INS-40-10-00009-P Excess Line Placements Governing Standards

10/6/10 N.Y. St. Reg. INS-40-10-00009-P

NEW YORK STATE REGISTER

VOLUME XXXII, ISSUE 40

October 06, 2010

RULE MAKING ACTIVITIES

INSURANCE DEPARTMENT

PROPOSED RULE MAKING

NO HEARING(S) SCHEDULED

 

I.D No. INS-40-10-00009-P

Excess Line Placements Governing Standards

PURSUANT TO THE PROVISIONS OF THE State Administrative Procedure Act, NOTICE is hereby given of the following proposed rule:

Proposed Action:

Amendment of Part 27 (Regulation 41) of Title 11 NYCRR.

Statutory authority:

Insurance Law, sections 201, 301, 2105, 2118 and art. 21

Subject:

Excess Line Placements Governing Standards.

Purpose:

This will increase the minimum surplus to policyholders required to be maintained by new and current excess line insurers.

Text of proposed rule:

Section 27.1 is amended by adding a new subdivision (s), to read as follows read as follows:

(s) Eligible means that an insurer not authorized in this state has satisfied the requirements of this Part, including establishing the requisite trust fund and maintaining the minimum surplus.

Section 27.13(b) and (c) are amended to read as follows:

(b) No excess line broker shall place coverage with an unauthorized insurer, unless [its] the insurer's financial statements or other evidence demonstrate that [such] the insurer:

(1) is solvent and otherwise substantially complies with solvency requirements for authorized insurers;

(2) has surplus to policyholders sufficient to support its writings, reasonable in relation to its outstanding liabilities, adequate to its financial needs and[, in no event, less than]:

(i) [in the case of individual incorporated insurers, US$15,000,000;] for an individual incorporated excess line insurer that:

(a) is eligible prior to January 1, 2011, the insurer maintains surplus to policyholders of not less than US$25,000,000 as of January 1, 2011, US$35,000,000 as of July 1, 2011, and US$45,000,000 as of January 1, 2012; or

(b) becomes eligible on or after January 1, 2011, the insurer maintains surplus to policyholders of not less than US$45,000,000;

(ii) [in the case of an] for an association of insurance underwriters consisting of individual incorporated excess line insurers located outside the United States, each insurer maintains surplus to policyholders of not less than [US$25,000,000]US$45,000,000 and the association maintains an aggregate surplus to policyholders of not less than US$10,000,000,000; or

(iii) [in the case of a] for a partnership of unlicensed insurers, each licensed in its domicile and which partnership is duly authorized by its domiciliary jurisdiction to insure risks on a joint and several basis[,] that:

(a) is eligible prior to January 1, 2011, each insurer maintains surplus to policyholders of not less than [US$15,000,000; and] US$25,000,000 as January 1, 2011, US$35,000,000 as of July 1, 2011, US$45,000,000 as of January 1, 2012; or

(b) becomes eligible on or after January 1, 2011; each insurer maintains surplus to policyholders of not less than US$45,000,000;

(3) as of January 1, 2014 and every three years thereafter, the insurer increases its surplus to policyholders in an amount not less than $3,000,000; and

(4) maintains a trust fund in compliance with section 27.14 of this Part.

(c) For purposes of subdivision (b) of this section, in the case of an insurance exchange created by the laws of a state other than this State, no excess line broker shall procure coverage from that exchange or any of its syndicates, unless:

(1) the insurance exchange maintains funds in trust or custodial accounts, under terms acceptable to the superintendent, in an amount no less than US$75,000,000, in the aggregate, provided that an amount at least equal to the greater of US$30,000,000 or one-third of the aggregate, is maintained on a joint and several basis for the protection of all insurance exchange policyholders;

(2) the syndicates of such insurance exchange maintain total capital and surplus, or their substantial equivalent, not less than US$100,000,000 in the aggregate; and

(3) each syndicate with which excess line insurance is placed [maintains] has surplus to policyholders sufficient to support its writings, reasonable in relation to its outstanding liabilities, adequate to its financial needs; and if the syndicate:

(i) is eligible prior to January 1, 2011, the syndicate maintain minimum capital and surplus, or their substantial equivalent, of not less than [US$15,000,000] US$25,000,000 as of January 1, 2011, US$35,000,000 as of July 1, 2011, US$45,000,000 as of January 1, 2012, or

(ii) becomes eligible on or after January 1, 2011 and the syndicate maintains minimum capital and surplus, or their substantial equivalent, of not less than US$45,000,000; and

(4) as of January 1, 2014 and every three years thereafter, each such syndicate increases its capital and surplus, or their substantial equivalent, in an amount not less than $3,000,000.

Section 27.13(l)(3) is amended to read as follows:

(l)(3) In no event shall the superintendent make an affirmative finding of acceptability when the unauthorized insurer's surplus to policyholders is less than [US$4,500,000] US$25,000,000; provided, that as of January 1, 2014, and every three years thereafter, the minimum amount shall be increased by US$3,000,000.

Text of proposed rule and any required statements and analyses may be obtained from:

Andrew Mais, NYS Insurance Department, 25 Beaver Street, New York, NY 10004, [phone], email: [e-mail]

Data, views or arguments may be submitted to:

Buffy Cheung, NYS Insurance Department, 25 Beaver Street, New York, NY 10004, [phone], email: [e-mail]

Public comment will be received until:

45 days after publication of this notice.

Regulatory Impact Statement

1. Statutory authority: Sections 201, 301, 2105, 2118 and Article 21 of the Insurance Law.

These sections establish the Superintendent's authority to promulgate regulations governing the placement of insurance with eligible foreign and alien excess line insurers through licensed excess line brokers. Insurance Law §§ 201 and 301 authorize the Superintendent to effectuate any power accorded to him or her by the Insurance Law and prescribe regulations interpreting the Insurance Law.

Article 21 of the Insurance Law sets forth the duties and obligations of insurance brokers and excess line brokers. Insurance Law § 2105 sets forth licensing requirements for excess line brokers. Insurance Law § 2118 sets forth the duties of excess line brokers with regard to the placement of insurance with eligible foreign and alien excess line insurers, including their responsibility to ascertain and verify the financial condition of an unauthorized insurer before placing business with that insurer.

2. Legislative objectives: Article 21 of the Insurance Law establishes minimum standards for the placement of New York risks with eligible excess line insurers, including an excess line broker's responsibility to ascertain and verify the financial condition of an unauthorized insurer before placing business with that insurer.

3. Needs and benefits: 11 NYCRR 27 ("Regulation 41") governs the placement of excess line insurance. Article 21 of the Insurance Law and Regulation 41 enable consumers who are unable to obtain insurance from authorized insurers to obtain coverage from unauthorized insurers (known as "excess line insurers") if the unauthorized insurers are "eligible," and an excess line broker places the insurance.

Although the Superintendent does not directly regulate excess line insurers and excess line insurers are not subject to the minimum capital and surplus requirements applicable to authorized insurers, the Superintendent is responsible for ensuring that adequately and appropriately capitalized insurers provide coverage to consumers. Further, excess line insurance policies are not eligible for coverage by any New York State financial security funds in the event of an insurer's insolvency. Therefore, Regulation 41 establishes certain minimum financial standards and surplus to policyholders requirements for excess line insurers to ensure the claims paying viability of excess line insurers.

Specifically, Regulation 41 currently requires excess line insurers to maintain a minimum surplus to policyholders of $15 million to support their writings in New York State. However, the Superintendent has not updated the current minimum surplus to policyholders requirement since January 1, 1994. Risks that are placed in the excess market require either declinations from three licensed insurers or listing on the export list, a list of insurance coverages for which the Superintendent of Insurance has determined declinations are not required. These are coverages that licensed companies do not want to write. The current $15 million minimum requirement may have been adequate in the past but with escalating jury awards, the amount is inadequate.

Policies being written today have higher limits and therefore the exposure is greater than it was in the past. Even the cost to defend a claim has risen greatly. Therefore, the requirement must be updated to recognize the aforementioned reasons as well as the effects of compound inflation in order to provide additional protection against insolvency. As a result, this amendment increases the minimum amount of surplus to policyholders that a new excess line insurer must maintain from $15 million to $45 million; provides significant incremental increases in the minimum surplus to policyholders for current excess line insurers, specifically, an increase to $25 million as of January 1, 2011, $35 million as of July 1, 2011, and $45 million as of January 1, 2012; and gradually increases the surplus requirements applicable to all excess line insurers in future years. Presently 96% of the eligible excess line insurers have the $25 million surplus required by January 1, 2011.

Moreover, this amendment increases from $25 million to $45 million the minimum surplus to policyholders requirements set forth in section 27.13(b)(2)(ii) of Regulation 41 for each insurer of an association of insurance underwriters consisting of individual incorporated excess line insurers located outside the United States, and increases from $15 million to $45 million the minimum surplus to policyholders requirements set forth in section 27.13(c) of Regulation 41 for each syndicate of an Insurance Exchange.

4. Costs: This amendment does not impose any compliance costs on state or local governments. The Insurance Department and excess line brokers should not incur additional costs.

However, excess line insurers may incur costs in securing the additional funds necessary to comply with the increased minimum surplus to policyholders requirements set forth in this amendment. Based on the Department's review of excess line insurers' 2009 capital and surplus to policyholders for foreign insurers and the 2008 capital and surplus for alien insurers, only 5 out of the 133 currently eligible insurers have less than $25 million in minimum surplus to policyholders. Of the 133 eligible excess line insurers, 25 have less than $45,000,000 in minimum surplus to policyholders. Some of the insurers are members of larger groups of affiliated insurers, and the Department anticipates that the parent company will provide its subsidiaries with the additional required surplus to meet the new minimum requirements. The Department does not believe that the amendment will discourage new insurers from entering the market or decrease competition in New York's excess lines market.

5. Local government mandates: This amendment does not impose any program, service, duty or responsibility upon a city, town or village, or school or fire district.

6. Paperwork: There is no additional paperwork required.

7. Duplication: This amendment will not duplicate any existing state or federal rule.

8. Alternatives: The Department conducted extensive outreach with the Property Casualty Insurers Association of America (PCIA), a trade association composed of more than 1,000 member property/casualty insurers and the American Insurance Association (AIA), a property/casualty insurance trade organization representing 350 insurers. The Department also conducted outreach with the Excess Line Association of New York (ELANY), a non-profit industry advisory association representing excess line brokers. The Department drafted the increased minimum surplus to policyholders requirements in consideration of the comments submitted to the Department by the foregoing associations.

PCIA and AIA commented that the Superintendent should not increase the minimum surplus to policyholders requirements. Specifically, AIA stated that an increase in the minimum surplus to policyholders requirements would create an "uneven playing field," with regard to existing excess line insurers who would be subject to a graduated increase and new eligible excess line insurers who would be required to meet the higher requirements immediately.

The Department considered increasing the minimum surplus to policyholders for existing and new excess line insurers as of a certain date. However, the Department believes that it is equitable and reasonable to implement the change in stages for current excess line insurers, which have already demonstrated a degree of viability in the market.

AIA also suggested that the Superintendent substitute a risk-based capital (RBC) model in place of specific minimum surplus to policyholders requirements. RBC is a method developed by the National Association of Insurance Commissioners (NAIC) to measure the minimum amount of capital than an insurer needs to support its overall business operations, taking into account the size and degree of risks taken by the insurer. The following four major categories of risk must be measured to arrive at an overall RBC amount: (1) off balance sheet risk; (2) asset risk; (3) credit risk; and (4) underwriting risk.

The Department, however, contends that the NAIC never intended for the RBC model to fully replace the minimum surplus to policyholders requirements, but rather complement it. The Department uses RBC to compare an insurer's performance to its peers, whereas, minimum surplus to policyholders provides a fixed cushion to absorb mounting losses that result from poor underwriting, poor reserving or even catastrophic occurrences. Furthermore, RBC concentrates on the quality of the minimum surplus to policyholders. The quantity or amount of surplus to policyholders helps the insurer endure difficult economic times.

Furthermore, alien insurers do not use the RBC model - only domestic insurers use it - and alien insurers do not have a risk model comparable to the RBC model. The Superintendent must apply a consistent approach in analyzing the financial condition of all eligible excess line insurers. Minimum surplus to policyholders is the most equitable and accurate way to assess an excess line insurer's financial strength and viability in the marketplace regardless of whether the insurer is alien or domestic.

Moreover, requiring a specific minimum surplus to policyholders rather than using the RBC model permits the Superintendent to respond to the needs of individual insurers or to market conditions if necessary. For example, section 27.13(l) of Regulation 41 provides the Superintendent with flexibility to permit an excess line insurer to operate with less than the required minimum surplus to policyholders in certain circumstances, such as when coverage is not available, based upon an affirmative finding of acceptability by the Superintendent.

In short, RBC is a useful tool for regulators, but maintenance of an adequate minimum surplus to policyholders is vital for an excess line insurer's survival and for protection of its policyholders, and is not a substitute for specific minimum surplus to policyholders requirements. Also, note that unlike the insurer trade associations, ELANY strongly supports increasing the minimum surplus to policyholders requirements.

PCIA commented that there is currently no solvency issue regarding excess line insurers, nor has there been one for years, and cited to the A.M. Best annual report entitled "2007 Special Report: U.S. Surplus Lines-Market Review" in support of its position.

Although the A.M. Best report cites no insolvencies, the report states that there were 36 financially-impaired excess line insurers between 1977 and 2007, and that excess line insurers had a significantly higher failure rate compared to authorized insurers (1.23% versus 0.80%). In addition, the report notes that with the current price softening on commercial lines business, increased competition from authorized insurers may force excess line insurers to focus on the riskier business. Note that most of the past insolvencies occurred in soft markets, because during a soft market cycle, insurers charge inadequate premiums for the risks that they write since there is so much competition in the marketplace. Additionally, insurers accept risks that they normally would not underwrite. When soft market conditions are combined with inadequate surplus to policyholders, an increase in insolvencies may occur. In light of the foregoing, the Department does not believe that the A.M. Best report supports PCIA's proposition that there are no solvency issues regarding excess line insurers.

PCIA further commented that the proposed amendment would discourage market entry of new excess line insurers, decrease competition in New York's excess line market, and noted that New York already has a principle-based requirement that the broker place business with a financially sound insurer. Therefore, PCIA asserts that there is no need to increase the minimum surplus to policyholders requirements.

The Superintendent has not updated the current minimum surplus to policyholders requirements since January 1, 1994, and therefore the Department believes that it should update the minimum requirement to recognize the effects of compound inflation and provide additional protection against insolvency. Furthermore, the types of business excess line insurers write generally present greater risk by their very nature than those written by authorized insurers. As such, a major catastrophe may result in a large loss to an eligible excess line insurer, which in turn may result in a substantial negative impact on its surplus to policyholders. However, if an insurer has a greater minimum surplus to policyholders, then the insurer has a better chance of weathering this type of loss.

In addition, an excess line broker may place insurance in the excess line market in the belief that the broker is placing the business with a financially strong insurer. However, if the minimum surplus to policyholders were to erode at a rapid pace due to poor management or external circumstances, then the $45 million minimum surplus to policyholders requirement would prevent the surplus to policyholders from being severely depleted by acting as a floor.

PCIA also commented that the federal Nonadmitted and Reinsurance Reform Act of 2009 (the "Act") may preempt the Department's proposed amendment to Regulation 41.

Although the United States House of Representatives passed the Act, and it is currently pending in the United States Senate, the Department cannot put necessary amendments on hold while waiting to see whether the U.S. Senate passes the Act.

PCIA further commented that this proposal would have a significant impact on a number of existing excess line insurers that would have to secure additional surplus to policyholders, and that the proposed increase to required minimum surplus to policyholders may deter new entrants to the market.

Only a few excess line insurers currently have less than the proposed initial $25 million in minimum surplus to policyholders. Further, the subsequent increase from $25 million to $45 million is graduated, and will be phased-in to minimize the impact this increase in minimum surplus to policyholders will have on the few insurers that do not currently have $25 million. Therefore, these few excess line insurers should have ample time to secure additional surplus to policyholders.

With regard to PCIA's claim that the proposed increase to required minimum surplus to policyholders may deter new entrants to the market, it is possible that some new entrants may be deterred from entering the New York excess line market. Nonetheless, there currently is healthy competition and adequate capacity in the present New York excess line market, and entry of those insurers that would have difficulty raising the required minimum surplus to policyholders would not be in the best interest of New York insureds, since these insurers may not have the wherewithal to pay claims.

PCIA also stated that only three other states currently require an excess line insurer to maintain more than $15 million in minimum surplus to policyholders.

The Department notes that other states require an excess line insurer to have done business in another jurisdiction for a specified length of time (generally two to five years) before it may become an eligible excess line insurer in that state (also known as "seasoning"). However, New York does not have such a requirement. Without a seasoning requirement, excess line insurers are less experienced and as a result, may make more underwriting errors until the insurers' underwriters master the intricacies of difficult lines of business by developing underwriting expertise through experience. Therefore, the Department believes that excess line insurers must maintain an adequate minimum surplus to policyholders cushion to effectively operate in the New York marketplace and remain solvent, since excess line insurers tend to underwrite riskier lines of business.

One alternative to this amendment that the Department originally considered was to increase the surplus to policyholders requirement to an amount in excess of $45 million, because the rate of inflation appears to be increasing. However, the Department considered the needs of insurers affected by this amendment and the potential burden the higher requirement might impose upon them, and concluded that increasing the requirement to $45 million is reasonable and adequate. Moreover, the full increase to $45 million will not take effect immediately for current eligible excess line insurers.

9. Federal standards: There are no minimum standards of the federal government for the same or similar subject areas.

10. Compliance schedule: Eligible excess line insurers must comply with the regulation within the time frames specified in the regulation.

Regulatory Flexibility Analysis

The Insurance Department finds that this rule will not impose any adverse economic impact on small businesses and will not impose any reporting, recordkeeping or other compliance requirements on small businesses. The basis for this finding is that this rule is directed at excess line insurers, none of which fall within the definition of "small business" as found in section 102(8) of the State Administrative Procedure Act. The Insurance Department has monitored Annual Statements of excess line insurers subject to this rule, and believes that none of them fall within the definition of "small business", because there are none that are both independently owned and have fewer than one hundred employees.

The Insurance Department finds that this rule will not impose reporting, recordkeeping or other compliance requirements on local governments. The basis for this finding is that this rule is directed at insurance companies, none of which are local governments.

Rural Area Flexibility Analysis

The Insurance Department finds that this rule does not impose any additional burden on persons located in rural areas, and the Insurance Department finds that it will not have an adverse impact on rural areas. This rule applies uniformly to regulated parties that do business in both rural and non-rural areas of New York State.

Job Impact Statement

The Insurance Department finds that this rule should have no impact on jobs and employment opportunities since it only increases the minimum amount of surplus to policyholders required to be maintained by new excess line insurers, provides incremental increases in the minimum surplus to policyholders for current excess line insurers and proposes a gradual increase in surplus requirements in future years applicable to all excess line insurers. The intent is to recognize the effects of compound inflation and provide for additional protection against insolvency.

The rule will also indirectly affect excess line brokers, who place business with excess line insurers. Most excess line brokers are small businesses as defined in section 102(8) of the State Administrative Procedure Act. However, the Department does not believe that the rule will discourage market entry of insurers or decrease competition in the state in the surplus lines market. Therefore, there would be no adverse impact on jobs and employment opportunities in New York.