It appears the problem is with the surveyor, not with the insurance company, per se. Perhaps you should enquire as to why he made the recommendation. He seems to have confused "nice to have if you can afford it" with "you can't be safe unless". "CYA" comes readily to mind. The same happens thousands of time a year with "Home Inspection" surveys. Both groups of "professionals" now have pre-programmed "recipies" for their surveys on their computer and can crank out tons of useless paper to prove how valuable are their services. The problem now is that the insurance company has been awakened and they will do their best to have you "correct" his "recommendation" to "fix" a "defect".
I can see some advantage to having installed engine room fire protection, regardless of fuel, but I would not consider it a necessity. After all, The U. S. Coast Guard does not require it, and they are the ones who determine the legal safety standards. It also begins the slide down a very slippery slope.
We had Halon in the engine room of our Atlantic 44. Looks good on paper. However, without having automatic kill solenoids for the engines, they would have ingested and exhausted the Halon in seconds (and kept on running). We had those, which obviously also required automatic sensing and discharge of the system. Can you see the $$$$$$$$ flying out of the boating budget? (Actually, I seem to recall Halon is now prohibited except for recharging existing systems.)
Co2 can do the job a bit better, but the engines will even use a lot of it before they choke off, so the installation must carry much more gas than would normally be required to extinguish the fire. The bottles are huge and heavy compared to Halon, and the costs are as high in the long run.
Dry chemical systems make a mess and I suspect will also do internal damage to the engine if it is running.
Fixed systems are also generally installed with annual inspection tags, which if not maintained are subject to fines on Coast Guard inspection even if the system itself is not required. The slope gets steeper......
If you install an extinguisher port, it will be a lot cheaper. But beware that they then will probably specify that you will have to carry dedicated extinguishers with X-number of cubic feet of extinguisher medium. Probably still cheaper, but something else to deal with.
I don't envy the pleasure of the next few rounds in the fight. I'd do some research, maybe starting with the ABYC paragraph he quoted. I suspect it is only a recommendation, not a requirement, for ABYC approval of construction. It may apply to commercial use, or to conditions other than your use as a pleasure boat. But I think I'd also shop for a new survey and a new insurance company.
Look here for a similar survey:
http://www.captfklanier.com/documents/p ... survey.pdf