Lack of Modernization Limits the Surplus Lines Industry
By Steve Stephan JD
The surplus lines regulatory environment makes it possible for Insurtech companies to offer novel and innovative insurance products. This market was designed to be a safety valve for emerging risks, unique risks, and hard-to-place insurance products not available from the admitted market. Customized Insurtech products can reduce costs for consumers and insurance companies, improve efficiency, and enhance customer satisfaction. Unfortunately, the lack of modernization has not kept up with the rapid advancements envisioned by Insurtech companies. We must innovate to secure the future of the surplus lines industry.
REGULATORY REFORMS FOR MODERNIZED SURPLUS LINES
Accessing highly customized insurance products in the surplus lines market is limited by several compliance requirements that have not been modernized. This article will discuss the most obvious regulatory reforms that would enable technology innovations for surplus lines.
1: Eliminate Diligent Search For Each Policy
Surplus lines brokers are generally required to verify that a diligent effort was made to place the policy in the admitted market before a risk is placed in the surplus lines market. There’s an incentive to use admitted markets because taxes are lower, the policy form is more competitive, and the large volume of data available for admitted lines allows admitted markets to price products competitively.
However, the general trend over the history of surplus lines regulation has been to lessen the regulatory burden caused by documenting the diligent search. There are many exemptions from the diligent search, but they are not consistent from state to state, with the exception of the federal exemption in the NRRA.
Inconsistent exemptions are not ideal. To modernize surplus lines even further, diligent search requirements should be eliminated. But, it is possible to implement some Insurtech products and systems in the surplus lines market while waiting for a more comprehensive solution.
2: Phase Out Notarized Documents
Some states require notarized documents for surplus lines transactions. However, states are increasingly abolishing the requirement for notarized affidavits.
It is unclear that anything is gained by notarized signatures. In fact, notarized documents make it more difficult to operate in remote environments that are being embraced by employers. Requiring notarized documents limits the surplus lines industry’s ability to embrace new Insurtech solutions.
3: Remove the Requirement For Documents Signed by the Insured
Another inconsistency across state lines is requiring documents to be signed by the insured. In the context of commercial insurance, it is unclear if any additional protection results from a signature by the policyholder.
Commercial policyholders are more sophisticated and have been advised by a professional insurance advisor of their choosing. The agent has a disincentive to use the surplus lines market since the tax is commonly higher. Surplus lines insurance typically is not covered by state guaranty funds, so there is a need to ensure personal lines policyholders are aware of this. However, the guaranty fund protection is not as useful to commercial policyholders since the limits of the guaranty funds can be as little as $300k. Eliminating the diligent search for commercial lines when the carrier’s financial strength exceeds the state standard could help to modernize the surplus lines industries.
4: Abolish Paper Filings
Though many states have been transitioning away from paper filing, some states still require agencies and businesses to submit paper copies of their tax filings.
Requiring paper filings is a very outdated regulation. Using paper costs more time, money, and causes more strain on the environment. Paper filings stand in the way of Insurtech automated systems and do not add any consumer protection. To further the modernization of the surplus lines market, paper filings need to be abolished overall.
5: Eliminate Estimated Taxes
Another way to pave the path for new technological advances in Insurtech is to eliminate the requirement for estimated taxes. Instead, an automated underwriting system linked with an automated surplus lines tax system would calculate, report, and pay taxes based upon the applicable tax rate and fees in each state.
However, if the state still requires an estimated tax, then the potential efficiencies gained by a nationwide automated system are lost for those states. The surplus lines industry can transition towards better Insurtech solutions if the need for estimated taxes was eliminated.
6: Do Away With Paper Checks
Some states still require a paper check for surplus lines taxes. Similar to limitations we discussed above with paper filings, requirements for paper checks limits the surplus lines industry.
The logistics of using paper checks in the surplus lines market stands in the way of a fully automated system. It is typically labor-intensive. Furthermore, requiring paper checks does not provide additional consumer protection for a policyholder.
If states were to do away with paper checks, it would open up the possibilities for improved automated systems in the surplus lines industry.
7. Implement Export Lists
Adopting export lists for exempt lines is one way states can modernize the surplus lines market. These lists allow agencies and businesses to file without needing to provide diligent search.
Currently, 22 states are authorized to create an export list of insurance products or lines that don’t require a diligent search. However, only 18 of those states have actually implemented export lists. Five states have authorization for an export list but have not adopted one. The result is that diligent search is required for lines that have been placed in the surplus lines market for years and are obviously not available in the admitted markets.
As more states implement export lists, the modernization of surplus lines will continue and allow for improved Insurtech solutions. Additionally, states should craft a definition of Insurtech or lines of Insurtech business that can be added to existing export lists. If companies have products in the sandbox, the state could also add these same products to the export lists.
8: Create Stamping Offices Where Authorized By Law
Another way to further the modernization of the surplus lines industry is by creating stamping offices. Several states currently have laws on the books enabling the creation of a stamping office. Stamping offices have the ability to deploy additional dedicated resources to automate the surplus tax lines system.
Creating stamping offices eliminates the need to divert assets from the Insurance Department to create an automated tax reporting system. Instead, this technology is funded by stamping fees. This streamlining of funds through the stamping office will promote improved modernization for surplus lines.
9. Enable Tech Company Tax Reporting
Some states currently prohibit outsourcing tax reporting. This is problematic because tech companies are more likely to create innovative solutions than surplus lines brokers. Tech companies mainly focus on providing technology solutions for inefficient processes. But prohibiting the outsourcing of tax reporting negatively impacts these tech companies who are trying to improve the surplus lines industry.
Contrastingly, programmatic filing is available in many states and offers the possibility to alleviate the burden of tax filing. By choosing to enable companies the ability to outsource their tax reporting, states can promote modernization within the surplus lines industry.
10: Discontinue Agent Signatures on Documents
In addition to requiring original signatures of the insured and notarized documents, some states still require the original signature of agents on documents as well. Just as we discussed above, these requirements limit the surplus lines industry from adopting efficient, modernized solutions.
Requiring original signatures on documents inhibits a fully automated system. If states were to discontinue this requirement, agencies and businesses would be able to adopt beneficial automated systems.
MODERNIZATION THAT IS CURRENTLY WORKING
The regulatory environment is ripe for technology innovations. Many of the obstacles to a digitized surplus lines tax system have already been modernized or eliminated by one state or another.
Technology companies have made great strides to automate the cumbersome surplus lines compliance and tax process. An example is the products created by InsCipher to automate tax calculation, tax reporting, and billing mechanisms. The InsCipher products have not only reduced barriers to entry for new Insurtech platforms but have been embraced by many regulators as a more efficient process. The InsCipher products enable novel Insurtech platforms to be launched, expanded, or scaled without the start-up cost and infrastructure of a surplus lines tax team.
FURTHER BENEFITS OF SURPLUS LINES INDUSTRY MODERNIZATION
Additionally, modernization could benefit regulators as well. A modern regulatory system would be preferred over creating a separate regulatory system with a completely different mechanism (regulatory sandbox, federal regulation, commercial deregulation, etc.). Modernization could also result in fewer policyholders attempting to use the direct procurement laws to bypass much of the burden associated with surplus lines tax compliance.
CONCLUSION
Surplus lines regulation has been modernizing for years. Some advancements include the Non-admitted and Reinsurance Reform Act (NRRA), additional diligent search exemptions, commercial lines deregulation, automated tax payments, and many other improvements.
Yet, there are still many areas in need of improvement. The ability of Insurtech companies to deliver customized insurance solutions has been compromised by this lack of modernization. If we hope to see major advancements in the surplus lines market, we must first start by addressing these issues.
InsCipher is an insurtech company providing software and services that are revolutionizing inefficient insurance processes. Save your agency time and money by automating surplus lines compliance, filing, and reporting. Want to learn more? Request a free demo today!
