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Surplus Lines Policies Leave Consumers Unprotected When Disaster Strikes

As traditional insurers like State Farm cease writing homeowners insurance policies in coastal areas and even states like California and Florida, surplus lines insurers have come flooding into the market. Unfortunately, the result is that more and more consumers are left without important policyholder protections. It doesn’t have to be this way.

What is a Surplus Lines Insurer and what is Surplus Lines Insurance? To define surplus lines insurance and surplus lines insurance, we must first talk about the traditional insurance market. Generally, in order to sell insurance policies in a state, an insurance company has to become an “admitted” or “authorized” insurer in that state. This means that the insurer submits statutory financial statements to the state showing that it is financially sound and maintaining adequate reserves (something that is important when it comes time to pay claims), files and gets approval for its rates, and submits the insurance forms that it is going to issue for approval by the state. When a department of insurance examines a form, it can ensure that it provides standard protection, eliminate prohibited language, and make sure that the policy language is readable.

Admitted insurers also participate in the state’s insurance guaranty fund, which acts as a backstop if an insurer becomes insolvent and does not have sufficient funds to pay claims.  As a result, when an insurer is authorized or admitted, a consumer has some assurance that the insurer is financially stable, offers reasonable rates, and is selling policies that provide the standard protections that homeowners policies have provided for the last forty to fifty years.

These assurances are important because insurance policies can be difficult for most people to understand and because insurance policies are intangible products that cannot be evaluated by consumers as easily as a physical product such as a car. Other intangible products, like investments, also are regulated for these same reasons. 

Surplus lines insurance is insurance sold by surplus lines insurers. These insurers have not been admitted or authorized in the state and can only be sold through authorized surplus lines brokers subject to certain requirements. These minimal requirements generally require the broker to affirm that the broker has attempted to find adequate insurance from admitted carriers but has been unable to do so and to affirm the financial soundness of the company. 

They only require surplus lines insurers to pay a special tax. Surplus lines insurers do not have to file the same financial disclosures, do not participate in the state’s insurance guaranty funds and often do not file their policy forms for approval. In addition, their claims practices may not be subject to examination by the state department of insurance. 

Surplus lines insurers also typically do not have their own in-house claims department or their own adjusters. An insured with a claim may find that they don’t even know who their insurance company is and can’t talk to a direct employee of the insurance company. Rather, surplus lines insurers will often hire another company, that will perform many of the traditional insurance functions for them, such as underwriting and writing premiums. They also will outsource the claims handling and may have no one employed by the insurer that the policyholder can contact in connection with a claim. 

Until the fairly recent past, surplus lines insurers typically confined themselves to sophisticated commercial products purchased by sophisticated purchasers. In addition, surplus lines insurers (with the exception of Lloyds of London) were typically authorized insurers in at least one state. This is because state laws governing this type of insurance require that out-of-state surplus lines insurers be admitted in at least one state. This means that they were being regulated by at least that state’s department of insurance. Also, they could not sell surplus lines coverage in their own state.

However, in the last decade, many states have passed domestic surplus lines laws allowing a surplus lines insurer to qualify to sell insurance in their home state without being admitted and without being subject to the same regulations as admitted carriers. They then sell surplus lines insurance in other states and claim that they are “admitted” because of their status as a domestic surplus lines carrier. This maneuver allows them to sidestep extensive regulation in any state.  It also has become more and more common for surplus lines insurers to sell homeowners insurance policies in coastal areas. 

Unfortunately, this means that the consumers who need protection the most do not get it for the policies they rely on the most. It also means that surplus lines insurers can    essentially ignore the Unfair Settlement Practices Act’s requirement that insurers “adopt and implement reasonable standards for the prompt investigation and settlement of claims arising under [their] policies.”  For many policyholders, facing a hurricane insurance claim can be a greater hardship than the hurricane itself. 

What can be done? First, I believe that regulators should not allow surplus lines carriers to go totally unregulated. Surplus lines carriers should have to file forms that are understandable and provide expected homeowners policy protections. State departments of insurance should also examine the claims practices of all insurers who issue homeowners policies in their states. Ultimately, states should eliminate or tightly restrict domestic surplus lines insurance laws that allow an insurer to sell surplus lines coverage in its home state and effectively sidestep very important regulations. 

Second, surplus policies should carry better disclosures that outline the above-described differences between surplus lines insurers and admitted insurers. Many state’s disclosure requirements simply require that a policy state that a surplus lines policy is issued pursuant to that state’s surplus lines law. This type of disclosure does nothing for a consumer. The policy should be required to disclose that it 1) is not subject to financial disclosure and solvency requirements, 2) not backed by the insurance guaranty fund, 3) and that its forms have not been approved by the state department of insurance. 

Third, states should authorize policyholders to recover attorney’s fees from surplus lines insurers when those insurers wrongfully deny claims. When an insured purchases a homeowner’s policy, they are purchasing protection against catastrophe, not a lawsuit. 

Regrettably, homeowners with Hurricane claims often do end up in litigation against surplus lines carriers. We take pride in representing those homeowners. As always, if you have any questions or need anything, please don’t hesitate to reach out to us at (205) 894-8900.

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