By Donald S. Malecki, CPCU

Agents or brokers who deal with the excess and surplus lines markets often do so because it may be the only option available for placing coverage when the risk is a difficult one for underwriters to accept, or they may seek out specialty coverage for the risk that the standard lines market simply is not interested in handling.

The excess and surplus lines market has exploded in size and in the diversity of coverages it offers over the past several decades. One of the best indicators of this can be found in The Insurance Marketplace, a publication focusing on nonstandard and specialty lines insurance coverage markets and published annually by The Rough Notes Company. Taking the 1996 issue, which represents its 33rd year, and comparing it with earlier editions is proof positive of this market's growth in size and the innovative coverages it makes available.

Agents or brokers can access the excess and surplus lines market directly, or they can go through wholesalers. However, the latter approach is not always voluntary, because some insurers require that the agent or broker (retailer) deal with a wholesaler as an intermediary.

Agents or brokers who routinely place business through the excess and surplus lines markets using wholesalers should establish a good working relationship with those wholesalers. The more the agent or broker learns about the requirements of those wholesalers, the better the rapport between the two will likely be, and the less the chances that misunderstandings will occur.

However, agents or brokers need to understand that, generally speaking, the addition of a wholesaler into the chain of events does not necessarily create a buffer upon which the agent or broker can rely when a dispute arises over the issuance of a policy. What this means is that if a certain coverage is requested but not issued and this discrepancy is not discovered until after a loss, it may be difficult to assess any part of the liability to the wholesaler.

The reason the wholesaler generally is insulated from problems (in those cases when the wholesaler is not the "pen"), is that its role is often limited to serving as an independent conduit between the agent and broker and ultimate issuer of insurance. Without some closer, legal relationship with, and thus reliance on, the wholesaler, the agency may not have anyone to blame but itself in cases where the problem could have been avoided with the exercise of standard care.

Case illustrates agent's duty

A case in point is Broadus v. Essex Insurance Co., 621 So.2d 258 (Sup.Ct. Ala. 1993), where the insured sued the retail agency, wholesale broker and the insurer after a claim was denied based on a policy exclusion.

Briefly, the facts are as follows: The insured contacted his insurance agent to request a certain coverage. The agent, in turn, contacted his wholesaler whose role, it was said, was to assist agents in finding insurance companies that provide the kind of coverage requested.

The wholesaler obtained certain information from the agent which was relayed to the insurer. The insurer, in turn, informed the agent, through its wholesaler, that a policy would be issued subject to certain terms. The agent relayed that information to its insured who not only accepted it, but also paid the premium.

After the insurer denied a claim based on a policy exclusion, the insured sued seeking damages against its agent, the wholesaler, and the insurer. The lower court ruled in favor of the wholesaler, and the insured appealed. The higher court affirmed that decision of the lower court over a strong dissenting opinion.

The basis for the court's decision was that the wholesaler had no right to, and did not, control the activities of the retail agent. Furthermore, the retailer acted at all times as an independent agent for the insured, whereas the wholesaler acted as an independent broker passing on information upon request between the insured and the insurer.

The court also held that by simply passing information between the insurer and the retailer and performing certain administrative duties in connection with the policy on behalf of the insurer, the wholesaler did not create the kind of relationship with the retailer that would subject it to liability under the doctrine of respondeat superior, i.e., the master is responsible for the acts or omissions of its servant.

The above case is cited as a representation of the kind of problems that can befall agents or brokers who deal with the excess and surplus lines market. Much will depend on the fact pattern in each case. As a matter of fact, the dissenting opinion in this case was over the business relationship of the defendants. The dissenting justice was of the opinion that the retailer was an agent of the wholesaler, and that the wholesaler was the general agent of the insurer. A finding of this kind of relationship would have changed the outcome of this case had it been adopted by the court in reaching its majority opinion.

Another interesting case involving the principal and agent relationship between the agent, wholesaler and insurer is Gulf Gate Management Corporation v. St. Paul Surplus Lines Insurance Company, 646 So.2d 654 (Sup. Ct. Ala. 1994). This case involved the allegation of negligent failure to procure liquor liability coverage discovered following the submission of a claim arising out of the intoxication of a bar patron and resulting death of an auto accident victim. This case is too lengthy and complex to discuss here, but it is recommended reading for those who are interested in these kinds of principal and agent cases involving agents and brokers, wholesalers and surplus lines insurers.

The caveat and difference

One or two cases do not make binding precedent to be followed in all cases a certainty. However, it would behoove producers who deal with the excess and surplus lines market through wholesalers to take note of the fact that if there is a problem over the lack of coverage, the wholesaler may be insulated from liability, particularly when the wholesaler acted strictly as an independent contractor and conduit—and that appears to be the custom and practice in most dealings involving wholesalers in the excess and surplus lines market.

This caveat is not unique to the excess and surplus lines market. This same warning applies to producers who deal with underwriters in the standard market. However, there is an important difference—generally speaking—between the two marketing approaches.

From the standpoint of the standard marketing approach, the use of agency agreements make it clear that the relationship between the producer and insurer is on the basis of principal and agent. However, if there is some problem with coverage, it is possible, depending on the fact pattern, to shift all or part of the liability to the underwriter.

However, the addition of a wholesaler between a retailer and insurer does not generally add anything to the defense of the retailer who is alleged to have failed to check the policy after issuance but before delivery. In fact, it is the custom and practice of the insurance business to review such policies before delivery to determine if the policies being issued depart from what was requested.

The above comment is not meant to be demeaning of the excess and surplus lines business, or of even the standard lines market. It simply reflects a fact of our business and that implementing good risk management practices on the part of agents or brokers should be an automatic part of their operations. It can make a world of difference for the career producer.

The case of the stamping fee

Another interesting case in this area involved the stamping fee charged an insured who purchased insurance through the excess and surplus lines market and its impact on the accountability of those directly involved in this market. The case is Ord & Norman v. Surplus Lines Association of California, 45 Cal. Rptr. 2d 292 (1995).

This case arose after a law firm, which was sued for malpractice, learned that the nonadmitted insurer was insolvent and that no protection was available from that state's guaranty association. The law firm therefore filed suit against the insolvent insurer, the broker, and the Surplus Lines Association of California (SLA).

SLA is a private nonprofit association that acts as a clearinghouse or conduit for information between the state's department of insurance and the state's insurance brokers who deal with nonadmitted insurers. In its role, SLA provides the insurance department with information filed with SLA regarding the financial health and operations of nonadmitted insurers. It also notifies California brokers when a nonadmitted insurer is barred from doing business in that state by a department's cease and desist order.

Apart from the above, SLA has no regulatory authority or power over nonadmitted insurers. The stamping fee charged with the issuance of each policy, and paid for by the insured, pursuant to statute and departmental regulations, is collected in order to support the expenses of SLA incurred in assisting the department of insurance.

In this particular case, SLA had forwarded a notice to brokers warning them against doing business with the insurer in question, but the policy was purchased by the law firm before the insurance department had taken such action against this particular insurer.

In any event, one of the main allegations of the law firm was that the stamping fee created a special relationship between the insured and SLA, which required the SLA to warn the insured of the impending problem.

The court, however, disagreed and ruled against the law firm, holding that the stamping fee created no special relationship. The fact that there was no direct contact between SLA and the law firm meant that SLA did not create or increase the danger faced by the law firm.

The court also noted that there was no close connection between the SLA and the loss suffered by the law firm and "no moral blameworthiness" in SLA's conduct. The court explained that it was unfortunate that the law firm had purchased its policy before the state's department of insurance had issued its cease and desist order, but this did not mean that the SLA had breached any legal duty owed to the law firm, or that it was in any way negligent.

This case is noteworthy, not only because it is interesting, but also because it dispels the notion that a stamping fee or tax fee does anything more than reflect an additional charge, made to provide what some states recognize as a necessary service.