Surplus Lines Fundamentals SILA Phoenix AZ October 24, 2009 Roy Simpson; Manager, Regulatory Compliance Endurance Insurance US Los Angeles CA firstname.lastname@example.org Julia Van Buren; Regulatory & Compliance Administrator U.S. Risk Insurance Group, Inc. Dallas TX email@example.com Steve Stephan JD NAPSLO, Kansas City MO firstname.lastname@example.org The Goal of This Class is to: • Enable you to navigate the complex challenges of surplus lines compliance. • Provide you with resources and references to achieve surplus lines compliance. Preamble • Your broking staff must understand responsibilities for surplus line compliance is theirs and not the non- admitted insurers they use. • State regulators impose compliance on the surplus lines licensees as they often do not have direct regulatory/supervisory access to non-admitted insurers. This does not mean surplus line carriers are not regulated; they are regulated in their state or country of domicile. • Unlike admitted insurance placements, surplus line licensees are responsible for completion of surplus line filings that notify the state of a surplus line placement and remitting the premium tax for the placement. We start with a question: why is surplus lines compliance so difficult? • Taken individually, state surplus line regulations are relatively simple to understand. • The complicating factor of multi state exposure placements occurs because most states require that licensed Surplus Line Brokers follow their regulations even if no transactional activity occurred within their state. • Many state surplus line regulations were written prior to the issuance of non-resident surplus line licenses, beginning in the 1800’s. • While states have achieved (for the most part) licensing reciprocity they have not updated surplus line regulations for more uniformity. Surplus Lines Insurance • Also known as “Excess & Surplus” is a class of insurance designed to meet the needs of insureds with large, unusual and difficult to place insurance risks. Examples include earthquake, oil field operations, environmental remediation/clean up and medical trials. The general public most often hears of the “exotic” coverages such as an actors voice, a model’s face, an athlete's injury and precious artwork. • Additionally, increased coverage capacity excess of coverage admitted (or non-admitted) insurers can provide is a frequent reason for using this market. Surplus Lines Insurance • A major advantage of the surplus lines market is the freedom to tailor coverages for difficult to cover risks. • Surplus line insurers are not required to file rate and forms with the states as admitted carriers must and therefore are not confined to the use of their prefiled coverage’s “in a box”. Surplus Lines Carrier Eligibility • Surplus lines (“non-admitted”) insurers are not licensed (admitted) to transact insurance in a state (or states). • Surplus line insurers can become eligible for use in a state by inclusion on an eligibility list for placements made by licensed Surplus Lines Brokers. • Many states require non-admitted insurers to apply for inclusion on their eligibility list (also known generically as “white lists”). Other states leave it up to the Surplus Lines Broker to use financially stable surplus line carriers. Finally some states subscribe to the use of non- admitted insurers on the NAIC list of Alien Insurers for use by Surplus Line Brokers. Surplus Lines Carrier Eligibility • Be aware that a carrier can be non-admitted in one state and admitted in other states of a multi state placement. • Additionally, while a carrier may be admitted or eligible surplus lines in a state (or states), the carrier may not be admitted or eligible surplus lines in other states on a multi state placement. • In these instances, the carrier may have to be “fronted” by eligible paper or replaced entirely if eligible surplus lines or admitted paper cannot be used in lieu of the ineligible paper for the state(s) where they are not eligible SL or admitted. Authorized Placement of Surplus Lines Insurance • Generally, this class of insurance must be obtained through the services of licensed Surplus Lines Brokers. • Surplus Line Brokers are heavily regulated by the states and must file affidavits with the states advising of the placement(s), collect and pay surplus line taxes to the states and pay filing fees (known as “stamping fees”) to the state or Surplus Line Association. • Surplus Line Brokers are also required to file monthly, quarterly, semi annual and/or annual surplus line tax reports with the states, in addition to the affidavit filings. • “Independently Procured Insurance” - There is an exception to the surplus line broker license rule: many (as usual, not all) states allow direct procurement of non admitted insurance by insureds. The insured is responsible for the filing and payment of the premium tax for the “independently procured” insurance premium in these instances. • Insureds that directly procure coverage from non-admitted carriers are often (not always) exempt from the regulatory requirements surplus line brokers must meet. Authorized Placement of Surplus Lines Insurance • States vary on their definition of “independently procured”. • Some states consider a non-admitted placement to be independently procured if all of the insurance transaction occurred outside of the state; even if a surplus lines licensee in another state made the placement. • Other states consider a placement to be independently procured only if no broker/producer of any type was involved with the placement – the insured must go directly to the non-admitted insurer without any producer involvement. • Insureds directly procure non-admitted coverage for various reasons such as: needing more capacity than the admitted and eligible surplus lines market can provide, lower premiums, absence of diligent search requirements (with an exception or two), reduced tax liability in some instances and unique coverage needs that otherwise cannot be met through conventional means. • This subject is highly controversial regarding the filing and payment of independently procured taxes and great care should be taken with insureds when discussing this subject. Insureds should be referred to their own attorneys and tax advisors and they alone should make the final decision regarding tax filings and payments. (Todd Shipyards & Dow Chemical) SL Policy Advisories/Warnings & Stamps • States require specific notices to insureds be affixed to or stamped upon surplus line policies advising them the surplus line carrier isn’t subject to state regulatory authority and guaranty fund protection does not apply (except NJ). • This is a crucial regulatory requirement that must be met to avoid errors and omission issues for the producer in the event of a surplus line carrier insolvency. • Each state has unique advisory language and care must be taken to use the exact statement, font size, color and placement as required for multi state placements. A Word About State Insurance Guaranty Funds • Except for New Jersey, state insurance guaranty funds do not apply to surplus line insurers that become insolvent. • As a practical matter, many state insurance guaranty funds are not available to all insureds (there are exceptions of course). Additionally, funds are generally limited in the amount of coverage available. • You can find more information at the National Conference of Insurance Guaranty Funds @ http://www.ncigf.org/ • Many states prohibit using the availability of guaranty funds to influence an insured’s insurance purchases. The Language (definitions) • Knowing the terms and players in surplus lines placements is critical to success. • Transact: generally defined as the solicitation, negotiation or selling of insurance. A transaction can occur by mail, telephone, email, fax or any electronic means in addition to live transactions with an individual. • Exposure: refers to the insurance risk in a state or states and is not used interchangeably with “transact”. There can be “exposure” in a state without a “transaction” occurring there. • Admitted: the class of insurers that are licensed in a state (or states). Admitted insurers are required to file the forms and rates they will use for their placements and are restricted to the use of the form and rates they file. There are some exceptions to this rule now. Some states allow admitted insurers to go outside of their filed forms and rates under very specific circumstances for large “industrial insured’” or commercial policyholders”. • Non-admitted: refers to unlicensed insurance companies. Some use this term interchangeably with “surplus lines” however there is a distinction between the two terms. Non-admitted refers to an unlicensed insurer that cannot transact business in a state, or states. “Surplus Lines” is generally used as an indicator the insurer is an eligible or authorized surplus line insurer that may be used by surplus line licensees for insurance placements in a state, or states. Definitions (cont.) • Surplus Lines Broker: this is an individual that holds a Surplus Lines license in one or more states. The Surplus Lines Broker can go direct to a surplus lines insurer but may have to access the market through a “Wholesaler”. See the definition for “Wholesaler” below. A Surplus Lines Broker must be licensed as a Property/Casualty Producer prior to obtaining a Surplus Lines License. Some states require a separate exam for this license while others view the license as an additional “Line of Authority” or allow the issuance of the license based upon an application and payment of fee. • Retail Broker: this is a Property/Casualty licensed Producer and may be licensed in one or more states. The Retail Broker represents the insured and must go through a licensed Surplus Lines Broker to access the surplus lines market. To complicate this issue a bit, many Retail Brokers are licensed as Surplus Line Brokers so they can go directly to surplus line insurers for their placements. • Wholesaler: a surplus lines licensee that represents the surplus lines insurer. Retail brokers can go to a Wholesaler for surplus lines insurance. A Surplus Lines Broker must often go through a Wholesaler because the surplus lines insurer has given exclusive rights to the wholesaler for access to their market. This is often referred to as “giving the pen” to the Wholesaler to write coverage on behalf of the insurer which gives the Wholesaler underwriting and binding authority for them. Definitions (cont.) • Diligent Search: Refers to the requirement to approach a minimum number of admitted insurers prior to going to the non-admitted market. This is generally the Retail Broker’s responsibility. They are usually required to provide the Surplus Lines Broker or Wholesaler with the Diligent Search results and information. The SL broker in turn completes the required surplus line filing(s). While several states provide exemptions from diligent search requirements, an insured’s direction to omit the diligent search usually does not relieve the SL Broker from the requirement. This can be a source of friction between a broker and their insured. The best resolution is to address the need for the diligent search with the client early in the process. Export List: Many states publish a list of coverages that are exempt from Diligent Search requirements. These lists are generically referred to as “Export Lists” but the term may vary in your particular state. For example, the list is referred to as a “Placement List” in Alaska. If the coverage is on an export list, then the Surplus Line Broker can go directly to the surplus line market without conducting any type of Diligent Search. A complicating factor for multi-state exposures is that not all states have an Export List or other exemption for diligent search requirements. Given this, a Diligent Search may need to be completed even if your (or your client’s) resident state does not require it. White List: many states publish a list of eligible or authorized (do not use admitted or licensed when referring to surplus line insurers) non-admitted insurers. Surplus Line Brokers are restricted to the use of those eligible or authorized non-admitted insurers for exposures in those states. Definitions (cont.) • Black List: a list of insurers published by some states that may not be used under any circumstances by Surplus Line Brokers. Independently Procured Insurance – also known as Self Procured or Directly Procured. This refers to insurance that insureds obtain directly from a non-admitted insurer without the use of a Surplus Line Broker (or any broker). Because insureds are not regulated by the insurance departments, they usually can go to the non-admitted market without completing a diligent search of the admitted market and are not restricted to the use of eligible or authorized surplus line insurers. There are exceptions to the diligent search requirements and use of authorized surplus line insurers so the non- admitted insurer underwriter needs to make certain those requirements are met prior to transacting directly with an insured. Additionally, many states impose a tax on the premium for such placements that the insured must file and pay. A broker should not offer advice to their insured regarding the payment of a direct procurement tax beyond assisting them with completion of forms. The insured should consult their own tax advisors, or attorney, regarding this item. The rules for this type of placement are not universal therefore caution is required for direct procurement of non-admitted insurance. *All states do not allow independent procurement of non- admitted insurance and require the use of a licensed surplus line broker when non-admitted insurance is purchased. (for example WA, WY, MT & OR) Definitions (cont.) Exempted Coverages: many states (but not all) exempt certain coverages from the reporting and payment of surplus line taxes and fees. The exemptions must be carefully reviewed and understood and applicable licensing requirements followed. The application of the “Exempted Coverage” may be limited to certain types of insureds, such as “Industrial Insureds” or “Commercial Policyholders” in some states. Again, careful review of the applicable insurance code(s) is essential. As in all cases involving Surplus Lines, an exemption in one state does not apply to exposures in other states without the exemption. Commercial Insured, Commercial Policyholder, Industrial Insured”: these are interchangeable terms describing a class of insured. The exact definitions vary by state as does the benefit of being in these categories of insured. The terms generally apply to insureds that have large, unique or difficult to place risks and spend above a given threshold for their insurance premiums and have a full time insurance buyer. Definitions (cont.) • Surplus Lines Affidavit: the generic term for state required surplus line filings made by a surplus line broker after a surplus line placement is completed. These filings may be made through a Surplus Line Association or directly with the state Department of Insurance, depending on the requirements of the states involved. Surplus Lines Tax Report: A separate state required tax filing to report surplus line premium and make surplus line payments to the state. These tax reports are due on different schedules; monthly, quarterly, semi annual and annual. Some states require the reports even if no surplus line premium was generated in their state (a/k/a “zero reports”). • Domestic Insurer: An insurer that is domiciled in the regulating state. For example; if the insurer is domiciled in New York, the insurer is considered a “domestic insurer” by New York regulators. Definitions (cont.) • Foreign Insurers: an insurer that is domiciled in a state other than the broker’s or insured’s state. Alien Insurers: an insurer that is domiciled outside of the US. • Courtesy/Accommodation Filing: are surplus line filings made by a surplus lines licensee that had no involvement with the placement for another broker that does not have the required surplus lines license for their placement. Most states no longer allow this type of filing and require a properly licensed surplus line broker to actually be involved in a placement to be in compliance with state regulations. Keep in mind if a courtesy filing is submitted in a state that still allows the practice, the submitting surplus line broker will assume responsibility for meeting state compliance as though they actually placed the business. Definitions (cont.) • Surplus Line Association (AKA: “Stamping Offices & Service Offices”) – there are 16 states with surplus line broker supported Surplus Line Associations. Except for Colorado, Surplus Line Brokers file their affidavits for surplus line placements with the Surplus Line Associations. In addition to providing training to Surplus Line Brokers, the Associations also act as an intermediary between the Surplus Line Broker and state Department of Insurance. The Associations are supported by collection of a “stamping” or filing fee from the broker based on a percentage of the premium filed or a flat fee for each policy filed. A side note; the term “stamping fee” comes from the action only a few Surplus Lines Associations still perform; stamping of the actual policy verifying it was filed. Fortunately, most states currently do not require the policy be stamped, greatly reducing the paper flow. US IRS Excise Tax US IRS Excise Tax - Another tax that may be applicable when using non- admitted insurers is the US IRS Excise Tax. The tax is 4% of the premium (1% for reinsurance, life, annuity contracts and sickness & accident policies) and is filed quarterly using IRS multi-purpose Form 720. The tax may apply to premiums paid to Alien (IRS uses the term “foreign”) insurers for US risks. The alien insurer premium may be exempt from the IRS excise tax if they have a “closing agreement” with the IRS or pay US tax through a US subsidiary or parent company. Alien insurer premium may also be exempt if they are domiciled in a country that has a treaty with the IRS exempting them from the tax. Unfortunately the IRS does not publish a list of alien insurers that are exempt from the excise tax (although many are). If in doubt ask the alien insurer to provide a copy of the closing agreement with the IRS or prove domicile in a country with a qualified, or unqualified, treaty that exempts the premium from the excise tax. This issue is much too complicated to go onto detail here; basic information can be found at the US IRS website at: http://www.irs.gov/businesses/small/article/0,,id=186963,00.html or consult your internal tax department. While the IRS looks to “the last entity to touch the premium in the US” to file and pay the excise tax, they will pursue payment with any of the parties in the transaction, including any US broker involved with the placement. Canada, Puerto Rico & Virgin Islands • Canada, Puerto Rico and Virgin Island surplus line placements. Canadian provinces do issue non-resident licenses but may be restricted to US border state producers. Additionally, not all Canadian provinces issue a “special broker” license (for surplus line placements) to non-residents. Failure to use a properly licensed resident or non-resident broker for Canadian placements can result in provinces applying monetary penalties up to 60% of the Canadian premium depending on the location of the risk. If in doubt about the licensing status of a US broker (or brokers) when making a placement with Canadian exposure, a properly licensed resident Canadian broker must be involved PRIOR to binding. • Puerto Rico and the Virgin Islands do license non-residents as surplus line brokers however, a corporate entity license must be obtained first. If the placing US broker is not properly licensed in Puerto Rico or the Virgin Islands, a resident broker must be used for the placement PRIOR to binding. Resident brokers in Canada, Puerto Rico and the Virgin Islands cannot assist after binding has occurred to bring the placement into compliance. “Commercial Deregulation” • The following information is not related to surplus line insurance but pertains solely to ADMITTED (licensed) insurance placements (no surplus line license is required). • Many states have implemented insurance regulations that allow admitted insurers to quote or place business using forms, or rates, which are not subject to prior filing and approval with the department of insurance. This is generically referred to as “commercial deregulation” but terminology varies among the states (see reference to “NY Free Trade Zone” below). • This allows an admitted carrier underwriter to compete more effectively with non- admitted insurers that do not have to file the rates and forms they use. • This type of insurance placement is typically reserved for large commercial insureds and do have their own set of criteria that must be met by both the policyholder and the carrier. As always, the criteria varies by state and must be reviewed individually to confirm the placement is in compliance with state regulations. • New York is an example of one state that provides for this type of exception to the use of filed rates and forms and is referred to as the “New York Free Trade Zone”. Specific information can be found at the NY Department of Insurance website under Information for Agents & Brokers, “Frequently Asked Questions, Industry”, then look under Free Trade Zone. The NY insurance law can be reviewed by seeing Article 63 of the Insurance Law and Insurance Department Regulation No. 86 (11 NYCRR 16). • As this type of placement is not a “surplus lines” placement, there is no surplus line tax to file and pay. The admitted carrier is responsible for payment of applicable admitted taxes to the state(s) with exposure. Payment of Surplus Line Taxes and Fees • Surplus line brokers are generally responsible for payment of surplus line taxes and fees to the state(s) and Surplus Lines Association(s) with exposure for their placements. • Who pays if more than one surplus lines licensee is involved with a placement? • It is generally considered the responsibility of the surplus lines licensee closest to the surplus lines insurer to file and pay SL taxes and fees. As a practical matter, the states are most concerned with the receipt of surplus line taxes than who filed them. • For example; PA insurance law requires the broker closest to the insured to file and pay the surplus line tax (PA statute 1617).However PA generally does not make an issue of whether or not the insured’s broker files or the wholesaler files; just as long as the taxes are filed and paid. • Currently, many retail brokers file and pay the SL taxes even though it may technically be the wholesalers responsibility to do so. • These are generally business decisions made by the retail broker and not necessarily based on state insurance regulations. • A complex placement may have multiple wholesalers/surplus lines licensees with some agreeing to file while others don’t; therefore it is less complicated for the retail broker to make all the filings and remit the taxes. Insured Reimbursement of SL Taxes to the Broker. • Insured reimbursement of surplus line taxes to the broker: • Be aware that while many states are not concerned that a surplus line broker collect the taxes and fees from the insured (they just want them paid), several states require the taxes and fees to be collected from the insured. • Failing to collect the taxes and fees from an insured is viewed as rebating by the states that require the insured to reimburse the broker for the taxes. Rebating is prohibited in all states, except California. Florida does allow rebating but only under very specific circumstances – a broker can offer rebates but only if they do it for ALL of their insureds (not a likely scenario). • Using the two states mentioned as examples of the differing requirements: • California requires the surplus line broker to file and pay the surplus line tax regardless if it is collected from the insured or not. • Florida requires the surplus line broker to collect the surplus line tax from the insured and is prohibited from remitting the tax without doing so. Florida considers the payment of the tax by the broker to be rebating if they do not collect the tax from the insured (FL Statute 626.932). • The many states (CA for example) that do not codify a requirement to collect surplus line taxes and fees from an insured are generally silent on this subject. In these instances, brokers collect the taxes and fees from their insureds by contract or custom and practice. Keep in mind; states ultimately will hold the surplus line broker responsible for the surplus line taxes whether collected from the insured or not. Insured Exemption(s) From Payment of Surplus Line Taxes • Some insureds are exempt from the payment of the surplus line tax under very specific circumstances which may leave the broker without recourse for the collection of the tax from the insured. The surplus line broker cannot avoid payment of the surplus line tax by claiming their insured’s exemption. While this situation does not occur often it can obviously impose a severe financial burden upon the surplus line broker when it does. Additionally, conflicts arise when a state requires the insured to remit the tax to the broker and these situations need to be resolved PRIOR to binding. • Examples of exempt insureds can be; Indian Reservations, public works projects such as former military post conversions to public use and military installations. Again, the exemptions are not applicable in all states and careful review is required to determine the applicability of the insured’s tax exemptions (or not) for surplus line taxes. • The irony of these insured exemptions from the payment of surplus line taxes is they do pay admitted premium tax as it is included in the premium. Given that it is a seamless transaction, the payment goes unnoticed. The Insurance Cycle • The insurance business is cyclical as business is in general. • Insurance premiums, insurer profits & coverage availability rise and fall during the cycle. • We see insurers tighten underwriting standards during a “hard market” resulting in higher premiums for their product. • A “soft market” results in relaxed underwriting standards and lower premiums. • The use of surplus line insurers generally rises in a hard market as admitted insurers decline more of the business submitted to them. • As the market “softens”, the non-admitted market declines and the admitted market rises based on increased availability of admitted products as underwriting standards relax. • A reminder; the cyclical nature of the insurance business is somewhat softened for surplus line insurers based on the types of coverage’s they write and the classes of business they insure. • E&O (errors & omissions), environmental impairment/remediation liability, K&R (kidnap & ransom), excess liability, quake & flood, DIC (differences in condition), automobile racing and event cancellation are examples of coverages the surplus lines market is willing to write. • Airports, railroad operations, harbor facilities, tattoo parlors, security services (especially armed services) and medical/drug/alcohol treatment centers are examples of the type of businesses that surplus line insurers are more willing to write than admitted insurers. • Coverage in the non-admitted market is generally obtained through the use of a surplus lines broker or, if permissible, direct procurement by insureds as previously described. Surplus Line Associations & Stamping Offices • The two terms are often used interchangeably, but can (or not) refer to the same thing; • “Stamping Offices” are generally considered the source for submitting surplus line affidavits, and in some instances copies of the policy, for recording and “stamping” of the policy. • Stamping offices are supported and paid for by a fee for the service the surplus lines broker pays. • “Surplus Lines Associations” are usually informational associations formed by surplus line brokers. Surplus line filings are not filed with this type of organization but they can provide direction for proper surplus line compliance. • There is overlap for the use of the two terms: Many stamping/filing offices are identified as “Surplus Lines Association” such as “The Surplus Lines Association of California”, “Excess Lines Association of New York” and the “Pennsylvania Surplus Lines Association” and others. • There are currently 14 “stamping offices” in the US. They are in: AZ, CA, FL, ID, IL, MN, MS, NV, NY, OR, PA, TX, UT and WA. • Surplus line affidavits (if required) are submitted directly to the state Department of Insurance in the remaining states. The Surplus Line Filing Process • Affidavits and filing deadlines vary but there are requirements and information generally needed for all surplus line filings: • A coverage document be it a binder, covernote or dec page, a copy is generally required with the submission of an affidavit . • Policy number and the premium being filed. • Surplus lines licensee and license number. • Diligent search information (unless exempted). • Type of coverage. • Location of risk. Surplus Line Filing Process • Filing deadlines range from 30 days from the policy effective date to a year – some states no longer require a submission at all. • Complete the affidavit/diligent search report completely and accurately. Use the correct and proper names of insurers, especially when completing the diligent search report. For example; using “Lex” or “AIG” is not permissible as “Lex” is not the full and correct name for Lexington Insurance Company. “AIG” isn’t even the name of an insurance company but refers to the parent company of a group of insurers. Also, ensure you are not given a non- admitted insurer name (such as Lexington) to use for a diligent search report as this should reference only admitted insurers. • Obtain the proper signatures for the filing forms. • After the complete filing package is complete and submitted you may receive a “tag” in response to your filing. • Tags are notices advising you of a deficiency in the submitted filing and usually a correction is required. Tags occur because of incorrect, or insufficient, information, late filings, unsigned forms, lack of a proper coverage document etc. • Tags must be responded to within the time requested (unless advisory only). A report may be sent to the appropriate department of insurance if the surplus line broker fails to respond. Surplus Line Filing Process • Endorsements evidencing additional or return premium. • Endorsements must be filed in order to remit additional surplus lines tax or receive a refund of taxes. • State requirements vary: some are as simple as submitting a copy of the endorsement reflecting the AP or RP and the appropriate additional or return tax. • A few states do have filing forms for endorsements but are not as complex as the original filings may have been. Surplus Line Filing Process • Stamping Fees: Stamping offices (and some states) charge a fee for processing and recording submitted surplus line affidavits. • A stamping fee invoice is sent to the surplus lines broker based on the volume of premium filed and are due upon receipt of the invoice. • Surplus Line Taxes are usually paid as a separate transaction by submitting tax reports as required. This will be covered in more detail in the Taxation & Reporting section of the presentation.
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