What Is a Surplus Lines Insurer and How Does It Work?
Discover how surplus lines insurance provides essential coverage for unique and complex risks that standard insurers cannot handle.
Insurance serves as a safeguard, offering protection against unforeseen risks that individuals and businesses encounter. While the majority of insurance coverage is secured through “admitted” or standard insurance carriers, a specialized segment of the market exists to address risks that fall outside the conventional scope. This is known as surplus lines insurance. It covers unique or complex situations that the standard market is unwilling or unable to underwrite, ensuring even unusual exposures can find financial protection.
What is Surplus Lines Insurance
Surplus lines insurance provides specialized coverage for risks not available from state-licensed insurers. Its “non-admitted” status means the insurer is not directly licensed by the state where the policy is sold. Unlike admitted carriers, which are subject to strict state regulations on rates and policy forms, non-admitted insurers operate under specific state guidelines governing surplus lines transactions.
Though non-admitted, these insurers are not unregulated. They are regulated in their home state or country and must comply with the surplus lines laws of the state where the risk is located. Oversight occurs through licensing and regulation of surplus lines brokers and financial solvency requirements for the carriers. However, a significant difference for policyholders is the absence of state guarantee fund protection for surplus lines policies. This means that if a surplus lines insurer becomes insolvent, policyholders do not have access to a state fund that would typically pay claims if an admitted insurer fails.
Why Surplus Lines Insurance Exists
Surplus lines insurers exist to fill critical gaps in the standard, or admitted, insurance market. Standard insurers often decline coverage for several reasons, and the surplus lines market provides a necessary alternative for these hard-to-place risks. This market acts as a “safety valve” for the industry, ensuring that coverage can be found for a wide variety of exposures.
Surplus lines coverage is sought for unique or unusual risks that do not fit standard underwriting models. These include niche industries, specialized operations, or events lacking historical data for traditional insurers. For example, insurance for a celebrity’s body part, an Emu farm, or a motorized cooler fall into this category. High-risk exposures are another factor, where the potential for loss is substantial or the data to accurately price the risk is limited. This applies to businesses in hazardous industries like construction or those with extensive loss histories, or properties in catastrophe-prone areas.
Capacity issues also drive demand. Standard insurers may be unwilling or unable to take on the full amount of coverage required for a large or complex risk, leading to a need for additional capacity from the non-admitted market. Emerging risks, such as new technologies like cyber liability in its early stages, often lack established underwriting data or policy forms. The flexibility of surplus lines insurers allows them to quickly develop innovative solutions for these evolving exposures.
How to Access Surplus Lines Insurance
Individuals and businesses cannot directly purchase surplus lines insurance. The process requires working through a licensed insurance professional. A retail insurance agent will collaborate with a specialized, licensed surplus lines broker to secure this coverage. Surplus lines brokers possess the expertise and licenses required to access the non-admitted market.
Most states require a “diligent search” rule. Before placing coverage with a non-admitted insurer, the retail agent or the surplus lines broker must demonstrate diligent attempts to find coverage in the admitted market and that they were unsuccessful. This often involves obtaining a certain number of rejections, such as three, from admitted carriers. This ensures the standard market is exhausted before resorting to the specialized surplus lines market. However, some states have exceptions or have eliminated this requirement for certain commercial purchasers or specific types of risks.
Disclosures regarding this lack of guarantee fund protection are provided to the insured. Surplus lines transactions are also subject to state premium taxes and reporting requirements. These taxes, which vary by jurisdiction (1% to 5% of gross premiums), are handled and remitted to the state by the licensed surplus lines broker.