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 Boston at the 2002 Annual Convention of the National Association of Professional Surplus Lines Offices (NAPSLO).

Since 1972, surplus lines company insolvency rates have mirrored those of traditional insurers, with an average failure frequency rate less than 1%. The similarity of failure frequency rates between the admitted and non-admitted markets attests to the pricing discipline of the surplus lines market, particularly considering the lack of rate regulation. During the period from 1987 to 2002, both markets have experienced a higher failure frequency rate compared to the 1972-1986 period, although insolvency rates or the property/casualty industry had generally stabilized in the late 1990s.

Best sad that the tragic events of September 11, 2001 accelerated the hardening of the reinsurance and primary markets and exacerbated the lessened capacity that was already affecting commercial lines such as aviation, energy, and ocean marine that are among the traditionally predominant surplus lines. Opportunities for surplus lines insurers to increase premium volume at decidedly higher average rates are plentiful. However, as business moves into the surplus lines market, loss cost inflation and higher reinsurance costs are expected to mitigate the benefit of favorable rate activity somewhat.

Premium Growth & Business Opportunities

At year-end 2001, direct premium volume for the surplus lines industry increased by nearly 35% over the prior year.

This increase primarily reflects the increased rates and prices of the hardening market and the migration of business from the standard market into the surplus lines market. This compares very favorably to the 11% growth experienced by the property/ casualty industry during 2001.

 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 22.7% for the composite versus 4.8% for the property/casualty industry. However, the underwriting results achieved by the surplus lines market have weakened in recent years, primarily the result of competitive pricing pressures and a reduction in the level of favorable loss reserve development on prior accident year.

While several niche surplus lines companies have been successful, larger carriers continue to dominate this market. Size and flight-to-quality trends have benefited the large surplus lines carriers, with the top 25 groups commanding an 86% share of the market. Going forward, A.M. Best believes that many mid-sized surplus lines carriers will continue to align with larger diversified organizations that provide greater operating and financial flexibility. However, surplus lines companies that are part of larger organizations may find their ability to take full advantage of the market conditions impaired if their parent organization is having difficulty achieving its profit goals.

Ratings 

Consistent with prior years, Best found that most professional surplus lines companies have maintained higher ratings than that of the property/casualty industry. The median Best’s Rating for the professional surplus lines composite remains A (Excellent) versus the industry’s median rating of A- (Excellent). A.M. Best attributes the more favorable ratings to four factors:

• Demands of the market that surplus lines carriers maintain a higher level of capital, due to their lack of guaranty fund protection in virtually all states; 

• Surplus lines writers tend to operate with moreconservative operating leverage with sidelined capital waiting to take advantage of market opportunities;

• Disciplined underwriting coupled with strong risk management techniques that have consistently produced favorable loss experience; and

• A majority of the leading surplus lines writers are strategic members of large, well-diversified insurance organizations.

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. 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.

Annual Study

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.

Background

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.