Financial guarantee insurance and the Appleton Rule — what you should know

There’s no getting around it — circumstances regarding the use of financial guarantee insurance (FGI) in surety are complex and challenging. To help clarify matters, here are the answers to five key questions:

Financial guarantee insurance is a guarantee against nonpayment of principal and interest on a debt obligation or other monetary obligation.

This is different from guaranteeing performance obligations, which are a principal’s contractual obligation to perform some obligation beyond the mere payment of money. Multiline insurers are restricted in their ability to write FGI. These FGI restrictions originate largely from a New York statute but apply in other states as well due to the extraterritorial application of New York’s insurance law (discussed below). Unfortunately, the New York statute is confusingly drafted and it can be very difficult to determine whether a particular obligation constitutes prohibited FGI.

While Appleton is a primary consideration, it arises from a separate statute and has implications beyond FGI.

Appleton is frequently invoked in evaluating potentially prohibited FGI, leading some to think erroneously they are the same thing, but FGI and Appleton are not the same. Appleton is a New York insurance regulation created in the early 1900s requiring insurers in the state to abide by its insurance code, even when conducting business in other states (it has since been enacted as a statute). FGI is governed by the insurance code and thus falls within the constraints of Appleton. Appleton gives extraterritorial effect to the New York Insurance Code, making it a national concern for those who wish to be licensed in the state.

FGI statutes contain exceptions that allow sureties to write bonds on obligations that would otherwise meet the statutory definition of prohibited FGI.

Many bonds that are typically written by sureties meet the definition of FGI. For example, utility payment bonds, appeal bonds, and certain lease bonds are all guarantees of an obligation to pay a monetary obligation. The reason sureties are nonetheless able to write these bonds is that the New York statute contains a number of specific exceptions that allow multiline insurers to write bonds that would otherwise be prohibited as FGI. In addition, the New York statute also contains a general exception that permits the writing of otherwise prohibited FGI so long as the aggregate amount owed by the principal does not exceed $10mm (known as the “$10mm exception”).

The penalties for writing prohibited FGI can be severe.

The statutory penalties for writing prohibited FGI are the same as those for committing other violations of the New York Insurance Code, including civil monetary penalties of up to $1,000 per violation. In addition, Appleton adds other severe consequences. Under Appleton, writing impermissible FGI could result in revocation of licenses or denial of license applications, removing an insurer’s ability to conduct any insurance business (including surety, personal, and commercial lines) in New York. Such a license revocation could obviously be disastrous to a large multiline insurer.

California, Connecticut, and Florida have their own FGI statutes.

To further muddy the waters, three other states besides New York have passed statutes prohibiting multiline insurers from writing FGI. While they are similar to the New York statute, these statutes have one important difference — none of them include the $10mm exception. The result is that a bond that could be written in New York and 46 other states under the $10mm exception could not be written in California, Connecticut, and Florida.

In summary, FGI and the New York statute are complicated, and determining what is a permissible surety bond and what is prohibited FGI can require a close reading of the statute, caselaw, guidance from the New York Department of Financial Services, and other resources. Working with a surety that has an in-house legal department, such as Liberty Mutual Surety, is key to ensuring you are adhering to the proper laws and regulations.

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