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INSURERS: BULLETIN 96-04

STATE OF CALIFORNIA
DEPARTMENT OF INSURANCE
45 FREMONT STREET
SAN FRANCISCO, CALIFORNIA 94105


Bulletin No. 96-4 

May 30, 1996

To: All Licensed Surplus Line Brokers and Other Interested Persons

Subject: Affiliation with Nonadmitted Insurers; Permissible Transactions by Surplus Line Brokers and Nonadmitted Insurers


The purpose of this bulletin is to provide information to licensed California surplus line brokers concerning the Commissioner's views of certain surplus line market practices with respect to transactions performed in this state by licensed surplus line brokers, particularly those affiliated with a nonadmitted insurer or part of a corporate family that includes a nonadmitted insurer. The term nonadmitted insurer as used in this bulletin is limited to nonadmitted insurers eligible for placements by California surplus line brokers under section 1765.1 of the Insurance Code.(fn1)

The Insurance Commissioner appointed a Task Force composed of both California Department of Insurance ("CDI") staff members and insurance industry representatives in August 1995 to review the CDI's administration of the applicable statutes and relevant court cases and its impact on current market practices in this segment of the industry with respect to surplus line brokers' transactions and affiliations with nonadmitted insurers. Having carefully considered the Task Force's conclusions, the Commissioner determined that it would be beneficial to inform the industry of the CDI's general policy in administering the statutes and regulations governing surplus line transactions.

1. Regulatory overview

The Insurance Code authorizes California surplus line brokers to conduct an "insurance brokerage business" in this state. Section 1765(b). Insurance brokers are distinguished from insurance agents by the fact that brokers act, primarily, on behalf of the insured and not on behalf of the insurer. See CIC Section 33. The reverse is true of insurance agents. It is also well-established, however, that brokers have a "dual capacity," performing activities as agent of the insurer for certain purposes and as agent of the insured for others. See, e.g., Section 1732, Maloney v. Rhode Island Ins. Co., 115 Cal. App. 2d 238, 251 P.2d 1027 (1953). This implicit authorization for a surplus line broker to perform various agency activities on behalf of a nonadmitted insurer does not authorize a surplus line broker to perform core management functions for a nonadmitted insurer, or a cumulation of core insurance company functions, so that the result is tantamount to establishing and operating a managing general agency or branch office of a nonadmitted insurance company in this state without a certificate of authority. See Mor-Ben Insurance Markets Corporation v. Department of Insurance, 179 Cal. App. 3d 1233, 225 Cal. Rptr. 281 (1986); Section 700, 703, 1776; cf. Section 810.

2. May a surplus line broker be affiliated with a nonadmitted insurer?

No statute or regulation prohibits a licensed surplus line broker from being affiliated with a nonadmitted insurer, directly or indirectly. However, the Commissioner believes that there is a strong potential for conflict of interest when an officer or salaried employee of a nonadmitted insurer is affiliated with a surplus line broker.

To remove such potential conflicts, the Commissioner will consider when reviewing such affiliate relationships whether they comport with the substance of section 1649. Section 1649 prohibits an officer or salaried employee of an admitted insurer from acting as a fire and casualty insurance broker. While section 1649 does not on its face apply to nonadmitted carriers or their officers or employees, the Commissioner considers this section as providing guidance as to how this type of potential conflict is to be handled in the nonadmitted context. Accordingly, the Commissioner objects to a California surplus line broker having officers and salaried employees acting as brokers who are also officers or salaried employees of its affiliated nonadmitted insurer. However, the Commissioner has no objection to overlapping officers or salaried employees of a nonadmitted insurer and its affiliated surplus line broker who serve in administrative capacities, such as corporate counsel or accounting positions, for both entities and are not transactors under the surplus line license.

3. What transactions may be performed in this state by a surplus line broker that is affiliated with a nonadmitted insurer?

Transactions that a licensed California surplus line broker is permitted to perform in this state are the same regardless of whether or not the surplus line broker is affiliated with the nonadmitted insurer with which it does business. The scope of such permissible transactions is enumerated below.

     A.   Solicitation 

          (1)  California surplus line brokers may advertise and
               solicit using print, electronic media and direct
               mail advertisements.  These advertisements may
               describe the products available through the
               surplus line broker, so long as the nonadmitted
               insurer's name is not used in connection with a
               specific product.  This would not prohibit a
               California surplus line broker from identifying
               which nonadmitted insurers have given it placing
               authority if the nonadmitted insurer's name is not
               used in a manner that connects it with any
               specific product.  However, the surplus line
               broker must provide the name of the nonadmitted
               insurer if it is requested by a prospective
               insured or his, her or its representative.

               Section 703 makes it a misdemeanor for any person
               other than a surplus line broker to advertise in
               California on behalf of a nonadmitted insurer.  As
               interpreted by the Mor-Ben court, this provision
               exempts surplus line brokers from criminal
               penalties but does not affirmatively authorize
               surplus line brokers to engage in advertising on
               behalf of a nonadmitted insurer or any of the
               other acts enumerated in that section.  It has,
               however, long been the CDI's position that surplus
               line brokers may advertise and solicit on their
               own behalf and in their own name, but not in the
               name of the nonadmitted insurer.
          (2)  Nonadmitted insurers may not mail advertisements
               or solicitation materials to insureds or
               prospective insureds located in California.  See
               People v. United National Life Insurance Company,
               66 Cal.2d 577, 58 Cal.Rptr. 599, 427 P.2d 199
               (1967); Section 703(b).

          (3)  Nonadmitted insurers may not advertise in
               publications specifically targeted at the
               California market.  Section 703(b).

          (4)  Nonadmitted insurers may advertise in national
               publications that would reasonably be expected to
               reach California insureds or prospective insureds,
               so long as the nonadmitted insurer includes a
               disclaimer such as "not licensed in California,"
               "this product may not be available in all states,"
               "unavailable except through a licensed surplus
               line broker," or similar language.  However, if a
               nonadmitted insurer's product is mentioned in such
               advertising, the nonadmitted insurer will be
               deemed to have solicited in this state unlawfully
               if it sells the product to a California resident
               even though such disclaimer appeared in the
               advertisement.

          (5)  Except as permitted in subsection 3.A.(4) above,
               advertising of a nonadmitted insurer or its
               products in California by anyone other than a
               surplus line broker is not permitted.  Sections
               703(b).

     B.   Acceptance/Declination of Risks; Binding Authority;
          Risk Quotation

          (1)  The ultimate decision as to rate setting and
               establishing underwriting guidelines must be
               performed by the nonadmitted insurer outside the
               State of California.  However, surplus line
               brokers may be delegated prior written authority
               to bind coverage (i.e. "binding authority") on
               behalf of a nonadmitted insurer in accordance with
               section 1764.2(a).  Binding authority may not be
               delegated to any person in this state other than a
               licensed California surplus line broker.

          (2)  Although the ultimate authority to set rates and
               establish underwriting guidelines may not be
               delegated, the prior written authority delegated
               to the surplus line broker may grant the surplus
               line broker authority to apply an appropriate rate
               and quote based on the rating or underwriting
               guidelines established outside the state by a
               nonadmitted insurer.
         
     C.   Surplus Line Brokers' Certificates Evidencing the
          Placement of Insurance; Policies; Preparation,
          Execution, and Issuance

          (1)  With respect to surplus line broker's certificates
               evidencing the placement of insurance, surplus
               line brokers are permitted to print, maintain,
               execute and issue in this state "certificates in
               their own name and not in the name of the
               nonadmitted insurer," evidencing the placement of
               insurance.  Section 1764 et seq.  A specimen of
               such certificate that the Insurance Commissioner
               considers to comply with this requirement is
               attached.  Surplus line brokers' certificates, so
               long as they comply with 1764 and contain all the
               provisions of the insurer's policy as required by
               section 381(fn2), are
               contracts of insurance enforceable against the
               insurer to the same extent as the insurer's own
               policy. 

               Please note that the term "certificate" is used to
               describe different kinds of evidence of insurance,
               not all of which qualify as "surplus line brokers'
               certificates" under section 1764 et seq.  For
               example, the standard "ACORD(fn3) certificate" is not designed
               to serve as a surplus line broker's certificate
               under section 1764 et seq. and should not be used
               for that purposes (although a surplus line broker
               may issue an ACORD certificate for its intended
               purpose, i.e., at the request of an insured under
               a properly issued and evidenced policy to
               demonstrate to a third party that the insured in
               fact possesses insurance).  [ACORD is a trade name
               for "Agency Company Organization Research
               Development," an organization which develops and
               markets insurance forms.]

          (2)  With respect to nonadmitted insurers' policies,
               unless and until the Legislature authorizes
               otherwise, surplus line brokers are not authorized
               by current statutes to execute, countersign or
               otherwise issue, in this state, an insurance
               policy in the name of a nonadmitted insurer.  In
               addition, surplus line brokers may not, in this
               state, print, maintain, assemble or compile policy
               forms on behalf of a nonadmitted insurer in this
               state.

               If the nonadmitted insurer has given the
               California surplus line broker prior written
               authority to issue certificates in the name of the
               surplus line broker as evidence of insurance in
               lieu of a policy, the certificate will be an
               effective and enforceable contract of insurance.

               A surplus line broker, on behalf of the insured,
               may prepare appropriate documents that constitute
               a formal, bona fide offer to the insurer
               containing proposed terms and conditions of
               coverage, provided such documents appear on their
               face to be an offer.  The insurer may then accept
               or decline the offer; however, any acceptance of
               the offer by the insurer must be bona fide.
               Surplus line brokers may print, maintain, assemble
               or construct such an express offer of coverage for
               presentation to a nonadmitted insurer.

               After acceptance of the offer (which must occur
               outside the state), the insurer will deliver the
               policy to the surplus line broker for delivery to
               the insured (or other intermediate party).

     D.   Claims 

          (1)  A surplus line broker may be given prior written
               authority to pay undisputed claims on behalf of a
               nonadmitted insurer.  A surplus line broker,
               however, may not decline or negotiate claims or
               provide any claims management.  All non-paid
               claims must be referred to the nonadmitted insurer
               or to a licensed adjuster designated by the
               nonadmitted insurer. 

          (2)  Claims adjustment functions may be performed in
               this state on behalf of a nonadmitted insurer by a
               properly licensed insurance adjuster, regardless
               of whether or not the licensed adjuster is
               affiliated with the nonadmitted insurer.  A
               surplus line broker may be licensed as an
               adjuster, subject to the provisions of section
               816, which provides in substance that a person who
               has been given any discretion in the settlement of
               claims may not be compensated in any way that is
               contingent on the amount of such claims
               settlements, unless:

               (a) the person's discretionary settlement
               authority is no more than $500 per claim,

               (b) the person is compensated wholly or partly by
               contingent commission based on underwriting
               results, so long as the insurer is not guaranteed
               a return which may exceed actual underwriting
               profit,

               (c) the claims settlement authority relates
               exclusively to reinsurance contracts between
               insurers, or

               (d) the person is compensated according to a
               schedule of charges that increases consistently in
               reasonable brackets as the size of claim
               increases.  Section 816(a)-(d).

     E.   Management Functions

          (1)  Performance of certain key management functions in
               this state by or on behalf of a nonadmitted
               insurance company is deemed to be the transaction
               of insurance as contemplated by sections 35 and
               700 of the Insurance Code, and accordingly,
               requires a certificate of authority.  The
               Commissioner has concluded that the following are
               insurance company management functions that may
               not be performed in California on behalf of the
               nonadmitted insurer by a surplus line broker or
               other representative of the nonadmitted insurer,
               whether or not affiliated with the nonadmitted
               insurer, without a certificate of authority:

               (a)  Arranging or placing treaty reinsurance.

                    (However, this does not prohibit a surplus
                    line broker from arranging or placing, on
                    behalf of an insurer, facultative
                    reinsurance, which is procured by the surplus
                    line broker in order to obtain capacity for
                    the coverage and limits requested by the
                    insured.  Surplus line brokers should also be
                    aware that in arranging or placing such
                    reinsurance they are subject to the
                    Reinsurance Intermediary Act, Ins. Code
                    Sections 1781.1-1781.13.(fn4))

               (b)  Managing insurance company investments.

                    (However, this does not prohibit a surplus
                    line broker from investing premiums that are
                    held in a fiduciary capacity in accordance
                    with sections 1734 or 1734.5.)

               (c)  Managing payroll and personnel matters,
                    including making personnel decisions,
                    concerning employees or officers of a
                    nonadmitted insurer. 

               (d)  Managing claims.
              
                    (However, this does not prohibit a surplus
                    line broker from receiving notices of claims
                    and paying [but not denying or negotiating]
                    the claims or referring them to the
                    nonadmitted insurer outside this state or a
                    California licensed adjuster designated by
                    the nonadmitted insurer.)

     F.   Electronic Transactions

          The Commissioner is cognizant of the great strides the
          insurance industry is making to utilize new electronic
          capabilities in improving the efficiency and
          competitiveness of its methods of doing business.  The
          consumers will be among the ultimate beneficiaries of
          these technological advancements.

          While new types of electronic equipment, networks and
          means of communication are increasing the speed and
          efficiency of transactions and permitting greater
          automation of processes formerly handled in person,
          these improvements have not affected the fundamental
          nature of insurance transactions, which consists of an
          insured seeking to buy, and an insurer to sell,
          policies, with various intermediaries representing one,
          the other or both of those parties in bringing about
          the transaction.  An insurer, or insurance producer
          representing an insurer, who has an Internet "web site"
          is doing fundamentally the same thing as it did when
          advertising or offering insurance through a magazine ad
          and including a pre-stamped, self-addressed return
          mailer for interested insureds. 

          Thus, in light of the legal principles governing
          solicitation by nonadmitted insurers described in
          section 3.A. above, a nonadmitted insurer whose web
          site would reasonably be expected to reach, or is
          purposefully directed at, California insureds or
          prospective insureds must include a disclaimer
          regarding its unlicensed status in California.  Failure
          to include such a disclaimer may render unlawful
          whatever California business is subsequently written
          for insureds who were solicited through the web site.

          Similarly, a nonadmitted insurer whose web site would
          reasonably be expected to reach, or is purposefully
          directed at, California insureds or prospective
          insureds, would be in violation of California law if
          the insurer's web site enables a California resident
          inside California to obtain an executed policy without
          it being procured by and through a licensed California
          surplus line broker.  Whether a nonadmitted insurer
          mails, faxes or transmits over the Internet its
          executed policy to a person located in California
          without delivering it through a licensed surplus line
          broker, the transaction has the same substantive effect
          and in each instance is equally subject to regulatory
          action by the CDI.

          Unless and until the Legislature authorizes otherwise,
          any surplus line transaction conducted via electronic
          media must be performed through a licensed California
          surplus line broker, rather than directly between an
          insured and a nonadmitted insurer.  Furthermore, the
          surplus line broker must not simply be an electronic
          connection between the nonadmitted insurer and the
          applicant or insured.  One way to demonstrate the
          absence of a mere electronic connection would be to
          ensure that the insured or the insured's representative
          can communicate with an individual surplus line
          licensee or named transactor of an organizational
          surplus line licensee at any point in the transaction.

         
          Surplus line brokers may communicate with the personnel
          or computers of nonadmitted insurers through any form
          of electronic media for any and all aspects of an
          insurance transaction.  This includes preparing an
          offer containing the form of a policy that the insurer
          is being requested to execute by means of an
          interactive link with the nonadmitted insurer.
          However, surplus line brokers must comport with the
          statutory requirement (Ins. Code section 35) that
          policy issuance by the nonadmitted insurer or its
          representative occur outside of California.  One
          example of an acceptable electronic transaction would
          involve all of the following steps:

          Step 1 - A California surplus line broker, on his or
          her computer terminal in California, contacts a
          nonadmitted insurer's computer.  The nonadmitted
          insurer's computer must be located outside of
          California. 

          Step 2 - On his or her computer terminal, the surplus
          line broker calls up an input screen from the
          nonadmitted insurer's computer or server located
          outside this state (or from the nonadmitted insurer's
          web site located on the server of an independent Server
          Provider(fn5)) which contains a
          program or template of the insurer's underwriting and
          rating guidelines.  Those guidelines must have been
          established by the insurer outside California. 

          Step 3 - The surplus line broker inputs the data about
          the applicant required for the insurer's computer to
          perform underwriting and rating of the applicant. 

          Step 4 - Assuming the nonadmitted insurer's program
          approves binding on specified terms and at a specified
          rate, the computer may automatically transmit a policy,
          bearing electronic facsimile signatures.  The policy
          may be printed in the surplus line broker's California
          office and the surplus line broker may deliver the
          policy to the insured or the insured's representative.

          All of the foregoing steps may be performed
          automatically by the nonadmitted insurer's computer, so
          long as that computer or server is located outside
          California (or from the nonadmitted insurer's web site
          located on the server of an independent Server
          Provider).

Questions concerning this bulletin should be directed to:


Rebecca Westmore
(916) 492-3186
State of California
Department of Insurance
300 Capitol Mall, 17th floor
Sacramento, California 95814

 


Footnote #1: All statutory references are to
the California Insurance Code unless otherwise indicated.


 


Footnote #2: Section 381 provides:
          "A policy shall specify:
          (a)  The parties between whom the contract is made.
          (b)  The property or life insured.
          (c)  The interest of the insured in property insured,
               if he is not the absolute owner thereof.
          (d)  The risks insured against.
          (e)  The period during which the insurance is to
               continue.
          (f)  Either:
          (1)  A statement of the premium, or
          (2)  If the insurance is of a character where the exact
               premium is only determinable upon the termination
               of the contract, a statement of the basis and
               rates upon which the final premium is to be
               determined and paid."

          With respect to subdivision (d) of Section 381, all
          terms, conditions, exclusions, riders, and endorsements
          should appear in, or attached to, a surplus line
          broker's certificate evidencing the placement of
          insurance if issued pursuant to prior written authority
          from the nonadmitted insurer.


Footnote #3: ACORD is a trade name for
"Agency Company Organization Research Development," an
organization which develops and markets insurance forms.


Footnote #4: Under the Reinsurance
Intermediary Act, a "reinsurance intermediary-broker" (i.e., a
person or corporation who solicits, negotiates or places
reinsurance cessions or retrocessions but has no power to bind
the ceding insurer, Section 1781.2(g)), must be a licensed
producer in California, Section 1781.3(a)(1), must ensure that he
or she has written authorization from the ceding insurer that
conforms to section 1781.4 and must maintain specified records
for at least ten years after expiration of each reinsurance
contract transacted, Section 1781.5.  Persons who act as
reinsurance intermediary-managers (defined in Section 1781.2(h))
are subject to more extensive requirements.


Footnote #5: As used in this bulletin,
"Server Provider" means a person or entity, other than an
insurance agent, broker, surplus line broker or insurance
company, that is in the business of operating computer hardware
and software facilities the purpose of which is to receive and
fulfill requests by users of the Internet for data stored on or
otherwise accessible through such facilities.

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