Surplus lines industry solvency record continues to mirror total industry's record, according to A.M. Best annual report

The solvency record of the domestic surplus lines industry continues to mirror that of the total property/casualty industry, according to a study by the A.M. Best Company. The Annual Review of the Excess & Surplus Lines Industry was released today in San Antonio at the 2001 Annual Convention of the National Association of Professional Surplus Lines Offices (NAPSLO).

Since 1971, surplus lines company insolvency rates have 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.

A.M. Best said that "despite the challenges faced by these insurers, the surplus lines market continues to maintain a high level of financial strength and solid operating results, which are supported by sound underwriting guidelines and effective risk management techniques."

Modest surplus size is the leading characteristic of the 65 identified surplus lines insolvencies since 1971. Of those firms, 85% maintained surplus of less than $25 million and more than 50% had surplus of less than $5 million.

Premium Growth

Direct premium for the surplus lines industry increased by nearly 10%, This increase reflects primarily 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 on prior years.

The migration of business into the surplus lines market is largely attributed to a reduction in capacity from the standard market combined with increasing pressure form 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.

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.

A.M. Best attributed the more favorable ratings to: demands by the market that surplus lines carriers maintain a higher level of capital; surplus lines writers tend to operate with more conservative operating leverage; more disciplined underwriting coupled with strong risk management techniques; and a majority of the leading surplus lines writers are strategic members of large well-diversified insurance organizations.

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. A.M. Best also encouraged states to established a stamping office, if they have not done so.

• Stiffer punishment and fines. Stronger and more effective laws should be passed by state legislatures 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. Information that would enhance the industry’s ability to detect problematic brokers or companies should be made more readily available by state insurance departments, the NAIC, and other insurance related entities. 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.

The Annual Review of the Excess & Surplus Lines Industry, commissioned by the Derek Hughes/NAPSLO Educational Foundation, is the eighth annual study of the surplus lines industry which analyses the various segments of the U.S. excess and surplus lines market and provides A.M. Best’s perspective on the industry’s operating performance, financial condition, solvency trends, stability and emerging issues in the market.

In addition to examining the solvency of the surplus lines industry, the report reviewed the status of Commercial Lines Deregulation and the impact of Mergers and Acquisitions on the industry.

Although the excess and surplus lines industry has modest market share, it provides important insurance coverage for hard-to-place or unique risks that do not fit the underwriting guidelines of the standard commercial lines market companies.

The excess and surplus lines industry can be divided into five segments: U.S. domiciled companies which underwrite more than 50% of their direct premiums in surplus lines; Lloyd’s of London; regulated alien companies; domestic carriers which write small amounts of surplus lines risks; and unregulated alien insurers.

NAPSLO is a national trade organization headquartered in Kansas City, Mo., representing the surplus lines industry and the wholesale insurance marketing system. The Derek Hughes/NAPSLO Educational Foundation was established by the NAPSLO Board of Directors in 1991 to improve education for members of the insurance industry about the surplus lines industry.

A.M. Best Company, located in Oldwick, N.J., was founded in 1899 and is the nation's leading provider of insurance company ratings and financial information as well as a specialized publisher of insurance periodicals and electronic products.