Chapter 2
Unauthorized Entities


Important Lesson Points

The important points addressed in this lesson are:

the recent trend in agents marketing unauthorized insurance products
damage caused to those who rely on coverage from unauthorized insurance entities
seeming discrepencies in regulations covering group health insurance and other employer-provided benefits
types of scams used by unscrupulous marketers of unauthorized insurance products
enhanced penalties for violating Florida's Unauthorized Insurance regulations


Introduction

The sale of insurance by unlicensed entities poses a grave danger to the public.   These entities and contracts are not subject to the safeguards built into state insurance laws.  "Policies" issued by unauthorized "insurers" are not required to maintain adequate reserves to pay policyholder claims.   In many cases,  operators of these "unauthorized entities" embezzle the premium payments -- and when claims begin to mount, the house of cards simply collapses. Moreover, since the "insurers" were unlicensed, their policies are not covered by the state guarantee fund.   So policyholders are left holding the bag -- liable for expenses they thought would be reimbursed.   This usually ruins their personal credit and has profound impacts on other aspects of their lives.  In the case of phony health insurance, coverage by "unauthorized entities" means that duped policyholders do not have "continuous credible coverage" -- a typical requirement for obtaining new group coverage.  Even if "policyholders" don't suffer financial ruin due to unpaid claims, they may find it difficult or impossible to obtain new coverage once the scam is discovered.

 The sale of phony insurance usually occurs when the insurance market is tight.  When legitimate insurance is difficult to obtain, the insurance-buying public is susceptible to dishonest operators marketing coverage offered by unauthorized entities.  In many cases, the promoters of these plans operate in the shadows of the regulatory structure.   The patchwork, federal/state nature of insurance regulations works to their advantage:  by claiming federal jurisdiction, they avoid state regulation -- and by claiming to be insurance products (which are primarily regulated by state law), they avoid federal oversight.    

To combat the sale of phony insurance, the Florida legislature recently passed laws to stiffen the penalties applied to those found guilty of operating an unauthorized insurance entity and those agents who sell phony policies.  In addition, the new law requires all insurance pre-licensing and continuing education courses to cover the topic of unauthorized entities.  These efforts are designed to make agents aware of the scope of the problem and the methods that unscrupulous operators use when offering phony insurance.  Lastly, the Department of Financial Services created a new Unauthorized Entities Section within the Division of Insurance Fraud to investigate and enforce the laws against the sale of bogus coverage.

This chapter addresses a number of areas agent must consider to exercise due diligence of the products they offer:  The previous chapter provided a general outline of federal and state regulatory framework -- this chapter will examine detailed state and federal laws governing insurance, the type of scams used by dishonest promoters, the penalties agents face for selling bogus insurance.  


Recent Regulatory Developments

The last half of the 20th century  witnessed rapid changes in the insurance industry. Life insurance companies developed variable annuities as retirement vehicles.  Health maintenance organizations (HMOs) evolved from private employers’ in-house clinics into giant for-profit providers of managed health care.  As the century ended, the long-standing separation of the banking, security brokerage and insurance industries, which resulted from collapses from the Great Depression, was repealed.   In 1956, the Securities and Exchange Commission argued successfully for joint state-federal regulation of variable annuity contracts.   In 1974, Congress enacted the Employee Retirement Income Security Act (ERISA) to govern private-sector pension plans and employee benefit programs such as HMOs. [ERISA is discussed in greater detail later in this course.] The  Financial Services Modernization Act of 1999 imposed increased uniformity on state regulation of insurance, but by and large left insurance in the hands of state regulators.  While recent Supreme Court decisions have overturned state prohibitions against banks selling insurance products.


 The  Financial Services Modernization Act of 1999, also called Gramm-Leach-Bliley, overturns the Glass-Stegel Act.  Glass-Stegel was passed as a response to the collapse of the financial structure during the Great Depression.  This Act prohibited banks from owning insurance companies and required separation of merchant banking (securities underwriting) from commercial banking activities -- as these were believed to have accelerated the collapse.  Due to mergers between various financial institutions, and spurred particularly by the merger of Citigroup and Traveler’s Insurance, Congress repealed Glass-Stegel’s restrictions, opening up multi-faceted financial services firms offering integrated banking, brokerage and insurance products to their customers.  This legislation attempts to increase uniformity in the regulation of related financial institutions.  As part of the reformed regulatory regime, the federal government retained primary jurisdiction over banking and security activities and the states were left in control of insurance.  The new law does require the states to act more uniformly, in particular the licensing of agents.  If a majority of the states did not provide for reciprocity of non-resident agent licenses by 2002, the federal law threatened to impose a nationwide system of agent licensing. Florida enacted reciprocity reforms in 2002, as did a majority of the states.  The net effect of this law is that the states retained jurisdiction, subject to a federally mandated uniformity clause.    Specifically, Florida now accepts the NAIC’s “Uniform Application” for licensure of nonresident agents and allows for transfer of an agent’s license from another state if the agent becomes a resident of Florida.
 Two United States Supreme Court rulings, prior to 1999’s passage of The  Financial Services Modernization Act, opened the insurance and annuity markets to banks and other financial institutions.  One of those cases, Barnett Bank v. Nelson, directly overturned a Florida law that prohibited the sale of insurance products by banks.  The other case, NationsBank v. Variable Annuity Life Insurance Company (VALIC), allowed national banks (operating under a federal charter and subject to the federal Comptroller of the Currency’s jurisdiction) to avoid state regulation of the sale of variable annuities.  These cases added to the growing calls for  reform of financial industry regulations, leading to The  Financial Services Modernization Act of 1999.


Regulation Today

As a result of these changes, the debate of state versus federal regulation continues:  “states’ rights “advocates argue for continued state jurisdiction; those who view insurance as interstate commerce argue for repeal of McCarran-Ferguson and for uniform, enforceable nationwide regulation.  Almost every Congress since 1977 has introduced a bill to repeal McCarran-Ferguson.  These efforts have failed, in part, due to the efforts of the NAIC (National Association of Insurance Commissioners) to “impose” some level of uniformity on the states.  As reported in the Wall Street Journal:  “many insurers believed that national regulation was creeping up on them in the unlikely form of the National Association of Insurance Commissioners...[which was] armed with its own computer resources and a talented staff that was increasingly tackling consumer-oriented issues.”
This debate continues amid political considerations:  the desire of states to retain their jurisdiction, the federal government’s argument for more uniform, centralized regulation, and the insurance industry’s preference for less-intrusive governmental regulation (and a natural desire to be regulated by whoever is perceived as the weaker regulator -- prior to World War II that was the federal government, since then the states have been seen as less-stringent regulators).    The NAIC balances on the  tightwire: trying to preserve state regulation by increasingly centralizing insurance regulations into a nationwide system.

In summary, under McCarran-Ferguson Act, insurance regulation in the United States is, in reality, a patchwork quilt of state-by-state laws -- coordinated to some extent by the National Association of Insurance Commissioners (NAIC).  In addition, some aspects of insurance regulation are subject to federal mandates that supercede those state laws.  It has been relatively easy for unscrupulous operators to exploit the seams within this confusing patchwork of rules and laws -- and bilk thousands of unsuspecting consumers out of millions of dollars by selling “phony” insurance plans.  In 2002, as a response to this trend, the Florida legislature increased the penalties for companies and agents who sell “phony” insurance.


Alphabet Soup of Regulations

ERISA & MEWAs

One key area unscrupulous insurance promoters exploit is based on the wording of ERISA (Employee Retirement Income Security Act) -- a law passed in 1974 to safeguard private-sector pension plans and employee benefit programs.  This federal law seemingly supercedes state regulation of employer-provided benefit plans, such as health insurance.  In reality, ERISA imposes certain requirements on many persons offering employee benefits, but does not override state insurance laws that may apply to these plans.   In fact, Congress amended this law in 1983, to more clearly spell out continued application of state insurance laws over “ERISA plans“ -- including licensing of entities selling health care benefits.  Unfortunately, the language of that amendment was written as an “exemption” to a “preemption” -- in effect a double negative.  The net result was to create more confusion than it solved.   For twenty years, operators have continued to dodge state licensure by claiming an exemption as an “ERISA plan”.  By  misinterpreting the complex and technical language of ERISA, these promoters have bamboozled unsuspecting employers who find affordable, legitimate health insurance coverage hard to come by.  

One way these promoters exploit the unsuspecting is by packaging the benefit plan as a “multiple employer welfare arrangement” or MEWA.   ERISA applies to health plans established by an individual employer, or a “group or association” of employers.  Single employer plans are exempt from state regulation, while multiple employer, or so-called association plans,  are subject to state insurance laws.  The 1983 amendment to ERISA, specifically addressed these “multiple employer welfare arrangements”.  But as noted earlier, the amendment to ERISA, to the untrained eye, seems to grant MEWAs an “exemption” from state insurance law -- rather than subjecting it to state regulation.    


The following is a warning to agents from Luke Brown, supervisor of the Unauthorized Entities Section within the Office of Insurance Regulation's Division of Fraud:

In the face of a difficult health insurance market, the purveyors of “the answer” have created products and plans, cloaked them with names, and filled them with terminology that may at first glance make them look like something other than insurance as you know it.  You’ll be told that they are exempt from Department regulation.  Don’t take it at face value.  They have not been subjected to Department examination for actuarial soundness or solvency, and they are not backed by any guaranty funding the likely event of insolvency.  Your clients may not qualify for guaranteed-issue coverage once this “coverage” ends.

Some tips for analyzing plans claiming to be ERISA:

Is the plan offered to more than one employer?  Is everyone a prospect?  Any plan involving for than one employer is a Multiple Employer Welfare Arrangement and is subject to licensure and regulation by the Department of Insurance.

Does the employer have a voice in the day-to-day operation of the plan?  A true ERISA plan must by single-employer based.  Shouldn’t the employer have the power to control the health plan’s operation?  Does this plan provide for that control.

Do the organizers or promoters tout their “substantial experience in the insurance industry”? (But didn’t they say that this wasn’t insurance?)

Is someone making a profit?  Don’t be misled by mere claims that the entity is nonprofit; it’s easy to print those words on letterhead and forms.

Does the plan purport to be an association plan?  Genuine out-of-state group association plans are not subject to Department regulation, but they are underwritten by authorized insurers (Section 627.654, Florida Statutes).  The involvement of a stop-loss carrier at some attachment point is not the same as the plan being “underwritten.”

Ask hard questions.  Make them commit. Conduct your own due diligence.

By the way, it is both a violation of the Insurance Code and a crime to solicit to sell an unauthorized insurance product; by touching it you will jeopardize your Florida insurance license.  Likewise if an unauthorized insurer fails to pay claims, the agent who sold the product is responsible for payment (Section 626.901, F.S.)

In sum, If it seems too good to be true, it probably is.  STAY AWAY FROM IT.

Just as some promoters used the “association or group” wording to claim an ERISA exemption, others exploit a legitimate exemption for “collective bargaining agreements” in the federal law as a way to avoid state regulation.  Sometimes promoters will market their bogus plans as a “union plan”, “union ERISA plan” or “union MEWA”.  

 
VEBAs

Another variation on this scam is the so-called VEBA or “voluntary employee’s benefit arrangement”.    Like the MEWA argument, promoters of VEBA rely on the conflicting jurisdiction of federal and state laws.   Technically, VEBAs are unrelated to MEWAs or ERISA, but the scam plays out just the same.  VEBAs are legitimate arrangements under the federal tax code -- and provide tax-deductions for employer who fund employee benefits.  Promoters of bogus insurance have twisted that concept into an alleged-exemption from state insurance laws.

Again, from Mr. Brown of the Unauthorized Entities Section of the Department of Financial Services:

....  The most recent generation of health insurance scams was recently hatched. Billed as a VEBA (Voluntary Employees’ Beneficiary Association), their promoters and the agents who sell them again twist reality to suit their needs — all to the detriment of the consumers who depend upon you.

A VEBA is a creature of the Internal Revenue Code (Sections 419 and 419a). It is not an insurance concept. Instead, it is merely a vehicle by which certain employee benefits, including health-care benefits, can be funded. It is a tax-exempt (not regulatory-exempt) vehicle that allows an employer to deduct payments made to the VEBA to fund the payment of employee benefits. It may afford certain tax benefits including allowing the use of pre-tax dollars to fund benefits. Although promoters often use the word “trust” in conjunction with a VEBA, it does not change the basic nature of a VEBA.

So explained, the next question is obvious: Who or what is the risk-bearing entity to which the consumer and provider looks for the payment of claims? A third-party administrator? An agent, broker or MGA? One whose name you recognize? One that at present has a Florida license? Regardless of how advanced the administration may be, a TPA is not authorized to bear risk. Regardless of whether the broker or MGA claims to be your “life partner” in the deal, they don’t bear risk. Don’t be fooled just because the promoter of the plan now has a license.

As has been said over and over again, unless the plan is single-employer based and fully self-insured, the risk-bearing entity must have a Certificate of Authority from the Florida Department of Insurance as an insurer or as a multiple employer welfare arrangement (MEWA) — it is that simple. If the scheme does not meet the fully self-insured and single-employer based criteria, it is subject to both licensure and regulation by the Department — regardless of what the promoters say. Under current law, a MEWA is never eligible for ERISA pre-emption from state insurance regulation.

Because a VEBA is merely a funding mechanism (and a very complex one at that), the need for either a fully self-insured, or a fully licensed risk-bearing entity persists. The fact that the VEBA (the funding mechanism) is a creature of federal law does not change that reality at all — again, regardless of what the promoters say. ERISA is a creation of federal statutory law, and the VEBA concept is not a part of that body of law.

 The fast-talkers will argue that they have filed, or will file, the Form 5500, which validates ERISA status, and thereby, pre-emption from state insurance regulation. Bull. The reality is that anyone can file a Form 5500 for anything and doing so, in and of itself, is meaningless. It’s akin to saying, “I’m an insurance agent, and I play the piano.” One thing has nothing to do with the other. The only thing that counts is an official written determination or opinion by the United States Department of Labor on the bona fides of that plan in its then-current form. You cannot rely upon anything short of that as proof of pre-emption from state insurance regulation, especially from a fast-talker who has led you down this path before.

Don’t do it. Your professional and personal reputation, your license, your livelihood, and most importantly, the welfare of the people whom you serve are at risk if you do.


PEOs

Profession Employment Organizations or PEOs can also play a part in the unlicensed sale of insurance.  PEOs or “employee leasing firms” have become an increasingly popular way for smaller businesses to economize on administrative costs and provide competitive benefit packages to their employees.  Employee leasing arrangements, in effect, transfer employees from one firm, the client or recipient firm, to the leasing firm or PEO.  The client firm then leases the employees back from the PEO.  In effect, the PEO becomes the employer of record for a large number of employees.  The PEO processes payroll; remits income, FICA and unemployment taxes; obtains worker compensation coverage; and provides employee benefits such as group life and health coverage.  Because of economies of scale, the PEO is able to provide these services and benefits at a substantially lower cost than the client firm could.  In some cases, providing services and benefits that the smaller client firm could not obtain at all.  The employees continue to work for the client firm and receive a more substantial benefit package.   Everyone, client firm, employees and PEO, wins.   And this is all perfectly legal.  However,  ERISA views the employer-employee relationship as more than just a technical transfer of employees between client and the PEO.  Since the client firm continues to control the work rules for the employee, under ERISA the client firm is considered the employer.  The PEO‘s benefit package -- which is available to the employees of many different employers -- is therefore classified as a MEWA.  As such, it is subject to state insurance regulations.  Claims by dishonest PEOs that their are exempt from state insurance laws due to ERISA’s pre-emption are just as bogus as claims by any other MEWA. Furthermore, Florida law** specifically prohibits PEOs from sponsoring a self-insured health plan.  (And since ERISA’s exemption applies only to fully self-insured plans, a PEO cannot claim an exemption under ERISA.)

So -- regardless of the guise of the deception, no matter how many acronyms the promoter cares to use -- any benefit plan which assumes risk for two or more, unrelated employers is subject to state insurance regulation.   Likewise, if there is a commingling of funds of unrelated employers -- at any level such as primary insurance, re-insurance, stop-loss coverage -- the plan is subject to state insurance laws.  



Penaties and Enforcement Efforts

Effective October 1, 2002, Florida-licensed insurance agents who sell unlicensed insurance could face a felony charge and lose their license under a new law enacted in the 2002 legislative session.   To make agents aware of the problems of caused by authorized insurers, the new law requires a discussion of unauthorized entities in all insurance education courses.

In the recent past, the Department of Financial Services has shut down several entities selling unlicensed health insurance plans and two entities that were selling unauthorized medical malpractice insurance to health care providers. These entities have left at least 30,000 Floridians with more than $6 million in unpaid claims. In conjunction with barring these entities from doing business in Florida, the department is investigating dozens of licensed agents for selling unauthorized insurance.

Florida's Unauthorized Entities law enhanced the penalty for selling unauthorized insurance from a second-degree misdemeanor to a third-degree felony, punishable by up to five years in prison and a $5,000 fine per count. In addition, Florida law requires anyone who solicits, negotiates or sells an insurance contract for an unauthorized insurer to be held financially responsible for unpaid claims.

While investigating unlicensed entities, department regulators have determined that the operators of unauthorized entities would not have been able to reach potential buyers without the assistance of licensed agents. Both employers and agents have been enticed by the low premiums unlicensed entities charge, but the rates are often not actuarially sound and money is not set aside for reserves. Because unlicensed entities do not participate in a state guaranty fund (a fund designed to cover unpaid claims in the event of bankruptcy), policyholders in unlicensed plans are usually left with unpaid claims when the businesses fold.  The Department usually become aware of a plan's termination when policyholders began complaining about slow or no payment of claims -- but by that time, there is little the Department can do to protect the "policyholders".   

The Department offers a reward of up to $25,000 for information leading to a conviction.

The department’s Bureau of Agent and Agency Investigations has 60 investigators available to look into potential violations and take appropriate administrative action against an agent’s license. The Division of Insurance Fraud has more than 100 sworn law-enforcement investigators who can file criminal charges. Further, the department has created an Unauthorized Entities Section dedicated to tracking and taking civil action against these phony plans.

To summarize, possible consequences for acting as an insurer without a proper license:

conviction of third-degree felony  [Florida Statutues Section 624.401]
liaiblity for all unpaid claims  [Florida Statutues Section 626.901(2) ]
suspension or revocation of all insurance licenses [ [Florida Statutues Section 626.621, .611 amd .6215]

Consequences for aiding and abetting an unauthorized insurer:

conviction of third-degree felony  [Florida Statutues Section 626.902(1)]
liaiblity for all unpaid claims  [Florida Statutues Section 626.901(2) ]
suspension or revocation of all insurance licenses [ [Florida Statutues Section 626.621, .611 amd .6215]