October 3, 2011

Surplus lines market suffers fourth year of declining premiums, according to annual A.M. Best report on market

The surplus lines industry suffered an unprecedented fourth year of declining premiums in 2010, according to the annual report on the surplus lines market published by the A.M. Best Co. The report will be released at the NAPSLO Annual Convention and NAPSLO members will receive a copy in the mail and can also download a copy from NAPSLO’s website.

The report said the declining premiums are the result of the recession’s impact on declining payrolls and competition from standard market insurers. In addition, the report said volatile financial markets and competition from Bermuda-based carriers also present challenges to the market. 

A net operating profit for the surplus lines industry was generated, but underwriting results worsened appreciably, driven primarily by increased catastrophe-related losses and higher loss totals for the lead “other liability” line of business. Although the surplus lines industry still outperforms the overall property/casualty industry in most measures, the gap continues to narrow. 

Another key finding in the report is that for the seventh year in a row, the surplus lines industry recorded no financial impairments, compared with 11 financial impairments for the admitted property/casualty (P/C) industry.

The sustained, high level of market competition noticeably affected the performance of surplus lines insurers over the past two calendar years. To offset the effects of the soft market, some surplus lines companies resorted, again, in 2010 to reserve releases from prior year’s favorable loss development, the benefits from which A.M. Best Co. said it believes will not be as robust in 2011 because the reserve cushion is being depleted.

Best said that for surplus lines insurers, a major source of downward pressure on pricing and profit margins has been and remains the standard-market insurers that compete on risks traditionally insured in the surplus lines market.

Both the surplus lines composite and the overall P/C industry experienced a decline in total return on surplus (equity). The surplus lines composite still outpaced the total P/C industry by a small margin, producing a 10.9% return, down from 14.4%, compared with the P/C industry’s 9.8%, down from 11.5%. The decreased total for the composite reflected the 16.2% decline in net income and a 21.0% drop in unrealized capital gains in 2010.

This followed a significant improvement in unrealized gains in 2009 due to the financial markets’ recovery following the global financial crisis in 2008. The P/C industry suffered a larger, 35.0% decline in unrealized gains in 2010, driving the decrease in its total return on equity.

Despite the highly competitive market conditions, surplus lines specialists, particularly market leaders, were able to generate considerable operating profits and returns on revenue and surplus, which again outpaced the returns of the P/C industry by a wide margin. 

A 13.0% decrease in surplus lines Direct Premiums Written at the AIG companies in 2010, compared with 2009, allowed Lloyd’s to take over as the top surplus lines writer in 2010. Combining Lloyd’s surplus lines DPW with those of second-ranked AIG, the two organizations held approximately 35% of the total surplus lines market, down slightly from approximately 37% in 2009.

Going forward, A.M. Best believes the surplus lines market should continue to generate positive underwriting results driven by adherence to disciplined underwriting and, to a degree, favorable prior-year loss-reserve development. The results in 2011 will likely bear the definitive impact of increased catastrophe-related losses, as was the case in 2010. While rates on some personal lines business and on specific lines and classes of commercial lines business have showed an uptick through midyear 2011, it remains unclear whether selected rate increases will gather enough momentum to make up for the increased frequency and/or severity of catastrophe losses.

A.M. Best believes the second half of 2011 and 2012 will continue to present very challenging market conditions for the core commercial lines segment, which is integral to the performance of the surplus lines market.

Annual Study

The Special Report on the Surplus Lines Market, commissioned by the Derek Hughes/NAPSLO Educational Foundation, is the 18th 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, regulatory and legislative issues revolving around the Nonadmitted and Reinsurance Reform Act and the surplus lines distribution systems were focus of the special sections topic of the report.

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.