On May 30, 2017, Texas House Bill 2492 made its final ascent to the office of Governor Greg Abbott. The bill passed through the Texas Legislature virtually unopposed. Assuming Governor Abbot signs the legislation, surplus lines insurers domiciled in Texas will for the first time be authorized to conduct business in the state.[1] Cue the excitement! Under current Texas law, only surplus lines carriers domiciled outside the state are permitted to write surplus lines coverage in Texas.

Defining Surplus Lines Insurance

Surplus lines insurance is a segment of the insurance market which allows consumers to buy specifically tailored lines of insurance. To prevent ensuing confusion, the following will clarify some important industry terms.

An “admitted” or “standard” carrier is an insurance company that is licensed by the state department of insurance which authorizes the carrier to write lines of insurance. A surplus lines carrier is often referred to as a “non-admitted” or unlicensed carrier.[2] There is also a distinction between nonadmitted carriers and “alien” insurers (insurers based outside the United States) — these foreign carriers write approximately 20 percent of the U.S. surplus lines premium annually.[3] Lastly, a “domestic” surplus lines insurer is domiciled in a particular state and authorized to write surplus lines policies for risks within and outside that state.[4] The majority of states do not authorize domestic surplus lines insurers to do business in their state of domicile.

Typically, the carrier is licensed in another state. An “eligible” surplus lines insurer is an unlicensed insurer that has met the eligibility requirements established by the state’s insurance code. Most states maintain a list of eligible carriers.[5]

So, when does a consumer rely on a surplus lines insurer? Standard (admitted) insurers may reject or limit coverage when the risk is too high or state law prohibits consumers from securing such coverage. Risks typically written in the surplus lines market fall into three basic categories: (1) nonstandard 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 are willing to provide.[6] These “non-standard” risks could include emerging risks (such as cyber) or catastrophe exposure (such as flood, hurricane or wildfire). Notably, cyberliability coverage is the fastest growing surplus lines business in history as a $1 billion line.[7] When the consumer seeks coverage for this type of risk, the surplus lines insurers are positioned to offer options or solutions that vary from the coverage terms and conditions of the standard market.[8]

While surplus lines insurance practice differs from standard insurance market practice, every state insurance code contains specific regulations governing surplus lines insurance.[9] Additionally, there are risks to the consumer who purchases surplus lines coverage. In Texas, for instance, surplus lines insurance is not backed by the Texas Property & Casualty Guaranty Fund Association which is an association that pays claims in the event the insurer becomes insolvent.[10]

The Current Confusion and Need for New Legislation

Surplus lines regulations and requirements vary from state to state, and compliance with legalities can cause chaos and confusion. This is especially troubling in light of the fact that the surplus lines market is a growing force within the insurance industry. In 2016, nationwide excess and surplus lines premiums totaled $25.9 billion (3.27 percent increase from 2015), according to the 14 stamping offices across the country.[11]

The Surplus Lines Stamping Office of Texas (SLTX) provides information concerning premium and filing totals from 14 offices across the country. The SLTX indicated an increase in premium filings[12] of 3.1 percent (or 3.6 million) over the last year.[13] Texas, Florida and Mississippi accounted for the highest amount of surplus premium totaling around $10.5 billion.[14] Like many states, Texas currently allows a carrier to operate on a nonadmitted basis because an insurer can only be admitted as a licensed carrier in a single state. In other words, the insurer is not permitted to operate as a surplus lines insurer in Texas if it is admitted in Texas. Typically, if an insurer wants to write business and operate as a surplus lines carrier in Texas, and it is already admitted in Texas, it is forced to form another company that is licensed in a different state to write business on a nonadmitted basis.[15] Under this business scheme, problems inevitably arise because states have diverse regulations that govern two important facets of the industry: surplus lines taxes and surplus lines stamps.

Every state charges an insurance premium tax to insurance companies licensed and admitted to do business in that state. The tax is usually accounted for in the policy’s premium. Unsurprisingly, each state may have varying tax rates which can change on a yearly basis. A carrier’s nonadmitted status in a state is charged the same premium tax rate separately in compliance with the visibility requirement under state law.[16] Additionally, states usually require state-specific wording must be stamped onto the policy to clearly indicate (or warn) the consumer it is receiving coverage from a surplus lines carrier. The agent or broker must also abide by state law requiring timely issuance to the insured.[17]

Complying with every state’s laws concerning these aspects of the surplus lines insurance business is complex, costly and presents a risk of legal liability. Ultimately, a surplus lines carrier has more familiarity and knowledge of its own state regulations. Thus, a domestic surplus lines insurer which is authorized to conduct surplus lines business in its state of domicile has an advantage over out-of-state carriers and drive economic competition within the insurance market.

With streamlined regulation and the possibility of increased revenue wrought by more domestic business transactions, states and insurers alike could greatly benefit from enacting new domestic surplus lines insurance legislation — legislation such as House Bill 2492.

The Probable Impact of House Bill 2492

Under the new legislation, Texas (domestic) surplus lines insurers will now have the ability to underwrite Texas-based risks. To qualify as an “authorized” domestic surplus lines insurer, insurance companies must meet certain eligibility requirements and may not concurrently write admitted risks in Texas.[18] Surplus lines procurement requirements and disclosures will still apply to domestically placed risks. Accordingly, the surplus lines insurance market will likely experience heightened competition in surplus lines writing.

The surplus lines insurance segment enables businesses of all industries to innovate and encourages expansion in commerce. With the “unprecedented level of technological advances in products and services in so many different industries, the excess and surplus industry will continue to be the first choice for risk managers and agents as they work to place coverage for new and untested exposures.”[19] Ultimately, domestic surplus lines insurers could increase state revenue and create more job and economic opportunities.[20]

The bill will also attract more insurers into the Texas market. Writing coverage on a surplus lines basis in an insurer’s home state may provide significant advantages. While declination and due diligence requirements must be met, the insurer enjoys freedom from rate and form and may be exempt from many provisions of its home state’s insurance laws.[21] The insurance industry in some states accounts for more gross domestic product of that state than other industries such as construction, transportation or food services industries.[22]

Presently, Texas regulates over 200 surplus lines companies (obviously, none of which are domiciled in Texas).[23] Moreover, there are already hundreds of authorized carriers domiciled in Texas.[24] The new legislation provides ample opportunity for economic growth and efficient use of insurers’ capital and resources. This prediction is further substantiated by the fact that the Texas market for surplus lines insurance is likely to see greater demand by insureds — House Bill 1559 no longer requires declination by admitted market for commercial insureds.[25]

Ten states currently have passed domestic surplus lines insurance legislation similar to Texas House Bill 2492. These states are: Arizona, Arkansas, Delaware Illinois, Louisiana, Missouri, North Dakota, New Hampshire, New Jersey and Oklahoma.[26]

With enactment of House Bill 2492, Texas will join the ranks of states authorizing domestic surplus lines carriers on January 1, 2018.

[1] See H.B. No. 2492, available at http://www.legis.state.tx.us/tlodocs/85R/billtext/pdf/HB02492F.pdf#navpanes=0, supra

[2] AAMG, “Excess and Surplus Lines FAQ’s,” available at http://www.aamga.org/faqs.

[3] NAPSLO, “What is Surplus Lines,” available at https://www.napslo.org/wcm/About/What_is_Surplus_Lines/wcm/About/What_is_Surplus_Lines.aspx?hkey=edaa38ab-2c87-4861-a8ad-aa9b615c620e.

[4] SLTX Surplus Lines Stamping Office of Texas, “Understanding Domestic Surplus Lines Insurers (DSLI),” available at http://www.slsot.org/Press%20Release/DSLI%20FAQ%20with%20Map.pdf.

[5] See, e.g., Surplus Lines Stamping Office of Texas, “Texas Surplus Lines Insurers List with Financial Summaries,” available at http://www.slsot.org/Company/Insurerslist.html.

[6] Supra note 3.

[7] Andrea Wells, Insurance Journal, “What’s Driving Surplus Lines Insurance Growth?” available at http://www.insurancejournal.com/news/national/2015/10/12/384546.htm.

[8] SLA, AAMGA, NSLA, FSLSO, PCI, “Surplus Lines Insurance,” available at http://www.pciaa.net/docs/default-source/industry-issues/the-surplus-lines-primer-2016-v3.pdf?sfvrsn=2.

[9] See, e.g., 28 TEX. ADMIN. CODE § 15.8; Additionally, in 2011, Texas enacted Nonadmitted and Reinsurance Reform Act compliance legislation. The NRRA mandates that beginning July 21, 2011, the insured's home state will be the only state with jurisdiction over surplus lines transactions and the only state that can require a tax be paid by the broker. See 28 TEX. ADMIN. CODE, Chapter 15, et seq.

[10] TEX. INS. CODE § 981.101

[11] PCI, “Surplus Lines Stamping Offices Report Continued Premium Growth in 2016,” available at http://www.pciaa.net/industry-issues/surplus-lines-reform/bulletins-news-releases/surplus-lines-stamping-offices-report-continued-premium-growth-in-2016.

[12] (filings of premium taxes and policies, more information available at http://www.tsla.org/faqs.htm#Q4).

[13] Supra note 11.

[14] Id.

[15] Elisabeth R. Curzan, Insurance Journal, “The Problem with Domestic Excess and Surplus Lines Insurer,” available at http://www.insurancejournal.com/news/national/2014/09/16/340523.htm.

[16] Jonathan Waterman, Ethos Insurance Partners, “Surplus Lines Insurance: Understanding Taxes and Stamps,” available at http://www.ethosinsurance.com/surplus-lines-insurance-understanding-taxes-and-stamps.

[17] Id.

[18] Supra note 1.

[19] James C. Drinkwater, Property Casualty 360°, “Surplus Lines in 2017: Where do we go from here?”, available at http://www.propertycasualty360.com/2016/09/23/surplus-lines-in-2017-where-do-we-go-from-here.

[20] Supra note 4.

[21] Locke Lord, “Louisiana Adopts Domestic Surplus Lines Legislation—More States on the Way,” available at http://www.lockelord.com/newsandevents/publications/2016/02/louisiana-adopts-domestic-surplus-lines-legislation--more-states-on-the-way.

[22] For instance, the state of Illinois insurance industry contributes 3.67 percent of the GDP to the state (higher than many other industries) more information available at http://www.propertycasualty360.com/2016/09/23/surplus-lines-in-2017-where-do-we-go-from-here.

[23] Texas Department of Insurance, available at https://apps.tdi.state.tx.us/sfsdatalookup/StartLookupAction.do;jsessionid=qq93Z20LXrVBtnwnlMQWp1T3Q0VJJpQQXpwRRmMmZ5JJvL71vGfM!354988471?inquiryId=13.

[24] Texas Department of Insurance, available at http://www.tdi.texas.gov/webinfo/colists.html.

[25] H.B. 1559 (a qualified industrial insured’s licensed surplus lines agent will not be required to put forth a diligent effort in attempting to find coverage in the admitted market before seeking coverage in the surplus lines market) more information available at https://legiscan.com/TX/bill/HB1559/2017.

[26] Supra note 4.