The Diligent Effort Debate
When writing surplus lines business, it is the obligation of the surplus line broker to maintain a copy of the originating producer’s documentation of diligent effort. The diligent effort is confirmation that coverage has been requested and declined from authorized insurers within the admitted market. But what is the point of the diligent effort?
Diligent Effort: An Obsolete Practice or Important Protection?
There are two schools of thought regarding the diligent effort. The first school of thought is that the diligent effort is obsolete and unnecessary. In fact, four states no longer require the diligent effort and have either statutorily removed the requirement, or the statutes are silent on the matter.
The other school of thought is that the diligent search is essential because it is the one remaining vestige separating the non-admitted market from the admitted market. The non-admitted market is heavily regulated by the various departments of insurance. Some would argue that if the diligent effort were removed, there would no longer be any distinguishing factors separating the admitted from the non-admitted market, leading to further regulation. From my perspective, the diligent effort protects the surplus line broker in the event the non-admitted carrier becomes insolvent.
The diligent effort is the trade-off for freedom from submitting forms and rates. The surplus lines insurer can create coverage forms and rates for hard-to-place risks that are not insurable in the admitted markets. An additional benefit is that it protects the surplus line broker in the event the non-admitted carrier becomes insolvent.
Admitted vs. Non-Admitted Markets
In the admitted market, the carrier is the regulated entity, but in the non-admitted market, the surplus line broker is the regulated entity. If a non-admitted carrier becomes insolvent and an insured files a claim the non-admitted carrier cannot pay, occasionally the claimant may pursue other avenues for recovering payment of the loss.
Coverage placed through the admitted market is covered by the State Guaranty Fund. When you purchase your auto insurance, for example, you see a flat premium dollar amount. Included in the premium are taxes, fees, and assessments paid to the state. A portion of the assessments are withheld for the State Guaranty Fund to cover losses. Think of it as the FDIC of insurance.
Conversely, coverage placed through the non-admitted market is not protected by any State Guaranty Fund (except New Jersey which has a guaranty fund for non-admitted homeowner’s coverage for up to four dwellings). If the non-admitted carrier becomes insolvent, there is no Guaranty Fund protection for the insured in the event a loss occurs.
Remember, the claimant may not be able to recover monies from the non-admitted carrier because the non-admitted carrier usually does not have sufficient assets if they are insolvent.
What if the Claimant’s Loss is Disputed?
Let’s take this a step further. What if the surplus lines broker disputes the insured’s claim? What happens? The claimant could pursue the surplus line broker. If that happens, the only protection the surplus line broker has is the diligent effort. If the surplus line broker can prove that coverage could not be placed through the admitted market, the judge may still rule in favor of the claimant; however, the penalty could be mitigated because the coverage was not insurable through the admitted market.
The Debate Continues…
In the end, whether or not a state statutorily requires a diligent search, it is the surplus line brokers’ responsibility to comply with all the state laws, statutes, and regulations as set forth by each state. These requirements include obtaining the required forms for filing. The diligent effort provides proof to the department of insurance that a diligent effort was made to place coverage in the admitted market, but was declined due to underwriting guidelines, capacity, or coverage not eligible, etc. Additionally, surplus line brokers’ are responsible for ensuring that the non-admitted carrier meets eligibility criteria to write policies in the state, and to ensure the non-admitted carrier is financially sound.
The debate over the necessity of the diligent effort has been going on for many years and will undoubtedly continue for many more years to come. What are your thoughts on the diligent effort requirement? Comment below!
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