States Ease E&S Terror Exclusion Restrictions

During the past two years, the surplus lines market has experienced a marked resurgence, primarily due to hardening rates and the desire of the standard market to drop miscellaneous lines and concentrate on core writings.

This trend was accelerated after the events of Sept. 11. Commercial lines insurers and their brokers found it increasingly difficult to renew property-casualty coverages in the United States due to their reinsurers' reluctance to cover terrorism risks and by Congress' delay in adopting a federal backstop for losses from future terrorist events.

In order to ease this potential market disruption, the National Association of Insurance Commissioners and 46 states approved optional terrorism exclusion language for general liability and commercial lines coverages proposed by the Insurance Services Office earlier this year. The four states that had not yet adopted the ISO exclusion as of this writing are California, Florida, Georgia and New York.

In spite of the approvals, one critical exposure–fire following a terrorism event–may not be excluded in most states from terrorism coverage. Twenty-nine states have adopted the Standard Fire Policy. In these jurisdictions, an insurance department is not permitted by statute to approve an exclusion on property policies written by an admitted company where coverage is otherwise mandated under the Standard Fire Policy, including coverage for “fire after a terrorism event”.

Some relief from this statutory mandate is available to surplus lines writers.

Based on a recent study conducted by Edwards & Angell, LLP, at least 17 states that have adopted the Standard Fire Policy and also approved (for admitted companies) the ISO terrorism endorsements containing a limited exception for fire, are not imposing a similar coverage limitation on surplus lines insurers. The basis for this is that these states do not regulate surplus lines insurers or review surplus lines policy forms.

New Jersey would also fall under this category although it requires form approval as discussed in greater detail below. The 16 other states are: Hawaii, Idaho, Illinois, Massachusetts, Michigan, Minnesota, Missouri, Nebraska, North Carolina, North Dakota, Oklahoma, Texas, Virginia, Washington, West Virginia and Wisconsin.

A smaller number of states that have adopted the Standard Fire Policy take the position that the language applies to any insurance policy–including surplus lines policies–insuring property in the state. Therefore, eligible surplus lines insurers in these jurisdictions must comply with the Standard Fire Policy language with respect to the fire peril, whether it is a monoline fire policy, or part of a multiple peril package policy.

The 12 states in this category are: Arizona, California, Connecticut, Georgia, Iowa, Louisiana, Maine, New Hampshire, New York, Oregon, Pennsylvania and Rhode Island.

In 22 jurisdictions (including the District of Columbia) that have not adopted the Standard Fire Policy, ISO has filed, and the states have adopted for use, an optional terrorism exclusion for property lines without a limited exception for fire. In these states, admitted companies would be permitted to make reference filings adopting the ISO form without the limited fire exception, thus allowing them to exclude exposures involving fire following a terrorist event. Surplus lines insurers in these states would be permitted to use a terrorism exclusion at least as broad as the ISO form.

Four major surplus lines jurisdictions–New York, California, New Jersey and Pennsylvania–have recently issued clarifying opinions or amended their original positions in regard to the use of terrorism exclusions in fire or multi-peril policies. A summary of their current positions is as follows:

New York

In New York, an informal opinion from the Office of the General Counsel dated April 19, 2002, represents the current position of the Department of Insurance. It states, in short, that a terrorism exclusion in a property-risk policy that is written on a surplus lines basis is permissible, but that such an exclusion is prohibited in regard to the peril of fire. This is true whether the coverage is written on a stand-alone basis or as part of a multi-peril policy.

The OGC Opinion further states that there are certain other statutorily mandated coverages, in addition to the peril of fire, where a terrorism exclusion would not be permitted. These coverages include motor vehicle insurance and workers compensation insurance.

California

In California, earlier this year, the Department specifically rejected the ISO terrorism exclusion, although it is now considering terrorism form filings submitted by admitted companies on a case-by-case basis. California has also adopted the Standard Fire Policy and thus the department would not be permitted to approve a terrorism exclusion for admitted companies that excludes “fire following a terrorist event.”

With respect to surplus lines, the California department takes the position that a surplus lines insurer may not avail itself of exclusionary language that is not acceptable on an admitted basis. Since the department will not approve terrorism exclusions for admitted companies that do not contain the limited exception for fire, it would impose the same restriction for surplus lines insurers.

This restriction applies to all fire policies written by surplus lines insurers, whether written on a stand-alone basis or as part of a multi-peril package. Surplus lines insurers must also adhere to the Standard Fire Policy with respect to cancellation and non-renewal provisions.

New Jersey

New Jersey has approved the ISO terrorism exclusion for admitted companies and also follows the Standard Fire Policy. Surplus lines insurers that desire to use a terrorism endorsement that is broader than the ISO version approved for use by admitted companies must submit the form to the New Jersey Department of Insurance for approval through its surplus lines agent.

The Department has approved and will continue to accept terrorism exclusions for surplus lines insurers that are broader than the ISO version. The departments new flexibility in this regard is based on its desire to be more “consumer friendly” and its stance that the surplus lines market should serve as an “escape valve” for the admitted insurance market.

Pennsylvania

Pennsylvania has adopted the ISO terrorism exclusion without changes and also follows the Standard Fire Policy.

Regarding surplus lines, Pennsylvania Insurance Laws require that a policy or contract form used by a surplus lines insurer not differ materially from policies or contracts customarily used by admitted insurers for the kind of insurance involved. Thus, a surplus lines insurer wishing to use a terrorism endorsement that does not follow the ISO version or is not otherwise acceptable for use by admitted companies, would have to submit the form for approval to the Department through its surplus lines agent.

Thus far, the Pennsylvania department has only approved terrorism endorsements submitted by surplus lines insurers that follow the ISO form. It is unlikely, therefore, that an exclusion broader than ISOs would be deemed acceptable for surplus lines insurers.

With respect to fire policies, surplus lines insurers may not exclude coverage for fire following a terrorist event with respect to any fire policy, whether stand-alone or part of a multi-peril policy. If surplus lines insurers opt to use the ISO terrorism endorsement with such policies, they must therefore use the “applies in standard fire policy states” version.

Attorney John P. Dearie Jr. is a partner in the New York office of Edwards & Angell, LLP, a full service law firm focusing on Financial Services, Technology and Private Equity. Mr. Dearie may be reached at: JDearie@ealaw.com

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, July 22, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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States Ease E&S Terror Exclusion Restrictions

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