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Special Considerations for Excess and Surplus Lines Brokers

June 13, 2019

By: Cynthia Borrelli and Michael J. Morris, Bressler Amery & Ross, P.C.

This article addresses special considerations about surplus lines (SL) brokers like the surplus lines agent’s (SLA) license status, due diligence searches by agents of admitted marketplace prior to a SL placement, and broker disclosure of status of excess and surplus (E&S) insurers as unauthorized. Audit recordkeeping reports and tax collection by SLA are also detailed.

SURPLUS AND EXCESS LINES PLACEMENTS OF INSURANCE are subject to markedly different laws and regulations than those in the admitted marketplace. Excess and surplus lines insurers are not fully licensed and should export coverage from their states of domicile and only through a duly licensed SLA in each jurisdiction. Failure to fully comply with each state’s SL rules can create substantial risk to the insurer, agency, brokerage, and even the insured. All market participants should be well-versed in the rules of SL placements and aware of the numerous potential pitfalls before becoming involved in this market sector.

Surplus Lines Insurance Overview

To those unfamiliar with commercial insurance, a brief introduction to the concept of SL insurance may be helpful. In the ordinary insurance transaction, the insurer is licensed by applicable state insurance regulators to provide the particular lines of insurance coverage sought by the insured policyholder in the states where it resides and/or operates. The insurer is subject to the jurisdiction of the applicable regulators. The regulator’s rules and/or the laws of the applicable states may require the insurer to conform to any of these core regulatory requirements placed on admitted insurers:

  • File and seek approval of its policy forms
  • File and seek approval of premium rates
  • Be subject to the state’s specific capital and surplus requirements
  • Be subject to market conduct examinations

SL insurance is coverage offered by an insurer that is not licensed (i.e., admitted) in the state(s) where the policyholder is located under a specific set of laws and regulations that permit such transactions under the limited circumstances where the policyholder’s insurance needs cannot be met by the admitted insurance market. The policyholder’s insurance needs are in surplus of what is available in the admitted market—hence, surplus lines. Under those limited circumstances, coverage is exported into the state by an out-of-state carrier offering a solution to the insured’s unique coverage needs.

SL insurance coverage has become increasingly common for many reasons, not all of which are immediately evident. There is the obvious benefit that the insurer’s policy forms and rates are only subject to review by the insurer’s domestic regulator, which in many instances is an alien (i.e., international) government agency. The insurer is also subject to severely limited regulatory monitoring, as it forgoes the licensing and admissions process, instead opting for an eligibility process. Because the very concept of SL insurance is predicated on the non-admitted status of the insurer—and, hence, lack of regulatory jurisdiction over the insurer—most SL regulation is directed at the producers who stand in the middle of the transaction between insureds and insurers. A non-domestic regulators’ hook into the transaction is limited to jurisdiction over the producer. Thus, there are generally both extra requirements and enhanced regulatory scrutiny of SL producers.

Surplus Lines Producer Licensing

All persons who sell, solicit, or negotiate a policy of insurance must be licensed as an insurance producer in the relevant jurisdictions, and they must also be licensed to transact the applicable lines of business. This means that to sell a policy of life insurance, the producer must hold life agent and/or broker authority in the state where it is selling the policy. Property, casualty, health, and disability are additional common lines of authority that tie to certain types of products. SL is effectively treated as an additional line of authority that must be held by any producer involved in the transaction, even though SL can refer to a variety of property and casualty coverages that, if offered on an admitted basis, would be covered by the traditional lines of authority.

A licensed producer must hold SL authority to participate in an SL placement. SL authority requires more training and a separate licensure examination. Holding an SL license subjects the producers to added regulatory scrutiny as well because SL licensees are required to do the following:

  • Maintain detailed records of transactions
  • Submit regular reports to state regulators on the SL insurance they placed
  • Be responsible for remitting premium taxes to applicable taxation authorities (described in further detail below)

In short, SL is not a business line in which producers should simply dabble. Producers with clients seeking SL coverage often contact and involve an SL licensee and specialist in the sale of insurance to the client. This expertise is essential.

It is imperative that any person who sells, solicits, or negotiates SL insurance coverage hold a producer license with that line of authority. A property/casualty licensee cannot have a third-party SL broker simply paper the transaction and share commission, while the property/casualty licensee with no SL authority exclusively communicates with the client. SL coverage is distinct from coverage in the admitted market, and it is the SL licensee’s obligation to communicate these distinctions. These distinctions can include, but are not limited to, the following:

  • The obligation of the SL licensee to collect and remit premium tax
  • The lack of regulatory oversight of policy forms and premium rates
  • The absence of the backstop of state insurance guaranty association coverage1

For this reason, regulators will pursue enforcement action against producers who engage in sales practices that separate the SL licensee from the insured.

Non-Admitted & Reinsurance Reform Act

While SL placements can be complex from a regulatory compliance standpoint in comparison to admitted market transactions, the producers’ compliance obligations were simplified by the Non-Admitted & Reinsurance Reform Act of 2010 (NRRA), passed by Congress as part of the DoddFrank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). A primary effect of the NRRA was to limit the obligation of SL producers to collect premium taxes on SL policies to a single state’s premium tax regime. This was a significant undertaking because SL policyholders often are large, sophisticated, multistate (if not multinational) entities with insured business operations across numerous jurisdictions. Additionally, a primary function of SL regulation is to ensure the existence of a mechanism by which states can collect premium tax revenue on policies placed with nonadmitted insurers. Following passage of the NRRA, only the insured’s home state regulator’s SL laws and regulations apply to the collection of premium taxes on the transaction, despite the fact that most premiums on the policy may be allocable to risks located in different states. The NRRA, as drafted, envisioned states’ entry into one or more multistate compacts by which home states that collected 100% of the premium tax revenues on a policy with exposures across multiple states would allocate and true-up premium tax receipts such that the home state taxation authority did not collect a windfall share of premium taxes on policies written to large multistate insureds. Several years later, no significant multistate compact has taken root, and although some states have entered limited agreements with specific other states, the national compact foreseen by drafters of the NRRA does not exist.

Notwithstanding the interesting and unforeseen tax policy consequences of the Dodd-Frank Act, one major and net positive change resulting from the NRRA is that identifying the applicable state rules for collecting premium taxes on an SL transaction is now much easier. The NRRA defines home state as one of the following:

  • The state in which an insured maintains its principal place of business or, in the case of an individual, the individual’s principal residence.
  • If 100% of the insured risk is located out of the state referred to in the clause above, the state to which the greatest percentage of the insured’s taxable premium for that insurance contract is allocated.

When contemplating engaging in an SL transaction with an insured, producers must be able to identify the insured’s home state so that the applicable set of state premium tax collection and remittance rules and procedures can be followed.

Obligations of the Originating Producer and Surplus Lines Producer

Assume that a licensed insurance producer has a customer with unique coverage needs. The producer believes that the SL market may be better suited for this particular customer’s coverage. What must the producer do to place the customer with an SL carrier?

Good Faith Effort to Find an Admitted Carrier

As a baseline requirement, most states require the originating producer to undertake a good faith effort first to place the customer with a carrier in the admitted market. To demonstrate such good faith effort, in the ordinary course, a producer must complete an affidavit or certification attesting to efforts to place coverage in the admitted market. States can require producers to contact as many as five admitted carriers authorized to write the lines of insurance sought by the customer and obtain declinations to write the customer’s requested coverage before the producer is permitted to begin placement efforts in the SL market.

An originating producer without SL authority should make diligent efforts to contact admitted insurers before handing the customer off to an SL licensee for placement in the SL market. A producer holding both the underlying lines of authority for the coverage sought by the customer as well as SL coverage may be tempted to proceed directly to shopping the SL market to meet the customer’s needs. This producer must still undertake the good faith search of the admitted market required by applicable state law.

State Affidavit or Certification Forms

The affidavit and/or certification form and the good faith efforts to place in the admitted market the form represents are critical to avoiding regulatory sanctions. Each state’s certification or affidavit form will include the following:

  • Space to identify the names of the insurers contacted
  • The representatives of the insurer with whom the producer spoke
  • Identification of the reason for declination of coverage

All portions of this form must be completed accurately and truthfully—producers and insurers cannot have standing agreements or arrangements for declination of coverage. Such arrangements are likely to be exposed during regulatory audits or market conduct examinations and will result in adverse enforcement activity for producers and carriers alike. Moreover, when state regulators conduct audits of SL activity, the affidavits/certifications of good faith efforts will be at the top of the list of requested documents. Regulators will not hesitate to make inquiries of the identified contact persons if violations are suspected.

Check the Applicable State’s Exportable List and White List

A notable and significant exception to the general rule that producers must engage in a diligent search of the admitted market before offering an insured SL coverage is that most states offer a list of specific lines of coverage for which the state has determined that there is no adequate admitted market, and such coverages may be exported to the SL market without a diligent search of the admitted market. This list is known as the exportable list in most states. The breadth of coverages included on such exportable lists can vary significantly from state to state. Under many states’ rules, if a producer is relying on the exportable list to place an insured in the SL market, the SL policy in question must be boldly marked exportable. States with exportable lists generally have an administrative process in place to regularly review what types of coverage are not readily available in the admitted market and hence should be included on the exportable list. SL market participants should regularly review and check for updates to the exportable list as it can certainly save significant time and expense.

Once the effort to place in the admitted market is complete or the producer has determined that the coverages sought by the insured are all on the applicable state’s exportable list, and an SL producer is ready to present non-admitted coverage to the customer, the SL producer must identify those SL carriers that are eligible to write such coverage. Even though the fundamental concept of SL insurance is that the carrier is not licensed or otherwise directly regulated by the state in which the insured is located, many states have chosen to impose limited financial solvency supervision and deposit requirements on SL insurers seeking to write business in the state. While the requirements for an insurer to gain approval to write SL insurance in a state are beyond the scope of this article, it is critical for the SL producer to be aware of whether the states in which the insured is located have such requirements and whether the carriers the producer has shopped have previously complied. Many states may have a voluntary list of state-authorized SL insurers generally known as a white list, which producers can consult prior to making SL placements to ensure proper authorization. If the insurer has not previously written an SL policy in the state and/or is not on the white list, the producer may be able to work with the insurer to supply the state with certified financial statements demonstrating the solvency of the insurer and/or evidence of sufficient deposits to qualify as an eligible insurer.

Ensure Delivery of Applicable Disclosures to Insured

Most states’ laws require a disclosure form be provided to the customer indicating that SL policies have the following disadvantages in that they are:

  • Not filed nor approved by the applicable state regulator
  • May have different terms and conditions than would otherwise be allowed for an admitted carrier’s policies
  • Generally not afforded guaranty fund coverage in the event of insolvency of the SL insurer

The SL producer is generally required to obtain and then retain a customer-signed disclosure form. Many of these same disclosures may be included in a required stamp on the SL policy, but at minimum, the fact that the policy is surplus line (i.e., non-admitted) and not subject to guaranty fund protection will be included in the stamp.

Collection of Premium Taxes

SL producers are required by applicable state law to collect premium taxes from insureds on policies placed in the SL market. The SL producer is generally required to collect from the policyholder the effective rate of premium tax in effect in the insured’s home state for the entire premium charged under the policy following NRRA and state legislative enactments. The SL producer must diligently document funds collected from the insured and regularly remit receipts of such premium tax dollars to the applicable state taxing authority.

Abide by Higher Standard of Record-keeping

SL producers are required to maintain a higher standard of record-keeping than ordinary producers. SL producers are generally required to assign a case or file number to each prospective SL coverage purchaser, must attach this unique file number to each document produced during the placement, and must maintain records of such placement for a state-specified number of years. The SL producer’s file on the placement must include all of the following documentation:

  • Good faith search efforts and admitted insurer declinations
  • Disclosure forms obtained from the insured
  • Any commission sharing arrangement or fees charged to the originating producer or insured (if permitted by applicable state law)
  • Taxes collected and remitted
  • Communications with the insured

Such documentation should be kept by the SL producer in a readily accessible, and preferably easily searchable, electronic format, such that files can be produced to a regulator on demand. Failure to maintain records in an organized format can quickly lead a regulator to expand the scope of an inquiry or audit.

Comply with Limitations on Commission Sharing and Fees

Producers and their employers should be mindful of limitations on commission sharing and fees charged by SL producers due to the referral relationships that frequently exist among producers for the placement of SL coverage. In a referral arrangement where the SL producer will earn commission on the sale of a policy to an insured referred by another producer, to share in the commission the originating producer must generally be licensed as producer in the applicable jurisdictions with authority to write the lines covered by the SL policy. Most states’ laws will prohibit, for example, a licensed life and health (only) agent from sharing commission with an SL agent on exported property/casualty coverage. Additionally, many SL producers attempt to charge fees for the rather substantial efforts required of them in the placement of SL coverage. Some states permit SL producers to charge such fees subject to obtaining signed disclosures from the insured and/or strict limitations on the amount of fees that can be charged, while other states may prohibit such fees.

Additional Considerations

The compliance concerns noted thus far do not mention procedures required by a particular state’s SL stamping office. At present, 15 states maintain SL stamping offices that effectively function as compliance-ensuring clearinghouses for SL transactions, including Arizona, California, Florida, Idaho, Illinois, Mississippi, Minnesota, Nevada, New York, North Carolina, Oregon, Pennsylvania, Texas, Utah, and Washington.

Stamping office refers to printing the disclosure to the policyholder on the face of the policy form that the policy is written by a non-admitted insurer. Many stamping offices have adopted this disclosure to ensure that each transaction has generally complied with the requirements described herein and elsewhere. For producers transacting SL business in these states, it is imperative to consult with and review the procedures of the applicable stamping office. In the other 35 states, the compliance of each transaction with applicable SL law is primarily the responsibility of the SL producers and is self-enforced. Hence, a robust internal compliance and selfmonitoring function is imperative for agencies and brokerages to avoid significant compliance pitfalls and potential adverse enforcement action.

Surplus Lines Placement Compliance Flowchart

The following Surplus Lines Placement Compliance Flowchart provides a chronological visual depiction of key events in the course of a compliant sale of a surplus/excess lines insurance policy, depicting how an insurance producer may identify a customer’s need for insurance coverage that is not necessarily available in the admitted (i.e., licensed) insurance market, and may therefore turn to the market of coverage available from eligible non-admitted insurers through a licensed surplus lines producer. The flowchart highlights the diligent efforts that must be undertaken by the producer with the primary relationship with the customer and the surplus lines producer, and further delineates the point at which substantive engagement with the customer regarding sale, solicitation, and negotiation of surplus lines insurance coverage must be handled by the surplus lines-licensed producer.


To find this article in Lexis Practice Advisor, follow this research path:

RESEARCH PATH: Insurance > Managing Insurance Representatives > Checklists

Cynthia Borrelli is the head of the Insurance Law Practice Group at Bressler, Amery & Ross, P.C. Cynthia brings three decades of knowledge and insight to the firm and her clients. She provides quality legal advice relating to property-casualty and life, annuity and health, managed care, disability insurance, and reinsurance matters, with particular emphasis on insolvency regulation. Michael J. Morris is an associate in the firm’s Insurance and Business practice groups and concentrates his practice on representing and advising insurance industry clients in the handling of regulatory matters.

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1. Except in New Jersey, where there is a Surplus Lines Insurance Guaranty Fund for limited lines. See N.J. Stat. § 17:22-6.70 et seq.