OGC Opinion No. 04-02-23: Short-Rate Penalty

OGC Op. No. 04-02-23

The Office of General Counsel issued the following opinion on February 20, 2004, representing the position of the New York State Insurance Department.

Re: Short-Rate Penalty

Question Presenteds:

1) May an authorized insurer apply a short-rate penalty when an insured cancels its commercial package insurance policy midterm because the insurers A.M. Best Co.s rating has dropped from an "A" to a "D?"

2) Where another insurer will assume the renewal rights of the "D" rated insurer, may the "D" rated insurer offer to waive its short-rate penalty only for insureds who, after cancelling their policies, re-write them with the assuming insurer?

Conclusions:

1) An authorized insurer may apply a short-rate penalty when an insured cancels its commercial package insurance policy midterm, if so provided in its rate filings, and the policy provides for such, despite that the insurers A.M. Best Co.s rating has dropped from an "A" to a "D." The insureds obligation to maintain insurance with an insurer that has a certain A.M. Best Co. rating arose from a contractual obligation that was distinct and separate from its dealings with the insurer, and does not involve the application of any Insurance Law provisions.

2) Where another insurer will assume the renewal rights of the "D" rated insurer, the "D" rated insurer may not offer to waive its short-rate penalty only for insureds who, after cancelling their commercial package insurance policies, re-write them with the assuming insurer because this would constitute rebating and discrimination, in violation of N.Y. Ins. Law § 2324 (McKinney Supp. 2004).

Facts:

An inquiry stated the following:

An insurance contract contains a "short-rate" penalty clause that applies when the policyholder initiates a mid-term cancellation. When the policyholder entered into the contract, the company held a financial strength rating in the "A" range from rating service A.M. Best Co. In the interval, the companys A.M. Best rating has slipped to the "D" range. The policyholder states that it has other contractual obligations to maintain insurance coverage from a carrier that has a good financial rating; and that this particular carrier, having fallen to a "D," placed the insured in the position of having to move to another carrier to avoid violating its contractual obligation to maintain acceptable insurance.

* * * *

[I]t should be noted that the "D-rated" carrier (Company X) worked out an arrangement whereby its renewal rights have been acquired by another carrier (Company Y). The Web site of Company X states that "[Company X] will prorate all cancel and rewrites that are transitioned to [Company Y]."

The type of policy involved here is a commercial package insurance policy, providing liability and property insurance.

Analysis:

Application of Short-Rate Penalty

N.Y. Ins. Law § 3428(a) (McKinney 2000) states:

Except as provided in subsection (d) of this section, whenever an insurance contract made or issued in this state is cancelled or otherwise terminated by the insured before the expiration thereof in accordance with the terms of such contract, the earned premium to be retained by the insurer shall be determined by the applicable rate filing, if any, otherwise in accordance with the provisions of such contract.

Thus, an insurer may apply a short-rate penalty for mid-term cancellation by the insured if so provided in its rate filings, and the policy so provides.

In this instance, the policy does provide for a short-rate penalty for mid-term cancellation by the insured. Since the insurer is authorized in New York, it is assumed that the rates filed with the Department reflect this provision.

Since the insureds obligation to maintain insurance with an insurer that has a certain A.M. Best Co. rating arose from a contractual obligation that was distinct and separate from its dealings with the insurer, and does not involve the application of any Insurance Law provisions, the insurer may lawfully impose the short-rate penalty.

Conditional Waiver of Short-Rate Penalty

N.Y. Ins. Law § 2324 (a) (McKinney Supp. 2004) states, in relevant part:

(a) No authorized insurer, no licensed insurance agent, no licensed insurance broker, and no employee or other representative of any such insurer, agent or broker shall make, procure or negotiate any contract of insurance other than as plainly expressed in the policy or other written contract issued or to be issued as evidence thereof, or shall directly or indirectly, by giving or sharing a commission or in any manner whatsoever, pay or allow or offer to pay or allow to the insured or to any employee of the insured, either as an inducement to the making of insurance or after insurance has been effected, any rebate from the premium which is specified in the policy, or any special favor or advantage in the dividends or other benefit to accrue thereon, or shall give or offer to give any valuable consideration or inducement of any kind, directly or indirectly, which is not specified in such policy or contract, other than any article of merchandise not exceeding fifteen dollars in value which shall have conspicuously stamped or printed thereon the advertisement of the insurer, agent or broker, or shall give, sell or purchase, or offer to give, sell or purchase, as an inducement to the making of such insurance or in connection therewith, any stock, bond or other securities or any dividends or profits accrued thereon, nor shall the insured, his agent or representative knowingly receive directly or indirectly, any such rebate or special favor or advantage, provided, however, a licensed insurance agent or a licensed insurance broker may retain the usual commission or underwriting fee on insurance placed on his own property or risks, if the aggregate of such commissions or underwriting fees will not exceed five percent of the total net commissions or underwriting fees received by such licensed insurance agent or insurance broker during the calendar year. (emphasis added.)

Based on the information that was provided to the Department, the policies do not state that a waiver of the short-rate penalty would be applied to those insureds who cancel their policies and have them re-written by the assuming insurer. Therefore, waiving the short-rate penalty in this manner constitutes an unlawful rebate and an inducement to the making of insurance as prohibited by N.Y. Ins. Law § 2324.