SURPLUS LINES COMPANIES

In today's tough property markets, many agencies find themselves using the surplus lines companies more and more. It's fortunate, for both agencies and policyholders, that this type of company exists for the "hard to place" risks.

Often a surplus lines company is referred to as a "non-admitted" or an "E&S" (for excess and surplus) company. A surplus lines company is one that does not come under the same regulatory standards by the Department of Financial Services as "admitted" companies do. (Examples of admitted companies are Hartford, Florida Family, State Farm, SAFECO, and Auto Owners. Examples of surplus lines companies are Scottsdale, Lexington, Penn-America, and Lloyds.) Surplus lines companies offer flexibility to agencies by being willing to write the "hard to place" business many admitted companies won't write. Surplus lines companies can offer creativity and flexibility through deductibles and specific policy language that may make a risk acceptable to the company. Properly used, surplus lines companies are great tools available to agents and customer representatives. There are, however, cautions to be aware of when using surplus lines companies.

Just what are the implications to a client who has a policy with a surplus lines company? They are significant and it's important that agents, customer representatives, and clients understand what they are.

• For starters, the Florida Insurance Guarantee Association (FIGA) does not protect surplus lines policyholders. This means that if a policyholder has a claim with a surplus lines company who is financially unable to pay the claim, FIGA does not step in and cover the loss. After Hurricane Andrew there were about a dozen "admitted" companies who became insolvent and FIGA stepped in to cover those claims. Had those companies been surplus lines, there would have been no FIGA protection. Additional companies have become insolvent since Hurricane Andrew and FIGA has responded in the same way; policyholders of the "admitted" companies were protected while policyholders of surplus lines companies were not. It's important to note that FIGA does not cover an unlimited amount of claims of insolvent admitted companies. For specifics on how much protection is provided by FIGA, see our free Education Library article titled "Florida Insurance Guaranty Association."

• The forms and conditions of a surplus lines company may (and usually do) differ greatly from the policy forms used by "admitted" companies. Not all surplus lines companies use standard ISO-type policy forms, making it necessary to carefully read all forms and exclusions. Unique exclusions are found in surplus lines policies and it's important to read the endorsements to see what they say.

• With some lines of business, it is not uncommon for the deductible to be significantly higher under a surplus lines policy than under the policy of an admitted company.

• There may be a "minimum earned premium," which means if the client cancels the policy before the expiration date, they won't get back a full pro-rata share of the premium. Minimum earned premiums of 25 percent are very common. Minimum earned premiums of 50 percent do exist on some selected risks, and it's not unusual to find a policy that is "fully earned" which means if the client cancels the policy, no money is due back. These "fully earned" premiums are often found on special event policies or short term policies to cover vacant structures as an example. For example, suppose the insured obtains a surplus lines policy with an annual premium of $10,000 under a 25 percent minimum earned provision. If the insured decided to cancel the policy a month after purchase, the 25 percent minimum earned feature will dictate that the insured will get back a maximum of $7,500. That is a hefty amount of money not returned to the client, especially if they were not made aware of the feature at the time of purchase.

• A surplus lines company can be used only if the agency has no admitted company willing to write the risk. If there is an admitted company available to the agency, the risk must be placed with that admitted company and cannot be placed with a surplus lines company. As part of an application process to a surplus lines agent, the retail agent must submit a "diligent effort" form to show that there are no admitted companies willing to write the risk. Failure to use a "diligent effort" to locate coverage with an admitted company is both inviting an E&O claim and violating Florida Statutes. If the full amount of insurance cannot be procured through an admitted company, it is permissible to use a surplus lines company. For example, if an admitted company offered a policy with a $25,000 deductible and the policyholder desired a lower deductible, it's permissible to use a surplus lines company. It's also permissible to use a surplus lines company in a case where the admitted company had an A.M. Best rating of "C" but the policyholder (or their mortgage company) required a B+ rating or better. As a final example, if the admitted company offered a commercial package policy without the peril of windstorm, the entire risk can be placed with a surplus lines company.

• Rates for surplus lines companies are not regulated like the rates for admitted companies are. This allows the surplus lines company flexibility in setting a premium for a particular risk, thus many risks are written that otherwise would not be written due to insufficient premium paid to the company.

FAIA suggests that agencies use some type of "waiver" to advise clients of the implications of being placed with surplus lines company. A sample waiver is shown below:

This waiver acknowledges the (agency name) has explained to me or my representative that surplus lines companies are not regulated to the same extent as admitted companies in Florida and there is an added risk to the insured in placing coverage with a surplus lines company. I have been advised that this insurance coverage is subject to Florida's surplus lines statutes. I am aware that corporations or individuals insured by a surplus lines company do not have the protection of the Florida Insurance Guaranty Association to the extent of any right of recovery for the obligation of an insolvent company. Therefore, by my directive (agency name) has placed coverage with a surplus lines company: I expressly waive any and all rights that I may have against (agency name) in the event the surplus lines carrier fails to honor my claim for any reason, including but not limited to bankruptcy, reorganization, or liquidation.

I further understand the policy forms, conditions, premiums, and deductibles in use by surplus lines companies are different from those found in policies used by admitted companies and that I should carefully read the entire policy.

The surplus lines marketplace is a viable alternative to agents who are unable to obtain coverage for their customers through an admitted company. Insurance professionals should become familiar with the legal requirements for using these surplus lines companies, should understand how this marketplace differs from admitted companies, and should make certain policyholders understand the repercussions of having coverage with a surplus lines insurer.

------