Subrogation professionals are often required to deal with a variety of insurance companies, including those admitted or licensed to transact business in a particular state and those which are not. Understanding the difference can assist the claims handler and subrogation professional in the daily handling of their claims. This article briefly summarizes the different types of insurance available and the concept of insurance regulation overall.
Summary of Insurance Regulation
In 1868, the U.S. Supreme Court decided the landmark decision in Paul v. State of Virginia, 75 U.S. 168 (1868). It held that the business of insurance is not “commerce” as contemplated by the Commerce Clause of the U.S. Constitution. Simply put, insurance policies are not commerce at all. Even though the insurance industry was subject to widespread abuses in the mid-to-late-1800s, the Court believed that policies are not commodities to be shipped or forwarded from one state to another. As a result, the regulation, taxation, and governance of the insurance industry was left to the states. This quickly led to the formation of the National Association of Insurance Commissioners (NAIC) in 1871, which is a standard-setting and regulatory group overseen by the main insurance regulators from all 50 states.
In 1944, the Supreme Court changed its mind, in U.S. South-Eastern Underwriters Association, 322 U.S. 533 (1944), and decided that insurance was “commerce.” This created a regulatory vacuum which led to the enactment of the McCarran-Ferguson Act of 1945. 15 U.S.C. §§ 1011-1015. This federal law said that states should continue to regulate and tax the business of insurance.
In 1999, Congress passed the Financial Services Modernization Act (a/k/a Gramm-Leach-Bliley Act), which repealed the old Glass-Steagall Act and established a regulatory framework which permitted affiliation between banks, securities firms, and insurance companies. It called for states to allow insurance companies to compete to meet consumer needs. Following the subprime mortgage market crisis in 2007, Congress passed the Wall Street Reform and Consumer Protection Act of 2010 (a/k/a Dodd-Frank Act), which created the Federal Insurance Office and “reformed” reinsurance and surplus lines insurance companies. In general, however, regulating insurance has remained primarily with the states.
National Association of Insurance Commissioners (NAIC)
Over the years, the NAIC has evolved into the U.S. standard-setting and regulatory support organization for our industry. It is created and governed by the chief insurance regulators from all 50 states, the District of Columbia, and five U.S. territories. It is nearly 150 years old and today is the glue that holds together a disparate conglomeration of insurers which includes standard lines, excess lines, captives, direct sellers, domestic carriers, alien carriers, Lloyds of London, mutual companies, and stock companies. The NAIC performs and provides, among other things, the following tasks and services:
- Provides accreditation of national solvency standards;
- Oversees centralized processing for licensing, rate and form filing, and producer licensing;
- Facilitates peer review; and
- Conducts regulatory oversight.
NAIC members form the national system of state-based insurance regulation in the country, protecting consumers. The insurance industry is regulated more heavily than any other because of the complexity and limitless variables which can enter into an insurance contract or policy.
Insurance companies and other businesses offering insurance-related products must be licensed before they can sell their insurance or services. The U.S. has over 7,800 insurance companies and they are all required to be licensed in their state of domicile and any other state where they are licensed to sell policies. Failure to become licensed can result in suspension and fines. States often license insurers using the NAIC’s Uniform Certificate of Authority Application (UCAA). The NAIC database also helps states keep track of the non-stop mergers and acquisitions which continually change the face of the players involved.
Insurance agents and brokers must be licensed to sell insurance. There are over two million such “producers” in the country. The National Insurance Producer Registry (NIPR), a non-profit affiliate of the NAIC, is a collection of information on producers nationwide and helps states coordinate oversight efforts for producers who operate in more than one state.
Regulation of Policies and Policy Terms
Each state’s regulatory framework ensures that its residents are protected from unscrupulous insurance producers and carriers, by overseeing and regulating the actual terms contained in a policy. This ensures that the policy complies with state law. These regulations help avoid gaps in coverage or exemptions or exclusions which might be unfair to unsuspecting consumers.
In property and casualty insurance, many states require the insurer to file rates and receive prior approval before offering an insurance product. These are known as rate or policy form filings. Regulators attempt to ensure that rates are competitive. Health insurance is subject to prior rate in all states, and the Department of Health and Human Services provides federal oversight of any rates that are “unreasonable.” Market regulation is accomplished through “market conduct examinations” which may be routine or as a result of a consumer complaint. The NAIC’s Market Conduct Annual Statement (MCAS) compiles market data and provides state regulators with valuable information which allows uniform market analysis and benchmarking.
Admitted vs. Non-Admitted Insurers
An “admitted” insurer is one which has been approved and licensed by a state’s insurance department. Also known as a “standard market carrier,” an admitted insurer must comply with all state regulations and is usually backed by the state guaranty fund should it fail. To become an admitted carrier, an insurance company applies to the state commissioner, is approved, and must file and have approved its various insurance forms and rates. This process usually takes a while. Once licensed to do business in a particular state, the carrier must pay a portion of the premiums it receives to the state, which go into the state guaranty fund.
A “non-admitted” insurer, on the other hand, isn’t approved or licensed by the state and its insureds will not be protected by the state guaranty fund. Non-admitted insurers are also known as “excess and surplus lines” carriers. [An article involving “non-admitted” (non-standard) insurer subrogation written by MWL can be found HERE. ] These non-standard carriers have not gone through the approval process and their forms have not been filed with the state. Therefore, they enjoy greater flexibility in writing and designing policies to meet unique and specific underwriting risks. These carriers are regulated by a state’s Surplus Lines Office, but this oversight is far less invasive and thorough than with admitted carriers.
The above-referenced Dodd-Frank Act, passed in 2010, included a law named the Non-admitted and Reinsurance Reform Act (NRRA). This federal law created a model for more simplified collection of surplus lines premium taxes, insurer eligibility, and commercial purchaser exemptions. It also limited regulatory authority to the home state of the insured. States scrambled to update their surplus lines laws, and as of 2018, every state except Michigan and the District of Columbia has legislation complying with the NRRA. If Michigan is determined to be the home state of the insured, 100% of the premium tax is paid to the state of Michigan within 30 days of the effective date of the policy, even when multi-state policies are involved. Michigan law requires the following information be printed, typed, or stamped in red ink in 10-point type on each surplus lines policy, cover note, or other document that indicates a surplus lines policy:
This insurance has been placed with an insurer that is not licensed by the state of Michigan. In case of insolvency, payment of claims may not be guaranteed. This notification shall not be concealed in any manner.
If the home state of the insured is Michigan, then any surplus lines broker is required by Michigan law to be licensed in Michigan.
Excess and Surplus Lines Insurance
As mentioned above, surplus lines insurance (a/k/a specialty insurance) fills the need for coverage for risks declined by standard/admitted carriers. It is a supplement to the admitted or standard market and covers risks that do not otherwise qualify for coverage, such as hard-to-place risks with unique (expensive collector car) or high-loss exposures or an insured with recent losses or an extensive history of claims. Surplus lines insurance is usually sold to businesses with high exposure, although non-standard auto insurance is routinely sold to individuals with bad driving records. Most surplus lines insurance business consists of property and casualty coverages, and life and health insurance is usually not sold in this market. Workers’ compensation is normally only written by admitted carriers. Besides high-risk insureds, the surplus market will also sell mainstream insurance products to companies that an admitted market will not insure. Excess insurance (providing coverage only above a stated amount or a specified primary policy) is also a form of specialty insurance because it allows a high-exposure risk to be covered by an admitted policy by supplementing its limits.
The NRRA preempts many state insurance laws, regulations, provisions that apply to non-admitted insurance sold, solicited by, or negotiated with an insured whose home state is another state. Surplus lines is often called the “safety valve” of the insurance industry, because it fills the need for coverage in the marketplace by insuring those risks declined by the standard underwriting and pricing processes of admitted insurance carriers. The surplus lines market is huge, with over $45 billion in premiums written last year. It is a solution for consumers that are not “one size fits all,” and provides insurance products skillfully tailored to meet specific needs for non-standard risks.
Risks typically written in the surplus lines market fall into three basic categories:
(1) non-standard risks, which have unusual underwriting characteristics;
(2) unique risks for which admitted carriers do not offer a filed policy form or rate; and
(3) capacity risks where an insured seeks a higher level of coverage than most insurers will provide.
Examples include high risk-insurance for chemical and flammable incidents; safety-critical products for transportation; structural integrity products for construction; pharmaceutical and medical products against product failure; environmental liability products; and privacy protection products against identity theft.
The surplus lines market is laser-focused on minimizing the risks of doing business in a world where the unforeseen is inevitable. It has also been effective in introducing new products to the market. New and innovative products, and processes and procedures for which there is no loss history are difficult, if not impossible, to price or rate for insurance purposes, but the specialty market is uniquely qualified to cover these emerging risks because they have developed this expertise through decades of experience.
There are professional trade associations that cater to this large segment of the insurance industry, including the Wholesale & Specialty Insurance Association (WSIA), which is the offspring of a merger between the American Association of Managing General Agents (AAMGA) and the National Association of Professional Surplus Lines Offices (NAPSLO) in 2017. According to A.M. Best, the solvency record of surplus lines insurers has historically equaled the admitted marketplace. There have been no insolvencies over the past 14 years.
One of the most significant regulatory requirements imposed by state surplus lines laws is that a surplus lines broker must complete a diligent search of the admitted markets. A diligent search represents the attempt to find the coverage from admitted insurers before a policy is placed in the surplus lines market. What qualifies as a “diligent search” varies from state to state. In Florida, for example, § 626.914 defines it as follows:
Seeking coverage from and having been rejected by at least three authorized insurers currently writing this type of coverage and documenting these rejections. However, if the residential structure has a dwelling replacement cost of $1 million or more, the term means seeking coverage from and having been rejected by at least one authorized insurer currently writing this type of coverage and documenting this rejection.
Florida retail or producing agents must verify this diligence with documentation This “three company” requirement is typical in many states. A producer searching for a surplus product will sometimes enlist the help of a broker/agent with specialized capabilities to find a carrier. Known as a surplus lines producer or wholesaler, this broker/agent acts as the middleman between the “retail” producer and the carrier with specialty coverage. “Wholesale” insurance, therefore, is simply specialty insurance obtained in this fashion. There are two types of wholesale/surplus lines brokers:
- Managing General Agents
- Surplus Lines Brokers
The latter work with the retail agent and insurer to obtain coverage for the insured; but unlike a managing general agent, a surplus lines broker does not have binding authority from the insurer. In many states, including Illinois, the licensed surplus lines producer is required to confirm that the insurer meets certain financial standards before purchasing a policy.
The licensed surplus lines broker in each state is also responsible for providing the insured with a written statutory notice regarding a surplus lines transaction. Every state requires a notification to the insured customer in a surplus lines transaction that advises them that the surplus lines policy is not covered by the state guaranty fund and is placed with a surplus lines company not subject to many of the state’s regulations.
As the sole regulated entity in the wholesale product transaction, the surplus lines broker must hold a surplus lines license. Every state, as a part of its surplus lines law, requires the issuance of a surplus lines broker license.
Fifteen states have created surplus lines stamping offices. They are usually formed by surplus lines brokers as a form of self-regulation to foster and facilitate compliance with the unique regulatory requirements applicable to surplus lines transactions. For example, the Surplus Lines Stamping Office of Texas (SLTX) is a non-profit unincorporated organization in Austin created by the legislature in 1987 that ensures the integrity of the surplus market. In most states, a surplus lines policy and any endorsements must be filed with these offices in a timely manner (usually within 30 to 60 days after the issue date. In 2015, the SLTX reported that, with 375,370 such policies having been issued, less than 2% were filed late. Over two-thirds of surplus lines premiums flow through these offices and associations.
In the dawn of 2020 and beyond, the wholesale/surplus lines industry remains very competitive, which is always good for the consumer. The rising cost of oversight (technology, infrastructure, information management, etc.) is a ubiquitous challenge, but wholesalers are in a strong position to increase efficiency as technology develops and becomes less expensive. Capital is abundant, but education on the wholesale distribution system is still lacking. Selling this niche product to businesses that do not understand or appreciate their exposures and want to spend minimal efforts and overhead to preparing for the unforeseen yet inevitable remains a challenge.
If you should have any questions regarding this article or subrogation in general, please contact Gary Wickert at firstname.lastname@example.org.
Ashton T. Kirsch, co-author and attorney at Matthiesen, Wickert & Lehrer, S.C.
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