Surplus Line Insurers
A state’s Department of Insurance is responsible for licensing, or “admitting,” an insurance company to sell insurance in the state as well as regulating the admitted market. In Texas, admitted insurance companies are subject to requirements and standards provided in the Texas Insurance Code. They are also members of the state’s guaranty fund. The Texas Guaranty Association protects Texas resident policyholders in the event the member insurance company becomes insolvent and can’t pay claims. While it is beneficial for Texas residents to obtain insurance from a Texas-licensed company, standard insurance companies may not be able to provide necessary coverage. Surplus lines insurers fill this need by insuring risks that are declined by the standard underwriting and pricing processes of admitted insurance carriers. These risks tend to be non-standard or unique risks, where tailored policies are required to meet specific needs; capacity risks, where the insured seeks a higher level of coverage than most insurers will provide; or for new, emerging endeavors, where there is little to no loss history to provide accurate insurance pricing and rates. Surplus lines insurers are considered foreign insurance companies as they are not required to be licensed in the individual states where they do business or where your property is located. And while Texas must approve the companies that can do business in the state, they are not subject to the same regulations as admitted insurance companies and are not members of the guaranty association.
Surplus lines insurers includes both U.S. domiciled insurers as well as non-U.S. domicile, or alien, insurers. Though these companies aren’t regulated by the states in which they operate, surplus lines transactions are regulated through a licensed surplus lines broker. Texas has surplus lines laws, which require the surplus lines broker to be licensed in Texas and the agent must complete a diligent search to find a Texas-licensed insurer first. But in Texas and some other states, the vast majority of commercial insurance is written by surplus line insurers, even for traditional commercial property insurance coverage. A trend we are seeing in these surplus lines policies is the presence of an arbitration clause. While Texas law is silent regarding mandatory and binding arbitration, many states have blanket prohibitions on arbitration agreements in insurance policies. But because surplus line insurers are not regulated by the states where they do business the protections afforded by states’ Department of Insurance regarding arbitration may not apply.
For example, say you have a surplus lines policy that was delivered in Texas to the named insured, a Texas resident, for property in Texas that was damaged also in Texas, but the policy has an arbitration clause that requires the arbitration to occur in New York, applies New York law, and limits recoverable damages, which is common in these types of property policies. This is highly beneficial for the insurer as it discourages policyholders from asserting valid claims because of the increased costs to travel to New York to dispute your claim, discourages the arbitration panel from conducting a physical inspection of the property, and discourages depositions and interviews of key witnesses, who reside in Texas. Also, it reduces the capacity of experts to meet, compare data, and align or narrow the engineering and cost information that is inherently a part of any disputed claims process. This insurer tactic also reduces your ability to recover damages provided under Texas statutes, such as the Texas Prompt Payment of Claims Act as well as not allowing additional damages and attorneys’ fees. In sum, it increases costs for policyholders, reduces the ability of the parties or the arbitration panel to fully assess the condition of the property, and can ultimately reduce the claim payment. The insurer can then limit or eliminate what it must otherwise pay out on valid claims. Furthermore, if a surplus lines insurance company becomes insolvent, policyholders’ claims may not get paid because the surplus lines insurer is not a member of a guaranty fund.
In addition to this uncertainty surrounding arbitration provisions, insurers have availed themselves of an obscure provision of the Federal Arbitration Act to ensure that any disputes arising out of the policy remain in arbitration. That provision, known as the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (or the “New York Convention”), provides for federal court jurisdiction to enforce arbitration clauses buried in the fine print of the insurance contract. In essence, if a policyholder brings a lawsuit involving a foreign insurer, whether in state or federal court, the insurer can ask a federal court to compel the parties to arbitration. Additionally, if the parties proceed to arbitration and an award is issued, the federal court will also have jurisdiction to enforce that award. In Texas and elsewhere in the Fifth Circuit, insurers have largely been successful in enforcing those arbitration provisions, even if – as is true in many cases – the insured had no idea that the arbitration clause even existed. The New York Convention has been a powerful tool for surplus lines insurers.