pursuant to section two thousand one hundred eighteen of this chapter…

Before addressing the preemption issue, we must express our doubts that service contract reimbursement insurance (SCRI) even constitutes liability insurance within the meaning of the LRRA. Under Section 3905(b) of the LRRA, a risk retention group may only issue policies of liability insurance, as defined therein, and no other kind of insurance. However, a policy that satisfies the financial responsibility obligation imposed by Article 79 is not one of liability insurance. Rather, it is in the nature of a contract of surety or guarantee. Article 79 does not impose a liability obligation on a SCRI insurer and a SCRI insurer may not write liability insurance coverage within the scope of its license under N.Y. Insurance Law § 1113(a)(28) (McKinney 2000). N.Y. Insurance Law § 1113(a)(28) provides, in pertinent part, and as originally enacted in 1997:

(28) "Service contract reimbursement insurance" means insurance issued to a provider pursuant to article seventy-nine of this chapter whereby the insurer agrees, for the benefit of service contract holders, to discharge the obligations and liabilities of such provider under the terms of the services contracts issued by such provider, including the return of unearned provider fees upon any termination or cancellation of service contracts, in the event of non-performance of any such obligations or liabilities by such provider. [Emphasis supplied.] 1

However, assuming that SCRI is liability insurance under the LRRA, we will address the preemption arguments.

While states are generally precluded under the LRRA from regulating a non-domiciliary risk retention group (RRG), there are certain exceptions. Section 3905(d) of the LRRA, entitled "Clarification concerning permissible State authority" provides for a reservation of state authority with respect to financial responsibility. It states, in pertinent part:

(d) State authority to specify acceptable means of demonstrating financial responsibility

Subject to the provisions of section 3902(a)(4) of this title relating to discrimination nothing in this chapter shall be construed to preempt the authority of a State to specify acceptable means of demonstrating financial responsibility as a condition for obtaining a license or permit to undertake specified activities. Such means may include or exclude insurance coverage obtained from an admitted insurance company, an excess lines company, a risk retention group, or any other source regardless of whether coverage is obtained directly from an insurance company or through a broker, agent, purchasing group, or any other person. [Emphasis added]

N.Y. Ins. Law § 5913 (McKinney 2000) provides that:

Whenever pursuant to the laws of this state or any political subdivision of this state a demonstration of financial responsibility is required as a condition for obtaining a license or permit to undertake specified activities, if any such requirement may not be satisfied by obtaining insurance from an insurer not authorized to do business in this State, such requirement may not be satisfied by purchasing insurance from a risk retention group not chartered in this State.

Accordingly, the Department concluded that the New York service contract financial responsibility statute is excepted from federal preemption under the above-cited provisions of the LRRA and the corresponding provisions in the New York Insurance Law in that a service contract provider may not use service contract reimbursement insurance issued by a risk retention group to fulfill its financial responsibility requirements.

Although National Warranty Insurance Company, RRG v. Greenfield, 24 F. Supp. 2d 1096 (D. Or. 1998), aff’d 214 F.3d 1073 (9th Cir. 2000), concluded that Oregon’s service contract financial security law was preempted by the LRRA because it unfairly discriminated against RRGs, two other circuits have concluded differently and upheld state financial responsibility laws that did not accept policies issued by a RRG. See Ophthalmic Mut. Ins. Co. v. Musser, 143 F.3d 1062 (7th Cir. 1998); Mears Trans. Group v. State of Fla. 34 F.3d 1013 (11th Cir. 1994). There has been no decision on point in the Second Circuit, which is where New York is located.

The inquirer suggests, however, that the Preferred Physicians case, supra, is controlling in New York on this issue. We disagree. The plaintiff in the Preferred Physicians case did not challenge a state financial responsibility statute, as that term is defined in the LRRA. What was challenged therein was the Department’s application of New York’s Excess Insurance Law ("EIL"), which affords excess medical malpractice insurance, at no charge to the insured, to physicians and other medical professionals who are covered by a primary medical malpractice insurance policy issued by an insurer authorized (by virtue of a license) to conduct an insurance business in New York State. Because physicians and other medical professionals are not required in New York State to secure malpractice insurance as a condition for a license to practice medicine, the EIL does not constitute a financial responsibility statute as defined in the LRRA2 and the Court did not construe § 3905.

The LRRA preempts state laws that either regulate the operation of a RRG or otherwise discriminate against a RRG, 15 U.S.C. § 3902(a)(1), (4). Noting that the concept of discrimination requires more than merely showing that a protected class was disadvantaged, the Second Circuit did not decide the issue of whether the EIL discriminated against RRGs in Preferred Physicians. Rather, the Court stated that, as a matter of law, it was unclear whether the LRRA forbids only intended targeting of RRGs, or whether it also prohibits acts with an unintended disparate impact. The Court did not undertake to answer these questions because the parties had not briefed them adequately and because the Court believed that on remand the issue might become moot, once the actual facts were established. Accordingly, the Court vacated the judgment of the lower court that had granted the plaintiff summary judgment and remanded the case to the District Court for findings of fact.

Upon remand to the District Court, the parties engaged in further discovery but before the case could be submitted for judgment based upon its findings of facts a formal stipulation of discontinuance was executed by the parties on October 28, 1998, and so ordered by the District Court on November 6, 1998.

Moreover, there is no evidence that § 7903(c) was enacted with the intent to discriminate against risk retention groups nor is there any evidence that the statute has a disparate impact against RRGs as opposed to other unauthorized insurers that have not complied with New York’s excess line laws. N.Y. Ins. Law § 7903(c), unlike the EIL, is a financial responsibility statute as defined in the LRRA. As such, it is encompassed under the reservation of rights provided to the states under LRRA § 3905(d), which saves such state laws from federal preemption. Congress, by including this statutory provision in the LRRA, recognized the importance that states retain their authority to devise and implement, without preemption by federal law, financial responsibility laws in connection with the granting of licenses and registrations to engage in specified activities. New York has a legitimate interest in requiring financial responsibility to be demonstrated by an insurance policy issued by an insurer subject to all of its insurance laws and regulations and under its regulatory supervision. Accordingly, such a distinction created in the statute is not per se discriminatory against a RRG.

For further information, you may contact Principal Attorney Paul A. Zuckerman at the New York City office.

1  Home Warranty Corp. v. Caldwell, 777 F.2d 1455, (11th Cir. Ga. 1985) and Home Warranty Corp. v. Elliott, 572 F. Supp. 1059 (D. Del. 1983), which addressed the issue of surety insurance. Under the original 1981 Product Liability Risk Retention Act, a RRG was able to provide incidental coverages in addition to liability coverage, but the 1986 amendments eliminated that ability to provide incidental coverages.

2 The Insurance Department, for purposes of argument only in Preferred Physicians, and to demonstrate the legitimate concerns New York State had in enacting the EIL, compared the EIL to a financial responsibility statute. However, the Department never took the position that the EIL is a state financial responsibility statute. Unlike the EIL, N.Y. Ins. Law § 7903(c) is a financial responsibility statute under the LRRA’s definition.