Surplus Lines, Cyber and Identity Exposures

Two kinds of client questions land at the edge of a personal lines producer’s authority. One is the home or collection that no insurer licensed in Michigan will write. The other is the loss that arrives through a screen: a stolen identity, a drained account, a locked laptop. The first part covers surplus lines insurance and a placement from first search to delivery. The second reads the standard homeowners 3 form (edition 05 11) against the household cyber exposure to see what it pays and what it leaves out. Names and figures in the examples are invented for practice.

What Surplus Lines Insurance Is

Michigan defines surplus lines insurance as insurance in the state procured from, or continued or renewed with, an unauthorized insurer. It includes insurance for which applications are solicited from Michigan residents, policies issued or delivered to them, insurance negotiated in whole or in part in the state, and insurance whose premium is remitted from within the state (MCL 500.1903(1)(d)). An unauthorized insurer is one not authorized to transact insurance in Michigan. Surplus lines is also called the nonadmitted or excess and surplus market. Its customers are risks the authorized market declines or cannot price: an old cottage on an eroding bluff, a vacant building, an unusual collection, a hazard that the standard forms exclude.

Two consequences follow from where this business sits.

• The Insurance Code does not regulate an unauthorized insurer’s rates, except that a rate must not be unfairly discriminatory, and does not regulate its forms, except that a policy must not misrepresent its true nature (MCL 500.1904). The client may find different terms from one surplus insurer to the next.
• An insurer that can write in Michigan solely by virtue of chapter 19 is not treated as an authorized insurer for the purposes of the property and casualty guaranty association (MCL 500.7911(2)), so a policyholder should not expect that association to stand behind a claim.

Who Sells It and Who Writes It

Only a licensee under chapter 19 may solicit, bind or otherwise act as agent or broker in a surplus lines transaction (MCL 500.1905(1)). A producer without that license who has a client in need brings the risk to one who holds it. A licensee may compensate a licensed resident agent for the business, and the agent may collect the premium for the licensee. As between the insured and the licensee, the licensee is treated as having received it (MCL 500.1916).

The licensee places the coverage with an eligible unauthorized insurer. For an insurer to be recognized as an eligible surplus lines insurer, the Director must find that it is in a stable and unimpaired financial condition and it must continuously maintain capital and surplus of at least $1,500,000 (MCL 500.1920(3), (4)). An eligible unauthorized insurer must also keep a deposit of at least $75,000 for Michigan policyholders or a trust fund of at least $1,000,000, and must appoint the Director as its agent for service of process (MCL 500.1921). A licensee may place a risk with an unauthorized insurer that is not eligible only in strict compliance with MCL 500.1950 (MCL 500.1905(4)(c)).

A Placement Step by Step

Kevin and Anya Lindahl own a cottage on a dune above Lake Michigan. Four insurers licensed in Michigan have declined it because of the bluff’s erosion history and the age of the wiring. They ask a surplus lines licensee to place it.

1. Availability. A licensee may not place insurance with an unauthorized insurer if the coverage is available from an authorized insurer (MCL 500.1910(1)). Some coverages are presumed available, and homeowners insurance on an owner-occupied dwelling worth less than the Michigan basic property insurance association’s maximum limits is one of them (MCL 500.1910(2)(c)). The presumptions are rebuttable. Coverage is presumed unavailable if the licensee cannot obtain it after a diligent search among authorized insurers (MCL 500.1910(3)(b)). A careful licensee keeps the four declinations in the file to document the search.
2. Choosing the insurer. The licensee offers coverage only to insurers in stable and unimpaired financial condition, and an insurer recognized as eligible meets that requirement (MCL 500.1920(1)).
3. Disclosure before placement. The licensee must tell the Lindahls that the coverage is being placed with an insurer not licensed in Michigan and that payment of loss may not be guaranteed if the insurer becomes insolvent (MCL 500.1905(5)).
4. The fee. The annual premium is $3,200. For a personal lines policy the licensee’s fee cannot exceed the greater of $100 or 10% of the premium, and 10% of $3,200 is $320. The licensee charges $250. The fee must be outside the premium, disclosed in detail in writing before the sale, and itemized on the declarations, the billing statement or other documentation of cost (MCL 500.1915).
5. Taxes. The licensee reports each half year and pays a 2% tax and a 0.5% regulatory fee on premiums written (MCL 500.1905(3)(d)). The fee in step 4 is not part of the premium for the tax. The tax is 2% of $3,200, or $64. Computing it on $3,450 would produce $69 and overstate it by $5.
6. Evidence. A licensee relying on an insurer’s prior written authority or on a communication that coverage has been obtained must deliver a policy, binder or certificate within 30 days after binding (MCL 500.1912). Every policy or cover note carries in red ink, in at least 10-point type, the notice that the insurance is placed with an insurer not licensed by the state of Michigan and that claims payment may not be guaranteed if it becomes insolvent (MCL 500.1922). If more than one insurer shares the risk, the evidence states whether each obligation is joint or several and, if several, each insurer’s proportion (MCL 500.1911(2)).

The Lindahls then hold a policy the authorized market would not give them, at the cost of different terms and without the guaranty association behind the claim. The producer’s task is to make that trade clear before the client signs.

Cyber and Identity Exposures

Household cyber exposure means loss caused by a computer, an online account or stolen personal data. The common forms are identity theft, unauthorized use of a card or bank account, loss or corruption of data, and liability for something an insured did online. The standard homeowners 3 form was not written for these losses and answers them only in fragments.

Exposure	What the form does
Unauthorized use of a credit or debit card, forgery of a check, counterfeit currency	Pays up to $500, as additional insurance, with no deductible
Card use by a household resident or a person entrusted with the card	Excluded
Records on paper or computer software, and the cost to research, replace or restore the information	A special limit of $1,500 applies to a covered loss
Business data	Not covered, except blank media and prerecorded software
Electrical surge destroying computer circuitry	The artificially generated electrical current peril does not include circuitry of computers
Cost of restoring a stolen identity	The edition studied has no such coverage

Three short cases show the limits.

• Stolen debit card. A thief uses Brian’s lost debit card to withdraw $1,900. The form pays up to $500, and only if Brian complied with the terms under which the card was issued. The bank’s own rules decide the rest.
• The teenager. Brian’s son uses the card without permission for $300. The household-resident exclusion applies, and the form pays nothing.
• A hacked account. A criminal takes over Brian’s email account and sends a fraudulent invoice. A neighbor pays $6,000 to the criminal and demands it back from Brian. The liability coverage pays damages because of bodily injury or property damage caused by an occurrence. A purely financial loss is neither, so Coverage E does not respond.

Some insurers add identity restoration or cyber endorsements, or write a stand-alone personal cyber policy. Terms vary widely, and a producer should read the endorsement and not describe it from memory. A producer never tells a client that the homeowners policy covers cyber loss in general.

Lesson summary

• Surplus lines insurance is placed with an insurer not authorized in Michigan, through a licensee. The Code does not regulate the insurer’s rates and forms except to bar unfair discrimination and misrepresentation.
• An insurer that is in Michigan solely through chapter 19 is not treated as authorized for the guaranty association’s purposes, so the association should not be expected to stand behind a claim.
• Coverage may be placed in the surplus lines market only if it is not available from an authorized insurer, and a diligent search with a documented file supports that finding.
• The licensee must disclose before placement that the insurer is unlicensed and may not be guaranteed, deliver evidence within 30 days, and show the red-ink notice on the policy.
• On a personal lines policy the licensee’s fee is capped at the greater of $100 or 10% of premium, stays outside the premium and is excluded from the tax base.
• A standard homeowners policy pays $500 for card, check and counterfeit currency loss, limits records and data restoration to $1,500, excludes business data and covers no identity restoration expense in the edition studied.