Check out these legal requirements and procedures in dealing with Surplus Lines markets.

Let’s look at the legal and regulatory status of Surplus Lines companies. Because these carriers are usually not admitted to do business in a particular state, they fall under the state’s Surplus Lines laws and regulations, which usually include:

• A Surplus Lines premium tax of 2% to 9% to be paid by the client to the state and collected by the Surplus Lines carrier, broker, or the agent who places the business with the broker or carrier. Some states permit the client to deal directly with the Surplus Lines company.
• Some states maintain a list of approved Surplus Lines companies; others only allow approved listed companies to do business in the state. Although the approved companies don’t necessarily provide any financial guarantee, the state has still done some basic due diligence about the viability of these companies.
• In general, the state guaranty fund does not protect the client in case a Surplus lines carrier becomes insolvent.
• Most states define the circumstances that will dictate whether a Surplus Lines company may be used rather than an admitted company and the procedures when using one; including such criteria as whether or not a Surplus Lines company may be used only to get a lower rate (most states don’t permit this.) Most states allow use of Surplus Lines companies only when no standard market is available.
• Other requirements include notification of Surplus Lines status to the client, including notice by the Surplus Lines broker and agent representing the client, and notification of lack of protection by the state guaranty fund. Most states also specify which lines of insurance are not eligible and require notification that coverage might not be as broad as that written by a standard, admitted company. The state also dictates filing requirements for tax payment and reporting by the Surplus Lines broker, agent, or client. Some states allow the client to contact a Surplus Lines company directly.

Although this is a generic, non-inclusive list, it provides an overview of our topic: E&O agency risk management techniques to employ when using Surplus Lines markets.

OVERVIEW

First and foremost, always try to place the risk with an admitted standard company. When that’s not possible, always explain to the client that, while there are other sources available to provide coverage, there might be some risk involved.

Although most states have specific requirements for notification to insureds, don’t assume that the client has any knowledge of the subject or that they’ll automatically read the policy and any notices relevant to the risk involved with a Surplus Lines market.

Let’s look at the process from three perspectives:

• The prospect, the information-gathering process and the resulting risk survey, which generates a proposal. 
• Binding coverage and delivering the policy issued.
• Follow-up after placing the account and the renewal review.

There are plenty of reasons for using Surplus Lines other than the unavailability of a market. Surplus Lines companies bring many innovative products to the marketplace. The coverage need might be for a specific limited exposure for which a standard market might be too broad or have restrictive underwriting requirements.

Also, most Surplus Lines Companies use non-standard forms or modified bureau forms — with a rate that’s not approved to be used in the state.

Begin by going through the information-gathering process (risk survey), which reveals a need for a specialty coverage that’s not available in the standard admitted market, and finds that a non-admitted Surplus Lines company has the coverage available in a non-approved special form with a non-approved rate.

You will then get a quote from a Surplus Lines broker who represents the company and obtains a copy of the form to be used.

Check the carrier’s Best report and rating; and if the rating isn’t “A” or better, notify the insured of this (you can also use other rating organizations for financial information about the surplus lines company). Ideally, you should go over the Best rating criteria with the client and be sure to note the rating in the proposal or quote,

After confirming that the Surplus Lines company is on the state-approved list, prepare a proposal (risk survey) that reiterates that forms and rates are not standard and approved by the state and that additional taxes and fees might apply to the premium shown on the quote.

You should also notify the insured that they won’t have the protection of the State Guaranty Fund if the Surplus Lines company becomes insolvent and is unable to pay a covered claim an /or refund unearned premium.

The next item is to determine proper language to use on the proposal (risk survey) and have the insured indicate and acknowledge that they understand all of these conditions and are willing to accept the risk.

The binder issued by the Surplus Lines broker might have standard wording, depending upon what the state requires when a Surplus Lines company is used.

Ask three or four of the Surplus Lines brokers that you use to provide the specific requirements and get them to send you a copy of what they use. Some brokers have their own statement, which might make the agent responsible for conveying the facts to their client, with the understanding that because the broker is once removed from the relationship with the client the agent needs to convey the facts to the client.

A typical broker wording might be:

“Because your agency does not have binding authority, all binders and certificates must be issued by (Broker Name). Your acceptance of this quote (binder) on behalf of the insured, confirms that you have fully explained the terms, conditions and forms to the insured and that both you and the insured fully understand these terms, conditions, and forms.”

This places responsibility on your agency to carefully review all proposals, forms, terms, and conditions with the insured. If you don’t know specifically what’s meant, get a copy of the endorsement from the broker or ask for an explanation and/or clarification.

If the broker does not provide a Best Rating for the company being used, ask the broker to provide one (and check it yourself). Most E&O insurers are very strict about adding a company insolvency exclusion to the policy; so if the Surplus Lines company becomes insolvent, a claim goes unpaid and the client sues your agency, the E&O carrier will enforce the exclusion and deny the claim.

Most states also require attaching a form to the front of the policy or putting a stamp on the front of the declaration page indicating that the policy is Non-Standard or Surplus Lines coverage and might include the tax and any fees, as well as the premium amount. There might also need to be a Surplus Lines broker countersignature endorsement that must be attached to the policy, together with the policy number, underwriting company and the Surplus Line broker’s signature.

A typical statement might read:

“This contract is registered and delivered as a Surplus Lines coverage under the insurance laws of (state) by an insurer not otherwise authorized to transact business in that state and not subject to supervision or examination by the Superintendent of Insurance. The insurance so provided is not within the protection of any guarantee fund of (state).”

In a hard market, your agency would tend to use Surplus Line Markets more than in a soft market, which would greatly increase the need for “due diligence” on your part. To avoid having a jury to determine due diligence, it makes sense to do whatever’s needed.

The next article will offer 10 proven tips for managing your E&O exposure in dealing with surplus lines companies.