Brokers Beware: Dealing with unlicensed insurers

An unlicensed insurer is not subject to the same regulatory supervision and capital requirements as an insurer licensed in Canada. If the unlicensed insurer becomes insolvent, policies will not be protected by the Property and Casualty Insurance Compensation Corp. (PACICC). The likelihood of fraud also becomes much greater. Another risk for brokers is that they may inadvertently place business with an unlicensed insurer that results in tax liabilities for the insured.

The consolidation in the property and casualty insurance industry in Canada over recent years has reduced the number of available markets for brokers. In addition, many insurers are reducing the number of brokers that they deal with and are eliminating brokers that have unprofitable loss ratios. The hard market that has developed since September 11th has resulted in a combination of a lack of capacity for a number of lines of commercial insurance as well as significantly higher premium rates for virtually all types of insurance.

During hard markets, it becomes more tempting for brokers to try to place business with unlicensed markets.

London and Bermuda have been the traditional unlicensed markets for certain types of commercial business. However, there are a number of other unlicensed markets that will now write Canadian business.

PLACING UNLICENSED INSURANCE

There are a number of restrictions applicable to insurance brokers when they attempt to place business with unlicensed insurers. Pursuant to regulation 991 made under the Registered Insurance Brokers Act (Ontario), the conditions for dealing with an unlicensed insurer are as follows:

The broker must inform the insured of the risks of dealing with an unlicensed insurer;

The broker must obtain written consent from the insured;

Sufficient coverage cannot otherwise be obtained at reasonable rates or on the form of contract required by the insured;

Automobile insurance cannot be placed with an unlicensed insurer except for excess coverage;

A quarterly return must be filed with the Office of the Superintendent of Financial Services (OSFI), which provides particulars of all unlicensed insurance placed; and

A premium tax must be remitted.

The effect of these rules is to impose a number of responsibilities on the broker that must be met before insurance can be placed with an unlicensed insurer. It will normally be necessary for a broker to approach a number of licensed insurers and have the risk either declined or the premium rate quoted be unreasonably high before the use of unlicensed insurers can be considered.

There are, however, a number of tax issues that must be considered by an insurance broker in dealing with an unlicensed insurer. Pursuant to the Excise Tax Act, a 10% tax is payable by the insured on premiums with respect to coverage written by an insurance company outside of Canada. It is possible to apply for a waiver of the excise tax in circumstances where it can be demonstrated that the coverage was not available in Canada on reasonable terms and conditions. It will also be necessary for the broker to collect and remit any applicable sales tax as well as premium tax.

FRAUDULENT COVERAGE

It may be very difficult for a broker to obtain sufficient information on an unlicensed insurer in order to be able to assess whether it is operating legitimately or fraudulently. If a broker deals with a fraudulent unlicensed insurer, or a managing general agent acting without authority, there will be a number of consequences.

It is likely that the premiums paid by the insured will be lost. The insurer that has had a policy fraudulently issued using its name by a managing general agent will likely have no responsibility to pay claims unless it can be proven that apparent authority to issue it existed. The insurance broker will be required to arrange alternate coverage. It is likely that an error and omission will result if a claim has occurred under the policy which has been fraudulently issued.

There have been a number of frauds involving managing general agents in recent years. A managing general agent was recently convicted in Saskatchewan for issuing a fraudulent insurance policy for an insurance company that he did not have authority to place business for. The managing general agent collected the premium from the broker but did not remit it to the insurance company that he purported to represent. A fraudulent policy was then issued to the broker. Such frauds are often not discovered until a claim occurs.

There are also similar issues in dealing with Lloyd’s. There are a large number of Lloyd’s syndicates that are currently writing business in Canada, and it is difficult to determine who has authority to bind a particular coverage. The process of accrediting Lloyd’s cover note holders is a lengthy one and it is important to determine that it has occurred. It often takes Lloyd’s a significant period of time to determine whether a person is actually authorized to write business on behalf of a particular syndicate.

If a managing general agent represents well-known and licensed insurance companies, then there should be no hesitation in dealing with it. However, there should be particular concern if a managing general agent represents unlicensed insurers. The signs of a fraudulent insurance coverage include a not well known insurer, rates significantly below market, poorly prepared policy wordings and policies that appear to be issued from a head-office outside of Canada.

FSCO has also become more aggressive in investigating and prosecuting fraudulent unlicensed insurers and managing general agents. The have issued a number of cease and desist orders. The Internet provides new opportunities for fraud to occur. A fraud may occur entirely outside of Canada making it very difficult to prosecute it. OSFI publishes a “warning list” on a monthly basis that provides information on fraudulent insurers. The Registered Insurance Brokers of Ontario (RIBO) also publishes a bulletin in which it warns of unlicensed insurers that may be attempting to fraudulently do business with brokers.

DEALING WITH UNLICENSED INSURERS

A broker that wishes to do business with an unlicensed insurer should do a significant amount of due diligence before coverage is placed. A particularly important issue is how claims will be handled. For example, it should be determined whether the unlicensed insurer intends to appoint a Canadian adjuster to investigate claims.

There is no question that unlicensed insurance has its place for certain types of commercial coverage such as financial guarantee, residual value, terrorism and environmental covers that may not be available in Canada. It is unlikely that unlicensed insurance would ever be appropriate for personal lines coverages. In particular, unlicensed insurance should never be used to provide automobile coverage since it will not comply with the requirements of the Compulsory Automobile Insurance Act (Ontario).

Unlicensed insurers are also not allowed to advertise, solicit insurance, carry on business or open an office in Canada. The broker must contact the insured outside of Canada. For example, many brokers placing large commercial policies will make regular trips to London or Bermuda to arrange coverage. If an unlicensed insurer contacts a broker in Canada, the broker should be suspicious. For most brokers, unlicensed insurance should be avoided and is a likely source of errors and omissions (E&O) claims for them. Managing general agents must also be carefully evaluated to confirm that they have authority to bind coverage.