OGC Opinion No. 07-04-03

The Office of General Counsel issued the following opinion on April 3, 2007, representing the position of the New York State Insurance Department.

RE: Article 79 Service Contracts – Amount of the Funded Reserve Account

Questions Presented:

1) Must a service contract provider who chooses to comply with the financial responsibility requirements of N.Y. Insurance Law Article 79, by means of maintaining a funded reserve account and financial security deposit, base its calculation of the amount to be held in reserve upon the gross sale price charged to the consumer for the service contract, or upon the amount remitted by the authorized dealer to the service contract provider?

2) How should the funded reserve account and the financial security deposit be properly calculated?

Conclusions:

1) Pursuant to Insurance Law § 7903(c)(2)(A) (McKinney Supp. 2006), the amount to be held in the funded reserve account is based on calculations that derive from the gross sale price charged to the consumers for the service contracts.

2) The funded reserve account and the financial security deposit are calculated by subtracting the claims paid from the gross consideration, and then multiplying the difference by the applicable percentage.

Facts:

The inquirer is an officer of ABC Inc., a registered service contract provider. A preliminary examination report by the Insurance Department concluded that ABC’s funded reserve account was deficient by more than $13 million.

ABC calculates its funded reserve account balance based upon the amount that ABC receives for its service contracts, after deducting the compensation paid to automobile dealers for selling the service contracts. Further, according to the inquirer, the balance is not based upon the total sales price charged to the customers for the service contracts. It is inquirer’s contention that this method of calculating the funded reserve account complies with Insurance Law § 7903(c)(2)(A).

Analysis:

Insurance Law § 7903(c) (McKinney Supp. 2006) requires service contract providers to assure the faithful performance of their service contracts by demonstrating financial responsibility by one of three methods. The method selected by ABC required it to establish and maintain both a funded reserve account and a financial security deposit. In pertinent part, Insurance Law § 7903(c)(2) provides that a service contract provider must:

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(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 . . . (Emphasis added.)

Insurance Law § 7905(e) (McKinney 2000) also is relevant to your inquiry. It provides:

Service contracts shall state the total purchase price and the terms and conditions under which the service contract is sold. The purchase price is not required to be preprinted on the service contract and may be negotiated at the time of sale with the service contract holder.

Moreover, Section 390.6 of N.Y. Comp. R. & Regs. tit. 11, Part 390 (Regulation 155) is germane to your question. It reads as follows:

Payment of the provider fee to a person authorized to sell or market the service contract in this State, or an administrator or other person authorized to receive payment, shall be deemed to be payment to the service contract provider.

The term “provider fee” is defined in Insurance Law § 7902(i) (McKinney Supp. 2006) as “the total purchase price or consideration paid for a service contract.” In other words, the “provider fee” of Insurance Law § 7902(i) is tantamount to the “gross consideration” mentioned in Insurance Law § 7903(c)(2).

When read together, these statutory and regulatory provisions establish that the amount to be maintained in the funded reserve account specified in Insurance Law § 7903(c)(2)(A) (McKinney Supp. 2006) must be calculated based upon the gross sale price charged to consumers for the service contracts, and not, as you contend, upon the net amount remitted by the authorized dealer to the service contract provider. (The same principles apply to the financial security deposit specified in Insurance Law § 7903(c)(2)(B).) Moreover, the required amount may not be reduced by the costs incurred by the service contract provider to sell the service contract, such as commissions or other compensation paid to another party for making the actual sale.

In addition, the Department notes that ABC has erred in calculating the required amounts for its funded reserve account and financial security deposit. ABC incorrectly calculated these amounts by multiplying the amount that ABC considered to be the gross consideration by the applicable percentage (i.e., 40% for the funded reserve account, and 5% for the financial security deposit), and then subtracting the claims paid. But the plain text of Insurance Law § 7903(c)(2)(B) – which provides that the funded reserve account shall be “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” – establishes that it is proper to subtract the claims paid from the gross consideration, and then multiply that difference by the applicable percentage. If the percentage is applied to the gross consideration prior to subtracting the claims paid, then in any situation in which a service contract provider’s claims ratio exceeds 40%, the provider would not maintain a funded reserve account, and would only be required to deposit $50,000 with the Superintendent. That result would be antithetical to Insurance Law § 7903’s aim of protecting purchasers of service contracts.¹

For further information you may contact Senior Attorney Brenda Gibbs at the Albany Office.

¹ Based on conversations with regulators in other states, the Department has confirmed that the majority of other states that have statutes similar to Insurance Law § 7903 have construed their statutes in the same way the Department construes Insurance Law § 7903. Given that such statutes are derived from a model developed by the National Association of Insurance Commissioners, the interpretation of a majority of the states is indicative of a common understanding of the intent and meaning of these provisions.