Increasingly, the world of insurance distribution has become highly specialized, utilizing technology and a multitude of parties to reach customers worldwide. The surplus lines industry is no exception. Surplus lines brokers are not merely intermediaries between insureds and eligible surplus lines insurers that may be interested in servicing a specialty insurance market. Rather, surplus lines brokers increasingly work with retail insurance producers who themselves need not necessarily hold surplus lines broker licenses but nevertheless bring together the insurance customer and the surplus lines broker. Producers will even take over some of the surplus lines broker's duties, such as the collection of premium tax or the completion of the "diligent search" of admitted insurers on behalf of the surplus lines broker.
Yet, the term "surplus lines broker" is itself a bit of an oxymoron. Under the laws of every state, any placement of surplus lines insurance must utilize the services of a surplus lines producer, and many states specifically refer to this intermediary as a surplus lines "broker." This requirement, of course, will require surplus lines insurers that wish to bring their products to market to engage with a surplus lines broker. This relationship will sometimes begin to look like a traditional insurer-agent partnership. Indeed, a growing number of nonadmitted insurers have been engaging surplus lines brokers in order to legally distribute their products but, perhaps paradoxically, the fiduciary duties owed by these brokers to their customers may cause inherent conflicts of interests. So then, can a surplus lines broker act in an agent capacity on behalf of a surplus lines insurer, notwithstanding being labeled as a broker under applicable law?
The answer is not as simple as putting a label on it. Below we take a look at a few state examples, as well as the role of a managing general agent in a surplus lines transaction.
On June 16, 2020, the Excess Line Association of New York (ELANY) (empowered under New York law to regulate surplus lines business in numerous ways, including stamping excess line insurance documents and reviewing eligibility of unauthorized insurers) published a new issue of ELANY Elaborates, What's In A Name (the EE) which eloquently discusses New York's view on the role of surplus lines agents. The simple rule in New York is that they don't, and cannot, exist. In particular, the EE notes that "[i]nsurance agents have no role in excess [surplus] line placements." But the rule comes with pretty big caveats that certainly give surplus lines brokers an "agent" feel. For example, N.Y. Ins. Law § 2118(f) allows surplus lines brokers to be granted binding authority on behalf of a surplus lines insurer, provided that the binding authority agreement is filed with ELANY.
It would seem to follow that if a surplus lines broker can receive binding authority from a surplus lines insurer, the binding authority agreement must then be subject to pretty strict standards in order to avoid an "agent" classification, correct? Well, not particularly. For starters, the EE and past ELANY guidance suggest that in order to avoid being designated as an impermissible agent under a binding authority agreement, the surplus lines broker needs to . . . not call itself an agent. Moreover, N.Y. Ins. Law § 2118(f) expressly deems the surplus lines broker "an agent of the insurer" for issuing notices of cancellation. The EE plainly recognizes that surplus lines broker activities may, in practice, "certainly sound like the duties of an agent."
Nevertheless, there is an important consideration when determining if a surplus lines broker impermissibly acts as an agent. Surplus lines brokers still, first and foremost, owe duties to the insured over the insurance carrier. The EE notes that granting a surplus lines broker binding authority or otherwise allowing it to engage in agency activities facilitates "the transaction of excess [surplus] lines business, but does not chang[e] the legal duty of loyalty an excess [surplus] line broker owes to an insured." As such, a surplus lines insurer and its surplus lines broker counterpart should not simply assume that they can act as one, cohesive unit with unified interests as the broker will ultimately owe its fiduciary duty to the underlying insurance customer and, therefore, it may be prudent to identify that the surplus lines broker owes fiduciary duties to its insured customers in an applicable binding authority agreement.
California is perhaps the strictest state when it comes to the regulation of surplus lines insurance. For example, a number of states generally allow for the presence of surplus lines insurers, but California expressly prohibits the transaction of any surplus lines in the state except through a surplus lines broker, subject to narrow exceptions under applicable law.
'Surplus lines brokers still, first and foremost, owe duties to the insured over the insurance carrier.'
But even if a surplus lines broker can transact surplus lines business within California, the activities it can actually perform in the state are themselves limited to many traditional "broker" functions. The primary guidance is derived from California Bulletin 96-04 (the "California Bulletin"). While nearly a quarter-century old, the California Bulletin remains mostly in full force and effect and, among other things, largely bars surplus lines brokers from acting in an agent capacity.
For example, the CA Bulletin notes that "[t]he ultimate decision as to rate setting and establishing underwriting guidelines must be performed by the nonadmitted insurer outside the State of California." The CA Bulletin also generally prohibits the compilation of surplus lines insurance policy forms in the state or otherwise issuing a surplus lines insurance policy in the state (although the surplus lines broker can of course deliver the policy to the insured when issued by the surplus lines insurer from outside the state). Further, the CA Bulletin bars the performance of "certain key management functions" by a surplus lines broker on behalf of a nonadmitted insurer, including placing reinsurance, managing investments, handling payroll and personnel matters and adjusting disputed claims (although obtaining a separate insurance adjuster license may permit the surplus lines broker to adjust disputed claims as well.)
If the foregoing sounds like a prohibition on a surplus lines broker acting in an "agent" capacity, that's pretty much the intent of the CA Bulletin. Indeed, the EE notes that "California does not even permit surplus lines risks to be bound within the state by insurers or producers." Yet, like New York, California does allow surplus lines brokers to push the envelope just a little bit.
For example, California also allows surplus lines brokers to be granted binding authority, and the CA Bulletin allows for surplus lines brokers to be affiliated with a surplus lines insurer, provided conflicts of interests are mitigated, specifically the avoidance of having officers and salaried employees of the surplus lines broker also hold similar roles with the non-admitted insurer.
What About Managing General Agents?
As a legal matter, most states do not recognize the term "managing general agent" or "MGA" in the context of surplus lines transactions. In particular, MGAs are usually defined under applicable state law as persons who (i) manage all or part of the insurance business of an insurer, (ii) produce premiums more than 5% of the insurer's policyholder surplus in any given year or calendar quarter, and (iii) either adjust claims of the insurer or binds reinsurance therefor. Typically, the term "insurer" is defined as an authorized or licensed insurance company, as opposed to surplus lines insurers that are typically deemed eligible in the state but are neither licensed nor authorized.
Yet, from a practical standpoint, the term "MGA" is often loosely used to refer to a wholesale agent of an insurer that helps facilitate the underwriting and binding of insurance and its placement through its retail producer counterparts. So then, can these MGA-esque entities be involved in surplus lines transactions? The short answer is yes, but with caveats. First, these entities must also be careful not to trip local laws, such overstepping California's bar on surplus lines activities occurring within the state other than permissible surplus lines broker activities.
Second, many state surplus lines laws can be interpreted to require wholesale agents themselves hold surplus lines broker licenses in order to facilitate the placement of surplus lines business, even if the retail surplus lines broker completes the legally-required surplus lines procedures for the placement of the policy as they too are engaging in the sale of insurance into the insured's home state.
The rise of insurtech and the app-based modes of insurance distribution have resulted in specialized means of reaching consumers and insurance carriers alike. The desire to quickly enter the surplus lines market - one that is largely exempt from state rate and form filing and approval standards - is often efficiently achieved through the utilization of a knowledgeable and connected insurance producer that can use its platform to facilitate binding and distribution of surplus lines insurance policies. But, while some states do recognize the concept of a surplus lines agent, many states do not have a place for agents within their surplus lines frameworks. It is incumbent on insurance producers and surplus lines carriers involved in the placement of a surplus lines insurance policy to study the laws of the state where a policyholder resides to determine how to proceed when establishing a business partnership.
This article is republished from Insurance Journal Magazine.
About Zach Lerner
Zach Lerner is a partner in the Regulatory and Transactions Insurance Practice Group in the New York office of Locke Lord LLP. The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or any of its or their respective affiliates. This article is for general information purposes only and is not intended to be and should not be taken as legal advice.