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

Chicago - September 16, 2006 - Despite a softening market, rising loss and reinsurance costs, low investment yields, and the potential for continued adverse loss reserve development, A.M. Best said profit and growth opportunities still exist within the surplus lines market, according to a recent report by the company.  

The A.M. Best Co. Special Report on the Surplus Lines Market, the 13th annual study commissioned by the Derek Hughes/NAPSLO Educational Foundation, was released today in Chicago at the 2006 Annual Convention of the National Association of Professional Surplus Lines Offices (NAPSLO). 

Best said, as anticipated, the market softening initially signaled by falling rates or moderating rate increases in 2004 has continued through the first half of 2006.  Conversely, the sizeable market losses suffered due to the effect of a hurricane season that produced an unprecedented 27 named storms, most notably Katrina, Rita and Wilma, has led to a resulting increase in primary property and property reinsurance rates.  Best said one big question coming into 2006 was whether market conditions on catastrophe-exposed business would carry over to other lines of coverage and other areas of the country causing a cessation or reversal of the soft cycle.

Premium Growth & Market Breakdown
The surplus lines market has expanded substantially over the last twenty years, increasing from approximately $4.0 billion in direct written premium to $33.3 billion in 2005. By contrast, the commercial lines segment of the U.S. property/casualty industry grew at a lesser rate, from $91.8 billion of direct premium written in 1985 to $263.1 billion in 2005.  

The growth of the surplus lines market, as a percentage of total commercial lines premiums over the past twenty years increased from 4.36% in 1985 to 12.65% in 2005.  During this same period, the surplus lines market as a percentage of the total property/casualty industry grew from approximately 2.0% to 6.8%.  The five-year growth in direct written premium of 229% for the domestic professional surplus lines group dwarfs that of the total U.S. property/casualty market of 51.7%.

Industry Review
Consistent with historical trends, the larger, more established groups continue to dominate the surplus lines market, with the 25 leading surplus lines groups making up approximately 82.5% of the total surplus lines direct premium in 2005

While the top surplus lines groups have historically produced the majority of direct premium written, the collective market share has become significantly more concentrated. In 1995, the top 25 groups held a 61.34% share of surplus lines premium, but in 2005 their market share had increased to 82.5%. In total, despite name and/or ownership changes, 16 of the top 25 groups/carriers remain the same.

The leaders within the surplus lines market, in terms of direct written premium, are American International Group (AIG)--primarily through its Lexington and American International Specialty Lines subsidiaries-- and Lloyd's. Combined, these two organizations commanded approximately 35.0% of the total surplus lines market in 2005, The U.S. continues to be Lloyd's biggest market, accounting for more than $9.4 billion in gross premium revenue in 2005.

Ratings
Over the past decade, domestic professional surplus lines insurers have maintained a higher proportion of "Secure" ratings than the overall property/casualty industry. Best said the percentage of rating units carrying Secure ratings as of July 2006 was 98.8% for domestic professional surplus lines companies, compared with 88.5% for the domestic U.S. property/casualty industry.

Solvency
Due largely to the significant improvement in underwriting performance of surplus lines carriers in recent years, failure frequencies have dropped to zero from 2004 through the first six months of 2006. Best said this dramatic result is mostly attributed to favorable market conditions, underwriting discipline and adequate pricing despite some evidence of price softening. Through solid operating performance and favorable underwriting results, surplus lines carriers have outperformed the P/C industry in recent years.            

Best said the surplus lines failure frequency rate of 1.07% for the most recent 30-year period (1977 to 2006) remains somewhat higher than the P/C industry’s average failure frequency rate of 0.93%. 

During the period 1998 to 2003, the surplus lines market exhibited a significantly higher failure frequency rated relative to its admitted-market counterparts. A major contributor to this result was the increased failure rate of program writers that relied heavily on managing general agents (MGAs) and the authority afforded to these agents by “giving away the pen”. 

Annual Study
The Special Report on the Surplus Lines Market, commissioned by the Derek Hughes/NAPSLO Educational Foundation, is the 13th 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 the financial review of the industry, the surplus lines distribution systems was a focus of the special sections topic of the report, examining licensing and compliance, tax reporting; pending legislation; commissions; relationships, and mergers and acquisitions.

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.

Copies of the report are available from NAPSLO at (816) 741-3910