On January 19, 2010, the California Department of Insurance (“Department”) convened a working group to discuss an initial draft of regulations addressing whether insurers can, should, or must make an election to change reporting and payment of premium taxes from an accrual basis to a cash basis, or vice versa. The general intent of the Department was expressed to permit, but not require, insurers to elect to report and pay taxes on a cash basis, as long as such election did not ultimately result in an underpayment of taxes. The discussion among regulators, insurers, and industry groups were informal and fruitful, with several specific suggestions being made and certain issues being raised for further consideration. Parties interested in submitting comments or suggestions at this point (before the formal Notice of Proposed Action under the Administrative Procedures Act) must submit their comments to the Department very quickly, although a specific cut-off date was not identified. In addition, all interested persons may participate in the formal proceedings and public comment period once initiated.
The draft regulations are intended to address a Memorandum Opinion adopted by the State Board of Equalization (“SBE”) on December 12, 2006. The Memorandum Opinion essentially reversed a long-held Department directive that insurers must report and pay taxes on an accrual basis, i.e., during the year in which they are written rather than the year in which they are received. Rather than require insurers to immediately switch from the historic use of the accrual method, the draft is intended to enable insurers to choose when, and whether, to switch to a cash basis.
The discussion first focused on which insurers and transactions would be subject to the regulations, and the Department confirmed that surplus line transactions, surplus line brokers, and insurers placing business pursuant to the surplus line laws would not be subject to the regulations. Nonadmitted insurers transacting business illegally in the state, however, would be subject to the regulations and would be required to pay the applicable premium taxes. In addition to some technical editing suggestions regarding the draft, the working group identified several open issues, including the following:
- Whether insurers currently using a cash basis could switch to use an accrual basis, or if this was solely a one-way election to move to a cash basis.
- Whether insurers would be permitted to switch back and forth over time, or if this was to be a one-time-only election.
- What circumstances would cause an insurer to prefer the accrual basis over a cash basis (e.g., a declining book of business).
- Whether an insurer continuing to use an accrual basis must calculate each year what its tax payments would be on a cash basis, and remit the greater amount of taxes to the Department, or if that requirement would apply solely in the year in which the insurer transitions from an accrual to a cash basis.
The Department, in cooperation with the SBE (who participated with the working group), will address each of these issues and the specific written comments submitted before promulgating the next draft. Promulgation of the next draft is likely to be in the form of a formal notice, pursuant to which there will be a public comment period.