The solvency record of the domestic surplus lines industry continues to mirror that of the total property/casualty industry, according to the Annual Review of the Excess & Surplus Lines Industry, the seventh annual report commissioned by the Derek Hughes/NAPSLO Educational Foundation.

Since 1971, surplus lines company insolvency rates mirrored that of traditional insurers, with an average annual failure frequency rate of less than 1 percent, according to the A.M. Best study. The similarity of failure frequency rates between the non-admitted and admitted markets attests to the pricing discipline of the surplus lines market, according to Best.

Premium Growth

Direct premium for the surplus lines industry increased by nearly 10%, primarily reflecting the migration of business from the standard market into the surplus lines market. This compared favorably to the 5% growth experienced by the property/casualty industry during 2000.

Over the past five years, operating results generated by the surplus lines market have continued to outperform the overall property/casualty industry, as evidenced by the five-year average pre-tax return on net premium of 27.6% for the composite versus 7.4% for the property/casualty industry. However, the underwriting results achieved by the surplus lines market have weakened in recent years, as a result of competitive pricing pressures and a reduction in the level of favorable loss reserve development in prior years.

The migration of business to surplus lines is largely attributed to a reduction in capacity from the standard market combined with increasing pressure from reinsurers. However, as business moves into the surplus lines market, the increased loss costs are expected to be mitigated by the impact of favorable rate activity.

Over the near term, A.M. Best expects that the surplus lines market will benefit from the re-underwriting initiatives being taken by the standard market. This should have a favorable impact on the surplus lines market’s operating performance as well as its balance sheet strength.

Ratings

The median Best’s Rating for the domestic professional surplus lines writers continues to be "A" (Excellent), which compares favorably to the standard market which registered a median rating of "A-" (Excellent). Overall, 94% of domestic professional surplus lines companies have secure ratings, compared to 88% of the property casualty industry.

Recommendations

As part of its study, A.M. Best made the following recommendations to lawmakers, policy makers, regulators, and insurance executives:

• Establish consistent eligibility requirements from state to state by the adoption of minimum surplus standards outlined in the National Association of Insurance Commissioners’ Non-admitted Insurance Model Act.

• Stiffer punishment and fines. Stronger and more effective laws should be passed by state and federal legislatures that would more severely penalize management of insurance companies (domestic or alien) and brokers that operate illegally or with gross negligence.

• Greater access to information. A.M. Best said that lists, such as the California Unacceptable Non-admitted Carrier List, the IID Alien Insurer or "White List" and the "Black Lists" generated by many states should be distributed more widely.