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Surplus Lines Insurance: Background and
Current Legislation
Baird Webel
Specialist in Financial Economics
December 17, 2009
Congressional Research Service
7-5700
www.crs.gov
RS22506
CRS Report for Congress
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repared for Members and Committees of Congress
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Surplus Lines Insurance: Background and Current Legislation
Summary
In general, insurance is a highly regulated financial product. Every state requires licenses for
insurance companies, and most states 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. Although any sort of insurance
could be sold by a surplus lines insurer, most such transactions tend to be for rarer and more
exceptional property and 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 focus of the Nonadmitted and Reinsurance Reform Act of 2009 (H.R.
2571/S. 1363), which passed the House by voice vote on September 9, 2009. This act was also
added as an amendment to the Wall Street Reform and Consumer Protection Act of 2009 (H.R.
4173) when it was considered on the House floor. H.R. 4173 passed the House on December 11,
2009. In addition, the National Insurance Consumer Protection Act (H.R. 1880), whose central
focus is the creation of a federal charter for the insurance industry, includes provisions aimed at
harmonizing state laws regarding surplus lines insurance.
Past Congresses have also taken up legislation on surplus lines insurance. Versions of the
Nonadmitted and Reinsurance Reform Act were passed by the House in both the 109th and 110th
Congresses, but the Senate did not act on surplus lines legislation in either case. Provisions on
surplus lines insurance similar to those in H.R. 1880 were included in the National Insurance Act
of 2007, but that bill was not acted on in the 110th Congress.
This report will be updated as warranted by legislative events.
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Surplus Lines Insurance: Background and Current Legislation
Contents
Background on Insurance Regulation .......................................................................................... 1
Regulation of Surplus Lines Insurance ........................................................................................ 1
The Surplus Lines Marketplace ................................................................................................... 2
Legislation .................................................................................................................................. 3
109th Congress ...................................................................................................................... 3
The National Insurance Act of 2006 (S. 2509/H.R. 6225) ................................................ 3
The Nonadmitted and Reinsurance Reform Act of 2006 (H.R. 5637) ............................... 4
110th Congress ...................................................................................................................... 5
The Nonadmitted and Reinsurance Reform Act of 2007 (H.R. 1065/S. 929) .................... 5
The National Insurance Act of 2007 (S. 40/H.R. 3200) .................................................... 5
111th Congress....................................................................................................................... 5
The Nonadmitted and Reinsurance Reform Act of 2009 (H.R. 2571/S. 1363) .................. 5
The National Insurance Consumer Protection Act (H.R. 1880) ........................................ 6
Contacts
Author Contact Information ........................................................................................................ 6
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Surplus Lines Insurance: Background and Current Legislation
Background on Insurance Regulation1
Insurance is regulated almost exclusively at a state level, unlike the other primary sectors of the
financial services industry, banking and securities. 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, the organizations themselves are
voluntary, non-governmental associations and can not require that any states enact their models.
As a 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. The recent financial crisis has added an additional argument for increased
federal attention to the regulation of insurance, particularly with the failure of AIG, a company
that happened to be the largest surplus lines insurer in the United States.
Regulation of Surplus Lines Insurance
Surplus lines insurance regulation differs from other insurance regulation both in substance and in
the primary focus. 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 to judge whether 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.
Most surplus lines transactions revolve around an intermediary, typically an insurance broker,
who may specialize in the unusual risks that require such coverage. Because they have relatively
1 See CRS Report R40771, Insurance Regulation: Issues, Background, and Legislation in the 111th Congress, 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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little oversight on surplus lines insurers themselves, the states generally focus their attention on
these intermediaries in regulating surplus lines insurance. 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 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 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 middle 1980s, the early 1990s, and the
early 2000s. Growth in net premiums for U.S. professional surplus lines insurers in three of these
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four periods has reached 70% at the peak and then dropped to nearly zero or below within a few
years afterwards.4 In 2007, surplus lines premiums for commercial insurance totaled $33.3
billion, 12.7% of the total commercial lines premiums of $263.1 billion. The surplus lines market
in the United States has two large groups, AIG and Lloyd’s of London, which had 21.0% and
14.0% of the market respectively. The next largest is Zurich/Farmers with 5.2% market share,
which was followed by a number of companies in the 2% to 4% range. The 10th largest company
had a 2.4% share, whereas the 20th had a 1.1% market share. 5
Legislation
109th Congress
The National Insurance Act of 2006 (S. 2509/H.R. 6225)
Senators John Sununu and Tim Johnson introduced S. 2509 on April 5, 2006, and it 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 it did not take other
action on S. 2509. Although not directly addressing surplus lines insurance, the bill could
potentially have had a significant impact on the operation of the current surplus lines market. S.
2509 would have created a federal charter for insurers and insurance intermediaries and given
them the choice of operating under the federal system instead of the state system. Holders of a
federal license would have been able to operate throughout the United States without separate
state insurance licenses. In addition, the National Insurance Act would have preempted 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 have offered the
possibility of avoiding the conflicting state regulatory system that surplus lines insurers currently
point to as a significant burden.
Representative Ed Royce introduced H.R. 6225 on September 28, 2006. It was jointly referred to
the House Committees on Financial Services and on the Judiciary. Although not identical to S.
2509, the bill was essentially similar and would have created the same dual regulatory system
with both federal and state charters available for insurers and insurance intermediaries. No
committee hearings were held on H.R. 6225.
Passage of either version of the National Insurance Act of 2006, however, would not have offered
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 have been required to
participate in state guaranty funds. In addition, federally chartered insurers would likely have had
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. The largest
4 A. M. Best, Excess and Surplus 2005, September 2005, p. 19.
5 Statistics from A. M. Best, U.S. Surplus Lines—Market Review, August 25, 2008, p. 6.
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surplus lines insurer, AIG, would seem very likely to become a national insurer as its then-
chairman testified before Congress supporting an optional federal charter in 2002.6 A.M. Best’s
2006 survey of the surplus lines industry concluded, however, that “ ... whether or not the
National Insurance Act becomes a reality, surplus lines insurers will continue to play a major role
in providing specialty coverage to commercial insurance consumers.”7
The Nonadmitted and Reinsurance Reform Act of 2006 (H.R. 5637)
Representative Ginny Brown-Waite, along with 16 cosponsors, introduced H.R. 5637 on June 19,
2006. It was referred to the House Financial Services Committee where hearings were held and
the bill amended and reported on to the full House (H.Rept. 109-649). H.R. 5637 was jointly
referred to the House Judiciary Committee which held a subcommittee hearing on the bill, but
took no further action. On September 27, 2006, the full House took up the bill under Suspension
of the Rules and passed it 417-0. The Senate received the bill and referred it to the Banking,
Housing, and Urban Affairs Committee, but took no further action.
H.R. 5637 was a relatively narrow bill, aimed directly at streamlining and addressing
inconsistencies in state regulation in the surplus lines insurance market. It would have done this
primarily through preempting various state laws. It generally would not, however, have replaced
the preempted state laws with federal standards, but instead would have done so with laws from
other states or model laws of the NAIC. The bill’s first two sections would have given 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 were purchasing a surplus lines policy that covered some risks in another state, the only state
that could collect taxes on that transaction would be the home state of that company. The bill
would, however, have allowed states to require reports detailing risks that may covered by
policies from other states as well as encouraged the creation of an interstate compact to develop a
uniform formula to allocate surplus lines taxes among the states. H.R. 5637 also would have
preempted state laws on eligibility requirements. In general, it would have preempted any state
laws that are different from the NAIC’s model law on nonadmitted insurance and required 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 would have preempted state
diligent search requirements for surplus lines purchases by “exempt commercial purchasers” as
defined in the bill.
H.R. 5637 addressed reinsurance as well as surplus lines insurance. As with the surplus lines
provisions, the reinsurance provisions had a similar “home state” approach to addressing
inconsistencies of state regulation of reinsurance. The bill would have given 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
was given authority for the regulation of solvency of the reinsurer. In order for the home state to
be given this primacy, the bill would have required the home state to follow NAIC standards with
regard to reinsurance credit and reinsurer solvency.
6 See the statement of M. R. Greenberg before the House Financial Services Subcommittee on Capital Markets,
Insurance, and Government Sponsored Enterprises, June 18, 2002, at http://financialservices.house.gov/media/pdf/
061802mg.pdf.
7 A.M. Best, Surplus Lines Market 2006, September 2006, p. 27.
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110th Congress
The Nonadmitted and Reinsurance Reform Act of 2007 (H.R. 1065/S. 929)
Representative Dennis Moore, along with 43 cosponsors, introduced H.R. 1065 on February 15,
2007; Representative Moore was a lead cosponsor of H.R. 5637 in the 109th Congress.
Representative Ginny Brown-Waite, the sponsor of H.R. 5637, was a lead cosponsor of the H.R.
1065. H.R. 1065 was nearly identical to the bill that passed the House in the previous Congress.
The only change was to the credentials necessary to be considered a “Qualified Risk Manager,”
which would be required for a company to be considered an “exempt commercial purchaser.” The
bill was considered under Suspension of the Rules on June 25, 2007, and passed the House by
voice vote.
S. 929, also entitled the Nonadmitted and Reinsurance Reform Act of 2007, was introduced in the
Senate on March 20, 2007, by Senators Mel Martinez and Bill Nelson. S. 929 was identical to
H.R. 5637 as passed by the House during the 109th Congress. It was referred to the Senate
Banking, Housing, and Urban Affairs Committee as was H.R. 1065 once it was received in the
Senate. Neither bill was acted on by the Senate in the 110th Congress.
The National Insurance Act of 2007 (S. 40/H.R. 3200)
Senators John Sununu and Tim Johnson introduced S. 40 on May 24, 2007, whereas
Representative Melissa Bean and Ed Royce introduced H.R. 3200 on July 26, 2007. S. 40/H.R.
3200 were substantially similar to S. 2509/H.R. 6225 from the 109th Congress. They would have
created an optional federal charter for the insurance industry, potentially offering surplus lines
insurers the choice of continuing to operate under the state system or to do so under the new
federal system. Although S. 2509/H.R. 6225 did not specifically address surplus lines insurance,
S. 40/H.R. 3200 included provisions doing so. In particular, S. 40/H.R. 3200 included surplus
lines insurance under the definition of an “insurance producer” and would have allowed a
national agency to sell surplus lines insurance. Thus, under S. 40/H.R. 3200, an individual surplus
lines broker or an agency specializing in surplus insurance could hold a national license and be
exempt from the various requirements, such as diligent search, placed by the states on surplus
lines brokers or agencies. In addition, S. 40/H.R. 3200 would have allowed only the state in
which an insured resides or maintains its principal place of business to tax a surplus lines
transaction. S. 40/H.R. 3200 would have also specifically exempted surplus lines insurers from a
national guaranty fund should one be created. These bills were referred to committee, but no
action was taken on them.
111th Congress
The Nonadmitted and Reinsurance Reform Act of 2009 (H.R. 2571/S. 1363)
Representative Dennis Moore introduced H.R. 2571 on May 21, 2009, along with 20 cosponsors,
including lead cosponsor Representative Scott Garrett. H.R. 2571 is substantially similar to H.R.
1065, which passed the House in the 110th Congress. It was referred to the House Financial
Services Committee and Judiciary Committee. Although neither committee marked up the bill,
the House took up H.R. 2571 on September 9, 2009, under suspension of the rules and passed the
bill by voice vote. Representatives Moore and Garrett also offered the language of H.R. 2571 as a
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floor amendment to the Wall Street Reform and Consumer Protection Act of 2009 (H.R. 4371).
This language was included in an en bloc amendment by Representative Barney Frank (H.Amdt.
529) that passed by voice vote on December 10, 2009. H.R. 4371 passed the House on a vote of
223-202 on December 11, 2009.
S. 1363, which is identical to H.R. 2571, was introduced in the Senate on June 25, 2009, by
Senator Mel Martinez with three cosponsors. It was referred to the Senate Banking, Housing, and
Urban Affairs Committee, which has not acted on the legislation.
The National Insurance Consumer Protection Act (H.R. 1880)
H.R. 1880 was introduced by Representatives Melissa Bean and Edward Royce on April 2, 2009.
It was referred to the House Financial Services Committee, Judiciary Committee, and Energy and
Commerce Committee. This bill includes language similar to the previous National Insurance Act
of 2007 that would (1) include surplus lines insurance under the definition of an “insurance
producer” and allow a national agency to sell surplus lines insurance and (2) allow only the state
in which an insured party resides or maintains its principal place of business to tax a surplus lines
transaction. Like previous bills, H.R. 1880 allows for the federal chartering of insurers and
insurance producers and loosens some restrictions on insurance rate and form regulation, so it
might have an impact on surplus lines insurance as some insurers and producers may choose to
become federally chartered, rather than remaining state-chartered surplus lines insurers. The
specific provisions of H.R. 1880, however, are different than the previous National Insurance
Acts, including the creation of a systemic risk regulation and the provision that some insurers
might be required to become federally chartered if judged to be systemically significant.
Author Contact Information
Baird Webel
Specialist in Financial Economics
bwebel@crs.loc.gov, 7-0652
Congressional Research Service
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