Commercial coverage gets scarcer as insurers scale back policy efforts.

"Admitted carriers" -- insurance companies licensed to do business in California and subject to regulation by the state Department of Insurance -- are writing less commercial insurance these days, thereby forcing businesses with high-risk exposure to turn to out-of-state "non-admitted carriers" -- also known as "surplus lines."

"There is a general retraction of admitted carriers," said Stephen R. Abrams, president of the Los Angeles chapter of the Independent Insurance Agents and Brokers Association (IIABA) of California. "Continental, Cigna, Aetna and Transamerica all have reduced their agency representation materially over the past 12 months and appear to be unwilling or unable to write commercial business. California businesses are undergoing a real insurance pinch and have had to find coverage wherever they can."

Frequently, this means turning to the higher-priced, limited coverage, minimally regulated surplus lines market.

"The surplus lines market, which functions as a safety net, responding when the admitted market is unable or unwilling to, has grown in recent years," said Bill Newton, president of L.A.-based surplus brokerage Lemac & Associates and president of the California Insurance Wholesalers' Association.

He said he fears there will be a continuing flight to the surplus lines market as admitted carriers -- chafing under state regulations -- continue to pull back or head out of state altogether.

Business is usually written in the non-admitted market when the risk is unusual or hazardous, companies have had high loss experience, or unique coverages are required. Surplus lines tend to price 25 to 50 percent higher than the standard market.

California leads the country with around 15 percent of the total surplus lines business, according to Lee Lewis, IIABA's technical director.

In 1992, surplus lines' largest classes were professional liability, general liability (catastrophic accident protection up to $1 million) and excess liability (over $1 million).

Surplus lines tend to write a disproportionate share of liability insurance for volatile and toxic chemicals, various forms of professional liability (including malpractice coverage for doctors, lawyers, CPAs and beauticians), commercial earthquake insurance, and all-risk property insurance of $100 million and more for shopping centers, manufacturing facilities and such.

Surplus lines have been in the limelight in recent years because some companies -- mostly based in the Caribbean -- fleeced unsuspecting Californians with phony cut-rate auto, health and small business insurance.

"Most of the abuse was against small retail stores, the elderly and other unsophisticated buyers," said Harmon Wasserman, vice president of West L.A.-based insurance agency Gelfand-Newman-Wasserman. "After the riots, many small businesses in South Central L.A., which had only been able to find coverage with non-admitted carriers, were unable to get compensation for their losses."

Then, state Insurance Commissioner John Garamendi enacted Regulation 2174, effective November 1992, requiring all non-admitted carriers to have at least $15 million in reserves to pay claims and making offshore carriers maintain a U.S. trust fund of at least $5.4 million. As a result, non-admitted carriers' ranks in the state plunged from 530 to about 132.

"Some of the carriers dropped out because they were the offshore scam companies, others dropped out because they were too small to qualify and some large, legit firms chose not to qualify -- either because they resented the regulation or because they were put off by its enormous paperwork requirements," Newton recalled.

The companies that dropped out wrote 17 percent of the premiums in California in 1992, so the impact on coverage availability was small.

Also tightening up on surplus lines, on Jan. 1, 1993, California Assembly Bill 2608 was enacted, requiring brokers and agents to be turned down by three admitted carriers before seeking a quote from a surplus line.

"When AB 2608 was passed most of us in the surplus lines market thought our volume would decline and that companies would flock to become admitted, but neither has happened," Newton said.

The new law also requires the client to sign an acknowledgement that he knows the company he is applying to is not admitted, is not subject to financial solvency regulations and does not participate in the insolvency funds created by California.

The detailed new forms have caused some agents and brokers to back away from writing surplus lines business, but agents with less fear of writer's cramp have picked up the slack.

"Garamendi's strategy is excellent, although it is not working perfectly because his agency is not checking to see if brokers and agents made the three calls to admitted carriers they claim on the forms," said Bill Witt, president of Moselle Insurance Inc., a North Hollywood insurance agency.

Until the recent riots, fires and earthquakes in California (and the floods and hurricanes elsewhere) the market was soft, pricing was low and agents could pretty much place what they wanted, reported Karen Oxman, secretary of the IIABA of Los Angeles.

"Now the property insurance market is getting harder, so surplus lines get used more," she said. "The lowest-priced earthquake insurance available in L.A. County costs $10,000 a year to start, which is too high for most small businesses."

Witt observed that lenders require earthquake insurance on property loans, but companies seeking such coverage are either unable to get it or have to pay premiums that have risen 400 percent.

"With some exceptions, the marketplace is extremely competitive," said Warren S. Stanley, president of Swett & Crawford Group, in Los Angeles, the nation's largest commercial insurance wholesaler. "Despite the recent catastrophes, the written-to-surplus ratio has never been lower -- so there's an historically high level of capital available."

Oxman advises companies to do business with the highest-rated insurer that will write their particular risk.

"Clients often foolishly force agents into accepting lesser-rated companies that offer lower premiums," she said. "If you are new in business, find out why you have to go into a surplus line. If it's because your agent doesn't do business with enough carriers, you may need another agent."

But, Newton added, "non-admitted does not mean inferior. Many admitted companies are low-rated and not as financially stable as some non-admitted firms."

And Stanley cautioned: "Bad insurance is worse than no insurance."