October 3, 2010

Surplus lines premiums decline for third year, yet may continue to generate positive underwriting results, according to A.M. Best

Breaking a two-decade run of fairly consistent gains, the surplus lines industry's direct premiums written declined for a third consecutive year in 2009, however it should continue to generate positive underwriting results driven by adherence to disciplined underwriting and favorable prior-year loss-reserve development, according to the A.M. Best Co.’s U.S. Surplus Lines Market Review report.

At 4.1%, the decline was still better than the previous year's 6.2% reversal, but higher than the overall property/casualty (P/C) industry's 3.3% DPW fall off. A major source of pricing pressure and profit margin compression still are the standard market carriers that compete on risks traditionally insured in the surplus lines market. Recessionary economic conditions, volatile financial markets and competition from Bermuda-based carriers are added challenges for this market, according to A.M Best.

The surplus lines market’s total return on surplus (equity), reflecting the impact of unrealized capital gains or losses, was much improved in 2009, due to the financial market recovery noted earlier. While both the surplus lines composite and the P/C industry, overall, experienced tremendous improvement in return on surplus, the composite still outpaced the total P/C industry by more than three percentage points. In terms of both five and 10-year average returns on surplus, the surplus lines composite exceeded the total industry’s by slightly greater margins.

Still, surplus lines specialists, particularly the market leaders, generated considerable operating profits and returns on both revenue and surplus. The partial rebound in the underwriting performance can be credited to the margins built up before the market softened. In 2009, favorable prior-year loss reserve development also helped offset aided underwriting performance. Surplus line specialists in 2009 released a significant percentage of prior year loss reserves relative to net premiums earned, as did the P/C industry, which led to a sizable benefit on their year-end combined ratio.

Nine of the top 10 U.S. surplus lines groups by DPW remained the same as in 2008, and the rankings from one to eight did not change. Berkshire Hathaway Insurance was the only group to drop out of the top 10, landing in the number 13 position.
  • Three groups experienced DPW growth: QBE Americas Group, Munich-American Holding Corporation and Endurance Specialty Group. QBE Americas Group is one of several groups that have made acquisitions to increase market share.
  • For the sixth year in a row, the surplus lines industry recorded no financial impairments, compared with 18 financial impairments for the admitted property/casualty industry.
The report said that there might be a twinge of tightening in the market, with a select few standard and specialty carriers beginning to step back from certain unprofitable classes. Recognizable trends have yet to emerge, however.

Annual Study

The Special Report on the Surplus Lines Market, commissioned by the Derek Hughes/NAPSLO Educational Foundation, is the 17th 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

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.