A.M. Best report shows E&S carriers maintain financial strength  

Surplus lines carriers retain a greater percentage of financial strength ratings in the secure category compared to the total property/casualty industry and also continue to have a similar solvency record as the overall industry, according to a report by the A.M. Best Company.  

The Annual Review of the Excess & Surplus Lines Industry, the 11th annual study by Best, was released today in Orlando at the 2004 Annual Convention of the National Association of Professional Surplus Lines Offices (NAPSLO).

The median Best’s Rating in 2003 for the domestic professional surplus lines composite was A (Excellent), while the standard market registered a median rating of A- (Excellent). In addition, the failure frequency rate of 0.88% for surplus lines carriers over the period of 1974 to 2004 remains similar to that of traditional insurers, which have an average frequency failure rate of 0.91%. The similarity of failure frequency rates between the non-admitted and admitted market attests to the pricing discipline of the surplus lines market, according to Best.

Premium Growth & Business Opportunities
Direct premium volume in 2003 for the surplus lines industry increased by approximately 28% to $32.8 billion, following an estimated 62% increase in 2002. The increased premium volume primarily reflects the increased rates during the hard market of 2001-2003 in addition to the tremendous migration of business from the standard market into the surplus lines market, the report said.

Larger insurers (as measured by direct premium volume) continue to dominate the surplus lines market. Size and flight-to-quality trends have benefited the larger, well-established surplus lines carriers, with the top 25 groups commanding an 85% share of the market.  

Best said that compared to the 12% growth experienced by the property/casualty industry during 2003, the results showed that the surplus lines industry benefited from its freedom of rate (and form) along with reapingthe  benefits of standard market carriers focusing on their core business and leaving risks traditionally handled within the surplus lines arena to surplus lines insurers.

Over the past five years, operating results generated by the surplus lines market have continued to outperform the overall property/casualty industry. These results are evidenced by the five-year average pre-tax return on net premium earned of 15.7% for the composite versus 3.3% for the property/casualty industry.  Additionally, the five-year average calendar year combined ratio of the surplus lines industry of 96.8% outperforms the 107.9% mark of the total industry by a sizable margin. 

Best said surplus lines carriers overall also remain very well-capitalized, maintaining relatively conservative underwriting leverage (0.8 times surplus), moderate common stock investment leverage (0.22 times surplus) while benefiting from generally favorable earnings prospects and greater retained earnings in 2003 and 2004.  Considerable growth in the asset base of surplus lines carriers has resulted.  In 2003, the capital and surplus within the surplus lines composite grew by 30.7%

Over the past several years, reserve margins among surplus lines insurers have diminished significantly, evidenced by diminished availability of prior year reserve redundancies to support future underwriting results.  In fact, in both 2002 and 2003, the surplus lines market experienced adverse loss reserve development overall. A.M. Best believes that the decelerating but still slightly higher average rates (compared to rate levels of two to three years ago) being enjoyed by surplus lines carriers at current market will continue through the end of 2004.  Because of the magnitude of the increases over the past few years, A.M. Best feels the rate softening is likely to continue as insurance carriers, overall, experience robust earnings boosting their desire to be more competitive in the marketplace and search for possible growth opportunities in the near-term.

Ratings 
On average, surplus lines carriers retained a greater percentage of financial strength ratings in the secure category compared to the total property/casualty industry. During the past three years, overall profitability trends have improved markedly, primarily a result of improved market conditions. As a result, the surplus lines composite faired better than the industry with a continued disproportionate number of property/casualty insurance companies being placed under regulatory supervision in 2003 and in the first half of 2004.

Solvency
The failure frequency rate of 0.88% for surplus lines carriers over the period of 1974 to 2004 is similar to the traditional insurers rate of 0.91%.  The failure frequency rate is derived by the number of companies that become insolvent in a given year, divided by the number of companies operating in the insurance market in that year.  Over the last 30 years, the rate of insolvency has on average directly correlated with the underwriting cycle.  The number and frequency rate peaked at the conclusions of soft markets evidenced by the sharp rise in failure frequency rates during the periods of 1984 to 1986, 1988 to 1993 and 2000 to 2002.   

From 2000 to 2002, insolvency rates for the property/casualty industry have been amplified, which A.M. Best attributed to several years of intense competition at a time when loss costs were unexpectedly rising sharply, which led to inadequate pricing and the need to strengthen loss reserves.   Over the period of 1994 to 1999, insolvency rates generally stabilized, which A.M. Best attributed, in part, to competition and excess capital, which led healthy insurers to rescue ailing insurers before the target became insolvent.  

Legislation
The report also examines recent legislative actions, including the Terrorism Risk Insurance Act of 2002 and the draft “Roadmap for Insurance Reform” proposed by Congressman Michael Oxley (R-Ohio) and the Subcommittee on Capital Markets, Insurance and Governmental Entities, chaired by Congressman Richard Baker (R-La.).

The “draft” proposal nicked named, the SMART Act (State Modernization and Regulatory Transparency Act) would create national standards through state enactments that meet criteria set forth in the Act. The “discussion draft” is a legislative version of Rep. Oxley’s “Roadmap for Insurance Reform” that he and Rep. Baker had previously discussed with the NAIC in March 2004 and, if enacted, would lead to the creation of national standards for state insurance regulation.

Annual Study
The Annual Review of the Excess & Surplus Lines Industry, commissioned by the Derek Hughes/NAPSLO Educational Foundation, is the 11th 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.

Background

       The excess and surplus lines industry 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 NAPSLO Board of Directors established the Derek Hughes/NAPSLO Educational Foundation 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.