I was sitting in my office, pondering the ineffability of the Short RateCancelation table, when the phone rang. It was Nora Newby, a new risk manager.She had a question: Could we explain what surplus lines are all about? Someonetold her they were what was left after our forefathers reduced the New YorkStandard Fire Insurance policy from 217 lines down to 165, but she thought theymight be pulling her leg.
I told her she was right, but for a full explanation, we would have to turnto my mentor, Uncle Pumblechook. I transferred her, and heard the following:
NN: Just what are surplus lines?
UP: They are insurance policies covering types of risks that licensedinsurance companies will not write.
NN: Why won't they write them?
UP: Because they don't know how to underwrite them.
NN: Then who does write them?
UP: Non-licensed companies called surplus lines insurers.
NN: They must be much larger than licensed insurers.
UP: No, they are usually smaller.
NN: Smaller? Why can a small company do what a large, licensed insurercan't?
UP: State regulators won't allow licensed companies to write just any oldthing.
NN: Why not?
UP: Because regulators wouldn't understand how to regulate the rates.
NN: Why do they have to regulate rates? Don't insurers know how to set theirown rates, and wouldn't competition keep the rates reasonable?
UP: Yes, but if that were true, regulators would lose some control, and theyhate anything they can't control.
NN: Are surplus lines insurers less stable than licensed insurers?
UP: Standard & Poor's thinks so. A.M. Best Co. does not.
NN: So who's right?
UP: Neither. Some SL insurers are great; others crummy. What use areaverages?
NN: So how do I buy a surplus lines policy?
UP: You go to your broker, who goes to a surplus lines broker, who goes to aretailer, who goes to a wholesaler, who calls up a friend named Moe who contactsthe surplus lines insurer. No, wait, I think I may have too many people inthere. Or do I?
NN: Why can't my broker contact the ultimate insurer direct?
UP: Regulators don't allow it. There is a special license for surplus linesbrokers, and a special tax on what they call "exported" lines.
If you deal direct, you can buy any unusual policy you want from anybody youwant, but if you ask a broker to do it for you, he'll be breaking the law.
NN: You mean I can't work out a broad policy to cover everything I need,take it to one broker and have a single insurer cover it all?
UP: I'm afraid you don't understand the system. It's not designed for you buyers.