Order Code RS22506
Updated October 19, 2006
CRS Report for Congress
Received through the CRS Web
Surplus Lines Insurance:
Background and Current Legislation
Baird Webel
Analyst in Economics
Government and Finance Division
Summary
In general, insurance is a highly regulated financial product. Every state requires
licenses for insurance companies and most closely regulate both company conduct and
the details of the particular insurance products sold in the state. This regulation is
usually seen as important for consumer protection; however, it also creates barriers to
entry in the insurance market and typically reduces to some degree the supply of
insurance that is available to consumers. Rather than requiring consumers who may be
unable to find insurance from a licensed insurer to simply go without insurance, states
have allowed consumers to purchase insurance from non-licensed insurers, commonly
called nonadmitted or surplus lines insurers. While, theoretically, any sort of insurance
could be sold by a surplus lines insurer, most such transactions tend to be for rarer and
more exceptional property/casualty risks, such as art and antiques, hazardous materials,
natural disasters, amusement parks, and environmental or pollution risks.
Although surplus lines insurance is sold by insurers who do not hold a regular state
insurance license, it is not unregulated. The sale of this insurance is regulated and taxed
by the states largely through requirements placed on the brokers who usually facilitate
the insurance transactions. The varying state requirements for surplus lines insurance
has led to calls for greater harmonization between the states’ laws and for federal
intervention to promote uniformity. Such federal intervention is the central part of H.R.
5637, the Nonadmitted and Reinsurance Reform Act of 2006, introduced by
Representative Ginny Brown-Waite. After committee action in both the Financial
Services and Judiciary Committees, the bill passed the House 417-0 under Suspension
of the Rules on September 29, 2006. It has not been scheduled for action in the Senate.
Although not specifically aimed at surplus lines insurance, the National Insurance Act
of 2006 (S. 2509 and H.R. 6225) could greatly affect surplus lines insurers by
introducing a federal charter that would allow such insurers to essentially bypass state
regulation altogether. Senator John Sununu introduced S. 2509 on April 5, 2006, and
Representative Ed Royce introduced H.R. 6225 on September 28, 2006. Neither bill has
been directly acted on by the committees of jurisdiction. This report will be updated as
warranted by future legislative events.
Congressional Research Service ˜ The Library of Congress

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Background on Insurance Regulation1
Unlike the other primary sectors of the financial services industry, banking and
securities, insurance is regulated almost exclusively at a state level. Although the
Supreme Court has ruled that Congress has the power to regulate insurance, the 1945
McCarran-Ferguson Act2 devolved this power to the individual states and this was
specifically reaffirmed in the 1999 Gramm-Leach-Bliley Act.3 It has long been
recognized that some uniformity in insurance regulation is desirable as it allows greater
efficiencies in the insurance market. This argument has grown stronger as insurers
compete more with banks and securities firms, who do have uniform regulation, and as
capital markets have become more globalized. Insurers rely increasingly on global
capital markets both as a place to invest premiums that are not quickly paid out in claims
and as a source of funding, particularly after a catastrophe that causes large losses.
Recognizing the need for relatively standardized regulation, the individual states
have developed model rules and regulations through the National Association of
Insurance Commissioners (NAIC) and the National Conference of Insurance Legislators
(NCOIL). Harmonization efforts by the states, however, have been hampered by the lack
of authority invested in either the NAIC or NCOIL. Although both are made up of public
officials, both organizations themselves are voluntary, nongovernmental associations and
can not require that any states enact their models. As consequence, there is significant
variation in how different states regulate insurance and there have been various calls for
Congress to act through a federal charter or some other kind of federal intervention.
Regulation of Surplus Lines Insurance
Surplus lines insurance regulation differs both in the substance of that regulation and
in who is the primary focus of the regulation. In regulating regular insurance transactions,
much of the state’s focus is on the insurer itself. States have specific requirements for
financial solvency, including how much capital an insurer must hold and how the insurer
can invest this capital. In cases of insolvency, states have established guaranty funds,
funded by the rest of the insurers in the marketplace, to pay off the insolvent insurer’s
claims. The states also regulate both the substance of an insurance policy and the price
of that policy, with many states requiring specific state approval before policy terms or
prices can be changed. In surplus lines insurance, states have some oversight on the
solvency of insurers, generally requiring that financial information be filed by surplus
lines insurers in order to judge whether or not the insurers are sufficiently capitalized.
There is, however, no participation in state guaranty funds by surplus lines insurers, nor
state oversight of policy terms and prices charged.
1 See CRS Report RL32789, Modernizing Insurance Regulation, by Baird Webel, for a more
complete overview of insurance regulation.
2 15 U.S.C. Sec. 1011 et seq.
3 P.L. 106-102, 113 Stat. 1338.

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Most surplus lines transactions revolve around an intermediary, typically an
insurance broker, many of whom specialize in the unusual risks that require such
coverage. Because they have such little oversight on surplus lines insurers themselves,
the states generally focus their attention in regulating surplus lines insurance on the these
intermediaries. To operate as a surplus lines broker, most states require an additional
license on top of the license required for insurance brokers in general. To retain this
license, surplus lines brokers are required to take various steps with surplus lines
transactions that are not required in regular insurance.
The first step in a surplus lines transaction is generally a state-required “diligent
search” of the regular insurance marketplace to establish that there is no licensed insurer
available to offer the required coverage. Typically, this requirement is satisfied by having
some number, usually three to five, licensed insurers decline to offer coverage with the
broker being responsible for an affidavit describing the search and certifying that no
coverage is available in the licensed market. In some cases, states have established lists
of coverages that are almost always placed in the surplus lines market and thus are exempt
from the diligent search requirements.
Once the consumer’s eligibility to use the surplus lines marketplace is established
following whatever state rules are in place, the broker would then approach various
surplus lines insurers seeking the desired coverage at a suitable price. At this point, while
the consumer is outside of the regular insurance market, the states generally continue to
establish standards to protect consumers against surplus lines insurers who might be
unable to pay claims that are made. Some states establish a list of eligible surplus lines
insurers, and state-licensed brokers are only allowed to transact with insurers on that list.
Others take the opposite approach and issue a list of ineligible insurers that may not be
used by state-licensed brokers. A third approach is to make the brokers responsible if a
surplus lines insurer refuses to, or is unable to, pay legitimate claims; this is seen as
causing the broker to be more cautious as to which insurance companies are used. States
also generally require that brokers provide specific disclosure statements to clients
purchasing surplus lines insurance detailing that the insurance is not subject to the same
regulatory oversight as insurance bought from state licensed insurers.
All states levy specific premium taxes on insurance and generally require a licensed
insurer to collect and remit these taxes as a condition of licensure. With the absence of
licensure requirements on surplus lines insurers, the requirement to remit taxes is placed
on the state-licensed broker. The precise amount of the tax depends on individual state
laws. The situation becomes somewhat unclear, however, when the consumer, the broker,
or the insured property are in different states. Such a multi-state situation requires
apportioning the premium taxes among the different states. State laws, however, differ
significantly not only on the amount of such taxes but also on what exactly is to be taxed
and how that tax should be apportioned among the multiple states.
The Surplus Lines Marketplace
The property/casualty insurance market has been marked by the so-called insurance
cycle, a tendency to have alternating periods of high prices and short supply (“hard
markets”) with periods of low prices and plentiful supply (“soft markets”). The size of

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the surplus lines market has been significantly affected by these cycles, with surplus lines
growing faster than the entire market in hard markets and more slowly in soft markets.
In the past 30 years, there have been generally hard markets in four periods: the late
1970s, the middle1980s, the early 1990s, and the early 2000s. Growth in net premiums
for U.S. professional surplus lines insurers in three of these four periods has reached 70%
at the peak and then dropped to nearly zero or below within a few years afterwards.4 In
2004, surplus lines premiums for commercial insurance totaled $33.0 billion, 16.4% of
the total commercial lines premiums of $262.1 billion.5 The surplus lines market in the
United States has two large groups, AIG and Lloyd’s of London, which have 21.3% and
13.9% of the market. The next largest is Zurich/Farmers with 4.9% market share, which
is followed by a number of companies in the 2% to 4% range. The 10th largest company
has a 2.5% share, while the 20th has a 1% market share.6
Current Legislation
Three primary pieces of legislation in the 109th Congress might significantly affect
regulation of surplus lines insurance: S. 2509 and H.R. 6225, both entitled the National
Insurance Act of 2006, and H.R. 5637, the Nonadmitted and Reinsurance Reform Act of
2006.
S. 2509 and H.R. 6225
The Senate version of the National Insurance Act of 2006 was introduced by
Senators John Sununu and Tim Johnson on April 5, 2006, and was referred to the Senate
Banking, Housing and Urban Affairs Committee. The committee held two hearings on
general insurance regulation in July 2006, where the bill was discussed, but has yet to
schedule direct action on S. 2509. While not directly addressing surplus lines insurance,
the bill could potentially have a significant impact on the operation of the current surplus
lines market. S. 2509 would create a federal charter for insurers and insurance
intermediaries and give the choice of operating under the federal system instead of the
state system. Holders of a federal license would be able to operate throughout the United
States without separate state insurance licenses. In addition, the National Insurance Act
would preempt state laws requiring product and price approvals for federally chartered
insurers. A federal charter as envisioned in S. 2509 would thus offer many of the same
freedoms currently enjoyed by surplus lines insurers, namely, the ability to sell insurance
across the country without individual state licenses and with product and rate flexibility.
At the same time, S. 2509 would offer the possibility of avoiding the conflicting state
regulatory system that surplus lines insurers currently point to as a significant burden.
The House version of the National Insurance Act of 2006, H.R. 6225, was introduced
by Representative Royce on September 28, 2006. It was jointly referred to the House
Financial Services and House Judiciary Committees. While not identical to S. 2509, the
bill is essentially similar and would create the same dual regulatory system with both
4 Excess and Surplus 2005, A.M. Best Special Report, Sept. 2005, pg. 19
5 Ibid, p. 7.
6 Ibid, p. 8.

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federal and state charters available for insurers and insurance intermediaries. No
committee hearings have been held or scheduled on H.R. 6225.
Passage of either version of the National Insurance Act of 2006 would likely not,
however, offer a uniformly positive federal option from the viewpoint of surplus lines
insurers. Unlike current state laws for surplus lines insurers, insurers with a federal
charter would be required to participate in state guaranty funds. In addition, federally
chartered insurers would likely have more stringent financial oversight than the states
currently undertake with surplus lines insurers. It is difficult to predict whether large
numbers of surplus lines insurers would actually opt out of the state system until the
details of a federal chartering system were put in place.
H.R. 5637
The Nonadmitted and Reinsurance Reform Act of 2006 was introduced by
Representative Ginny Brown-Waite with 16 cosponsors on June 19, 2006. It was referred
to the House Financial Services Committee where hearings were held and the bill marked
up. The bill as amended was ordered to be reported on July 26, 2006, and reported
(H.Rept. 109-649) on September 12, 2006. H.R. 5637 was jointly referred to the House
Judiciary Committee, which held a subcommittee hearing on September 19, 2006. On
September 27, 2006, the full House took up the bill under Suspension of the Rules and
passed it 417-0. The Senate has received the bill but has not referred it to committee or
scheduled any action on it.
H.R. 5637 is a relatively narrow bill, aimed directly at streamlining and addressing
inconsistencies in state regulation in the surplus lines insurance market. It would do this
primarily through preempting various state laws. It generally would not, however, replace
the preempted state laws with federal standards, but instead would do so with laws from
other states or model laws of the NAIC. The bill’s first two sections would give
preeminent regulatory and tax authority to the home state of the insured, preempting the
tax and regulatory laws of other states who might have a claim on the insurance
transaction such as the home state of the broker or the location of some of the insured
risk. Thus, for example, if a company in one state is purchasing a surplus lines policy that
covered some risks in another state, the only state that would collect taxes on that
transaction would be the home state of that company. The bill would, however, allow
states to require reports detailing risks that may covered by policies from other states as
well as encourage the creation of an interstate compact to develop a uniform formula to
allocate surplus lines taxes among the states. H.R. 5637 also would preempt state laws
on eligibility requirements. In general, it would preempt any state laws that are different
from the NAIC’s model law on nonadmitted insurance and requires states to follow the
NAIC’s listing of alien insurers in allowing brokers to place insurance with companies
from outside of the United States. It also specifically preempts state diligent search
requirements for surplus lines purchases by “exempt commercial purchasers” as defined
in the bill.
As indicated by the title, H.R. 5637 addresses reinsurance as well as surplus lines
insurance. Its reinsurance provisions have a similar approach to addressing inconsistencies
of state regulation. The bill would give preeminence to the home state of the insurer
purchasing reinsurance with regard to the regulation of credit for reinsurance and other
aspects of the reinsurance contract, while the home state of the reinsurer is given authority

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for the regulation of solvency of the reinsurer. The bill would require that in order for
another state’s laws to be preempted, the home state must follow NAIC standards with
regard to reinsurance credit and reinsurer solvency.
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