Property and Casualty Insurance: Effects of the Nonadmitted and Reinsurance Reform Act of 2010
Published: 2014-01-16T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Surplus lines insurers are critical to ensuring that businesses and individuals with difficult-to-insure risks can manage those risks. These insurers provide coverage for risks that the traditional, or admitted, insurance market is unwilling or unable to cover. Historically, insurance brokers who sell such coverage have found it to be time consuming and often difficult to allocate state taxes brokers collect and remit on insurance premiums on behalf of policyholders when the risks covered reside in multiple states. To help address this issue, Congress passed NRRA as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The act mandates GAO study changes in the surplus lines insurance market. This report (1) describes the size and condition of the surplus lines insurance market and (2) examines actions states have taken to implement NRRA's provisions and the effects of the act, if any, on the price and availability of coverage. To address these questions, GAO analyzed end-of-year financial data for 2008 through 2012 for insurers who sold surplus lines insurance in 2012 and interviewed insurance regulators from states with a large number of surplus lines insurers, industry associations representing interests in the surplus lines market, and large insurers and brokers. GAO also reviewed related studies and analyses.
In commenting on a draft of the report, the National Association of Insurance Commissioners provided technical comments, which GAO incorporated as appropriate.
section_title: What GAO Found
paragraphs: Surplus lines insurers' premiums written have increased modestly and the companies have generally remained profitable. From 2008 through 2012 premiums written by surplus lines insurers, who sell property/casualty insurance through brokers in states where they are not licensed, grew slightly from $24.8 billion to $25.2 billion and remained stable at around 5 percent of the property casualty market as a whole. Over this time, surplus lines insurers' premiums generally exceeded their claims and underwriting expenses and they remained profitable. Surplus lines insurers also saw capital gains over this period.
Almost all states have modified their laws to implement at least portions of the Nonadmitted and Reinsurance Reform Act of 2010 (NRRA). In 2010, Congress passed the act, which supporters argued would make it easier for surplus lines insurers and brokers conducting business across states. Under NRRA, only the "home state" of the insured--the state where the insured maintains its principal business or residence or, if the risk is 100 percent outside that state, the state to which the greatest percentage of the insured's taxable premium is allocated--may tax or regulate surplus lines insurance transactions. According to market participants GAO interviewed, the changes in states' laws have simplified compliance for multistate risks. While most home states are collecting and retaining 100 percent of premium taxes, a few states are participating in a tax-sharing agreement, as permitted under NRRA. According to industry associations, including those whom GAO interviewed, some states are making additional requests of surplus lines insurers beyond the requirements specified in NRRA. The National Association of Insurance Commissioners formed a subgroup to address this issue and in August 2013 issued options for improving compliance. Market participants said that NRRA has had little, if any, effect on the prices or availability of coverage, as this was not an intent of the act. The participants said that the insurance business cycles are primarily responsible for any changes in prices and availability. According to surplus lines insurers that GAO contacted, NRRA has caused little noticeable shifting in coverage between the admitted and surplus lines markets.

section_title: Letter
paragraphs: The surplus lines insurance market is a critical component of the larger  property/casualty (P/C) insurance market because it can provide  insurance coverage for risks that traditional insurers, sometimes referred  to as admitted insurers, are unwilling or unable to cover. In 2012, the  premiums for such coverage totaled over $25 billion. The risks covered  can include those with potentially catastrophic property damage and  liability associated with high-hazard products, special events,  environmental impairment, and employment practices, among others.  While admitted insurers must be licensed in the states where they sell  insurance, surplus lines insurers must be licensed in only one state but  may sell in others where they are not, provided they are authorized  according to the states’ surplus lines laws. In the surplus lines market,  specialized insurance brokers typically seek coverage on behalf of clients.  Unlike the insurers themselves, these brokers must be licensed to sell  insurance in every state where they operate and must have a special  license to operate in the surplus lines market.
In some cases, the risks that surplus lines insurers cover are spread  across several states. Each of these states can tax premium income at a  different rate, and historically it has often been difficult and time  consuming for brokers to determine how to apportion premium taxes and  determine which tax rates to apply. Also, some states have had differing  requirements for brokers with respect to providing important information  to policyholders, determining that a risk could not be placed with a  traditional insurer before allowing use of a surplus lines insurer, and  determining which insurers were eligible as surplus lines insurers. Surplus  lines brokers have cited these differences as challenges brokers face in  complying with state surplus lines regulations. To address these issues,  Congress passed the Nonadmitted and Reinsurance Reform Act of 2010  (NRRA) as part of the Dodd-Frank Wall Street Reform and Consumer  Protection Act (Dodd-Frank Act). In enacting NRRA, Congress sought to  streamline the process for taxing multistate risks, make it easier to access  the surplus lines market, and create uniform standards for regulating  surplus lines insurers.
NRRA also mandates that GAO study the legislation’s effect on the  admitted and nonadmitted markets—specifically, surplus lines coverage.  This report (1) describes the size and condition of the surplus lines  market and (2) examines actions states have taken to implement NRRA’s  provisions and describes the effects of the act, if any, on the price and  availability of insurance coverage in the surplus lines market.
To address these objectives, we analyzed end-of-year financial and  corporate data for 2008 through 2012 on all surplus lines insurers and the  surplus lines and P/C industries obtained from SNL Financial, A.M. Best,  National Association of Professional Surplus Lines Offices (NAPSLO),  and National Association of Insurance Commissioners (NAIC). We  identified a population of 199 surplus lines insurers that operated in  calendar year 2012 based on documentation from NAIC. These insurers  were eligible or approved to sell surplus lines insurance in 2012 and  actually did sell it in that year. We did not include risk retention groups in  our study population because the nonadmitted insurance reforms of  NRRA specifically excluded these groups. We also obtained and  examined states’ lists of eligible surplus lines insurers from state  departments of insurance, state surplus lines associations, and NAIC. We  interviewed officials with NAIC and the Federal Insurance Office (FIO).  We also interviewed several market participants, including surplus lines  insurers and their corporate parents; two large brokers; representatives of  multiple industry associations representing brokers, insurers,  underwriters, managing general agents, and actuaries; and state  insurance regulators and stamping offices. We selected these  organizations for interviews based on each having a role in the surplus  lines market. To assess issues related to data reliability, we reviewed  related documentation, conducted interviews with knowledgeable officials,  and reviewed previous related reliability assessments GAO had  conducted of these data and determined that no material changes had  been made in how the data were collected and tabulated. We determined  that, for the purpose of describing the size and condition of the surplus  lines insurance market, for this review, the data were sufficiently reliable.  We also reviewed past GAO work and the work of others who have  examined surplus lines and related insurance markets. Appendix I  provides detailed information on the methodology.
We conducted this performance audit from April 2013 to January 2014 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
subsections: section_title: The Admitted Insurance Market
paragraphs: Admitted insurers can be licensed to sell several lines or types of  coverage to individuals or families, including personal lines—e.g.,  homeowners, renters, and automobile insurance—and commercial  lines—e.g., general liability, commercial property, and product liability  insurance. Admitted insurers can sell insurance in one or more states but  must be licensed to operate in every state in which they sell coverage.  Their activities are regulated primarily by the states, which make and  enforce their own laws and regulations. State regulators license agents,  review insurance products and premium rates, and examine insurers’  financial solvency and market conduct. To help ensure adequacy and  fairness in pricing and coverage, state regulators oversee the insurance  rates and forms of admitted insurers.
Admitted P/C insurers have two primary sources of revenue: premiums  from selling insurance and investment income. They collected $293.9  billion in premiums in 1998 and $523.9 billion in 2012. Compared to the  liabilities held by life insurers, their liabilities tend to be fairly short-term,  so they generally invest in a mix of relatively low-risk, liquid, conservative  instruments, such as government and municipal bonds, higher-grade  corporate bonds, short-term securities, and cash. State regulators require  admitted insurance companies to maintain specific levels of capital in  order to continue to conduct business. To help ensure that policyholders  continue to receive coverage if their insurer becomes insolvent or unable  to meet its liabilities, states have guaranty funds (separate for life and P/C  insurance), which are funded by assessments on insurers doing business  in their state. All states have laws that permit surplus lines insurers to  sell coverage in their states, but do not cover their policies with state  guaranty funds (which are funded by assessments on admitted insurers  doing business in their state), leaving policyholders unprotected if their  surplus lines insurer becomes insolvent.
section_title: The Nonadmitted Insurance Market and Surplus Lines Insurers
paragraphs: P/C insurers provide coverage for numerous property and casualty risks,  but there are some risks that they will not cover—for instance, risks that  are difficult to assess, occur too frequently to be acceptable to admitted  insurers, are specialized or unusual, or require coverage that exceeds the  capacity of admitted carriers. In these cases, potential insureds may turn  to the nonadmitted market. This market functions as a safety valve,  offering insurance products for risks that the admitted market will not  cover.
Among the nonadmitted insurers are surplus lines insurers. These  insurers provide coverage for general, management, and professional  liabilities and commercial automobile, environmental, and property risks,  among other things, and tailor their products to meet the needs of the  insured. For example, they may write policies to cover a research  laboratory working on an unproven drug, special sporting or other events,  or liabilities arising from environmental impairment. They may also write  policies on new and innovative products that have little loss history— something admitted insurers would typically require in order to adequately  price the risk. Some of the carriers also write coverage for personal lines,  such as homeowners insurance in catastrophe-prone areas. Figure 1  shows that over the 5-year period from 2008 through 2012, these insurers  provided relatively larger amounts of coverage for commercial lines and  property liabilities, with lesser amounts of coverage for reinsurance and  personal lines. There was also a sizeable amount of coverage provided  by companies writing less than $1 million in premiums where the liabilities  covered were not clearly identified.
Surplus lines insurers have more flexibility with respect to the terms and  pricing of the coverage offered because, according to NAIC, unlike  admitted insurers, they do not need state approval to modify policy  exclusions and coverages. This flexibility to tailor the coverage provided  and the price at which they provide it enables nonadmitted insurers to  manage unique or large risks.
Surplus lines insurers can be domiciled—that is, headquartered—either in  the United States or abroad. Those domiciled in the U.S and licensed in  at least one U.S. state are known as “foreign” insurers in states other than  their state of domicile, while those domiciled in a foreign country are  known as “alien” insurers. A foreign surplus lines insurer is regulated as  an admitted insurer in the state in which it is domiciled, and that state is  its financial solvency regulator. Alien insurers wishing to enter the U.S.  surplus lines market must apply to NAIC’s International Insurers  Department (IID) for inclusion in the Quarterly Listing of Alien Insurers,  which reviews their financial condition as part of the alien insurer  application process. These insurers then become an eligible surplus lines  insurer in all states. Alien insurers may also apply to an individual state to  become authorized only in that jurisdiction. Table 3 in appendix II lists the  alien insurers approved by NAIC from 2008 through 2012, and table 4  shows their location—mostly in England and Bermuda.
Surplus lines insurers must sell their insurance through a broker. These  brokers are licensed retail agents that represent insurance buyers and  place coverage with surplus lines insurers. They are responsible for (1)  selecting an eligible surplus lines insurer, (2) reporting the surplus lines  transaction to insurance regulators, (3) remitting the premium tax due on  the transaction to state tax authorities, and (4) assuring compliance with  all the requirements of the surplus lines state regulations. To place  coverage in the surplus lines market, brokers must follow state due  diligence requirements. Although they vary from state to state, according  to an association representing surplus lines insurers and brokers, these  requirements generally call for brokers to establish that three admitted  companies licensed to write the kind and type of insurance requested  have declined to provide it before turning to a surplus lines insurer.
Historically, brokers and the surplus lines insurers have had to comply  with a multitude of state laws and regulations dealing with taxation,  oversight, and market access. For example, brokers have had to comply  with differing rules across states for things like providing policyholders  with important notices and determining which insurers were eligible for  placing business. Brokers also have had to remit taxes on all surplus lines  insurance transactions. Historically the revenue from surplus lines  transactions that took place outside the insurer’s state of domicile had to  be among all states where parts of the risks were located.
section_title: The Nonadmitted and Reinsurance Reform Act of 2010
paragraphs: NRRA, which generally took effect on July 21, 2011, contains provisions  that are intended to address the various regulatory concerns discussed  earlier and, in turn, streamline the brokers’ placement of insurance  coverage in the surplus lines market. The act creates a “home-state”  system of taxation and regulation to resolve difficulties in determining how  to tax and regulate surplus lines transactions. NRRA defines the home  state as the state in which the insured maintains its principal place of  business, or in the case of an individual, the individual’s principal  residence. If all the insured risk is outside this state, NRRA defines the  home state as the state to which the greatest percentage of taxable  premium taxed for that insurance contract is allocated. Under NRRA, the  home state has sole and exclusive authority to tax and regulate a sale of  surplus lines insurance. In addition, only the insured’s home state may  require a surplus lines broker to be licensed, even for transactions that  involve multiple states. NRRA also permits but does not require states to  form an interstate compact or otherwise establish procedures to allocate  premium taxes collected by an insured’s home state for transactions.  These compacts, if instituted, are intended to help states adopt  nationwide uniform requirements, forms, and procedures for reporting,  paying, collecting, and allocating premium taxes.
NRRA further seeks to simplify and make more uniform the criteria states  use to determine which insurers can be eligible to sell insurance on a  surplus lines basis. Specifically, NRRA states that a state may not impose  eligibility requirements on or establish eligibility criteria for surplus lines  insurers domiciled in the United States that are authorized to write  policies in their state of domicile. The act also states that the insurer  generally must maintain minimum capital and surplus levels as required  by NAIC’s Non-Admitted Insurance Model Act, which is the greater of $15  million or the minimum capital and surplus requirements of the insured’s  home state, or in certain situations, less than the minimum capital and  surplus when a state’s insurance commissioner finds an insurer  acceptable. This model act, among other things, is intended to protect  persons seeking insurance, assure such insurance is placed only with  reputable and financially sound insurers, and establish state regulation of  surplus lines insurance. NRRA also specifies that a state may not prohibit  a broker from placing surplus lines insurance with an alien insurer listed  on NAIC’s Quarterly Listing of Alien Insurers. Under NRRA, Congress  delegated to NAIC responsibility for reviewing and approving the financial  information of alien surplus lines insurers. Finally, NRRA contains a  provision specifying that, after July 21, 2012, a state may not collect any  fees for licensing a surplus lines broker unless it participates in NAIC’s  national producer database or an equivalent.
Although NAIC does not regulate admitted or surplus lines insurers,  according to NAIC officials it does provide services designed to make  certain interactions between insurers and regulators more efficient.  According to NAIC, these services include providing detailed insurance  data to help regulators analyze insurance sales and practices;  maintaining a range of databases useful to regulators; and coordinating  regulatory efforts by providing guidance, model laws and regulations, and  information-sharing tools.
section_title: Surplus Lines Insurers’ Premiums Written Increased Modestly and Companies Have Generally Remained Profitable
paragraphs: From 2008 to 2012 premiums written by surplus lines insurers grew by  1.6 percent (from $24.8 billion to $25.2 billion) and remained around 5  percent of the property casualty market as a whole. Over this time, even  though insurers’ claims and underwriting expenses generally exceeded  premiums, their net investment income allowed them to remain profitable.  As a result, surplus lines insurers also saw growth in capital holdings.
From 2008 to 2012, premiums written by the population of surplus lines  insurers that we examined rose modestly, mirroring trends in the overall  P/C market. While the total amount of premiums written (the sum of  premiums written by the surplus insurers on an admitted basis in their  states of domicile and on a surplus lines basis) declined following the  2008 financial crisis in both markets, it began increasing in 2011 and  continued to rise through 2012. In the surplus lines market, premiums  written increased about 3.2 percent in 2011, rising from about $22.2  billion in 2010 to $22.9 billion in 2011, and rose another 10.0 percent to  $25.2 billion in 2012. Premiums written in the overall P/C market rose  from $498.6 billion in 2008 to $523.4 billion in 2012. Surplus lines  premiums, which account for a small fraction of this overall P/C market,  declined slightly as a share of total P/C premiums in 2009 and 2010 but  began rising in 2011. In 2012, they accounted for 4.8 percent of the  overall P/C market (see fig. 2).
According to market analyses and surplus lines insurers and  representatives of industry we interviewed, surplus lines premiums can  fall for several reasons, including an overall slowdown in the economy  and a “soft” insurance market, which tends to occur after losses have  been relatively low. Economic slowdowns or downturns, such as the one  during the 2007-2009 financial crisis, can result in fewer new business  ventures of the type that would use surplus lines insurance. And in a  softening insurance market, generally after losses have been relatively  low, admitted insurers are often willing to write higher-risk coverage for  lower prices—coverage that might at another time be written by surplus  lines insurers. In contrast, during a “hard” insurance market, generally  after losses have been higher, admitted insurers are often less willing to  write high-risk coverage, and surplus lines insurers are more likely to step  in to write such coverage. With the U.S. economy in recovery, pricing  evidence suggests that since 2010 insurance markets have likely been  hardening, creating a flow of business from the admitted market into the  surplus lines market. Consistent with this trend, insurers that sell surplus  lines coverage saw the proportion of their total premiums from surplus  lines transactions increase slightly in 2011 and 2012, rising from 63.9  percent to 65.3 percent.
Most of the largest surplus lines insurers sell surplus lines coverage  almost exclusively, while smaller insurers that sell this coverage write  most of their premiums in the admitted market. Because U.S. surplus line  insurers are licensed as admitted insurers in their states of domicile, they  may sell some coverage on an admitted basis (see table 5 in app. III). Of  the top 25 surplus lines insurers as measured by total premiums written  (both admitted and surplus lines), 20 wrote over 98 percent of their  premiums as surplus lines in 2012, on average. Only three wrote less  than 95 percent. By comparison, the remaining smaller surplus lines  insurers received on average 38.9 percent of their premiums from the  surplus lines business during this period.
Since 2008, the list of top 25 surplus lines insurers has remained largely  unchanged, and these insurers have sold the bulk of surplus lines  coverage. Most of the top 25 insurers from 2012 were also among the top  insurers from 2008 through 2011 and in 2012 wrote about $16.9 billion in  surplus lines premiums, or about 66.9 percent of the market (see fig. 2).  The largest five surplus lines insurers each wrote over $1 billion in  premiums, with the largest U.S. based surplus lines insurer, Lexington  Insurance, writing $4.2 billion in premiums in 2012. Lloyd’s of London,  which is licensed as an admitted carrier in Illinois, Kentucky, and the U.S.  Virgin Islands, is the largest surplus lines insurer and wrote $6.3 billion in  surplus lines premiums in 2012, or about 25 percent of the total 2012  premiums written for all U.S. based surplus lines insurers. Lloyd’s surplus  lines premiums are written primarily to cover property exposures, and in  2012 their share of the surplus lines market premium was largest in  Texas (30 percent) and South Carolina (29 percent) and was at least 20  percent each in Florida, Georgia, Louisiana, Massachusetts, and North  Carolina. Table 6 in appendix III includes detailed information about  premiums written by the top 25 surplus lines insurers.
A majority of surplus lines premiums were written in a small number of  states. For example, from 2010 through 2012 just under half of the  surplus lines premiums written in the United States were written in 4  states, and almost two-thirds of the premiums were written in 10 states  (see table 7 in app. III). For each of these years, the top four states with  the most surplus lines premiums written were, respectively, California,  Florida, Texas, and New York—the four states with the most P/C  premiums written in the admitted market as well.
Insurer’s net income, which takes into account all aspects of the  company’s operations, including premiums written, losses, other costs,  and investment income, is a measure of profitability. As shown in figure 3,  the net income for P/C and surplus lines increased overall from 2008 to  2012. Net income for surplus lines insurers more than doubled over the  period, from $4.3 billion to $9.5 billion, but for P/C insurers it increased  nine-fold, from $3.7 billion to $37.3 billion, which is below the pre-crisis  highs of $66.4 billion and $63.6 billion in 2006 and 2007, respectively, but  has generally been trending upward.
subsections: section_title: Surplus Lines Insurers’ Net Investment Income Has Increased
paragraphs: Income from investments is important for surplus lines insurers because it  can allow them to operate at an overall profit despite unprofitable  underwriting operations. As we discussed earlier in this report,  investments of the broader P/C industry, which include surplus lines  insurers, were negatively affected by the 2008 financial crisis, and the net  investment income decreased for both surplus lines insurers and the P/C  industry from 2008 through 2012 (see table 1). From 2008 through  2012, the surplus lines insurers that we examined saw their invested  assets increase from $152.7 billion to $233.1 billion, respectively. These  assets were held in a broad range of instruments, but the bulk was in  bonds. An increasing percentage was invested in industrial bonds and  decreasing percentages in government and other bonds. These insurers  also held more in cash and other short-term investments from 2009  through 2012, but less so than in 2008. They have also tended to  increase their investments in common stock, but that amount remains  below 7 percent of total cash and investments (see table 8 in app. III).
Our analysis of data on net investment income earned (income earned  from all forms of investments) shows that from 2008 to 2012 the net  investment income increased for surplus lines insurers and decreased  slightly for the P/C market (see table 1). For surplus lines, this net  investment income rose from $6.1 billion to $10.22 billion, while for P/C  insurers it started the period at $53.1 billion and finished the period at  $50.1 billion.
Over this 5-year period, surplus lines and P/C insurers saw an increase in  their capital gains each year until 2011 when it dropped and then  increased again in 2012. Surplus lines insurers had capital losses of  $13.1 billion in 2008, rising to $9.6 billion in 2010, and dropping to $0.8  billion in 2011 because of a significant decrease in unrealized capital  gains. Capital gains increased to $8.7 billion in 2012 due to a rebound in  these capital gains. P/C insurers saw capital losses of $78.3 billion in  2008, but capital gains of $23.7 billion in 2012. According to an A.M. Best  report, in 2008 and 2009, the P/C industry’s assets were strained by  write-downs of devalued assets, mortgage-backed securities, and other  related assets, and the changes in 2010 and 2011 for both the P/C  industry and surplus lines insurers are largely attributable to their  increased investment in relatively short-term fixed income securities that  carry low interest rates.
section_title: Surplus Lines Insurers’ Generally Made Money on Their Underwriting Operations
paragraphs: From 2008 through 2012, surplus lines insurers generally have made  money on their underwriting operations. Insurers’ underwriting operations  generally consist of the premiums it collects and the expenses it incurs  related to insurance activities. Expenses can generally be divided into two  categories: (1) underwriting expenses and (2) loss and loss adjustment  expenses. Underwriting expenses are those incurred by an insurer as it  obtains business, such as brokers’ commissions, employee incentive  programs, and marketing. Loss and loss adjustment expenses are losses  insurers incur as they investigate and settle claims, including actual claim  payments as well as legal fees. Expressed as a percentage of premiums  written, these ratios are referred as the “expense” and “loss” ratios,  respectively. The insurer’s underwriting profitability can be measured by  summing the loss and the expense ratios. This sum, measured relative to  premiums written is referred to as the “combined” ratio, where a value of  less than 100 percent indicates that an insurer’s underwriting is profitable,  and a value of more than 100 percent indicates an underwriting loss.
The expense ratio for the surplus lines industry as a whole was greater  than the ratio for the broader P/C market (see fig. 4). In part, this could  reflect the higher costs associated with assessing and pricing the more  complex risks often covered by surplus lines insurers. The expense ratios  for the surplus lines industry increased slightly over this period, rising  from 28.2 percent in 2008 to 29.4 percent in 2012.
Since 2008, surplus lines insurers’ loss ratios have increased but  remained below those of the broader P/C market (see fig. 4). In 2012,  these expenses for the surplus lines insurers in our analysis were 70.6  percent of premiums written. According to an A.M. Best report, the loss  and loss adjustment cost percentage increased from 2010 to 2011 for  both admitted and surplus lines insurers because of large losses from  weather-related catastrophes and a weak economy. In 2012, surplus lines  insurers experienced losses because of Superstorm Sandy.
Figure 4 shows that from 2008 to 2012, the overall underwriting activity of  surplus lines insurers in our analysis was profitable every year except in  2011 (the industry was profitable in 2012 because the unrounded  combined ratio for 2012 was 99.94). In contrast, the 25 largest surplus  lines insurers had underwriting profits in 2008 and 2009, with an average  combined ratio of less than 100 percent in each of those years, but  showed losses for the remaining 3 years. An A.M. Best report noted that  the competitive insurance marketplace and the recent recession  combined to weaken surplus lines insurers’ underwriting performance in  2010 and 2011 and led to overall underwriting losses in the P/C market.  And according to the Insurance Journal, catastrophic losses especially in  New York and New Jersey, due to Superstorm Sandy in 2012, drove up  surplus lines insurers’ loss and combined ratios for 2012 to the point  where they exceed those of the total P/C market.
section_title: Surplus Lines Insurers’ Capital Has Been Increasing
paragraphs: Surplus lines insurers’ capital has increased since 2008, adding to their  bottom line. A key measure of their capital is “policyholders surplus.” A  higher level of policyholder surplus means that an insurer has more  capital available to pay claims. Figure 5 shows that the capital for surplus  lines insurers has been increasing since 2008, similar to an increase also  seen in the P/C market.
Table 2 shows that from 2008 to 2012 the surplus level for these insurers  was $71.3 billion in 2008 and rose to $132.4 billion in 2012, and for the  top 25 surplus lines insurers, their total policyholder surplus rose from  $15.6 billion in 2008 to $17.6 billion in 2012.
Surplus lines insurers have also experienced few impairments of their  capital (see fig. 6). Impairments occur when an insurer’s assets are too  low in comparison to their liabilities. According to an A.M. Best report,  accounting for the number of insurers in the industry, the surplus  industry’s average rate of impairment from 1977 to 2011 was 0.99  percent, slightly higher than the impairment rate of 0.90 percent for P/C  insurers. A.M. Best added that from 1998 to 2003, impairments occurred  because of the increased failure rate of insurers that relied heavily on  underwriting done by managing general agents and because some  parents of surplus lines subsidiaries became insolvent. A.M. Best added  that more recently surplus lines insurers have not experienced any  impairments since 2004, because of better underwriting performance,  improved financial market conditions, and more favorable pricing. Thus,  the recent experience of surplus lines insurers compares favorably to that  of admitted insurers, which experienced a higher percentage of  impairments.
section_title: NRRA Implementation Has Begun in Most States and Appears to Have Had Little Effect on the Pricing and Availability of Coverage
paragraphs: Almost all states have begun to implement NRRA, which our review of the  legislative history shows that Congress passed in 2010 to make it easier  for surplus lines insurers and brokers conducting business across states.  According to surplus lines insurers, brokers, and representatives of  industry associations, the act has simplified the collection of premium  taxes for multistate risks. Market participants we spoke with said that  NRRA has had little, if any, effect on the prices or availability of coverage,  as NRRA was not intended to affect these areas. The participants noted  that any changes in price and availability would be due to the insurance  cycle rather than NRRA.
subsections: section_title: Almost All States Have Modified Their Laws to Implement NRRA’s Home State Definition
paragraphs: As noted, NRRA created a home state system for the regulation and  taxation of surplus lines insurance. According to our review of state  insurance laws in all 50 states, as of December 2013, all states except  Michigan have amended their laws to address this provision, which  regulators and market participants we spoke with consider to be the key  provision of NRRA. We found that the states had largely adopted a  definition of the home state that closely matched the term as defined in  NRRA—that is, the state in which the insured maintains its principal place  of business or residence or, if all the risk resides outside that state, the  state to which the greatest percentage of taxable premium is allocated for  that insurance contract. According to officials of an association  representing surplus lines insurers and brokers, the home state provision  has produced significant benefits for the surplus lines industry by  reducing the need for insurers to comply with differing sets of rules,  disclosures, and requirements. As shown in figure 7, the act has also  simplified the payment of premium taxes for transactions involving a  multistate risk. Most market participants we interviewed agreed that the  home state provision has brought needed clarity to the market.
Under the home state system, as an option for collecting and allocating  premium taxes, NRRA permitted but did not require states to form an  interstate compact or otherwise establish procedures to allocate premium  taxes paid to a home state. These compacts, if instituted, were intended  to help states adopt nationwide uniform requirements, forms, and  procedures for reporting, paying, collecting, and allocating premium taxes  for multistate risks. To date, only a few states have chosen to participate  in an interstate compact. Two compacts exist, but only one was  operational as of November 2013. The operational compact, called the  Nonadmitted Insurance Multi-State Agreement (NIMA), includes five  participating states—Florida, Louisiana, South Dakota, Utah, and  Wyoming—and Puerto Rico (fig. 8). The other compact is the Surplus  Lines Insurance Multi-State Compliance Compact (SLIMPACT). It  comprises nine states—Alabama, Indiana, Kansas, Kentucky, New  Mexico, North Dakota, Rhode Island, Tennessee, and Vermont—but  requires 10 states (or 40 percent of surplus lines premiums written),  whichever comes first—to take effect. Having not reached the minimum  threshold, SLIMPACT is not currently operational.
Rather than joining an interstate compact, most states have opted to levy  (at their own state tax rate) and then retain 100 percent of the premium  tax when they are the home state of the insured (see fig. 8). Although  data were unavailable to analyze the net effect on taxes of states  adopting this approach, representatives from two industry associations  we spoke with have expressed support for it because of its simplicity and  view it as most consistent with the intent of NRRA.
Market participants, such as surplus lines insurers, and representatives of  the industry associations we interviewed said that a state’s decision of  whether to join a compact depended largely on the amount of revenue  involved. One analysis of the tax-sharing effect of NIMA, performed by an  association representing surplus lines insurers and brokers, showed that  a small amount of tax revenue, roughly $125,000 across the participating  states, was eligible for sharing among NIMA’s members. The largest  states in terms of premium, such as California, New York, and Texas, are  currently not members of an interstate compact. Rather, these states tax  and retain 100 percent of premium when they are the home state of the  insured, as discussed above. Market participants told us it is unlikely  these large states would join an interstate compact because they stand to  collect more revenue by using their current approach rather than by  joining an interstate compact. In addition, states apply a range of tax rates  to both single and multistate risks when they are the home state of the  insured (see table 9 in app. IV). For example, some states will use the tax  rate in their own state, while others will use the applicable tax rate from  the respective states where each portion of the multistate risk resides.
In addition, according to NAIC, all states except for Washington are now  participating in its national insurance producer database for licensing  surplus lines brokers, which NRRA made a prerequisite for collecting fees  for licensing an individual or entity as a surplus lines broker. The  database contains information on insurance producers’ (agents’ and  brokers’) name, address, state of license, and any regulatory actions  taken, among other elements. According to NAIC, the database, which is  updated daily, links state regulatory licensing systems into a single  common system. NAIC officials told us that they are working with  Washington on the implementation of the state’s surplus lines for both  initial licensing and renewals of surplus lines brokers and the state will be  participating in the database in December 2013.
section_title: To Assess Eligibility, Some States Are Making Additional Requests of Nonadmitted Insurers
paragraphs: Section 524 of NRRA establishes nationwide criteria for determining  whether insurers are eligible to sell in states where they are not  domiciled. In particular, the section discourages states from imposing  eligibility requirements on these insurers if they are authorized to write  coverage and meet minimum capital and surplus requirements in the  insured’s home state. However, a range of industry associations we  spoke with representing insurers, and insurance agents and brokers,  among others, noted that some states were taking actions that they  believed were inconsistent with Section 524. For example, the  associations said that some states were requesting information—such as  business plans, disaster plans, and policy forms—that the associations  believe were not relevant to confirming the criteria set forth in Section  524. They said that some states were also asking for fees or other  charges that are not specified in Section 524. According to the  associations, in some cases, states are applying different standards for  single and multistate risks, a particular issue for alien insurers. For  example, according to the associations, one state may consider an alien  insurer listed on NAIC’s Quarterly Listing of Alien Insurers as eligible to  sell coverage if the covered risk resides in more than one state; however,  if the policy is a single state policy, then the same alien insurer must meet  state-specific eligibility standards to write the policy. The associations say  that these actions place an additional administrative burden on surplus  lines insurers and result in a lack of consistency across states, which  NRRA was intended to address.
To reduce the requesting of additional information by state insurance  regulators, NAIC formed a subgroup that in August 2013 developed  options for improving access to financial information by regulators,  brokers, and the insured. These options, which received input from the  surplus lines industry, include the following:
NAIC will provide quarterly and annual summaries of insurer financial  data (surplus lines total direct premium written and policyholders’  surplus) to help states confirm an insurer’s financial health,   states will make greater use of NAIC’s automated systems to verify  insurer financial data, and   states will provide a link to NAIC’s Quarterly Listing of Alien Insurers  on their insurance department websites.
According to NAIC officials, they will continue to encourage states to  implement these suggestions and in 2014, the association may consider  a survey to gauge state implementation.
section_title: NRRA Appears to Have Had Little, If Any, Effect on Prices and Availability of Coverage
paragraphs: According to surplus lines insurers and brokers and representatives of the  industry associations that we contacted, NRRA has had little, if any, effect  on the price and availability of coverage in the admitted and surplus lines  markets. Market participants noted that the changes under NRRA were  intended to streamline and simplify the taxation and regulation of surplus  lines insurance, and these changes would not likely affect the price or  availability of coverage. Market participants noted that the insurance cycle  of soft and hard markets (rising and falling premiums), as discussed in  greater detail later, was the primary factor affecting the price and  availability of coverage. They added that in their view it would be difficult  to determine the precise effect, if any, of NRRA because it generally  would be difficult to separate the effects of laws and regulations from the  normal functioning of the insurance cycle.
While surplus lines insurers generally write tailored products, according to  a market participant, in some instances the insured (individuals or groups  covered by an insurance policy) may move from the surplus lines to the  admitted market. Insureds may do so because an admitted insurer  changed its underwriting and pricing standards to accept risks that it  previously did not accept. For example, an admitted insurer that did not  cover commercial apartment risks may decide to do so. According to a  study of surplus lines insurance, whether this strategy succeeds depends  on the admitted insurer’s underwriting and pricing expertise and ability to  comply with the state’s form and rate filing regulations. The study noted  that insureds may also migrate from one market to another because of  the insurance cycle, a concept noted by many of the market participants  that we interviewed. As we have discussed, in a soft market, admitted  insurers may lower their acceptability standards, broaden their coverage,  and decrease prices to retain customers and attract new ones. In a hard  market, by contrast, admitted insurers may raise their acceptability  standards, restrict coverage, and raise prices, so insureds may not find  the coverage they want in the admitted market and thus move to the  surplus lines market.
According to market participants, any changes in coverage would be due  to the insurance cycle rather than NRRA and there has been little  noticeable shifting in coverage between the admitted and surplus lines  markets as a result of NRRA.
section_title: Agency Comments
paragraphs: We provided a draft report to NAIC for review and comment. NAIC  provided technical comments, which we incorporated, as appropriate.
We are sending copies of this report to the appropriate congressional  committees. In addition, the report is available at no charge on the GAO  website at http://www.gao.gov.
If you have any questions about this report, please contact me at (202)  512-8678 or garciadiazd@gao.gov. Contact points our Offices of  Congressional Relations and Public Affairs are listed on the last page of  this report. GAO staff who made major contributions to this report are  listed in appendix VI.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: The objectives of this report were to (1) describe the size and condition of  the surplus lines insurance market and (2) examine actions states have  taken to implement the Nonadmitted and Reinsurance Reform Act’s  (NRRA) provisions and the effects of the act, if any, on the price and  availability of surplus lines coverage.
To describe the size and condition of the surplus lines market, we  obtained and analyzed, but did not independently verify, end-of-year  financial and corporate data, from 2008 through 2013, on 199 surplus  lines insurers from the following sources:
SNL Financial,
A.M. Best,
National Association of Professional Surplus Lines Offices (NAPSLO),
National Association of Insurance Commissioners (NAIC).
We identified surplus lines insurers as those that NAIC recognized as  eligible or approved to sell surplus lines insurance in calendar year 2012  and actually did sell it in that year. Specifically, we examined lists of  eligible surplus lines insurers from state department of insurance  websites, state surplus lines association websites, and NAIC’s website.  Several states published lists of insurers that are permitted to write  surplus lines coverage in their state. The lists provided various types of  information on each insurer but were not consistent in all cases. To  address this inconsistency, we cross-checked the lists with insurer  profiles from NAIC and SNL Financial and resolved any discrepancies.
We did not include risk retention groups, since the nonadmitted insurer  provisions of NRRA specifically omitted these groups.
Using the corporate and financial data described above, we analyzed  data on these surplus lines insurers’ financial characteristics, such as  their premiums written, expense ratios, and capital. We also examined  the general focus of their activities, such as whether they are involved in  commercial property, commercial general liability, personal lines, or  commercial medical malpractice. We used the types of coverage  identified in SNL Financial’s “designated focus,” which identifies the types  of coverage or broad categories of business provided by the insurer.  Specifically, if a company writes 60 percent or more of its overall P/C  premiums in a specific category, it is given a corresponding SNL- designated focus. SNL uses the following methodology to assign a focus  to a company: Companies with less than $1 million in net premium written  are not given a line of business designated focus. Companies whose  reinsurance business is greater than 64 percent (a figure determined by  SNL Financial) of their premiums written are classified as reinsurers.  Reinsurance companies with more than $1 billion in assets are  designated as large reinsurers. All other insurers are designated as  having a personal, commercial, or accident and health focus. A company  is designated as having a commercial lines focus if it has very diversified  operations within the commercial lines. Otherwise, SNL designates a  company as focusing on one of the following commercial lines:  commercial property (auto, multiperil, fire and allied, and inland and  ocean marine), commercial medical malpractice, commercial workers’  compensation, commercial financial lines (financial lines such as fidelity,  surety, and mortgage guaranty), and commercial general liability (other  and general liability).
To provide a comparison of the surplus lines market to the admitted  market, we drew upon a recent report we issued on the insurance  markets and the impacts of and responses to the 2007-2009 financial  crisis. This recent report examined, among other things, admitted  insurers’ investments, underwriting performance, and premium revenues.  To assess issues related to data reliability for the current report, we  reviewed related documentation, conducted interviews with  knowledgeable officials, and reviewed previous related reliability  assessments and determined that no material changes had been made in  how they collected and tabulated the data. We determined that, for the  purpose of describing the size and condition of the surplus lines  insurance market, for this review, the data were sufficiently reliable.
To examine actions taken by states to implement NRRA and the effect of  the act, if any, on the price and availability of coverage, we reviewed and  analyzed the insurance laws of the 50 states and the District of Columbia,  focusing on each state’s implementation of the “home state” provision of  NRRA. We focused on this provision because regulators and market  participants consider it to be the key provision of NRRA. To supplement  our analysis, we consulted a law firm’s law manual on the surplus lines  laws in the United States.
In addition, we interviewed staff from NAIC and the Federal Insurance  Office within the U.S. Department of the Treasury. We also interviewed  officials from two state departments of insurance (Delaware and Illinois),  based on these states having a large number of surplus lines insurers  domiciled in their state. We interviewed officials from two state surplus  line associations (New York and California) for the same reason. Finally,  we contacted relevant associations of the insurance industry, including:
NAPSLO,
Property Casualty Insurers Association of America,
American Insurance Association,
Council of Insurance Agents and Brokers,
American Academy of Actuaries, and
American Association of Managing General Agents.
We selected these associations for interviews because of their role in the  surplus lines market; in representing the interests of insurers,  underwriters, brokers, and others; or for their expertise. We also  interviewed four insurer parent companies, whom we selected based on  their large amounts of surplus lines premiums written and having  subsidiaries that operate in both the admitted and surplus lines markets.  To obtain the perspectives of those who serve as intermediaries between  insurers and the insured, we interviewed two large brokers. In addition,  we reviewed documents from NAIC including a compendium of state laws  on surplus lines, a sample bulletin for states’ implementation of NRRA,  and records from recent national meetings. We also reviewed related  industry reports and analyses of the surplus lines market.
NRRA mandated that we determine and analyze the extent to which there  has been a change in the number of individuals who have nonadmitted  insurance policies, the type of coverage provided under such policies,  and whether such coverage is available in the admitted insurance market.  We solicited these data from industry associations, surplus lines insurers,  and a large insurance broker, but were told that insurers do not track such  information. Representatives of industry associations and a few insurers  told us that coverage for individuals represents only a small segment of  the market, as the market largely focuses on coverage for businesses.  These representatives also said that any change in the number of  individuals with coverage before and after NRRA is likely to be small.  They added that any change in coverage would be due to the insurance  cycle rather than NRRA.
We conducted this performance audit from April 2013 to January 2014 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
section_title: Appendix II: National Association of Insurance Commissioner’s Alien Insurers
paragraphs: Section 524 of the Nonadmitted and Reinsurance Reform Act of 2010  (NRRA), as part of the Dodd-Frank Wall Street Reform and Consumer  Protection Act (the Dodd-Frank Act), says that states may not prohibit a  surplus lines broker from placing nonadmitted insurance with, or  procuring nonadmitted insurance from, a nonadmitted insurer domiciled  outside the United States (also called an alien insurer) that is listed in  National Association of Insurance Commissioner’s (NAIC) International  Insurers Department (IID) Quarterly Listing of Alien Insurers. This  publication includes a list of alien insurers that have filed financial  statements, copies of auditors’ reports, the name of their U.S. attorneys  or other representative, and details of U.S. trust accounts with the NAIC  IID and, based upon these documents and other information, appear to  fulfill the criteria set forth in the International IID’s Plan of Operation for  Listing of Alien Nonadmitted Insurers. According to NAIC, the listing  provides brokers, exempt commercial purchasers, and insureds with  assurance as to the eligibility of non-U.S. insurers with which excess and  surplus lines insurance business is being quoted or placed. Alien insurers  listed by NAIC must observe applicable state insurance laws and  regulations, including those covering trust funds. NAIC cautions brokers  that the appearance of an alien insurer’s name on this list is not an  endorsement by NAIC.
In order to be considered for inclusion in the NAIC publication, an insurer  must demonstrate that it meets IID’s standards on capital and surplus,  U.S. trust accounts, and integrity. First, a company must continually  maintain enough capital or surplus to meet its obligations. IID set the  minimum amount for April 2012 at $30 million and increased it to $45  million as of January 2013. IID also considers the size of the company,  the type of business underwritten by the company, and trends in the  company’s capital and surplus. Second, the insurer must establish a U.S.  trust account in a U.S. financial institution, consisting of cash deposited  with the trustee, securities, or an acceptable letter of credit on behalf of  U.S. policyholders. IID provides applicants details on the terms and  conditions of such accounts. Third, an insurer is to have an established  reputation of financial integrity and satisfactory underwriting and claims  practices. According to A.M. Best, as of August 2012, 34 states  maintained a list of regulated aliens, 11 states used IID’s “white list,” and  12 states used IID’s Quarterly Listing of Alien Insurers to qualify aliens as  surplus lines Insurers.
From January 2010 through April 2013, 72 surplus lines insurers were  listed in NAIC’s Quarterly Listing of Alien Insurers (see table 3). This  count combines the over 80 Lloyd’s of London syndicates into one entry.  Also over this time, several companies were added to the list while others  were dropped, and some companies changed their name.
The NAIC-listed alien insurers are domiciled in several countries, but half  of them were domiciled in England (see table 4). Another 14 were  domiciled in Bermuda. The rest are domiciled in other countries, most of  which are western European countries.
section_title: Appendix III: Surplus Lines Insurers’ Premiums Written and Investments
paragraphs: Table 5 shows that the largest surplus lines insurers write most of their  premiums in the surplus lines market, while smaller surplus lines insurers  write most of their premiums in the admitted market.
Table 6 provides detail on the surplus lines premiums written from 2008  through 2012 by the top 25 surplus lines carriers in each of those years.  The carriers are listed in order of descending surplus lines premiums  written for 2012.
Surplus lines premiums are concentrated in a few states (see table 7).  About half of the surplus lines premiums are written in 4 states, and just  under two-thirds of the premiums are written in 10 states. From 2010- 2012, the 10 states with the most surplus lines premiums written in their  states accounted for 62.8 percent, 63.3 percent, and 63.6 percent of the  total premiums in 2010, 2011, and 2012, respectively.
From 2008 through 2012, the 199 SL insurers that we examined had cash  and invested assets from $152.7 billion to $233.1 billion, respectively, in  several asset classes, and are mostly invested in bonds. An increasing  percentage was invested in industrial bonds and decreasing percentages  in government and other bonds. These insurers also invested somewhat  heavily in cash and other short-term investments, but less so than in  2008. They have also tended to increase their investments in common  stock, but that amount remains under 7 percent of total cash and  investments (see table 8).
section_title: Appendix IV: States’ Premium Tax Rates on Surplus Lines Sales
paragraphs: Appendix IV: States’ Premium Tax Rates on  Surplus Lines Sales Member of  interstate  compact  SLIMPACT  (when state is insured’s home state)
Member of  interstate  compact  no  (when state is insured’s home state)
section_title: Appendix V: Premiums Written of Parent Companies of Foreign Surplus Lines Insurers
paragraphs: The potential for business to shift between admitted and surplus lines  insurance companies owned by a given parent company depends in part  on the extent to which that parent’s subsidiaries offer the same coverages  on both an admitted and surplus lines basis, and in the same markets.  While we could not determine if the admitted and surplus lines insurance  subsidiaries owned by the parent companies listed in table 10 sold the  same coverages or in the same markets, we did examine whether there  was a change in the proportion of a parent’s subsidiaries business that  was done in the surplus lines market. We also examined the surplus lines  companies whose parents did not have other property and casualty (P/C)  subsidiaries.
As shown in table 10, SNL Financial, Inc. (SNL) P/C Groups (a proxy for  parents, including only P/C insurers) with surplus lines insurer  subsidiaries tend to have admitted subsidiaries whose premiums written  exceed that of the surplus lines subsidiaries, often by a large percentage.  Of the 25 companies with the highest premiums written in 2012, 4 had  over half of their premiums provided by their surplus lines business lines,  and of those, 1 (Ironshore, Inc.) had a significant portion of its premiums  (79.6 percent) provided by these business lines. American International  Group, Inc., the largest surplus lines provider as measured by 2012  surplus lines premiums written, wrote $5 billion in surplus lines premiums  in 2012, but that was 21.4 percent of its total premiums written. It shows  that surplus lines insurers whose parents have no P/C subsidiaries wrote  51.3 percent of their total premiums written in the surplus lines business  lines in 2012, which was more than double the 22.4 percent for parents  with P/C subsidiaries (see table 10).
section_title: Appendix VI: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Patrick Ward (Assistant Director),  Emily Chalmers, Pamela Davidson, John Forrester, Ronald Ito, Marc  Molino, and Jessica Sandler made important contributions to this report.