The role of surplus lines in the insurance world is often a misunderstood concept. The risks and benefits associated with this alternative form of coverage can seem confusing on the surface. Surplus lines insurance fills an important need in the marketplace, so it is critical to have a basic understanding of their use. Their ability to accommodate a wider variety of risk provides insurance for hard-to place, unique or high capacity risks, where insurance coverage was not otherwise available.

Risks that are typically written in surplus lines generally fall into three categories. Those are as follows:

1. Capacity or catastrophe-prone risks- coverage is too high or too risky than carriers are willing to take on. Such as a business located near hurricane or earthquake prone areas or a rock quarry company.
2. Unique risks. An example of this would be a business such as an Emu farm.
3. Non-standard risks with unusual underwriting characteristics. An example could be high-rise window washing or a food truck operator.

With standard insurance policies, the insurance carrier that writes the policy accepts the risk and collects premiums. The carrier must be “admitted” or licensed by the state where the policy is written. There are certain regulations and restrictions these admitted carriers must follow. They also pay into a state guaranty fund, which is meant to cover claims should the carrier become insolvent.

Part of being an admitted carrier means all policy forms, underwriting guidelines and rates have been approved by the state. Typically, carriers won’t file policy parameters for unusual or higher risks due to the complexity and high cost of filing, as it is not worth the effort. This means that when a business or individual comes need of coverage for something seen as usual or high risk, there is no coverage. This is where surplus lines come in.

Surplus lines or non-admitted carriers, take on risks declined by admitted carriers. Not licensed by the state, they are not subject to the types of regulations standard insurance carriers are. This results in increased flexibility, allowing for additional capacity and innovative underwriting. Rate and form flexibility provides for more creative, responsive and customizable market for specialty exposures.

As they are not regulated by the state, they do not pay into any guaranty funds, meaning no recourse for insolvent carriers. Non-standard policies are also subject to taxation differently than standard insurance policies, which have their tax included in their premiums.

As a safeguard, the state does indirectly regulate surplus lines through surplus lines brokers. A surplus line broker must be licensed by the state, and thusly regulated by the state. Surplus lines policies are typically written after coverage has been declined within the standard market. Most states require surplus lines brokers to prove there was a diligent effort to secure insurance from duly authorized companies before resorting to surplus lines.

Obviously, an inherent risk with surplus lines companies is they do not pay into any guaranty funds, so there is no payment of claims should the carrier become insolvent. However, since 1994, A.M. Best Company has conducted an annual survey of the surplus lines market, which accounts for about 14% of the commercial insurance marketplace. Their yearly findings show the solvency record of surplus lines carriers to be as good, if not better, than the overall insurance industry. So, while there is risk, over time it has proven to be a non-issue.

Our society and our businesses are changing at a rapid pace, meaning insurance needs are changing too. Surplus lines companies have the ability to react quicker to the demands of the marketplace, oftentimes resulting in a proving ground for new insurance products and underwriting concepts.

Employment Practices Liability and Professional Liability (Errors and Omissions) Insurance are examples of such concepts. With less restrictions and regulations, surplus lines are able to creatively and quickly come up with insurance solutions to complex and emerging risks.

Surplus lines insurance can be a source of confusion to many, so if you have any questions, Program Insurance Group is here to help. It is important to remember that all insurance is subject to actual policy language. Your insurance needs are unique. We offer tailor made solutions to meet those unique needs.

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