GENERAL THEATTORNEYOFTEXAS

AUSTIN ~~.TEXAS WVIJX.WILSON ATrouNEY GENxmcAL .December 9, 1958

Ron. Will.iam A.,Harrison OpinionNo. W-533 Commissioner of Insurance InternationalLife Building Re: Certai~nquestionsconAustin 14, Texas cerning reinsuranceby companies subject to the fire insurancerating laws relnsuri~ngfire insurancepolicies issued by companieswhich are not subject to such rating laws.
Dear Sir:

Your amended request for an opinion given.in lieu of your letter of May 5, 1958, is as follows:

"Mostcompanieswriting fire and casualty.insurance inTexas are subject to the provisions of Sub-chapter C of,Chapter 5 of the Texas Insurance Code which authorizes the State Board of Insurance to fix and pr.omulgate firesinsurancerates. However, reciprocals, Lloyd8 and countymutual insurancecompanies need'not conform to th,efire Insurancerates promulgated by the Board. It has come to the attention of the Board that a number of stock and mutual insurance companieswhich are subject to the rating laws are reinsuring 100% of the fire insurance coverageswritten by companieswhich are not subject to these rating laws. Polici~es of fIre insurance purportedlyare Issuedby a Lloyds or reciprocal or cpuatgmutual (whichwill hereinafterbe referred to as exempt ,companies) at rates fixed!

by such exempt company+
. without respect to the rates promulgatedby tie Board. At the inception the coverage Is reinsured 100% by the stock or mutual companywhich could not otherwise issue policiesat the rates used in the issuance of such policies.
"Werespectfully request your opinion on certain questions pertaining to the following facts:
"An exempt company has entered into a reinsurance contractwith,a non-exempt company. Such agreement Is in substance that the exempt company has agreed to cede

. ’Hon. William A. Harrsion, page 2 (WW-533)

to the non-exempt company all the ~premiums written by theeexempt company on certain fire insurancecoverages and in turn the non-exempt company has agreed to reinsure 100% of the liability of the exempt company. The only return to the exempt company is a small ced,ing commission. The non-exempt or reinsuring company has agreed to bear all of the expenses of servicing the business,paying the agent's commissionsand has even been de~legated

the authority to appoint agentsto act for the exempt,company in connectionwith the sale of the particular insurance in question. The non-exempt company assumes full responsibility to investigate, settle and defend all claims arising under the policy. The purpose of this arrangement is to permit the non-exempt company to obtain the business at rates lower than that which they are permitted to write under the applicable rates promulgatedby the State Board of Insurance. It IS standard procedure for the policy of the exempt company to have on its face or by endorsement language to the effect that the obligationsunder the policy are reinsured 100s by the non-exempt company. As a matter of practice the insured In settlement of,ang loss deals direotlywith the non-exempt reinsuring company. In many Instances the policyholdersare unwilling to ac- .cept the insurance of the exemptcompany until they have been furnished absolute evidence that the policy will be reinsur~ed100% by the pon-exempt company. "With.respect.

to the above,outline fact situation we,ask .thefollowingquestions:

/. 'j!(l)' Must the rate of premium charged the policyholder conform to the standardpremium promulgated by the State Board of Insurance for the particularrisk coveredunder the provisions of Sub-chapter C of Chapter 5 of the ' Texas Insurance Code of 1951 as amended? "(2) Id?the non-exempt.'reinsuring'company required to pay the gross premium.recelpts tax led& by Article .7064, R-S,, 1925'"
The ,speclficstatutoryauthority for fixing of rates of :fire~

insurancepremiums is contained inArticle 5.26 of " I, 'the.Texas Insurance Code as amended, Acts 1957, 55th Leg.,

p.,1.443;: C'h.497p Section (h) speCifically exempts from the operation of.Aptlcle 5.26 "CountyMutual Insurance Companies operating under Chapter 17 of this Code; Underwritersat a : &loyd's operatingunder Chapter, 18, of this Code; Reciprocals and inter-insuranceexchanges operating under Chapter 19 of 'this Codes".'Sub-chapterC of Chapter 5 of the'Texas InsuranceHon. William A. Harrison, page 3 W-533)

Code generally governs the power of the State Board of+Insurance to promulgate end fix rates of fire insurancepremlums charged on polrcles of fire fnsurenceand allied lines ~issuedin the State of Texas.

Article 5.26 as emended In 1957 requires the State Board of Insurance to promulgatemaximum rates of insurance ror fire risks. Insurance companies subject to the law must charge the rate8 fixed by the Board unless permission Is granted by the Board to deviate.

Initially, it 'isour opinion that the Legislature did not intend .for'theState Board ,ofInsurance to promulgate maximum rates for 'relnsurance"premiums.

'Relnsurence"is a contractwhereby onefor a considerationagrees to ,indemnlfg another, either Inwhole or Inpert, against loss or liability, the risk of which the latter he8 assumed under a separate and distinct contract a8 Insurer of a third party. 8 Couch Cyclopedia of Insurance Law,.

p. 7389, Sec. 2256; 24-D Tex. Jur. 980, Sec. 484.
Of course,,

reinsurance is a form of Insurance. However,we believe the Legislature Fn Sub-chapter C of Chapter 5 of the.Texas Insurance Code has recognized e distinction between "InsUrlng"and %einsuring". In Article 5.41, Texas Ins'urance

Code, it .is.provided:

:'"No,'company

shall engage or participate.In the insuring or reinsuring of.eny property inthis State against loss or damage by fire ~exceptIn compliance with the terms end provisions of this law; nor shall any.such'companyknowinglywrite insuranceat any les8errate thanthe rates herein provided for,

. . .' The,firstcleuse expresslyrecognizes the distlnction between-!'j.n&rance" ena 'reinsurance'and then the next clause deacribea~wha,tl's prohibited, that is, the company Is prohl; bited from '!'knowingly writing insuranceat .anylesser rate

. .',

. -.~See,also the first sentence of Article 5.42 indicatingthe Fntent of the Legislature to only regulate relations ~,betweena.c~ompanyand lts,pollcyholdersrather then **relations** :.bat.~aen,:co,~pdnle.s.. Again; the following leW3UVM from .Artlclis

5.27,..'".....

(l)t.being Intended that every contract or policy of.:lnsUrenc,e against the hazar~d of fire shell be issuedin'eccordenee ,withthe terms and provls,ions of this subchapter;

..; .,':.' is indicative of an intent to'exclude r.einsurance'.

"In a true contract of relnsurance the,reinsuring company does not iSSUe a 'contractor,policy of lnsurence against the~hezard of fire". The reinsurance contract Insures 'thepolicy $SSUing company against 1oSS by reasonHon. William A; Harrison,' page 4 (WW-533)

of having issued contracts or policies of insurance.

Again, this conclusion is reinforced by the language of the emergency~clauseof the originalAct permitting the Board to set maximum rates of fire insurance. Section 31 of the Act, 1913, p. 195, is as follows:

"The fact that there is now no sufficient law in this State prohibitingunjust discrimination In the collection of fire insurancerates as between citizens of the State; nor protecting citizens in securingreasonable rates, constitutesan emergency . . . . -'
We are not unaware of previous Attorney General opinions rendered on the same OP similarquestions. By opiniondated June 25, 1924 (Vol. 267, p. 267) the then Attorney General rendered an opinion to the State Fire Insurance Commission that properly licensed stock fire insurance companieswhich undertook to reinsure risks which were ln8Ured by companies not subject to the rating law were obliged to observe the rates for such risks which had been estab- 'lishedby the Commission. A year later by opiniondated August 4, 1925 (Book 274, p. 901) the Attorney General advised the Fire Insurance Commission that the writing of reinsurancewas not covered by the fire rating law. There is no discussion in this opinion of.the previous opinion of June 25, 1924. Then by opiniondated September 29, 1930 (Book 316, p. 903) the AttorneyGeneral advised the State Fire Insurance.

Commissioner in effect that reinsurancewas within the rating provisions of the statute.

You have orally.advisedme that in spite of these opinions It has been the consistentdepartmental interpretation that reinsurance in generalwas not subject to the rates promulgatedby the State Board of Insuranceand the predecessorBoard of Insurance Commissioners. We do not believe that the statutes in question are ambiguous, but rather that they clearly exclude from their terms reinsurante, and the two earlier opinions to the contrary are clearly in error.

However, your lester suggests transactionswhich do ,not fall within the usual purview of reinsurance and though we have held that reinsurance as such does not come within the provisions

of the fire insurancerate laws, the law does not prevent an inquirybeyond the form of a transaction into its true substance. We hold that under the fact situation given that the transaction in question is not one of reinsurance insofar as the rating laws are concerned. We further hold in response to your first question that the so-called reinsuring company has issueda policy of direct insurance. .IHon. Wllllam A. Harrison, page 5 (W-533)

The premium charged the policy holdermust conform to the .rates which the reinsuring company is permItted to use under 'theprovFslons of Sub-chapter C of Chapter 5 of the Insurance Code.

What then 1s the primary testto determinewhether or not a given transaction,regardless of the verbiage used, comeswithin the provisions of Sub-chapter C of Chapter 5? We believe that the statuteapplieswhen an Insurancecompany enters into a contract to directly Insure the hazards of fire and its allied lines. In support of this conclusion is the,language of Article 5.27 previously quoted stating the intent of the Legislature:

"Itbeing intended that every contract or policy of Insuranceagainst the hazard of fire shall be issued in accordancewith the terms and provislons of this sub-chapter."
The prlmarg test then as to whether or not the so-called reinsurance described by your request must conform to the rating provisions of Chapter C is whether or not under the terms of such so-calledrelnsurance contract the original insured has the right to proceed against the so-calledre- ?:~ insuring company if he should suffer a loss from the hazards of flre.&If the original policghold$r has a right to pro- ', ce,ed directly against the 'reinsurer there is.nothtng which distinguishes the obligation of'the so-calledreinsurer from thatwhich he would undertake should he Issue directly a pollcg on the risk in question---the "reinsurer" has contracted,to indemnifyagainst then hazard of fire.
'Wedo not intend to hold that every contractwhich gives the original policyholdera right to~proceedagalnst the so-called~reinsurermust conform to the provisions of Sub-chapter ,C..

Itisnot unusual for the original insuringcompany and,the reinsuring company to arrange conventional reinsurance 1 in.'such

a manner that the relnsurer assumes direct responslbflitiesto thee

polingholder. Here again we look to the b.. purpose;forwh%ch the Act was passed. As evidenced by the

emergency clause the original fire Insurancerating law was .: enacted to prevent discriminationbetween policyholders. ~''Thatpurpose.is servedwhen each policyholder similarly sltuated,obtalnFngdirect coverage from a non-exempt insurance company is able to obtain such coverage at the same rate of premfum. A polLcgholderwho has obtainedhis policies of Insurancedirect from a non-exempt company Is not discriminated again& as between hImself and anotherwho originally:,’

. _

Hon. William A. Harrison, page 6 (W-533)

obtains a policy from an exempt, companyat a lower rate of premium and then later, Independent of the original negoti- 'ations,the same non-exempt insurance company assumes all or part of the liabilltg of the exempt company on that particular policy. The secondpolicyholder in the purchase or acquisltlon of his policy obtainedno advantage of price or premium to which~he was not properly entitled. The latter policyholderbargained for and acquired indemnity in the exempt company only. But where the'policgholderobtains a policy from an exempt companywhich at Its inception contalns provisionswhich allow~him to proceed directly against the non-exempt company,, he has bargained for and obtained indemnity from the non-exempt company at a lesser rate than a policyhblderwho obtains a d~irect policy from.the nonexempt company, thereby creating the discrimination Intended to.be eliminatedby the law.

, We would point out that the determinationwhether

the transaction constituted ','reinsurance" as opposed.

to "direct insurance" Is largely a factual one dependent on assessment of the intent of the parties. That factual de-- t'ermination

ls~prlmarilgyourresponsibility,
Your secondquestlon is whether the reinsuring company is required to'pay the gross $remium receipts tax levied by Article 7064.

c Artkle 7064 exacts a tax on'the gross amount of

'premiums~receivedon.certainlines of insurance including fire Insurance. However,,expressly exempted ,fromthe provisions~ofArticle 7064,are 'premiumsreceived from other licensed companies for reinsuranc,e?.We are not here con-, cernedwith the substantialqu~estion:of whether or not reciprocal exchanges come underthe.terms of Article 7064.. Article 7064 requires the fnsurance company subject thereto to report-to then

Board'the;"gross amount of premiums' recelved on propertywhich is further defined:.,'~

II

. . (t)hegross premium receipts :where"referredto in thls.'law:shall be the total gross~amount .a of ~premiumsreaeived'onl each, and every kind of insur-

,. ,anceOS risk written, exc,epQ premlums received from other licensed cdmpan~l&sfor reksurance? :less, return premiums and dividends 'paIdpolicyholders;but there

,., ; shallbe no deductlon for premfums paid for reinsurance."
We.have held~under'the fact situationthat~the obllgation of the so-calledreinsurfng company.was ln~ fact a dire@t obllgationof.the reinsuring company ratherthan one of relnsurance. Thus,:we':be'li.eve, that the exemption inArticle 7064 "reinsurance~'?:',would,' not b.e,applicable.: sunderthe fact situation and with the,,:above,con~lusfons, .the.so-calledceding ': .,. .

Hon. William A. Harrison, page 7 (W-533)

companywould be collecting the premium both for itself and for the so-calledreinsuring company and in this sense the gross premium on the policy would have been received both for 'itselfand for the so-calledreinsuring company. Assuming that the ceding companywas a type of company subject to the tax under Article 7064, then both the assuming and ceding companywould be jointly and severally liable for the premium tax under Article 7064. If theceding company be exemptunder the terms of Article 7064 from such a premium tax, then only the so-calledreinsuring companywould be liable for the tax.

We reached the above conclusion in view of the fact that under the circumstancesgiven each of the two companies involvedas,sumes100% of the liab111typrovided in the policy. The Insured could elect to proceed either against the socalled ceding company or against the reinsuring company independently or could proceed against’them jointly in one switq Thus, each of the companies has assumed a jointand sev~eral

llabilltgunder the terms of the contract. Hence, eachwould be jointlyand severally liable for the taxes on the premium.
SUMMARY

Under fact situationgiven, where fire lnzurante polLcy of a company exempt from fire Insurancerating law is reinsured 100% by a company subject to this law: (1) The premium charged the pollcyholder must conform to the rates which the relnsurlng company is permitted to use under the rating law. (2) And both companies are subject to the premium tax levied by Article 7064 unless :exempted.
FBW:lm:wc Very truly yours, APPROVED: OPINIOR COMMITTEE: '. WILL WILSON Geo. P. Blackburn, ChaIrman Attorney General of Texas W.E. Allen Marietta McGregor Payne By s/FredB. Werkenthin REVIEWED FOR THE ATTORNEY Fred B. Werkenthin GENERAL BY: Assistant W,. V. Geppert