Self-insurance, risk retention groups, and captives have gained prominence. There's been a return to higher retentions, deductibles, and other risk-sharing programs, with corporations moving away from the cheap insurance that was available just a few years back.

Businesses apparently are either choosing, or being forced, to look at traditional insurance policies as just one of a variety of methods available.

While the traditional transfer of risk through insurance still commands a huge portion of the risk management menu, the hard market may be forcing some corporate insurance buyers to spend more time looking for nonstandard insurance solutions.

Part of this is because some corporations don't want to or financially are unable to retain more risk. Others are not large enough to shoulder the burden individually, so a captive or self-insurance just isn't feasible.

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 the fall of 2002, posits that the increase reflects the hardening primary property and 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.

1.Know whom you're dealing with.

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.

           I've always differentiated between E&S brokers and managing general agents (MGAs), 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.

There's nothing inherently good or bad about any of these specialty brokers, so it's 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; other may not. It's vitally important to understand this so there's no problem about whether coverage has actually been bound or not.

2.Relationships should matter.

Believe it or not, 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 very skilled at understanding risk and matching it with a carrier likely to write it.

It's 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, it's more difficult to establish a relationship from a party that is two steps removed from you, but it's 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 information—or make a sincere effort to do so.

3. Financial strength is, above all, the most important item to consider.

Excess and surplus lines 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 aren't included in state guaranty fund mechanisms. So there's not the same type of safety net available.

This doesn't 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 Best review, the surplus lines market has done better financially than the overall property and casualty 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%, while the property and casualty industry as a whole enjoyed a 4.8% return.

So, even though the E&S market isn't 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, as well as reviewing their financial history, before placing business with them.

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

4.If financials are the most important, coverage runs a close second.

E&S carriers and brokers exist for one simple reason: market conditions have made a place for them. They're the direct descendent of Lloyd's and have served the industry well.

The lack of regulation allows them to be more daring, to write the risks that standard carriers decline, to offer broader coverage. But there may be great variations in coverage, and it's the wise insurance buyer that receives the coverage form along with the binder. There's 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 be the difference between winning and losing when claims come due year into the future.