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Surplus Lines Risk Factors

A generation has passed since the last hard market and a substantial proportion of the people employed in agencies today have never experienced one. This means they have never dealt with surplus lines in such large volumes as we see today. Premiums placed through surplus markets have soared over the last two years. Beyond simply being a market willing to write accounts admitted markets no longer want to write, many surplus lines markets have introduced innovative products to further expand their sales.

I find that many people who are new to the industry are treating surplus lines placements as if no difference exists between surplus lines rules and admitted market rules. In fact, I have had producers and account managers say: “There’s a difference?” To help reintroduce some industry-wide knowledge, here are a few points that everyone working in agencies must know when placing business with non-admitted markets.

1. E&S (excess and surplus), surplus, and non-admitted markets are all generically different names for the same kind of carriers. For simplicity, I will use the term “surplus.”
2. Surplus markets do not operate under the same regulations and statutes as admitted markets. Admitted markets are far, far more regulated than surplus markets. Surplus markets can do pretty much what they want, which is a major reason agents should take extra steps and precautions when placing business with them.
3. Not all surplus markets can operate in any given state. Surplus markets must be listed (i.e., pay the correct fees/taxes) in each state and appear on what is colloquially known as the “White List.” The White List has different names in different states, but if a surplus lines carrier is not on the list, even if it is due to a temporary paper mishap, agents cannot place business with that carrier until that carrier is back on the list. Check your White List regularly.
4. Surplus lines carriers do not pay the same fees and taxes as admitted markets (including not being required to make form filings). As a result, clients placed with surplus lines carriers generally receive zero protection if the carrier goes insolvent. State guaranty funds do not protect consumers in these situations. Agents should notify their client/prospect, in writing, at the time of a proposal/quote with a surplus market, that the quote is with a surplus market and does not qualify for the state’s guaranty fund. Do not wait until the policy is issued to provide this notification.
5. Because guaranty funds do not backstop surplus markets, agents might want to verify that any surplus lines carriers they use have higher A.M. Best ratings than would usually be their minimum for an admitted carrier. For example, if an agency does not place business with any admitted carrier possessing less than a B+ rating, consider not placing any business with surplus lines carriers with a rating less than an A-.

An interesting side note is that surplus lines markets have a better record relative to insolvency than admitted markets.

6. In the past, in most states an agent had to obtain three rejections from admitted carriers before they could place a client in surplus markets. Some states have relaxed this rule and most other states completely fail to enforce it. The rule’s purpose is well-intended but rather pointless, especially in a hard market where admitted markets are extremely frustrated by agents requesting quotes everyone knows the carrier will reject.

The rule is also pointless because some of the surplus lines market products are far better and no alternatives exist. An exception often exists in many state’s regulations for this situation. Do follow your state’s rules. If something goes wrong, you will have more protection if you have followed the rules.

7. Things often go wrong in surplus lines from an agency’s perspective. E&O exposures are greater with surplus lines and therefore, agencies need specific procedures for surplus lines business.

From my non-attorney perspective and without any consideration of various state laws and regulations, just a commonsense perspective, there are duties that must be fulfilled when a retail agent places business with a surplus market. Some will argue that retail agents have no duty to provide these notifications and it is the insured’s responsibility, only, to review their own policies — but if that is the case, then the insured does not need you to act as their agent. Some such duties and procedures include addressing the following with your client:

• Surplus lines markets generally do not need to deliver a policy that matches their proposal. Therefore, the agent must carefully check whether the proposal and what they promised the client matches the actual policy.
• Surplus lines markets in general can delete coverages at renewal without notifying anyone. I have seen several million-dollar claims where agents missed a deletion. Retail agents need to check renewals and notify clients when coverages are deleted or reduced.
• Do not wait until the policy is delivered to communicate with the insured. Coverage begins on the effective date, not the delivery date. Therefore, if coverage is missing and you are aware of it, communicate with your client ASAP. Additionally, if you are not going to communicate reductions in coverage to your client and the policy is not delivered until after the effective date, then the entire argument that it is a client’s duty to read their own policy is moot, pointless, and wrong-footed. If you know prior to the expiration date that there are reductions in coverage in the renewal and the insured will otherwise only discover the reduction 30 days after the effective date when the policy is actually delivered, you have a responsibility to advise the insured of that fact. Otherwise, again, they absolutely do not need you as their agent.
• Read your forms. Surplus markets do not need to file their forms or follow industry standard formats. If you are used to selling generic admitted carrier forms and take for granted that surplus lines forms will read similarly, you are mistaken. Read each form carefully and ask questions if you do not understand something.

These are just a few of the important characteristics everyone selling surplus lines policies needs to know and it is by no means an exhaustive list. Hopefully though, these recommendations will cause agents who are inadequately familiar with surplus lines, which at this point includes most people in the industry, to stop and think things through rather than taking something for granted. Taking anything for granted in the surplus lines market is probably the worst mistake anyone can make.