Using the Excess and Surplus Lines Market

In California, the retail insurance agent faces many challenges. One of those challenges is the state-imposed requirement that if they have an admitted insurance company to write their clients’ business, they must place that business with the admitted company. The state has a guarantee fund that protects those consumers even in the event of an admitted insurance company failure.

The alternative for a retail agent, if they do not have an admitted company with which to place their client’s account, is to approach the excess and surplus lines marketplace (a.k.a. non-admitted markets). In California, only a licensed surplus lines broker can deal with a non-admitted carrier. For the various state laws, see your state insurance department.

Other than the financial guarantees provided by the state, the key differential between admitted and non-admitted insurance companies is the freedom afforded to non-admitted insurance companies to adjust rates and forms without the same restrictions imposed by the state on the admitted companies. This allows the non-admitted markets to remain responsive to the marketplace they serve which is, primarily, the business that is too volatile “find a home” in the admitted market.

A quick explanation of two key principals behind the existence of the non-admitted marketplace is necessary. The first is the idea that an esoteric risk cannot be underwritten the same as a homogenous one. Secondly, those esoteric risks can flaw the benefits of insuring large groups of homogenous risks. For example:

With a dynamite manufacturer and a greeting card shop, the risk level inherent in manufacturing dynamite is significantly higher than it is from running a greeting card shop. Is it reasonable to apply the same methodologies to insuring the dynamite company as the greeting card shop? No. Take it a step further. There may be a handful of dynamite manufacturers, but there are thousands of greeting card shops. If you try and lump the handful of dynamite manufactures in with the greeting card shops, two things happen: 1. The loss results get skewed much higher because of the large loss impact of a dynamite manufacturing risk—vs.—a greeting card shop risk. 2. The majority, the greeting card shops, end up paying unfairly inflated premiums to cover not only their own claims, but also the claims of the few dynamite manufacturing companies.

The admitted marketplace cannot cope with this type of situation because it does not have the flexibility to manage the risk accordingly. This can lead to financial instability for the admitted marketplace and the resulting impact on consumers.

Hence the advent of the non-admitted marketplace. The freedom of rate and form means that the non-admitted companies are able to extract those risks that are esoteric and rate them in accordance with their individual level of risk. They are also able to manage the risk more appropriately by using forms tailored to the unique risk. In this way, the insureds benefit and the overall market benefits.

The E&S or non-admitted marketplace represents a small, but important, segment of the overall insurance industry. This specialty marketplace fills an important gap in the availability of insurance coverage for the reasons outlined above.

To access the non-admitted market, a retail insurance agency needs to enlist the services of an excess and surplus lines broker (E&S broker) or managing general agency (MGA). The simple distinction between the two, similar to the retail world except the insured is a step removed, is that an E&S broker represents the agent and the MGA represents the insurance company. The broker does not quote the business or have binding authority while the MGA has one or both. An MGA also issues policies and endorsements. Both handle premium transactions, except in direct bill situations.

Collectively, and for the purpose of the remainder of this article, they are known as “wholesalers”. A wholesaler is a licensed entity that is responsible for bringing together the client of the retail agent and the specialty insurance marketplace. It should be noted that some wholesalers act as both a broker and as an MGA.

Risks that fall into the surplus lines market are, generally, unique. That uniqueness requires specialized knowledge and wholesalers are trained and prepared to deal with these accounts. Additionally, a wholesaler is able to manage multiple relationships: agents, insurance companies, claims services, TPA’s, etc. Finally, the wholesaler must be able to get a policy into the hands of the agent quickly and efficiently—this includes handling the premiums and, in the case of MGA’s, issuing and maintaining the policy (product). The ability of a wholesaler to know the business, manage a myriad of relationships, and distribute the product efficiently, highlights their distinct importance to the process.

The first step in accessing the surplus lines market is to understand which wholesalers offer the coverage that the retail agent requires. Some wholesalers offer a vast array of surplus lines products while others specialize in either a unique class of products or a single product. Some are national in scope, some regional, and some are very localized. A retail agent may have relationships with one or more wholesalers based on the needs of the customer base of the retail agent.

There are several key things an agent must consider when seeking the assistance of a wholesaler:

Markets. As with all insurance placements, the quality of the markets into which a risk is placed is key. The retail agent should look at the financial security and general reputation of the carriers that the wholesaler is offering. Generally, the quality of the represented insurance companies speaks volumes about the reputation and expertise (the next two items) of a wholesaler. Remember, these carriers hold the wholesalers to high standards much the same way a retail agents carrier would.

Reputation. It is important to be comfortable with the firm and its staff in that they are expected to act in utmost good faith at all times. Communication should be open and honest and the agent should be able to rely on the word of the person(s) they deal with at the wholesaler.

Expertise. The nature of surplus lines is unique and so is the knowledge and expertise of the wholesaler. The retail agent should seek out only established wholesale firms and/or people with specific expertise in the myriad of coverage offered by the surplus lines marketplace.

Stability. A wholesaler does not survive by cheating agents or companies. Those wholesalers that have served their respective communities well over time are usually the ones that are trustworthy and who do business properly.
Once the retail agent has selected a wholesaler, a contract must be executed between the two parties. Most contracts address several elements of the relationship: payment terms—including tax, policies governing cancellations, commission terms, claims processes, levels of authority, and more. The contract between a retail agent and a wholesale broker may cover even fewer elements.

Now the information is gathered, the relationship is set, the proper wholesaler with the proper product is selected—its time to do business!

The surplus lines marketplace is a market of last resort (in spite of its superior financial performance over the years). This quirk means that, often, by the time a retail agent approaches a wholesaler time is already running out. A complete submission/application with all relevant supporting documentation—such as loss runs, etc., mean that fewer questions will need to be asked. Fewer questions mean quicker turnaround time and that benefits all parties. If an agent can combine a complete submission with more lead time, that is a much better situation.

Assuming the wholesaler finds a suitable carrier for the particular risk, a quotation will be offered to the retail agent. The quotation should include the limits, deductible, premium, and the basic terms and conditions. At this point it is incumbent upon the retail agent to crosscheck the quote against what was requested. Sometimes the two can differ and it is better to know what the differences are before offering a quote to the insured.

If the quotation is accepted and coverage requested to be bound, the agent must advise the wholesaler as quickly as possible in writing. Leaving a voice mail message to bind coverage is not advisable and may not be legal.

At this point, the process differs significantly between what a E&S broker will do and what an MGA will do. The process is mostly transparent to the retail agent but understanding the differences may help manage the process a bit better.

At the binding stage a broker requests to the company that coverage be bound at X effective date. It is now the insurance company’s responsibility to confirm coverage has been bound. The company will issue a binder and they will issue the insurance policy. The company solely dictates premium payment terms and they may be more stringent than the terms a retail agency company may impose. The agent should be careful to heed any special payment terms as they may risk cancellation of coverage if the carrier does not receive payment on time.

In contrast, an MGA generally has the authority to bind the insurance company to the coverage. Remember, the MGA is an agent of the insurance company and quotes, binds, issues policies and endorsements, just like the company does. The MGA will issue a binder and will initiate the policy process. The payment terms are guided by the contract the retail agent has in place with the MGA. Usually there is a minimum and deposit premium required to bind, or within X days of binding, and the rest is due based off of the agent statement.

Endorsement requests follow the same path. The retail agent sends in the request and the broker or MGA handles accordingly. Ditto for the cancellation requests.

The area that causes the biggest E&O threat to a retail agent and a surplus lines broker or MGA is claims. The basic rules apply here and diligence is necessary to ensure that the claims process works as smoothly as possible. In most instances the broker/MGA acts only as a pass-through for claims, they have no or very limited claims handling authority. Getting the claims notification to the wholesaler quickly is key as that means they can get it to the carrier more quickly. There are some exceptions to this rule especially in the instance of a company owned MGU or an MGA that has an exclusive company or product.

A wholesaler who is on the ball will solicit the renewal of a policy well in advance of the renewal date. For an MGA this may mean that they will contact the retail agent requesting updated information or they may simply offer a renewal quote subject to no significant change in the risk. A broker will have to solicit the insurance company as well so there is an extra step involved.

Retail insurance agents can rest assured that the quality wholesalers operating in the marketplace today, have done their best to balance the interests of the agent, the insured, and the company. For more assurance agents can look to the two main associations, National Association of Professional Surplus Lines Offices (NAPSLO) and the American Association of Managing General Agencies (AAMGA). Members of these organizations are held to a high standard and must qualify for membership.

The surplus lines marketplace is a critical piece of the insurance puzzle. Without it the financial integrity of the vast majority of the marketplace would be negatively impacted. It is the commitment and dedication of surplus lines companies, MGA’s, and brokers that keep this vital industry contributing to society. Left alone to respond to natural market forces, the current distribution of the surplus lines product will continue being a reliable backstop for the millions of customers who dare to take the bigger risks.

Hull is chairman and CEO of Hull & Company, Inc., one of the nation’s largest and oldest Excess and Surplus Lines Brokers and Managing General Agencies. Founded in 1962, Hull currently does business from 14 offices located in California, Colorado, Florida, Hawaii, Montanta, Nebraska, North Carolina, and Texas. Its managment team has, combined, over 200 years of insurance experience.