As we embark upon a new decade, the surplus lines insurance market has never been stronger. Growth in specialty products and demand for insurance protection in an increasingly dynamic, technological climate has continued to drive excess and surplus lines business. In many cases, these changes have resulted in a new, “fresh” look at many of the statutory and regulatory standards, restrictions and allowances applicable to surplus lines insureds, brokers and insurers alike.
This article presents twenty “frequently asked questions” by insurance professionals who have a fundamental understanding of excess and surplus lines insurance but seek to understand the nuances of federal and state-specific surplus lines insurance laws.
LAWS APPLICABLE TO THE SURPLUS LINES INSURANCE INDUSTRY
While surplus lines insurers are excused from filing rates and forms, surplus lines insurance policies are not completely exempt from state regulation. For example, many states expressly apply their cancellation and nonrenewal of insurance policy requirements to the surplus lines market. Some states that traditionally prohibit the insurance of punitive damages nevertheless allow surplus lines insurers to assume such risks. Jurisdictions also differ as to whether defense-within-limits clauses and claims-made policy standards apply to the surplus lines market, to name just a few.
It usually depends on the purpose of the insurance. Most states specifically require that any automobile insurance seeking to satisfy the “financial responsibility” requirements of the driver under a state’s applicable motor vehicle laws be offered only by an admitted (licensed) insurer in the state. Many jurisdictions allow for “excess” insurance beyond the financial responsibility layer to be satisfied through the surplus lines market. Moreover, some (but not all) states allow cargo financial responsibility requirements, “Hired and Non-Owned Auto” (HNOA) and other forms of commercial automobile insurance policies to be satisfied through the surplus lines market, subject to a number of various restrictions and limitations.
In the commercial market, some states permit financial responsibility requirements to be satisfied via a surplus lines policy for certain types of commercial vehicles. As commercial automobile programs become more specialized and incorporate technological platforms (such as car-sharing and peer-to-peer services), traditional financial responsibility laws are being revisited. For example, many states have enacted legislation in the last few years allowing for the financial responsibility requirements of drivers for “transportation network companies” or “TNCs” such as Uber and Lyft to be satisfied through the surplus lines market. However, states differ as to whether commercial automobile programs may satisfy the financial responsibility requirements of their on-duty drivers through the surplus lines market when such states have not otherwise granted express authority to do so, such as in the TNC context.
TRIA applies to surplus lines insurance policies and, depending on the nature of the policy, TRIA can even capture insurance coverage issued to non-U.S. individuals with risks residing in the United States. Under TRIA, an insurer is required to “make available” terrorism coverage on certain lines of commercial property and casualty insurance policies. The term “insurer” is defined under TRIA to include all licensed insurers in the U.S. as well as surplus lines insurers. Under TRIA, whether or not an insurer must “make available” terrorism coverage hinges on whether the risk itself is located in the U.S. (or with respect to an U.S. air carrier, flag vessel or at the premises of a U.S. mission), not where the insured resides.
However, depending on the amount of actual risk actually located or otherwise attributable to commercial property and casualty risks in the U.S., federal regulations provide guidance that small amounts of U.S. risk or commercial P&C exposure in proportion to an insured’s global risk are considered “incidental” and not subject to TRIA.
Most states do not expressly apply their novation, transfer and/or assumption reinsurance consent requirements to the transfer of surplus lines policies as set forth under their applicable insurance codes. However, a number of states still require that the surplus lines insurer abide by the applicable policyholder notification requirements. Moreover, general principles of contract law could nevertheless prohibit the transfer absent consent from the applicable policyholder.
Some states are beginning to enact legislation to expressly allow for “insurance business transfers” of insurance policies between insurance companies applicable to both the admitted and surplus lines markets.
PERMISSIBLE TYPES OF SURPLUS LINES INSURANCE
It depends on the state. While the Nonadmitted and Reinsurance Reform Act of 2010 (NRRA) authorizes the placement of property and casualty insurance coverage on a surplus lines basis, a number of states, such as New York, expressly prohibit certain lines of insurance that are viewed as traditional lines of property and casualty insurance in other states from being exported to the nonadmitted market, such as financial guaranty insurance. Some states expressly allow for disability insurance to be written on a surplus lines basis, while others only allow narrow forms of “high limit” disability products to be exported. Workers’ compensation insurance is also treated differently among the various states.
There has been an increased push by the National Association of Insurance Commissioners (NAIC) in recent years to enact model legislation allowing for limited forms of health insurance (including short term medical, international medical and excess disability) to be written on a surplus lines basis. A number of states have already enacted laws allowing for certain types of health insurance to be written through the nonadmitted market. A select number of states have no restrictions whatsoever on the lines of insurance business that may be written on a surplus lines basis.
While a handful of such states in practice allow flexibility as to the issuance of non-property and casualty insurance coverage on a surplus lines basis, the general answer is no. For example, a travel insurance policy that offers to reimburse the insured for medical costs incurred while the insured is on a trip provides the insured a form of health insurance coverage that may not be offered through the surplus lines market in many states.
FILINGS, TAXES AND FEES
While surplus lines insurers are generally exempt from the rate and form filing requirements applicable to licensed insurance companies, most states that have surplus lines associations require filing of the surplus lines policy, and some of these associations may decline to “stamp” the policy (i.e., acknowledge the policy is acceptable under the state’s surplus lines laws and charge a stamping fee in connection therewith) if it offers insurance coverage in contravention of applicable law. Moreover, states that maintain stamping offices often levy a fee to stamp the policy.
At least one jurisdiction (New York) also requires the filing of surplus lines producer agreements with insurance carriers that grant the surplus lines broker binding authority as well, and the Excess Line Association of New York encourages specific language be utilized in such agreements.
Traditionally, the surplus lines broker is legally responsible for the payment of surplus lines premium taxes, but some states hold the insured and/or the surplus lines insurer also liable for such taxes if the broker does not satisfy its legal obligation.
Most states allow the surplus lines broker to pass the tax on to the insured. However, some states treat the payment by the insured of the surplus lines premium tax as an additional “fee” levied on the insured, and consequently that the broker obtain a written acknowledgment from the insured that its payment of the tax is in addition to the premium under the insured’s insurance policy.
The NRRA generally requires that all surplus lines premium taxes be paid to the “home state” of the insured. Under the NRRA, the home state of an affiliated group is the state of the member of the group that has the largest percentage of premiums attributed to it. An “affiliated group” is comprised of entities that are under common control.
While the NRRA addresses how to treat group policies where all insureds are affiliated, the NRRA is silent as to determining the home state of nonaffiliated groups. As a result, many states take the position that every certificate issued is its own policy and the certificate holder/member’s domiciliary state is considered the “home state” for each such certificate and require surplus lines premium tax be remitted accordingly. This rule is expressly codified in many U.S. jurisdictions with respect to surplus lines group policies issued through risk purchasing groups (RPGs) as well.
It depends on the jurisdiction. Some states expressly prohibit all forms of broker fees, whether charged on admitted or surplus lines placements. Other states provide more leniency as to the surplus lines market in particular. For example, Florida prohibits most types of broker fees charged on admitted insurance policies but amended its surplus lines laws in 2019 to specifically allow for the charging of “reasonable” broker fees on surplus lines insurance policies. Some other states only allow specific kinds of surplus lines broker fees, such as fees only on commercial insurance policies or fees meant to solely reimburse the costs of the surplus lines broker.
Nearly all states that allow for surplus lines broker fees require that the insured provide its written consent prior to being charged such fee, and some states require that such written consent contain disclosures to the insured relating to the computation of the fee and the various sources of the surplus lines broker’s compensation.
DILIGENT SEARCH REQUIREMENT
Assuming no exemption is available to a surplus lines broker or its retail insurance broker partner (such as a listing on the export list or insurance issued to an exempt commercial purchaser), most states require three (3) declinations to be obtained from admitted insurance companies, but this is not uniform throughout the country. For example, in Maine, under Bulletin 439 (November 26, 2019) “doing a specific number of inquiries does not mean that the producer has fulfilled this requirement.” By contrast, a few states (e.g., Louisiana) have eliminated the diligent search requirement altogether.
Some states require that evidence of the procurement of declinations simply be maintained in the offices of the surplus lines broker; whereas, others require that affidavits be filed with the applicable insurance department or surplus lines stamping office. A number of states expressly require the diligent search to be repeated each time a particular policy is renewed.
Usually, yes. Some states have narrow exceptions in some instances, particularly in the group policy context. For example, some states allow professional liability coverage written on a group basis through an RPG to satisfy the diligent search requirement one time in that state for all members of the RPG residing in that state during a given time period. By contrast, many states require that the diligent search be completed as to each certificate holder under a non-RPG group policy.
Many states do not allow price to be the sole factor for obtaining a declination, i.e., exporting to the nonadmitted market simply because it’s cheaper will not suffice. Moreover, some states do not recognize a declination with respect to a multi-peril policy where components of such policy could be written by the admitted market (and some states, like California, only allow exportation in such case if commissioner approval is granted). In addition, most states do not recognize multiple declinations obtained from both an insurer as well as an affiliate thereof, and some states do not allow the placement of surplus lines insurance with a nonadmitted insurer that is an affiliate of an admitted insurer from which a declination has been obtained.
ELIGIBILITY, MARKETING AND PERMISSIBLE ACTIVITIES
Alien (non-U.S.) insurance companies can write surplus lines business across the United States if they are listed on the Quarterly Listing of Alien Insurers (Quarterly List) as maintained by the NAIC which requires, among other things, an application to be submitted thereto and the establishment of a trust fund as security for U.S. policyholders. The information as reported to the NAIC must be updated on an annual basis. In addition, most alien insurers obtain listing on the eligibility lists or “White Lists” of the states that continue to maintain such lists in order to signal to the market that the insurance carrier is approved by the state. The Quarterly List and White List filings and associated U.S. trust obligations are often maintained for alien insurers by U.S. regulatory counsel or other U.S.-based representatives.
Another increasingly-used method of entering the surplus lines market is through the establishment of a “domestic surplus lines insurer” that is formed in a state solely for the purpose of writing surplus lines coverage nationwide. This strategy obviates the need to utilize two separate carriers to write surplus lines coverage in every U.S. jurisdiction (because traditional “admitted” companies cannot write surplus lines coverage in their home states) as well as the need to maintain a fully-licensed admitted carrier. Currently, 21 states have adopted domestic surplus lines legislation.
While all states require surplus lines insurance to be placed through a surplus lines broker, some U.S. jurisdictions restrict even the presence of a surplus lines insurer or its employees within its borders. For example, California generally takes the view that only surplus lines brokers may have a physical presence in the state with respect to surplus lines transactions, although domestic insurance companies affiliated with the surplus lines insurer may perform certain administrative functions unrelated to underwriting. Moreover, all managerial and underwriting decisions must be conducted outside the state. Other jurisdictions, such as New York, have adopted broader exceptions for licensed affiliates of surplus lines insurers to conduct certain functions on behalf thereof in the state.
In addition, depending on the state, surplus lines insurers may not always take advantage of various exceptions to licensing laws that are often available to admitted insurance companies, such as exemptions from adjuster licensing requirements applicable to authorized insurers in many states.
While the majority of the states do not expressly address marketing activities in the surplus lines space, a number of large states place substantial restrictions on marketing unauthorized products. For example, California and New York have promulgated robust guidance generally prohibiting the marketing of surplus lines products unless highly stringent standards are met, including the avoidance of targeted solicitation, restrictions on dissemination of certain policy terms, not calling attention to unauthorized insurers (subject to exceptions), and the inclusion of disclaimers regarding the unavailability of certain products to insureds in the state.
As online and app-based marketing tools become more prevalent, the surplus lines advertising laws are being revisited once again by insurers, brokers and legislatures alike.
When an individual places coverage on behalf of a surplus lines brokerage firm, the individual must hold a surplus lines broker license as well; a “regular” property and casualty license is not sufficient. However, most states allow a licensed property and casualty producer that does not hold a surplus lines license to act in a retail broker capacity when facilitating a transaction through a licensed surplus lines broker. However, strict attention must be paid to the activities conducted by the appropriately licensed entities to make sure that no regulatory lines are crossed, including but not limited to making sure that the surplus lines broker is the only licensee that negotiates insurance with an unauthorized insurer.
In addition, many states allow the retail broker to conduct the diligent search of the admitted market, although states differ as to whether the retail broker or the wholesale surplus lines broker must keep evidence of, and execute affidavits relating to, the satisfaction of the diligent search requirement.
Surplus lines brokers in the home state of the insured are generally prohibited from assisting insureds with respect to the “direct procurement” (also known as “independent procurement” or “direct placement”) of insurance coverage with unauthorized insurers. Rather, most states require that a prospective insured leave its home state and obtain insurance coverage directly from the unauthorized insurance company (or through a non-domiciliary broker) in a jurisdiction where the insurance carrier is licensed. However, some states allow brokers to act on behalf of their insureds and physically leave the state to procure the desired insurance coverage, provided that the broker abides by the governing tenets of direct procurement as if it were itself the insured.
FINES AND PENALTIES; INDUSTRY TRENDS
Traditionally, the surplus lines broker (and the designated responsible licensed producer of a surplus lines brokerage firm) is most exposed to sanctions in the form of fines and penalties for breach of applicable surplus lines insurance law as the licensed insurance actor in the state. However, a number of states have enacted statutes allowing for the inspection of books and records of unauthorized insurers and the ability to levy fines in connection therewith. In addition, there have been a few instances in recent years where states have entered into consent orders levying penalties and fines against surplus lines producers, insurers, and even insureds (particularly in the group policy context where master policyholders, such as associations, market surplus lines insurance products).
The term “InsurTech” refers to the wave of technological innovation impacting the insurance industry, from the way insurance is sold and administered to the types of risks for which insurance policies have evolved to provide coverage.
The surplus lines industry both benefits and suffers from the emergence of “InsurTech”. The utilization of dynamic pricing models and other algorithmic underwriting guidelines takes time to work its way through the admitted market process of rate and form approval, which is generally bypassed by surplus lines insurers. However, surplus lines products are required to be obtained through surplus lines brokers which restricts direct-to-consumer transactions. Moreover, surplus lines brokers must conduct a diligent search of the admitted market (absent an exception), which hinders the ability to quickly bind coverage through the internet or app-based products.
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