Theodore Pierce, executive director of the Surplus Line Association of California, added: "There was supposed to be a recovery, but that didn't happen and I don't think it's done yet."

Mr. Pierce was referring to the decline in premiums and policy count in California during the last three years.

After the first nine months of 2010 the California association processed 2.4 percent fewer policies than it did during the same time period in 2009, said Mr. Pierce. Using the same time comparison, Mr. Pierce said premium volume declined 13 percent.

California, with just over $1.9 billion in premium written after six months (a 15.4 percent decline compared with the first six months of 2009), is no longer tops in surplus lines. That distinction now belongs to Florida, with about $2.35 billion in premiums after six months.

Texas recorded about $1.59 billion in surplus premiums after six months, about a 10 percent drop from the first six months of 2009. New York rounds out the top four states with about $1.37 billion, compared with $1.81 billion a year ago at the end of June.

"The economy is not growing; there are no new risks," Mr. Maher said. "There is no new business being formed. Construction is way down. Payroll and revenues are down."

On the local front--aside from the implications of the federal Dodd-Frank Wall Street Reform and Consumer Protection Act--these big surplus line states are either dealing with or watching the effects of new state regulations and court decisions.

Raising Capitalization Requirements
California and New York are each moving toward new minimum capitalization requirements for surplus carriers from $15 million to $45 million. California Gov. Arnold Schwarzenegger signed a bill, AB 1708, in late September. Nonadmitted insurers on the state's list of eligible surplus lines carriers must meet capital surplus requirements of at least $30 million as of Dec. 31, 2011 and at least $45 million by the end of 2013.

Mr. Pierce said the old $15 million surplus requirement was "kind of a joke. You can't afford to play in this market with that." The surplus market consists of mostly general liability and earthquake policies.

New applicants to the California surplus market as of Jan. 1, 2011 must have $45 million in surplus, he added.

New York was waiting to see a draft amendment to current regulation that would also set a $45 million capital requirement.

Mr. Pierce and Mr. Maher said that although the regulation seems to be significant, a large majority of eligible surplus carriers in each state already meet the $45 million capital and surplus requirement.

Mr. Maher said 75 percent of carriers have at least $45 million in surplus. Mr. Pierce said 80 percent meet the requirement in California.

Another bill, AB 1837, is awaiting a signature in California. This bill would authorize a surplus insurer domiciled in California to have common directors with an affiliated nonadmitted insurer, so long as the common directors do not have a majority of the vote of the nonadmitted insurers and do not have any management functions.

The bill would also allow a domestic surplus carrier to perform specified administrative, claims adjusting and investment management services on behalf of an affiliated nonadmitted insurer that has qualified as an eligible surplus line insurer.

Also important to the market, a California appellate court ruled that surplus lines insurers should remain exempt from a 2.35 percent tax paid by admitted insurers.

In Texas, surplus carriers are now subject to assessments for the first time as part of a new funding structure of the state's last-resort insurer, the Texas Windstorm Insurance Association (TWIA).

TWIA used up all of the cash it had on hand after Hurricane Dolly in July 2008. It assessed member insurers $530 million. Now, after TWIA uses the cash it has on hand, and after a round of post-event bonds to pay for the first $1 billion in losses, the insurer will turn to insurers to fund the next round of bonds via assessments, including on surplus policies.

Mr. Ballinger called this prospect as "hairy, complex and onerous."