The rise of the domestic surplus lines insurer
To date, nearly half of all states have passed DSLI legislation.
With the increasing demand for niche, specialty insurance products driven in part by the “InsurTech” wave permeating the insurance underwriting, distribution and claims handling components of the commercial and personal lines insurance industry, excess and surplus lines insurance has become more popular than ever. Surplus lines insurance companies are not typically “admitted” in the U.S. jurisdictions where they place insurance policies, but rather are “eligible” to write insurance pursuant to the provisions of the Nonadmitted and Reinsurance Reform Act of 2010 (NRRA) and as further regulated under applicable state insurance law.
Traditionally, there have been two methods for an insurance company to gain surplus lines eligibility. One method, with respect to alien (non-U.S.) insurance companies is to obtain inclusion on the Quarterly Listing of Alien Insurers maintained by the National Association of Insurance Commissioners (NAIC). The second option is to become licensed as an admitted insurer in at least one U.S. jurisdiction whereby such company may write surplus lines insurance business in all other states as long as certain eligibility criteria are satisfied.
Historically, a problem that U.S. companies have faced, however, is that being licensed as an admitted insurer in a domiciliary state precludes writing surplus lines insurance business in that state. Fortunately, during the last 10-15 years, some states have begun embracing the concept of a “domestic surplus lines insurer” (DSLI) whereby an insurance company is licensed in its domiciliary state solely to transact surplus lines insurance business. To date, nearly half of all states have passed DSLI legislation. This article discusses some of the key benefits of pursuing the formation or purchase of a DSLI, as well as some of the challenges associated therewith.
Avoidance of multiple surplus lines insurance companies
Perhaps the principal reason to establish a DSLI is to prepare for a nationwide offering of a surplus lines insurance product. In the old days, to write surplus lines insurance business in all states, two insurers were required to be established; one in State A that became eligible to write surplus lines insurance in all other states, and one outside of State A specifically to write surplus lines insurance in State A. DSLI legislation solves this glaring inefficiency by allowing the establishment of one DSLI to service the E&S market nationwide.
Some flexibility on DSLI choice of domicile
There is a fair degree of flexibility as to where a DSLI may be domiciled, but states do differ on their requirements. For example, Illinois generally requires that the DSLI maintain its principal office in the state (see 215 ILCS 5/8), whereas, some other states, such as Delaware, only require a registered office that need not be the DSLI’s principal place of business (see 8 Del. C. 1953, §141). Similarly, some states impose director or incorporator residency requirements on DSLIs. Other factors considered under applicable states’ laws when determining where to domesticate a DSLI include investment standards, requirements for dividend payments, and existence of redomestication laws.
An often overlooked issue is whether the state where a DSLI’s activities are actually conducted permit such activities irrespective of whether the DSLI is domiciled in such state. For example, in California, which does not have a DSLI law, certain activities of a surplus lines insurer, including the establishment of underwriting guidelines, must occur outside the state, although some activities (mainly administrative and unrelated to underwriting) can be accomplished through the offices of an affiliated domestic California insurer. See Bulletin 96-4 and Cal. Ins. Code §1761. New York has a number of similar restrictions as well. See N.Y. Ins. law §2117.
Expeditious speed to market
While DSLIs generally utilize the same license application (the UCAA) as do their admitted carrier counterparts, DSLIs have a quicker path to launch. As an initial matter, because surplus lines insurance policies are generally exempt from the rate and form filing requirements applicable to admitted insurers, the domiciliary jurisdiction will not need to approve a product as part of the application process or otherwise before commencement of business. As a result, some states can approve a DSLI application within as little as two to three months.
There are some jurisdictions, however, that require an insurance company demonstrate success in the admitted insurance market first. For example, Wisconsin’s DSLI law notes that “[a]n insurer domiciled [and licensed for admitted insurance products] in this state may submit to the commission an application … to provide surplus lines insurance as a domestic surplus lines insurer.” Wis. Stat. §618.41. As such, because a DSLI must technically first obtain a non-DSLI certificate of authority in some states and then subsequently convert to a DSLI, a few jurisdictions like Wisconsin occasionally require an insurer prove success over time as an admitted carrier before granting a DSLI conversion. Some other domiciliary jurisdictions have been known to impose strict gross premiums written to policyholders’ surplus ratio limitations on DSLIs as well. It should also be noted that no matter the jurisdiction, a DSLI must still place all business through licensed surplus lines brokers.
Quick expansion into other states, but ‘white lists’ linger
DSLIs, by virtue of their eligibility status under the NRRA, need not obtain licenses in other states; rather, eligibility is automatically achieved through compliance with the NRRA and certain terms of the NAIC’s Non-Admitted Insurance Model Act (NIMA). Therefore, in theory, a DSLI can start writing nationwide the day it obtains its DSLI license in its domiciliary jurisdiction.
However, a few practical hurdles do remain. For example, each state can set its minimum capital and surplus requirements for DSLIs. While most states set this number at $15 million, some states require additional funds; for example, New York’s capital and surplus standard is $48 million, which would apply to a DSLI writing business in the state even if the DSLI is domiciled in a state with a lower capital and surplus threshold. In addition, many states still maintain anachronistic surplus lines insurance company “white lists” or “eligibility lists” that were originally used to afford eligibility to surplus lines insurers in the pre-NRRA days. While some states like New York and California have made their white lists voluntary, a number of states still require surplus lines insurers, including DSLIs, obtain inclusion on their eligibility lists, although such states are arguably preempted by the NRRA from doing so.
DLSIs cannot write all coverage lines but have flexibility to reinsure risks
Even though DSLIs are licensed in their domiciliary jurisdictions, DSLIs are nonetheless usually restricted to writing the same kinds of coverage as any other eligible surplus lines insurer in the state. For example, in Illinois, “[f]or the purposes of the [NRRA], a [DSLI] shall be considered a nonadmitted insurer” and, accordingly, “must agree not to issue a policy designed to satisfy the financial responsibility requirements of the Illinois Vehicle Code, the Workers’ Compensation Act, or the Workers’ Occupational Diseases Act.” 215 Ill. Comp. Stat. 5/445a. Similarly, DSLIs are prohibited from writing accident and health coverages, workers’ compensation insurance, financial guaranty insurance as well as a number of other lines of coverage in a multitude of states. See, e.g., N.Y. Ins. Law §2105(A).
An open question in some states is whether a reinsurer licensed as a DSLI is sufficient for a ceding company to take credit for reinsurance against its statutory liabilities. In Missouri, for example, “[c]redit shall be allowed … for reinsurance ceded to a Missouri [DSLI].” Mo. Code Regs. Ann. tit. 20, §200-6.700. However, the foregoing only expressly relates to a DSLI domiciled in that state; as DSLIs are not licensed in non-domiciliary jurisdictions, ceding companies domiciled in such other jurisdictions cannot necessarily take credit for reinsurance based upon a reinsurer DSLI’s eligibility status alone. Rather, the DSLI may need to pursue another avenue to allow a cedant to take credit for reinsurance, such as by obtaining accredited reinsurer status, posting collateral in trust or through letters or credit, allowing the ceding company to withhold funds or even obtaining certified or reciprocal reinsurer status.
Legislative gaps being addressed
The NAIC is working on revisions to the NIMA to help better address the ability for DSLIs to write surplus lines business nationwide from a legal perspective. A recent exposure draft promulgated by the Surplus Lines (C) Task Force clarifies that a DSLI would be “authorized” to write certain lines of insurance on a surplus lines basis and that any domestic insurer may be designated a DSLI upon authorizing resolution by its board of directors and evidence of at least $15 million in capital and surplus. This proposed change would help address the concern that the NIMA requires, as a condition to writing surplus lines insurance, that an insurer be “authorized to write the type of insurance in its domiciliary jurisdiction … .” We certainly expect in the coming months and years for more states to adopt DSLI legislation or otherwise expand current DSLI legislation to help foster and grow the DSLI marketplace.
Zachary Lerner is a partner at Locke Lord.