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Michael T. Griffin, Esq.
Michael T. Griffin, Esq.
ACCEL LAW GROUP P.C.
(860) 761-8550
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Martin J. DiVito, Esq.
ACCEL LAW GROUP P.C.
(860) 726-4205

SURPLUS LINES INSURANCE - WHAT IS ITS PURPOSE, AND WHY ARE SURPLUS LINES BROKERS SUBJECT TO SUCH STRINGENT REGULATION?

I. Introduction

Surplus lines insurance, also known as “excess lines” insurance, refers to coverage obtained either directly by an insured or through a licensed surplus lines broker (a “Surplus Lines Broker”) from a non-admitted insurer (i.e., an insurer that does not hold a certificate of authority to issue insurance policies in the state where a risk is located) (a “Surplus Lines Carrier”). Surplus Lines Carriers provide a market of last resort for risks that: (1) admitted insurers (i.e., insurers holding a certificate of authority to transact business in the state where a risk is located) (“Admitted Carriers”) are unwilling to underwrite, or (2) a state has determined are generally unavailable from Admitted Carriers. While this may be beneficial for insureds, the surplus lines market poses a unique question. Namely, how can a state regulate surplus lines insurance when it does not license Surplus Lines Carriers?

The answer to this question has been to shift the regulatory obligations typically imposed on Admitted Carriers to specially licensed Surplus Lines Brokers. Surplus Lines Brokers must navigate complicated, and often, confusing regulations to ensure they comply with obligations beyond those imposed on insurance producers selling admitted insurance products. This article provides a high-level overview of: (1) the regulatory framework applicable to the surplus lines market and (2) the licensing and other compliance obligations applicable to Surplus Lines Brokers.[1]

 II. Regulation of Surplus Lines Brokers

  1. Regulatory Framework

    The United States insurance industry is heavily regulated by each U.S. jurisdiction[2], and the surplus lines market is no exception. State insurance departments are generally tasked with overseeing surplus lines insurance products. However, several states, including California, Florida, and New York, have also established surplus lines associations to assist with this oversight function.[3]

    In addition to state oversight, there is also federal regulation of the surplus lines market. The Nonadmitted and Reinsurance Reform Act of 2010 (the “NRRA”)[4], among other things: (1) provides that an insured’s “home state” has the authority to regulate and tax surplus lines insurance business and (2) establishes a federal standard as to the criteria a Surplus Lines Carrier must satisfy to be considered an “eligible” Surplus Lines Carrier.[5] Multiple states, including Connecticut, Massachusetts, and New Jersey, maintain “white lists” of non-admitted insurers deemed to be eligible Surplus Lines Carriers. While it is not necessary for a non-admitted insurer to be on a state’s white list under the NRRA to issue coverage, the benefit of placing coverage with a “white listed” Surplus Lines Carrier is that the state has already verified the carrier’s financial solvency in the event of a claim. Nevertheless, prior to placing coverage with a Surplus Lines Carrier, a person must first be licensed as a Surplus Lines Broker.
  1. Surplus Lines Broker Licensing & Bond Requirements

    Nearly all U.S. jurisdictions require an individual person to hold a Surplus Lines Broker license in order to place a risk with a Surplus Lines Carrier. More than half of the U.S. jurisdictions require both an individual and the business entity s/he owns or is employed/engaged by to be licensed as Surplus Lines Brokers. To obtain these licenses, individual and entity applicants must hold active property & casualty (“P&C”) producer licenses or, if a state licenses insurance brokers separately, P&C broker licenses.[6] Surplus Lines Broker entities are required to identify an individual Surplus Lines Broker to serve as their designated responsible licensed producer, and, in a small number of states, Surplus Lines Brokers must post a bond to obtain a license.

    Upon satisfying the prerequisites above, an individual must typically pass an examination in his or her resident state to become licensed as a Surplus Lines Broker. Thereafter, Surplus Lines Brokers can seek to obtain non-resident Surplus Lines Broker licenses in other states provided they maintain an underlying, non-resident P&C license.[7]
  1. Diligent Search

    One of the core tenets of surplus lines insurance is the diligent search, known in some states as a diligent effort, that must be completed prior to placing a risk with a Surplus Lines Carrier. The diligent search requires either the retail producer (i.e., the underlying P&C insurance producer with the direct relationship with the insured) or the Surplus Lines Broker to contact a certain number of Admitted Carriers to confirm they will not offer coverage for the risk. The number of Admitted Carrier declinations varies from state-to-state. Although nearly half of U.S. jurisdictions require declinations from three (3) Admitted Carriers, some may require more than three (3), while others require fewer declinations or do not explicitly provide a required number of declinations.

    A diligent search is not always a condition to placing coverage with a Surplus Lines Carrier. The most common exception to the diligent search requirement includes those risks state regulators have determined are not readily available from Admitted Carriers (the “Exempt Coverages”). The Exempt Coverages may be identified by state regulators in an “export list” available to the public and include coverages for unique and complex risks such as special events and antique vehicles.[8] Several states exempt coverages offered to “exempt commercial purchasers” or “industrial insureds” from the diligent search requirement, but Surplus Lines Brokers must confirm whether their client falls within the relevant exception under the state’s insurance code.

    Surplus Lines Brokers must retain evidence that: (1) a diligent search was completed prior to obtaining coverage from a Surplus Lines Carrier; or (2) no diligent search was required. Certain states require specific forms to be completed and submitted to the appropriate regulatory authority (e.g., New York), while other states either require a description of the diligent search in policy filings (e.g., Alabama) or provide sample forms that may be used by the Surplus Lines Broker (e.g., Florida) and maintained in the Surplus Lines Broker’s records.
  1. Stamping Text

    In addition to confirming the eligibility of a Surplus Lines Carrier and that a diligent search was completed, Surplus Lines Brokers are also responsible for including disclosure language (i.e., “stamping text”) in policy documents before they are provided to an insured. The majority of U.S. jurisdictions require some form of stamping text to be included in the policy document.

    A common theme among the state stamping text requirements is language informing the insured that its policy is not protected by the state’s insurance guaranty fund. This is a notable distinction between admitted and surplus lines policies. In the event an Admitted Carrier becomes insolvent, insureds are afforded some protection under an insurance guaranty fund. However, since Surplus Lines Carriers are not licensed in and, therefore, do not contribute to the fund, no such financial protection is afforded to surplus lines policyholders. Given this financial risk, it is imperative that surplus lines brokers (1) perform a diligent search or verify the retail producer conducted such a search and (2) verify the eligibility of a Surplus Lines Carrier prior to placing the insured’s risk in the surplus lines market.
  1. Policy Filings

    To ensure compliance with applicable laws and regulations, more than thirty-five (35) U.S. jurisdictions require Surplus Lines Brokers to prepare and submit documentation related to surplus lines policies issued in the state to the insurance department or surplus lines association. These “policy filings” can take many forms. For example, Alabama requires Surplus Lines Brokers to provide information about the policy on a state-mandated document while others, such as California, require submission of actual policy documents (e.g., declaration pages, binders, etc.).

    Although policy filings are typically submitted electronically to the regulatory agency, states vary in terms of the timing of these filings and who is responsible for submitting them. As an example, states may require filings to be made (1) within a certain number of days after a policy’s effective date, (2) monthly, (3) quarterly, and/or (4) annually. Similarly, states vary as to whether the individual or entity Surplus Lines Broker must submit the filing and if a filing is required when no business is conducted during the relevant time period. These issues also arise in connection with surplus lines tax filings made by a Surplus Lines Broker.
  1. Stamping Fees

    Many of the states that require Surplus Lines Brokers to submit policy filings also require an associated payment, known as a “stamping fee”, which is: (1) calculated as a small percentage of the “premium” of the surplus lines policy; (2) meant to assist in funding the activities of the states’ insurance departments and/or surplus lines associations; and (3) payable by the Surplus Lines Broker at the time a policy filing is submitted. The stamping fee is separate and distinct from a state’s surplus lines tax.
  1. Surplus Lines Taxes

    All U.S. jurisdictions require Surplus Lines Brokers to submit tax filings and remit a tax, known as a surplus lines tax, to either the state insurance department or surplus lines association. As with many other aspects of surplus lines regulations, state laws vary with respect to many considerations related to surplus lines taxes, including: (1) whether the “premium” used to calculate the surplus lines tax (and stamping fee) includes fees charged by the Surplus Lines Broker; (2) when surplus lines tax filings and payments must be submitted; (3) whether the individual or entity Surplus Lines Broker must submit the tax filing and associated payment; and (4) whether a filing, often referred to as a zero tax filing, is required if a Surplus Lines Broker does not conduct any business during a specified time period. It is worth noting that states are consistent on one important issue – where surplus lines taxes must be paid. Specifically, following the enactment of the NRRA, surplus lines taxes, as well as policy filings and stamping fees, are only submitted in the insured’s “home state”.[9]

a. Calculation of “Premium”

State insurance laws indicate that the gross premium charged in connection with a surplus lines policy is part of the “premium” used to calculate the surplus lines tax. However, Surplus Lines Brokers need to consider whether fees they charge to an insured in addition to premium should be included as “premium” for purposes of the tax (and stamping fee) calculation. One potential distinguishing factor may be the purpose of the fees charged by the Surplus Lines Broker (i.e., whether such fees are simply for administrative services associated with selling and issuing the surplus lines policy or for additional services provided to the insured). With that said, this is not a definitive test, and Surplus Lines Brokers should seek guidance if there is any question as to whether fees must be factored into their surplus lines tax liability (or are even permitted in the subject state).

 b. Tax Filing & Payment Deadlines

As with policy filings and stamping fees, states vary with respect to when a Surplus Lines Broker must submit surplus lines tax filings and payments. The majority of states require a quarterly, semi-annual, or annual filing, but some states require monthly submissions. Surplus Lines Brokers must make timely filings to avoid fines and administrative actions for non-compliance.

c. Licensee Responsible for Reporting Surplus Lines Taxes

Another common issue is whether the individual or entity Surplus Lines Broker must report surplus lines business and submit tax (and stamping fee) payments. Some states require the individual licensee to report all surplus lines business under his or her license, while other states impose this obligation on the entity Surplus Lines Broker that the individual is affiliated with. When the entity makes the filing, many states still require the individual Surplus Lines Broker to submit a zero filing.

d. Zero Tax Filings

A majority of the U.S. jurisdictions require Surplus Lines Brokers to submit zero tax filings as confirmation that s/he or it did not sell any surplus lines insurance policies in the relevant time period. Failure to submit these zero tax filings can result in significant fines and penalties, even though a Surplus Lines Broker did not write any business during the relevant taxation period. 

III. Conclusion

Although surplus lines insurance is considered a non-admitted market, it is subject to extensive regulatory requirements. However, unlike in the admitted market, the compliance obligations are shifted to Surplus Lines Brokers as state regulators have little recourse against Surplus Lines Carriers. To complicate matters further, the onerous compliance obligations imposed on Surplus Lines Brokers vary greatly from state-to-state.

As a result, insurance producers should seek legal guidance and establish compliance guidelines before obtaining a Surplus Lines Broker license to ensure appropriate compliance protocols and procedures are in place to avoid administrative actions, fines and penalties.

References

[1] This article provides an overview of the licensing and compliance obligations applicable to Surplus Lines Brokers seeking to place coverage with a Surplus Lines Carrier.

[2] For purposes of this article, the term “U.S. jurisdictions” means the fifty (50) U.S. states and the District of Columbia.

[3] The Surplus Line Association of California, https://www.slacal.com/ (last visited Sep. 6, 2023); Florida Surplus Lines Service Office, https://www.fslso.com/ (last visited Sep. 6, 2023); Excess Line Association of New York, https://www.elany.org/home (last visited Sep. 6, 2023).

[4] 15 USCS § 8201.

[5] Id.; 15 USCS § 8202; 15 USCS § 8204; 15 USCS § 8206.

[6] As an example, New York requires an underlying insurance broker license prior to becoming a Surplus Lines Broker in the state. See Excess Line Association of New York, https://www.elany.org/elany-says.aspx?h=94&t=95 (last visited Sep. 7, 2023) (“Excess line broker licenses are available to New York residents licensed as brokers in New York and also to nonresidents from reciprocal states who 1) are licensed as excess or surplus lines brokers in their home states and 2) have or will obtain New York-nonresident broker licenses”).

[7] Id.

[8] Texas Department of Insurance, https://www.tdi.texas.gov (last visited Sep. 7, 2023) (“Businesses buy the most surplus lines policies, usually to cover unique risks. For instance, they might need liability coverage for a special event or to move hazardous materials. Some people buy surplus lines policies if they can’t get homeowners insurance from a standard company. Others buy it to cover very costly items, like an expensive art or classic car collection”).

[9] Under the NRRA, surplus lines taxes are no longer allocated between states when a policy covers a multi-state risk. Instead, the Surplus Lines Broker need only submit the tax in the insured’s “home state”, which is defined as follows (except with respect to affiliated groups): “… with respect to an insured— (i) the State in which an insured maintains its principal place of business or, in the case of an individual, the individual’s principal residence; or (ii) if 100 percent of the insured risk is located out of the State referred to in clause (i), the State to which the greatest percentage of the insured’s taxable premium for that insurance contract is allocated.” 15 USCS § 8206.