Reducing the Risk in Florida Surplus Lines

Like trapeze artists performing without a net, surplus lines specialists operate without the backing of the state guaranty fund, which picks up the pieces for insureds if their admitted insurer goes belly-up.

But some think that the riskiness of the surplus lines market can be overstated.

According to Erin K. O’Leary, vice president of Shelly, Middlebrooks & O’Leary Inc. of Jacksonville, Fla., surplus lines insurers face scrutiny by outsiders.

“The financial information for surplus lines insurers is submitted annually and reviewed by leading rating agencies such as A.M. Best, Standard & Poor’s and state insurance regulators,” notes O’Leary, who is a director on the board of the Florida Surplus Lines Association of wholesalers.

In fact, A.M. Best has reported for years that surplus lines carriers actually outperform admitted carriers when it comes to solvency.

While surplus lines insurers may not be high risk, the businesses they insure often are.

O’Leary’s wholesale firm’s bread and butter is insuring risks such as special transportation, commercial autos, truck cargo, residential and commercial contractors to name a few.

O’Leary and wholesalers like her face their own business risk in that their opportunities fluctuate with the mood of the admitted market. Florida’s storm-free years of 2006 and 2007 have enticed newly formed standard market insurance companies to try to make a profit in the state and existing companies have expanded their underwriting. This means many insureds covered by surplus lines in past years are being returned to the admitted market.

But surplus lines brokers and carriers are accustomed to having to adjust to the cyclical shift in business, according to O’Leary.

When standard markets are expanding like they are now in Florida, surplus lines markets can usually still count on business from some startups with heavy product liability, businesses with little or no history, firms with poor loss history or companies with heavy liability in loss leader industries such as blasting contractors.

Another way wholesalers adjust to the whims of the admitted markets is by serving new economic sectors, such as nanotechnology, where the lack of loss history detail makes standard carriers uncomfortable.

Know the Rules

The surplus lines market in Florida is bigger and more competitive than it is in many other states, according to O’Leary. Florida is ranked second in the nation in surplus lines premium and first for the number of policy transactions.

Florida’s surplus lines business has its own set of rules and just as surplus lines insurers have reduced the financial risk of doing business with them, retail and surplus lines agents can work together to minimize the risks of the surplus lines placement process by knowing the rules.

A Florida resident surplus lines agent is familiar with the rules and regulations of the state, according to O’Leary. (For a list of Florida surplus lines wholesalers, visit the Florida Surplus Lines Association Web site: www.floridasurpluslinesassociation.com.)

A retail agent must provide a completed diligent effort form listing three rejections from licensed admitted insurers before taking insurance to a surplus lines agent.

The diligent effort is just the beginning of the process for retail agents working with Florida surplus lines agents or wholesalers. O’Leary suggests that the entire process works best when retail and wholesale brokers get to know each other and build relationships.

“Develop a good quote to binder ratio with your broker,” O’Leary said. “The more successful the partnership between producing agent and brokers, the higher the priority your submission will receive.”

The best relationships involve being upfront about what markets are being approached.

“Communicate openly with your broker and identify the markets that have already been accessed to avoid duplication of the submission to the same market,” she advises.

According to O’Leary, retail agents should know that surplus lines policy forms, terms, conditions and deductibles are often different from those of the admitted market.

“Minimum earned premiums can apply, ranging from 25 percent to 100 percent. In brokerage business, payment terms differ; premium may be required before binding or within 10 days of the effective date of the transaction,” she added.

Data Efficiency

The efficiency of the surplus lines procedure is tied directly to the amount and quality of background data that an agent provides a broker when submitting the business.

“Provide complete and legible submissions with as much information as possible,” O’Leary says. “You must include historical information. The more information the underwriter has to review a file in a short period of time the better your response will be.”

Surplus lines agents have to review the submission from the agent to make sure all the necessary underwriting information is in order. If any information is missing, the surplus lines agent must go back to the retail agent to retrieve the missing data before taking the package to their underwriters.

“While immediate quotes might be available, your broker will need time to research the market to determine the best coverage and premium for the insured,” O’Leary says.

It is also important for a retail agent to provide the surplus lines broker with adequate lead time since there is no binding authority in brokerage business.

“Confirm you have a written binder from the authorized representative of the insurer,” she advises. “Follow up with a phone call to your broker if you do not receive a reply in a reasonably short period of time.”

The surplus lines agent has the contract with the insurance company and the retail agent is working for the client as a broker. The retail agent can only bind the client to the contract while the surplus lines broker or managing general agency is the only one that has the authority to bind the insurance company.

Experts note that wholesale brokers have a closing percentage (quote to bind) of between 20 and 25 percent.

When the retail agent calls to bind coverage, it is not technically considered bound until written confirmation is received from the surplus lines broker. That’s why a follow up phone call is always recommended, says O’Leary.

She also urges agents to confirm that the surplus lines insurer being recommended is eligible to write in Florida. An approved list of eligible surplus lines insurers can be located on the Florida Surplus Lines Service Office Web site at www.fslso.org.