Legislative Analyst's Office
Analysis of the 2002-03 Budget Bill
In California, the Department of Insurance (DOI) is responsible for regulating insurance companies, brokers, and agents in order to protect businesses and consumers who purchase insurance. Currently, there are about 1,400 insurers and 230,000 brokers and agents operating in the state.
The budget proposes total expenditures of $166 million for DOI in 2002-03. This is $2.4 million, or 1.5 percent, more than estimated current-year expenditures. About 98 percent of the proposed expenditures will come from the Insurance Fund, which derives its revenues from regulatory assessments and fees.
We recommend that the baseline of $1.1 million for the Tax Collection and Audit program be funded from the Insurance Fund instead of the General Fund. We further recommend the enactment of legislation to provide funding for the tax collection and audit function from the Insurance Fund on an ongoing basis. (Delete $1,131,000 from Item 0845-001-0001 and add $1,131,000 to Item 0845-001-0217.)
Insurance companies are required to pay a tax based on gross premiums. The tax generates $1.3 billion annually. The Tax Collection and Audit program within DOI is responsible for auditing all tax returns filed by insurance companies and brokers, as required by law. The department has four years to assess filers for unpaid taxes. The DOI completed nearly 1,400 audits of more than 2,300 returns filed in 2000. This included 1,329 desk reviews of filed returns and 53 on-site audits. This resulted in additional premiums tax assessments of $9.5 mil lion, or 0.7 percent of premiums tax revenue, and $12 million in penalties and interest.
Up until 1996-97, the tax collection and audit program was funded from the Insurance Fund. The department eliminated the program that year because of Insurance Fund revenue shortfalls requiring staffing cuts. Chapter 894, Statutes of 1997 (SB 512, Committee on Insurance), reestablished the program for 1997-98 with $908,000 from the General Fund, which has supported the program since that time. The current-year program level is $1.1 million.
Ensuring that insurance companies and brokers pay all premiums taxes due is part of the department's regulatory function. Therefore, it is appropriate that the program be supported from the Insurance Fund, which generates revenue from regulatory assessments and fees, as noted above. Accordingly, we recommend that baseline program funding of $1.1 million be paid from the Insurance Fund instead of the General Fund. We further recommend the enactment of legislation to provide funding for the tax collection and audit function from the Insurance Fund on an ongoing basis.
We recommend that the General Fund request for $636,000 and seven positions to increase the number of gross premiums tax audits be rejected because it is not cost-effective to audit all insurers each year. We further recommend the enactment of legislation to (1) eliminate the requirement that DOI audit all tax returns filed by insurance companies and brokers and (2) direct the department to prioritize tax audits. (Delete $636,000 from Item 0845-001-0001.)
The budget proposes an additional $636,000 and seven positions (from the General Fund) to audit all returns within a year of filing and to perform more on-site audits. In our view, it is unnecessary and not cost-effective to audit all tax returns. Rather, DOI should prioritize audits within existing resources, as the Board of Equalization (BOE) and Franchise Tax Board (FTB) do. For example, BOE audits about 3 percent of sales tax accounts each year, focusing on sales activities and records that are most likely to be reported incorrectly. Similarly, FTB audits less than 1 percent of all personal income and bank and corporation tax returns each year. Furthermore, DOI has four years to issue additional tax assessments so it is unnecessarily costly to complete all audits within one year of the filing date. Consequently, we recommend deletion of this request. We further recommend the enactment of legislation to (1) eliminate the requirement that DOI audit all tax returns filed by insurance companies and brokers and (2) direct the department to prioritize tax audits.
We withhold recommendation on budget bill language that authorizes additional expenditures related to filling vacant positions until the Department of Finance provides the following at budget hearings: (1) information on DOI's progress in filling vacancies, (2) an estimate of the funding level needed to support the filled positions as well as DOI's need for positions that are still vacant, and (3) whether the proposed language is needed in 2002-03.
The DOI has historically used excess salary savings from vacant positions to fund operating expenses. For the current year, as part if its efforts to reduce this practice and eliminate vacant positions, the Legislature adopted language that authorizes the Department of Finance (DOF) to augment DOI's appropriation by up to $4.9 million, with 30-day notification to the Legislature, to fund vacant positions. The language prevents DOI from siphoning funds from staff support to pay for operating expenses and creates an incentive for the department to fill a significant number of vacant positions it claimed to need.
The same language is proposed for 2002-03. We withhold recommendation on the language to provide DOI the same flexibility as in the current year. At the time this analysis was prepared, we understood that DOF was awaiting the department's report on its progress in filling vacant positions in the current year and the need for additional funds. Depending on the number of vacant positions filled, the 2002-03 budget may have to be adjusted to provide ongoing support for these positions and the necessity of the language reconsidered. Given the forthcoming report to DOF, we withhold recommendation on the proposed budget language. We further recommend that DOF provide information at budget hearings on DOI's progress in filling vacancies, including an estimate of how much the department would need in additional funds to support these positions through 2002-03, and whether the proposed language is still needed for the budget year.