Surplus Lines: Insurtech and Technological Opportunities, Challenges
Over the last year or so, the insurance industry has seen technological advances driving new products and distribution means to market. We have seen “insurtech” blossom from a term to describe the intersection between disruptive technology and traditional insurance products and marketplaces into a full-fledged movement to revolutionize the way insurance coverage is marketed, sold and provided, with industry-wide conferences taking the country by storm. In 2017, insurtech carrier, venture capital funded start-ups such as Slice and Lemonade made headlines on a regular basis for their innovative use of technology within the insurance industry through online and app-based distribution of coverage.
While a number of admitted insurance products are currently offered through insurtech companies, the surplus lines insurance market, as evidenced by its significant growth in 2017, has ample incentive and opportunity to similarly expand and evolve with improved technology as well, according to the Surplus Lines Stamping Office of Texas’ eNews, 2017 Record Breaking Year in Surplus Lines Market. However, the meaningful deployment of new technology poses unique challenges for the surplus lines market that are not always the same as those in the admitted insurance market. While surplus lines insurers are afforded great flexibility to adapt to the changing marketplace, they are also constrained by certain procedural obligations and restrictions not applicable to admitted insurers, such as having to comply with the diligent search requirement and prohibitions on advertising and direct contact with insurance customers.
This article discusses some of the challenges and opportunities that insurtech advances pose for surplus lines.
Diligent Search Requirement
In most U.S. jurisdictions, to place insurance coverage on a surplus lines basis, the surplus lines insurance broker must conduct a “diligent search” of the admitted insurance market to determine if comparable coverage is available through an authorized insurer, i.e., establish admitted market unavailability for the desired insurance product. The diligent search requirements vary among jurisdictions, but commonly include the broker’s filing of an affidavit confirming that declinations have been obtained from three separate and unaffiliated admitted insurers. See, e.g., Cal. Ins. Code § 1763(b). Generally, the diligent search is not satisfied simply because no admitted insurer offers the same insurance coverage at the premium rate offered by the surplus lines insurer; rather, the coverage must actually be different somehow in scope or substance from those kinds of coverages available in the admitted insurance market. See, e.g., Or. Rev. Stat. § 735.410 and Cal. Code Regs. tit. 10, § 2138.
The emergence of delivery platforms whereby consumers can bind coverage directly through online applications with the click of a button (or a tap of their smartphone) has transformed the delivery process of a variety of products. However, the surplus lines insurance industry faces the unique challenge of satisfying the diligent search requirement in connection with this mode of policy delivery. Unless the insured requesting coverage meets an “exempt commercial purchaser,” “industrial insured” or other state-recognized exemption from the diligent search requirement, a surplus lines broker is still required to survey the admitted market before placing coverage each time an insured requests non-admitted coverage. This, of course, poses a substantial challenge to the offering of such products as the process will be naturally disrupted until the broker obtains satisfactory declinations.
Make no mistake, this is not an issue of formality over substance. A number of surplus lines associations across the country have been raising concerns with insurtech companies and other market participants regarding proper compliance with the diligent search requirement.
Daniel Maher, executive director of the Excess Lines Association of New York notes that “this is a really fundamental issue. Our technology is moving ahead at an incredible pace… we have met with insurtech companies, and they understand they have regulatory barriers and want to figure out how to do this the right way.”
In addition, the Washington Surplus Lines Association has stressed the importance of satisfying the diligent search requirement and that the emergence of online and app-based delivery products will not obfuscate the need for brokers to obtain their proper declinations.
Several states are helping to ease the burden of satisfying the diligent research requirement as to new platform-based products. For example, 16 states currently maintain export lists that allow for certain identified coverages to be exported to the surplus lines market without the need for a diligent search. California has also recently amended its insurance laws to exempt certain surplus lines policies from the diligent search requirement if the insurance commissioner determines that “there is not a reasonable or adequate market among admitted insurers or that the type of coverage is for new, innovative products for which a reasonable or adequate market among admitted insurers has not had time to develop.” Cal. Ins. Code §§ 1763.1. Some states have recently gone so far as to eliminate the diligent search requirement altogether. See, e.g., La. Rev. Stat. Ann. § 22:432 (“Surplus lines insurance . . . may be procured without regard to the availability of coverage from authorized insurers.”)
The meaningful deployment of new technology poses unique challenges for the surplus lines market that are not always the same as those in the admitted insurance market.
Another avenue that surplus lines insurers and brokers often explore is to establish risk purchasing groups under the Liability Risk Retention Act of 1986. A risk purchasing group allows the grouping of members to collectively purchase commercial liability coverage and to avoid state laws restricting the ability to procure group coverage. New York, in particular, allows for a single affidavit to be executed and filed by a surplus lines broker on behalf of all members of a purchasing group in New York where coverage is procured for such members during a 30-day period. N.Y. Comp. Codes R. & Regs. tit. 11, § 301.6. This benefits insurtech companies that offer insurance products to New York risk purchasing groups as brokers can fulfill the diligent search before the binding of coverage for members in any given month, allowing for instantaneous and seamless issuance of policies.
Advertising by Surplus Lines Insurers and Brokers
As technology advances, we are seeing more creative and digital methods of advertising. However, websites and web-based applications increasingly bring insurance participants closer than ever, which can have the consequence of impermissibly drawing attention to an unauthorized insurer.
Advertising restrictions on surplus insurers vary among jurisdictions. For example, in California, an eligible surplus lines insurer may advertise in the state, provided that its unlicensed status is disclosed, and that the advertisement is not misleading, does not contain information about premiums or rates and, if the advertisement is made in any medium of general circulation, no specific product is mentioned. Cal Ins. Code § 703.1(a).
New York expressly prohibits any person from calling attention to a surplus lines insurer by advertisement or public announcement in the state but does recognize exceptions if a disclaimer is made that the insurer is not licensed in the state, does not solicit business in New York, and such advertisement is in a national publication not aimed at New York residents. N.Y. O.G.C. Opin. No. 2003-19.
With the offering of on-demand and other web-based products, additional advertising risks present themselves in ways that would have been unimaginable even a few years ago. For example, a website maintained by a surplus lines insurance company may be considered an advertisement and could potentially violate applicable law if not structured properly. Surplus lines brokers must also be cautious of advertising standards as well.
Many states prohibit a broker from identifying the actual names of unauthorized insurers in their advertisements. However, brokers are often allowed to advertise that specific kinds of insurance products are available in the nonadmitted market generally.
Information on a broker’s website or application that can lead an insured to conclude that a particular unauthorized insurer is offering products through such broker could trip advertising prohibitions. Therefore, as product offerings become increasingly seamless and have the (often unintentional) consequence of blurring the lines between the surplus lines broker and carrier, market participants should expect heightened scrutiny by state insurance regulators.
New Tech-Based Products
The challenges the surplus lines insurance industry now face with the emergence of insurtech start-ups may also lead to the greatest production of premiums for the nonadmitted market than has been seen in prior years. With new, innovative products and services developed in Silicon Valley, companies are looking for increasingly complex and tailored insurance policies to cover their unique needs. Surplus lines insurers are often in the best position to cover these new risks, just as they were when cybersecurity and liability risks were only viewed as emerging risks for a few types of industries, and states are beginning to recognize this reality.
For example, Transportation Network Companies (TNCs) like Uber and Lyft generally must satisfy minimum levels of automobile financial responsibility requirements applicable to the TNCs and their drivers. Typically, in the personal automobile space, such requirements may only be satisfied through “authorized” insurers in the state. Given the complex insurance needs of TNCs and the relatively new and evolving nature of the industry, satisfying such financial responsibility requirements through the admitted market can be difficult. Most state legislatures have addressed this concern in the last few years by expressly allowing surplus lines insurers to be issuers of TNC insurance policies. Of course, products are evolving faster than legislatures can sometimes react, and TNCs have been expanding beyond passenger transportation and into the product and food delivery space. As such, it remains to be seen if the states will interpret or expand their TNC laws to allow surplus lines insurers to adequately cover such services as well.
We have also seen an explosion in the personal and commercial drone market in recent years, and insurance products to address risks that drones present are quickly entering the marketplace. We have seen challenges with respect to the issuance of “on-demand” drone insurance whereby coverage may be turned “on” and “off” by the consumer, which may impact whether adequate notice of cancellation and nonrenewal are given under applicable law.
With respect to placement of drone insurance in the surplus lines market, some states, such as Alaska, have placed drone coverage on their export lists. In addition, in states that allow drone coverage to be freely exported, whether drone coverage is classified as an “aircraft” risk versus another line of insurance can impact whether coverage is seen as exempt from the surplus lines laws altogether.
For example, some states exempt “insurance of aircraft” from the surplus lines laws (which would arguably exempt drone coverage as well), whereas a number of other states exempt common carrier aircrafts only. See, e.g., Ark. Code Ann. § 23-65-302, and Nev. Rev. Stat. § 685A.020.
Broker Role in the Tech Era
The advancement of technological products will in many ways enhance rather than replace the role of the surplus lines broker. Brokers may be in the best position to help understand, craft and tailor offerings to potential insureds and adequately protect their interests as both insurance and non-insurance products become increasingly advanced and complex. Surplus lines brokers will likely find themselves offering a multitude of services both related and unrelated to the procurement of insurance and will wish to be compensated accordingly. As such, renewed attention will undoubtedly be given by state legislatures to the broker fee laws in various jurisdictions and their applicability to the surplus lines market.
Ultimately, we see the next generation of innovation as a rising tide that will lift all ships and benefit consumers, surplus lines brokers and their carriers alike.
Conclusion
As new technologies continue to emerge and develop, they create greater opportunities for the surplus lines market to expand and offer novel products to fill consumer needs. However, challenges in complying with surplus lines requirements are substantial. As states adopt statutes and regulations in response, brokers and carriers alike must be keenly aware of their legal duties and restrictions.
Lerner is an associate in the New York office of Locke Lord LLP and is a member of the Insurance and Reinsurance Department. Cavaliere is an associate in the Hartford office of Locke Lord LLP, where she concentrates on corporate, insurance and reinsurance law.