Author: Nancy Germond

In today's rapidly changing world, complex problems such as insurance for beachfront properties or emerging risks such as cyber challenges and active assailant incidents require unique solutions. This is where the surplus lines market can be a lifeline for the retail agent. When you tell your insured that you “can't write that risk," the agent who can write the exposure can then market your insured, and you can lose a valued client.

Surplus Lines Distribution Channels

Let's begin with some definitions of several surplus lines distribution channels.

Managing General Agent (MGA) – A specialized agent or broker usually is given underwriting authority from one or more insurers. MGA personnel can normally bind coverage, underwrite and rate submissions, appoint retail agents within certain areas and in some cases, settle claims. They usually specialize in certain coverages and have unique expertise to underwrite risks such as professional liability or in climate-impacted areas, windstorm coverage.

Wholesale Brokers – Function as an intermediary between the insurer and the retail agent. The wholesaler has no contact with the insured. Retail agents go to wholesalers to place hard-to-insure risks. Wholesalers include MGAs and surplus lines brokers. According to the National Association of Insurance Commissioners, “The licensed surplus lines broker is responsible for ensuring the surplus lines insurer meets eligibility criteria to write policies in the state and remits payment of the surplus lines premium tax to the “home state." 

Surplus Lines Broker -- A broker who places coverage through nonadmitted insurers. The surplus lines broker must be licensed in the state where coverage is written. 

Alien Insurer – Insurers domiciled outside a given country's. For example, Bermuda insurers would be alien insurers in the U.S.

Why the Need for Surplus Lines Coverage?

There are several reasons surplus lines coverage exists.

1.    To offer new or necessary coverage because a new threat arises, such as cyber protection or active assailant attacks.

Admitted carriers need more data points to develop forms and rates that state departments of insurance would regulate and approve. Coverage limits necessary for multi-billion-dollar companies to find the limits they need to manage their risks may require surplus lines coverage.

According to one expert, surplus lines coverage is a “proving ground" for new coverage. Surplus lines coverage offerings allow insurers to set and refine rates and discover how to manage the challenges arising out of the exposure. When state departments of insurance regulators have no rate history, they tend to not want to approve coverage.

Admitted carriers need more financial and loss data points so that the states can regulate these forms and premiums. Great products “incubate" in the surplus lines market, according to one expert.

2.    Commercial risks with high loss potential and/or the need for higher limits.

In high-value commercial real estate, for example, no one carrier could write the high limits needed to protect that property. Think of the World Trade Center or a large city with multiple properties like Miami, and the intricate coverage towers needed to protect those risks and cover the liability risks such as street, police, judicial, or other municipal risks.

In personal lines, any home used for Airbnb or home-sharing risks or with significant exposure to wildfire or tornadoes may go into surplus lines markets, for example.

3.    Distressed businesses with impaired risk profiles.

Areas located in high-crime areas or those properties that have suffered repeated losses from wind, hail, or water damage all can find coverage in the surplus lines market. Additionally, many insurers are reluctant to insure new business enterprises, for example a new plumbing company or a new computer consultant with no track record of expertise or losses.

Additionally, business owners who may be high profile or have earned an outrageous reputation, for example, a celebrity gossip page that routinely publishes unverified claims, would require coverage in the surplus lines market. No standard market would write that type of business; there is simply too much risk as potential “target defendants."

When a standard carrier non-renews a policy and other standard lines underwriters decline to quote, surplus lines markets may be your client's only resort. However, if there is a claim frequency or severity problem and the insured successfully manages and reduces the risk, that insured can often return to the standard insurance market.

The surplus lines market can accommodate almost any risk. Of course, coverage usually comes at a higher premium than standard markets, and often with higher deductibles and less comprehensive coverage.

What Are Some of the Top Surplus Lines Brokerages?

Lloyd's of London and their affiliates control about 16% of the surplus lines market in the U.S. There are several top players in the surplus lines market such as Markel, Berkshire Hathaway, WR Berkley through its network of over fifty insurance entities, AIG, Chubb through Westchester, Nationwide through Scottsdale Insurance, and more. All specialize in difficult to place risks that require creative solutions by charging an appropriate premium for the risk, tailoring the coverages that risk requires.

Cost Challenges

Surplus lines policies will cost more than standard business. Cost of reinsurance, risk concentration, and loss history will impact costs. Surplus lines insurers can charge a sufficient premium for the loss exposure because regulatory approval is less stringent.

Bear in mind, however, that coverage may not be as broad as insurance offered by standard insurers. Additionally, most forms are proprietary forms, not Insurance Services Office (ISO) forms, which can vary significantly from ISO forms. Working with surplus lines coverage, it's imperative that you read the forms so that you understand the coverage and any limitations. Collaborating with an experienced wholesaler can help, as well.

Tips When Working with Surplus Lines Insurers and Wholesalers

Developing relationships with surplus lines or wholesale underwriters can help you when you are trying to place unfamiliar coverage. For example, with hundreds of insurers writing cyber coverage, no agent can be familiar with all the forms. Wholesalers who specialize in cyber, for example, understand the loss exposures and can often help tailor coverage to offer strong protection for your clients.

Here are some items to review when working in the non-standard markets.

• Licensing – Is that broker licensed in the state where you are placing business?
• Insurance – Does that broker have an appropriate amount of errors & omissions coverage? Obtain a copy of their E&O coverage certificate before placing business with them.
• Knowledge – What is the background of the broker with whom you work? Does he or she have solid bench strength in the coverage you are writing?
• Accessibility – How accessible is that broker or underwriter? If you can't get phone calls returned or a reasonable turnaround on quotes, you can end up against impossible deadlines to place coverage.
• Multiple markets – Does the broker have multiple markets from which to choose? Are those markets financially strong?
• Hold-harmless language – If you sign a written agreement, watch for overly strict hold-harmless or indemnification language.
• Guaranty funds – Non-admitted insurers cannot access the guaranty fund in the states where they write coverage. States' departments of insurance do not monitor the financial strength of non-admitted carriers. Be sure you inform your clients about the lack of guaranty fund availability with surplus lines coverage. Be sure to put notices about non-admitted status in writing to your clients and at least annually monitor the financial strength of those carriers. Any B+ rating can head downhill fast.
• It is still a relationship business – Do not burn bridges by over-submitting accounts. Surplus lines underwriters or wholesalers only get paid if they write the coverage. Do not blanket wholesalers with quote requests.
  

Precautions When Working in Surplus Lines

According to one insurance underwriting expert, when retail agents procure coverage for their clients through a wholesale broker, they have no recourse if the wholesaler does not provide the requested coverage. Since the insured has no contact with that broker, the customer can only rely on representations made by his or her retail agent.

Even though the retail agents may tell the wholesaler exactly which coverages their clients want, the wholesaler has no duty to place that coverage as requested. The policy they produce will come with a disclaimer that the coverage furnished may not match the coverage the retail agent requested. This insulates the wholesaler from claims made by the client that the coverage is not correct.

It is the responsibility of the retail agent to carefully review the surplus lines policy to ensure that it includes all the coverages the insured requested. Many errors and omissions (E&O) claims arise from the retail agent not catching the discrepancy.

Here is an example. My brother wrote my friend's liability policy for his dog training kennel. This trainer sold personal protection dogs imported from the Czech Republic and provided personal protection training and handling to hospitals' and prison systems' personnel after importing these trained protection dogs. The trainer's dogs shipped all over the world, from South America to the Middle East.

The first policy arrived with coverage as requested. Upon renewal, however, my brother, who disliked working in surplus lines, asked me to review the policy. When I compared the renewal with the prior year's policy, I noticed the underwriter had endorsed a professional services exclusionary endorsement to the policy. By almost any standard (and we're not talking poodles here), providing dog training or handling services is a professional service.

This endorsement removed coverage for the trainer's professional services, with no protection for his training and dog-handling services. Had we not caught this endorsement (which the underwriter removed at our request), my brother could have had a big coverage issue and a potential E&O claim.

It is imperative that agents review the forms since non-standard forms are often proprietary and can contain coverage limitations not as prevalent in the standard lines markets.

In Conclusion

Some agents may consider surplus lines insurers as markets of last resort. Today, they function as incubators that meet the challenge of emerging and growing risks, such as active assailant events, cyber threats and wildfire and weather-related risks. They also provide critical insurance coverage in climate-impaired areas, and for clients who may have geographic, claims frequency, or reputational limitations. They serve an important role in the insurance industry.

For a good overview of the surplus lines market, and where some of the specific information from this article comes, listen to this podcast, Big Challenges! Big Solutions! on Twitter.

For an excellent overview on minimizing your exposure to an errors and omissions claim when writing surplus lines coverage, visit this link available only to our Big “I" Swiss Re policyholders. 

Last Updated: December 2, 2022