A few years ago I was invited to speak at a conference of insurance professionals in Rhode Island.  My topic was surplus lines insurance which at that time was a very hot topic, at least in Florida as there was a pending Florida Supreme Court case that had it turned out different, could have changed the surplus market insurance scheme in a big way.  As it turned out due to the Court’s ruling, the surplus lines carriers preserved their unique market position and the world in this insurance community did not stop or even wobble.

Having been retained recently on a couple of large commercial fire losses and getting reacquainted with some of the nuances of surplus lines, I thought now would be a good time to revisit this unique line of coverage with a couple of case studies that hopefully will shed light on some of the practical problems for policyholders if they happen to be insured by a surplus lines carrier.

First I want to share the Rhode Island Surplus Lines presentation. As you will see in the presentation, Florida has two statutes that lay out the law on insurance rules and regulations dealing with admitted and surplus lines carriers. It is very important to understand the differences and a practitioner must read the surplus lines statute if involved with a property loss insured by a surplus lines insurer.

Before going further, I think it is important to understand why the surplus lines business model exists.  Fundamentally, this insurance is in place to allow property owners or others who may have unique liability exposure to find coverage in the unregulated markets.  Thus, being unregulated as to price, it is an open market and surplus lines carriers will charge what they want for the risks they are insuring.

Not surprisingly, the typical property surplus lines policyholder is often substandard, high risk, and often owns an older property that in some cases is located in less than desirable locations. Thus, the regulated admitted carriers will not touch these properties. Nothing wrong with that and I get it, as the facts show, there is a big market out there given all the older properties that are still functional and commercially viable for their owners.

But as the following case studies illustrate, surplus lines insurance needs to be embraced with caution, as you may not be getting what you think you needed or wanted.

Our first case study involves a large commercial concrete block building that housed a retail outlet for mattresses as well as a repair section of the building to allow for rehabbing mattresses with minor flaws sold to them by a national chain. Once repaired, the mattresses were sold retail to the public. The building was occupied and functional, no structural or other known defects and the business tenant had a license issued by the city to conduct its business. The two things that threw it into the surplus lines market were its age and location. The building was originally constructed in the 1920’s and, although aged, it was in a neighborhood that catered to folks who would buy this type of product. So clearly, if the owners wanted insurance, surplus lines would be the only place they could find coverage.

Unfortunately, a fire started from unknown causes and the building was by all definitions a total loss. The policy limits were in the correct amount to replace the building so one would assume the carrier would pay policy limits and close their file. Not so, because the policy was surplus lines. The independent adjuster (I/A) wrote an estimate (actually a square foot take off) showing the loss to be somewhat over the policy limits, but then withheld 42% depreciation!  This over exaggeration of depreciation resulted in a payment below one half the policy limits. Now the insured has a big problem--the only way he can get the policy limits is to actually replace the building. Replacing the building will result in significant law and ordinance upgrades, costs which the policyholder has to pay out-of-pocket.

So here we have a client that bought replacement cost insurance, whose reasonable expectations were that if he had a total loss, he would be paid his policy limits. Not so with surplus lines as the Florida Valued Policy Law (which requires a payment of the policy limit in the event of a total loss) does not apply based on the wording in the surplus lines statute. In this case, the wording in the insurance contract governs the adjustment of the loss and that policy language required the policyholder to come out-of-pocket first before he was going to be paid his replacement insurance limit.

Does this seem fair to you? How many other surplus lines policies are out there where the owners in the event of a total loss will never get their policy limits because cost, zoning, law and ordinance issues will prevent them from rebuilding, thus not getting coverage for what they thought they would get when they bought “replacement cost” insurance.

Case study two is somewhat different since this involves a commercial shopping center, in excellent shape, fully leased out, and in an area that most property owners and retail operators could only dream about being a tenant or owner. But again the building originally built in the 1920’s could only find coverage in the surplus lines market. The owner of this shopping center will most likely rebuild but until which time he does, his surplus lines carrier is only paying the ACV of the loss and like my other client, law and ordinance issues will be costly. Interestingly, the I/A the surplus lines carrier hired did not retain a structural engineer, and as a result due to major structural damages from the fire, our view of this loss is considerably different than the cursory inspection and scope taken off by the I/A.  Is lack of detail the result of the surplus lines carrier doing it on the cheap?  That’s my hunch, but we will see.

Had this building been a total loss, this client like my other one would not have been paid policy limits but some unilaterally determined depreciated amount. Make no mistake about it, surplus lines is a necessary insurance scheme for risks others will not insure. But please remember that while they are taking on risks others do not want, they are also not the Mercedes of insurance.  In some cases you can expect big out-of-pocket losses if you are unable to rebuild even in a total loss situation.  In others, you may be dealing with a claim supervisor who is based out-of-state or in some cases out of the country that may be in charge of losses all over the country.  Claims are expensive, so is the cost to hire the right experts to determine the true scope and cost of the loss.

Finally, in my opinion the legislature needs to take into consideration that in a total loss situation, the policyholder’s expectations before a loss is that in the event of a total loss, they will get paid their policy limits. Under the current scheme, this is at best illusionary.  This can be fixed by adding a valued policy law requirement to a total loss situation for all surplus lines policies. At the same time, surplus lines carriers can still enjoy their niche in the market, which I understand is a profitable one.

In conclusion, before you send your check for the surplus lines premium, know what you are buying. If you have a loss, keep your eye on the ball, it’s your money and you may not be getting what you thought you bargained for. If you have questions regarding any property insurance claim related issues please call 800.321.4488 or contact us to submit a question to one of our public adjuster insurance claim experts.