Last fall, after an 18 month effort by the Commissioner, the Office of Administrative Law adopted new regulations designed to establish minimum standards respecting the financial stability, reputation, and integrity of non-admitted insurers proposed for use by any surplus lines brokers in California. The Commissioner also successfully sponsored legislation to beef up regulation of surplus lines brokers during 1992.

AB 2608, effective January 1, 1993, prohibits surplus lines brokers from placing insurance with non-admitted insurers unless they file documents showing that the particular insurance may not be obtained from licensed California insurers that write the type of business.

Operating under the new regulatory scheme has caused some consternation in the surplus lines brokers community. Commissioner Garamendi explains the department's approach to surplus lines enforcement issues.

Q. The 1992 amendment to Insurance Code Section 1763 and the promulgation of Regulation Sections 2174.1 through 2174.14 have been the subject of numerous discussions within the surplus lines community. The changes in the Code and Regulations seem to suggest that the legislature and the Department of Insurance are seeking to eliminate the surplus lines market from California. Do you agree with that assessment?
A. No. We recognize that there is a legitimate need for non-admitted markets. While the rules you referred to are designed to regulate all surplus lines brokers and carriers issuing policies on California risks, the intent of the legislation was not to place surplus lines on an endangered species list.

Q. In the Department's view, why was this legislation/regulation necessary?
A. The abuses that developed within the surplus lines market, which have been widely reported in the press, needed to be brought under control. The Department is particularly concerned about Insolvent alien surplus lines companies. Our concerns on solvency issues are reflected in the 2174 regulations.Minimum capital and solvency standards have long been a fact of lifefor admitted companies.

Q. But why the change in the diligent search requirements imposed upon surplus lines brokers by Section 1763?
A. As I mentioned earlier, we do recognize that there remains a need for surplus lines insurance. However, we found that many risks were being routinely written on a surplus lines basis even though coverage was available in the admitted market. Thousands of unsophisticated insurance consumers were being attracted to cheap automobile and health insurance marketed by offshore surplus lines companies. This is just not right, and it leads to significant opportunities for fraud.

In many instances, this would require the surplus line brokers to actually present each risk to as many as three or four hundred licensed companies in order to determine whether or not the insurance was exportable to the surplus line market. We concluded that this majority standard was unreasonable and would be difficult, if not impossible, for the Department to enforce. Additionally, we found the law woefully lacking in terms of the reporting requirements imposed on surplus lines brokers. The lack of strict reporting requirements enabled many surplus line brokers to avoid reporting the surplus lines policies that they transacted. We believed that strict reporting requirements were needed if we were to be successful in bringing these surplus lines abuses under control.

Q. Doesn't that 1992 amendment to Section 1763 amount to "throwing out the baby with the bathwater"?
A. Not at all. The 1992 amendment to Section 1763 did not change the basic standard for determining exportability-that being that a risk may be written in a non-admitted market if the coverage is not availablefrom licensed companies. The 1992 amendment requires brokers to document their diligent search of the admitted market and enables the Commissioner to enforce this requirement.

Q. Section 1763 seems overly broad in that California seems to be taking away an insurance buyer's prerogative to purchase insurance from a surplus lines company.
A. The law does permit insurance consumers to deal direct with any insurance company they choose-admitted and non-admitted. Sophisticated insurance purchasers that employ a risk manager are the ones most likely to be capable of dealing direct with a non-admitted carrier. When the insurance consumer lacks this capability and needs to employ the services of a broker, then the law does require a search of the admitted market first.

If fewer than 3 licensed companies actually write the type of insurance that the consumer is seeking, then the surplus line broker may offer the non-admitted as an alternative. In those cases, we want the insurance purchaser to be adequately informed about the company and to be sure that the consumer understands the difference between licensed companies and non-admitted ones. ( continued )

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