As a California insurer, knowing what your producers charge policyholders, particularly in an agency relationship, can be critical to avoiding penalties for underreported premium tax. To help insurers avoid this mistake, JLK Rosenberger has provided explanation and guidance below.
Broker or agent: what is the difference? We are all used to hearing about broker-agent relationships as a commonly used term to describe a producer-type arrangement, where the broker-agent acts as a middle man between an insurer and an insured. Even though any licensed producer may charge fees, there are guidelines to follow that strictly depend on whether you act in the capacity of a broker or an agent.
Why do I need to know the difference? The rules themselves are not complex, but it becomes tricky to identify them since they are coming from various sources, and quite frequently we see these rules being misapplied. As a result, a reporting entity may erroneously exclude or include fees charged by producers in its financial statements. Penalties may get hefty if these guidelines are overlooked. Let’s take a look at some of these rules as they apply to insurance producers in California.
- Definition. Section 31 of the California Insurance Code defines an insurance agent as “a person authorized, by and on behalf of an insurer, to transact all classes of insurance other than life, disability, or health insurance, on behalf of an admitted insurance company.” It is important to understand the term “transact” as it explains the activities that are expected to be performed by the agent, which may include solicitation, negotiation, and execution of the insurance contract or any transactions related to the previously executed contract on behalf of the insurer. Agent’s duties are typically summarized in a written agreement between the agent and the insurer. Furthermore, Section 33 provides a definition of an insurance broker as “a person who, for compensation and on behalf of another person, transacts insurance other than life, disability, or health with, but not on behalf of, an insurer.” The key difference in these designations is that the agent represents the interests of the insurer whereas the broker represents the interests of the insured.
- Regulation. Under the rules of Section 1704 of California Insurance Code, becoming an agent requires a notice of agency appointment known as an “action notice” to be filed by the insurer with the Department of Insurance. Brokers are not subject to this rule; however Section 1623 requires them to post a bond with the Department of Insurance.
How can underreporting of premium tax happen? In the agency relationship, producers are compensated by the insurer in the form of commissions and are not typically allowed to charge fees unless they acted above and beyond what was expected by the insurer or the service was unrelated to the insurance transaction. Additional charges may be viewed as a violation of the rating statutes because the fees were not part of a filed or approved rate filing. In this case, the Department of Insurance may hold the agent responsible for a violation of the broker fee regulations and take action against the insurer under the rating law. Since the insurer is ultimately responsible for any actions taken by the appointed agent, anything the agent charges the insured in an insurance transaction is subject to a premium tax. There is a risk that the agent may be mistaken for a broker, resulting in underreporting of a premium tax and other fees charged by a producer who is a broker but whose duties are not distinguishable from the ones of the agent and consequently leads to underreporting of premium tax. On the other hand, a producer who acts as a broker can charge any fees in addition to the commissions if the disclosure requirements are met, and the insured’s consent is obtained.
What are the disclosure requirements? The disclosures of brokers and agents should at least include the amount of fees to be charged, services to be performed for a fee, refund policy, and any other means of compensation the producer is subject to, such as commissions to be received for the transaction from the insurer. There are additional requirements for brokers producing policies for personal lines coverages, such as obtaining the applicant’s initials on a broker fees disclosure sheet, distributing consumer pamphlet on automobile and/or dwelling insurance and use of a broker fee agreement consistent with the sample agreement provided by the Department of Insurance.