To many insurance professionals, surplus lines policies are a mystery. Many think of it as a coverage for strange risks with odd provisions. But getting a grasp on surplus lines coverage is not difficult. Let’s take a short walk through surplus lines.
To begin, many aspects of the surplus lines business are straightforward. Unlike admitted carriers who may only sell insurance policies with prior approval by state authorities, surplus lines carriers are free to sell a wide range of policies so long as they are eligible non-admitted carriers. Under the law of most states, surplus lines statutes are designed to put eligible surplus carriers on an equal footing with admitted carriers. In almost every state, if an eligible surplus line carrier sells insurance in that state it is subject to the jurisdiction of that state. At the same time, a policyholder trying to sue an eligible surplus lines carrier in a given state must comply with the service of process requirements of that state. When a carrier submits to the jurisdiction of the state, it may not only be hauled into court in that state, but it usually submits to the statutory and common law rules of bad faith of that state.
Most surplus lines insurance business consists of property and casualty coverages. For the most part, it is sold mostly to businesses. Life and health insurance are usually not sold in the surplus lines market, although disability insurance occasionally is, and contracts of worker’s compensation insurance are usually limited to admitted carriers. While almost all third-party policies for out-of-the-ordinary risks are issued by surplus lines carriers, it should not be thought that surplus lines carriers sell only unusual or non-mainstream products. They also sell mainstream insurance products to companies that an admitted market will not insure.
In general, in order to buy surplus lines insurance, a business must seek coverage through a licensed insurance agent (e.g., an intermediary licensed by the state); that broker must then approach a surplus lines broker also licensed by the state. This process often entails several such contacts before the right insurer is found. Understandably, it is important that the licensing and regulation of surplus lines brokers is a principal focal point of state regulation of the surplus lines market. For instance, in Texas the Department of Insurance (“TDI”) carefully regulates admitted carriers. It regulates surplus lines insurers only indirectly, and only to a limited extent. Significantly, neither the rates nor the policy language of surplus lines carriers are subject to TDI review. Similarly, they are not subject to most Texas insurance law. As a consequence, surplus lines insurers have a flexibility which admitted carriers do not. It is for this reason that they can provide a market for offbeat, huge, substandard, or otherwise difficult-to-place risks.
Even so, TDI does engage in limited, indirect regulation over the surplus lines market. It does this in several ways. First, it licenses and regulates surplus lines agents. A licensed surplus lines agent may place business only with eligible surplus lines carriers. Second, TDI determines whether or not the non-admitted carrier is eligible to do business in Texas. Third, TDI maintains a list of eligible surplus lines carriers. Fourth, TDI keeps some track of the financial condition of surplus lines carriers. Finally, Texas law requires that insurance contracts entered into by eligible surplus lines carriers be “stamped” so as to clearly indicate the surplus line nature of the policy.
Surplus lines policies raise interesting litigation issues as well. For instance, can an insured successfully sue an ineligible surplus lines carrier upon theories he cannot use against other kinds of carriers? Can an insured successfully sue an eligible surplus lines carrier upon theories it cannot use against an admitted carrier? Do the statutory schemes designed to regulate surplus lines carriers provide insureds with implied causes of action which they do not have against admitted carriers? If a surplus lines carrier or surplus lines agent fails to obtain the statutorily required stamp, can this fact be used by an insured against the carrier or against the agent in a private lawsuit? Or, is this strictly a matter for regulatory authorities? Do lawyers for insurers have to be alert to novel possibilities in dealing with surplus lines carriers in ways they do not have to be when dealing with admitted carriers?
As stated above, surplus lines carriers are relatively free from state insurance regulation. Policy forms and rates are unregulated, and capitalization requirements are far different from those imposed on admitted carriers. This lack of regulation is the essence of what a surplus carrier is; that is, a “free agent” able to respond to the changing market conditions and coverage needs of certain insureds.
That said, there are still a few significant regulatory issues confronting surplus insurers, largely concerning the licensing of surplus brokers and the state oversight of surplus lines carriers to see that they do not write business that could go to the admitted market. This oversight is probably required because, as surplus carriers are free of assigned risk pools and guaranty fund assessments, a non-admitted carrier could potentially offer placement at a significant price advantage.
It is in the surplus carriers’ best interest for insureds to be able to confirm that one is doing business with an eligible, unadmitted carrier, as opposed to an unauthorized, illegal insurance operation. This need gave rise to the surplus stamping offices.
The most significant recent statutory development in surplus lines is the creation of stamping offices. These offices are a joint and voluntary venture between the surplus lines industry and state regulators. Their role is to encourage compliance and consistency outside of the regulatory structure. The stamping office concept emerged when California formed the first Surplus Lines Association in the 1930’s. The general function of a stamping office is to evaluate the eligibility of surplus companies, offer assistance to buyers, and generally educate the public about the surplus lines market.
Some have argued that stamping offices play an extremely important part in regulation of the surplus lines industry. Stamping offices permit easy access by insureds to the approved lists of eligible carriers, or disapproved lists, as the case may be. They facilitate the easy flow of information between the insurance office and the licensed surplus lines brokers, and just generally keep the lines of communication open. They also help the surplus brokers comply with the local stamping requirements.
It is usually required that every surplus lines policy be stamped. It is unclear what the consequences of technical glitches in this area are, but they appear to be heavily fact-sensitive. Unquestionably, strict compliance with stamping is a legal requirement in Texas, and significant penalties may accrue to the broker who fails to place the stamp.
Okay, now we have discussed the tip of the iceberg. Surplus lines policies pose many questions, but unfortunately, the law is sparsely developed. As in other complex, undeveloped areas of law, it means the possibility of exciting times is just ahead.
Brian S. Martin is a partner in the Insurance and Coverage Section of the Houston office of Thompson, Coe, Cousins & Irons, L.L.P. He has extensive experience in insurance coverage and defense matters, specializing in environmental, toxic tort and product cases. Martin is a frequent author and CLE speaker on insurance topics, including coverage and bad faith issues.
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