Surplus Lines Lessons from the 78th Legislature

With the regular session of the Texas Legislature now mercifully over (special sessions notwithstanding), it is instructive for the surplus lines industry to take a hard look at what occurred at the Capitol. In particular, the evolution of Senate Bill 14, the omnibus insurance bill, yields important lessons. SB 14 makes significant revisions to the regulation of both residential property and personal auto insurance, including oversight of rates, forms, underwriting guidelines, use of credit scoring, and withdrawal by an insurer from the market.

Lawmakers came to Austin in January after hearing complaints from an angry public over increases in homeowners insurance pricing and alleged abuses in insurance credit scoring. Legislators were irked that the bulk of the homeowners market was being written by unregulated Texas Lloyds plans and reciprocals, sectors where the Commissioner of Insurance had little authority to intervene. In early hearings on SB 14, it was clear that lawmakers had grave misgivings over allowing any residential property insurer to operate in an unregulated environment. Accordingly, debate centered on prohibiting migration of any personal lines business to unregulated affiliates and granting TDI sufficient power to oversee and regulate the market. Although surplus lines insurers only write a fractional share of the Texas homeowners market (just 1.3 percent in 2001), the rate autonomy they enjoy was potentially in jeopardy. It was difficult for legislators to fully understand the truly specialized nature of surplus lines insurers after hearing a variety of admitted insurers argue that they themselves deserved unique treatment. As for credit scoring, many viewed it as a form of redlining, prompting attempts to either limit its use or prohibit it outright.

Early drafts of SB 14 contained provisions that would have dramatically altered the surplus lines industry’s foundation of freedom from rate and form regulation. For instance, the original version of the bill passing the Senate required that all surplus lines insurers writing personal auto or residential property insurance file their underwriting guidelines and credit scoring models with TDI. The House removed these requirements, but added language that if the residential property premium of an insurer plus its surplus lines affiliates exceeded five percent of the total market, the insurer and the affiliates all must file their rates with TDI. Due in large part to the efforts of Texas Surplus Lines Association lobbyist Jim Shawn, eventually these filing requirements were eliminated. One section of the bill as finally passed remained to apply to surplus lines insurers, that of “rates standards.” These standards demand that rates must be “just, fair, reasonable, adequate, not confiscatory and not excessive for the risks to which they apply, and not unfairly discriminatory.” It is difficult to argue that these principles should not be applicable to surplus lines. In fact, to make such an argument probably does more harm than good.

Two key points emerge from this session:
Over the past two years, many Texas homeowners might have gone uninsured were it not for the surplus lines industry. Some saw the upsurge in surplus lines homeowners premium as a great problem. (Indeed, some perceive the volume of surplus lines business as a barometer of the health of the admitted market.) I viewed it as a sign that once again the surplus lines industry was successfully fulfilling its key function as the “relief valve.” This success requires great flexibility in rate and form to write the risks that are typical surplus lines coverages—complex, substandard, unique or high-capacity. However, the historic freedom of rate and form enjoyed by surplus lines insurers is not guaranteed. Market disruptions of the magnitude we have experienced in Texas recently create a climate where the legislature can easily prescribe the same medicine for all. It is quite possible that laws passed intending to improve availability will in fact result in exactly the opposite consequence, restricting access to the market of last resort. Therefore, education of lawmakers regarding the nature and role of surplus lines insurance remains imperative. Ultimately, the fundamental traits of the surplus lines industry—innovation, entrepreneurial spirit, and quick response—are each a fragile thing.

Surplus lines insurance’s “diligent effort” requirement theoretically serves to prohibit unfair competition with the licensed market. A risk can be exported legally to the surplus lines market only after the surplus lines agent has made a diligent effort to place the business with admitted insurers. Failure to rigidly adhere to the diligent effort law when writing personal lines is probably the gravest threat to the continuing freedom of rate and form for commercial lines writers in the surplus lines market. (In 2002, this market was more than 95 percent commercial lines in Texas.) Such abuse would invite close scrutiny and potentially severe punitive legislation from elected officials, to the detriment of the commercial market. So, a final, gentle suggestion for those agents and insurers writing Texas personal lines coverage as surplus lines business—don’t screw it up for everyone else!

Philip R. Ballinger is the general manager of the Surplus Lines Stamping Office in Texas.