‘Leeway Law’ Provides California Insurers with Flexibility in Investments

In Brief

• Once capital requirements are met, real estate, loans, stocks, and other options open up to diversify and boost returns.
• California law sets clear guidelines, and insurers must study them and make compliance an integral part of decision-making to avoid risking additional regulatory scrutiny.
• The added freedom should not be seen as a free pass.

The California Leeway Law, codified in Section 1210 of the California Insurance Code (CIC), plays a significant role in shaping the investment strategies of insurance companies operating within the state. This law provides insurers with a degree of flexibility in their investment choices, allowing them to diversify their portfolios beyond classes of investments not permitted under general investments and excess funds investments as described in CIC 1170 through 1182 and CIC 1190 through 1202.

Insurance company investment committees need to understand their states’ leeway laws to ensure that investments remain within the regulatory guardrails, particularly as insurance companies are becoming more aggressive in their investment strategies in order to maximize returns. Every state has laws and regulations limiting investments above a certain threshold. They vary from state to state, so for California-domiciled insurers, a periodic refresher in the California Leeway Law is recommended.

Overview

In California, domestic incorporated insurers are permitted to make discretionary excess funds investments once they have met their minimum capital requirements. Specifically, after investing an amount equal to their required minimum paid-in capital in specified securities, insurers can invest in other properties and securities as permitted in CIC 1190 through 1202. Investments not allowed under general investments and excess funds investments would generally be non-admitted assets. However, under the California Leeway Law and subject to certain limitations, the aggregate of these discretionary investments may be admitted.

Investment Limits

Under the Leeway Law, the total amount of discretionary investments an insurer can make is capped at the lesser of two values:

1. 5% of the insurer’s admitted assets, or
2. 50% of the excess of admitted assets over the sum of capital paid up, liabilities, and the surplus (as of the preceding December 31 filed with the Commissioner) required by Section 700.02

These limits ensure that while insurers have the freedom to diversify their investments, they do so within a framework that maintains financial stability and protects policyholders.

Types of Permitted Investments

The Leeway Law allows insurers to invest in a variety of assets, including but not limited to:

• Real estate
• Stocks and bonds
• Loans
• Shares of open-end diversified management investment companies

This broad range of permissible investments enables insurers to tailor their portfolios to their specific risk tolerance and investment strategies, which can enhance their returns and financial strength.

Impact on Investment Strategies

The flexibility provided by the Leeway Law can significantly impact the investment strategies of insurance companies. Here are a few ways in which this law may influence their decisions:

• Surplus – The Leeway Law permits insurance companies to invest in assets that may generally be non-admitted, preserving surplus that could otherwise impact key solvency measurements, such as Risk-Based Capital.
• Enhanced returns – The ability to invest in higher-yielding assets can potentially enhance the returns on an insurer’s investment portfolio. For example, investing in real estate or stocks may offer higher returns compared to traditional fixed-income securities. This can improve the overall profitability of the insurer and provide more funds to support policyholder claims and other liabilities.
• Strategic flexibility – The Leeway Law provides insurers with the strategic flexibility to respond to changing market conditions. In times of economic uncertainty, insurers can adjust their investment portfolios to mitigate risks or capitalize on emerging opportunities. This agility can be crucial in maintaining financial stability and achieving long-term growth.

Impact of Noncompliance

Compliance with the Leeway Law and other relevant regulations is essential to avoid penalties and ensure the insurer’s investment activities are aligned with regulatory standards. Investment committees need to be cognizant that these limits exist and be mindful that when you venture into new investments or your strategy changes, you must consider the regulatory aspect. It’s the last level of protection before you’re potentially eroding your surplus.

Remaining within the regulatory thresholds can be more challenging than it would seem, since investments and capital requirements change in value over time. But the cost of noncompliance can be significant since it results in a direct charge to surplus, exposing the insurer to solvency concerns and expanded regulatory oversight.

For example, say an insurer holds $100,000 in exchange-traded funds (ETF) that exceeded threshold limitations pursuant to CIC 1192.9. Without consideration of the Leeway Law, this particular insurer is invested in excess of its thresholds, so it has to non-admit the ETF of $100,000, directly reducing surplus by $100,000. They still own $100,000 worth of stock, but what they report publicly as an admitted asset is $0.

To avoid such a self-inflicted wound, insurance company investment committees must stay abreast of Leeway Law requirements and the regulatory threshold limitations on every investment in excess funds in their portfolios. Conducting periodic training sessions can help move this process forward.

Regulatory Oversight

Despite the flexibility offered by the Leeway Law, insurers are still subject to regulatory oversight to ensure their investments are prudent and do not jeopardize their financial stability. The California Department of Insurance monitors insurers’ investment activities and requires them to file annual statements detailing their financial condition and investment holdings.

Risk Management

While the Leeway Law offers significant benefits, it also presents challenges and considerations for insurers, including risk management. With greater investment flexibility comes the need for robust risk management practices. Insurers must carefully assess the risks associated with discretionary investments and ensure they do not compromise their financial stability. This requires sophisticated risk assessment tools and strategies.

We’re here to help

The California Leeway Law may significantly impact insurance company investments by providing them with the flexibility to diversify their portfolios and enhance returns. While this flexibility offers numerous benefits, it also requires insurers to implement robust risk management and compliance practices.

If you have questions about compliance with the California Leeway Law, we can help. Contact your JLK Rosenberger insurance team member, or click here to contact us. We look forward to speaking with you soon.