Buyers Guide To The E&S Market

Many of these companies are turning to surplus lines insurers and association programs to answer their risk financing needs.

The A.M. Best Company Inc., in its 2002 annual review of the excess and surplus lines industry, reported a 35 percent increase in direct E&S premiums in 2001. The report, issued in September of 2002, posits that the increase reflects the hardening primary property-casualty insurance market.

In other words, a lot of premium migrated from the standard market to the E&S market, with businesses paying much higher average rates for the coverage. Regardless of why this happened, there are a few simple rules that insurance buyers should keep in mind when dealing in the E&S marketplace.

Know the players.

This advice may seem simple, but the E&S marketplace introduces an entirely new set of players to the insurance-seeking equation.

For example, the surplus lines broker may be new to the insurance buyer. Typically this broker is a wholesaler who brokers non-admitted insurance policies to retail agents and brokers (the normal contact for the insurance buyer).

Admitted insurers are licensed to write business in a state and are represented by licensed retail agents or brokers. Non-admitted insurers may be licensed in their domicile state but not in others. They are accessed through a surplus lines or E&S broker. Specific state laws govern how business is written with these companies.

The E&S broker is rather like an independent agent or broker, often representing a number of both non-admitted and admitted carriers. A retail agent or broker sends business to these wholesalers, who in turn market it to their companies.

Ive always differentiated between E&S brokers and managing general agents, although they could be one and the same. MGAs typically are authorized to underwrite and price business in a specific program or with a specific carrier, which often is referred to as "having the pen."

An MGA therefore serves somewhat like an underwriter in the standard market, but often concentrates on one type of business that is written by a particular carrier or risk retention group. These programs often are referred to as association programs because they either are sponsored by, or cater to, a particular industry or trade group.

Theres nothing inherently good or bad about any of these specialty brokers, so its important to understand what type of relationship they have with the carrier and what other services they might be able to offer.

For example, some E&S brokers have binding authority with some carriers; others do not. Some MGAs have authority to underwrite and bind coverage; others may not. Its vitally important to understand this so theres no problem about whether coverage has actually been bound or not.

Relationships matter.

Sometimes the surplus lines market really is the best place for a risk. The E&S market exists because standard carriers simply cannot handle every exposure.

Many E&S brokers are skilled at understanding risk and matching it with a carrier likely to write it.

Its probably helpful, therefore, to establish open lines of communication with the surplus lines carrier and broker being used. From a day-to-day standpoint this may be difficult because now there are two go-betweens: the retail agent or broker who deals with the insurance buyer and the wholesaler that deals with the E&S carrier.

Granted, its more difficult to establish a relationship with a party that is two steps removed from you, but its definitely worth the aggravation. The better the relationship, the more room for better premiums and broader coverage. This means that, yes, you do have to answer all those questions and supply all that informationor make a sincere effort to do so.

No. 1 consideration: financial strength.

E&S companies are not regulated in the same way as licensed and admitted carriers. They are not subject to the same rate and form regulation as admitted insurers, and they arent included in state guaranty fund mechanismsso the same type of safety net is not available.

This doesnt mean, however, that surplus lines companies are financially inferior to standard carriers or that the coverage being offered is more restrictive. In fact, the exact opposite may be the case. The recent rash of standard company financial woes serves to prove that.

According to the 2002 A.M. Best review, the surplus lines market has done better financially than the overall p-c segment, even though recent soft market conditions did impact the results.

The review states that a composite of surplus lines insurers had a five-year average pretax operating return on net premium of 19.8 percent, while the industry as a whole had a 4.8 percent return.

So, even though the E&S market isnt regulated in the same way as standard markets, individual financial strength and product offerings are not necessarily weaker. Businesses contemplating using a surplus lines carrier should consider how rating agencies have measured the carrier, and review its financial history, before placing business with the carrier.

In addition, wise buyers need to know the history not just of the surplus lines company, but also of the surplus lines broker handling the business. The retail agent or broker should have an established relationship with the surplus lines broker being used. Just as with retailers, there are Cadillacs and Yugos in the wholesaler universe.

Coverage running a close second.

E&S carriers and brokers exist for one simple reason: market conditions have made a place for them. Theyre the direct descendent of Lloyds and have served the industry well.

The lack of regulation allows them to be more daring, to write the risks that standard carriers decline and to offer broader coverage. But there may be great variations in coverage, and the wise insurance buyer receives the coverage form along with the binder. Theres no leaving it to chance in this market.

Besides coverage, the terms and conditions of the policy also should be studied. For example, some policies may require a minimum deposit and/or earned premium at inception. Most require payment of a surplus lines tax and possibly other additional fees.

While there are many differences between the standard and surplus lines insurance markets, both have proven their worth in the world of risk management. Understanding the surplus lines mechanism, however, could mean the difference between winning and losing when claims come due in the future.

Reproduced from National Underwriter Edition, June 16, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.