Surplus Lines Market Shows Signs of Shaping Up

When retail agents or brokers cannot find coverage for a unique or high-risk insured with a company in the standard or admitted market, they often turn to the surplus lines—or excess and surplus (E&S)—market for answers. During 1999, the surplus lines market grew and the increase reflects some price firming in the marketplace. So will this trend continue in the coming years?

“With regard to the rates, it’s hard to say whether or not there is going to be long-standing firming or that it’s going to a hard market,” said Doug Ostermiller, senior financial analyst for A.M. Best Company. “There’s indication, but I think we have to see a lot more taking place before we can say, ‘okay, the market has hardened.'”

Nevertheless, growing evidence suggests that the market has begun to firm, Ostermiller said. “Prices have bottomed out and some insurers have taken significant losses—and they can’t take losses indefinitely,” he said. “Some carriers have left the market, and the standard market has begun to focus on its core operations.”

Migration in the market

Historically, the surplus lines market was protected from competition with traditional markets. However, in recent years, the E&S market has undergone a series of changes in response to intensifying competitive pressures. For example, the E&S market witnessed an invasion of standard carriers, and according to A.M. Best, this migration began last year and has continued through the first half of 2000. The shifting of business is largely attributed to a reduction in capacity from the standard market combined with increasing pressure from reinsurers.

“The standard market was looking for premium volume so they expanded what they were willing to write,” Ostermiller said. “As a result, they started making in-roads into what was traditionally the E&S market, but now that trend is starting to reverse.”

One thing Ostermiller feels will help solidify the firming market is an increase in rates in the reinsurance market. “And we’re starting to see that take place—so depending on what happens with [this] market, it will definitely help,” he said.

The good news is that the pricing environment for the surplus lines market as a whole is firming. “In certain classes or lines of business we’re seeing dramatic increases because of a reduction in capacity,” Best’s Ostermiller said. “It’s tough to say that all lines are moving in tandem—some are more, some are less.”

Debating the dereg question

Through July 2000, commercial lines deregulation has been enacted in 20 states and defeated in only four states (Connecticut, New York, North Dakota and Texas). Deregulation is considered crucial to maintaining a level playing field with banks and securities firms, due to last year’s passage of the Financial Services Modernization Act.

“Deregulation is going to have an impact [on the surplus lines market],” Ostermiller said. “It was a big deal in 1998 and the beginning part of 1999, but towards the latter part of 1999 and 2000, it wasn’t in the forefront as an issue, so it’s tough to say what’s going to happen.”

According to A.M. Best’s special report, “the surplus lines community argues that if the admitted market is deregulated, then the surplus lines market should also be deregulated so that exempt commercial insurance consumers can benefit from a competitive marketplace.”

Overall, the rating agency is supportive of deregulation initiatives that are designed to promote a healthy and efficient market.

Lloyd’s maintains dominant role

A.M. Best categorizes the surplus lines market into four broad subgroups: domestic professional companies; domestic specialty companies; regulated aliens (which includes Lloyd’s); and unregulated aliens.

Lloyd’s plays an important role in the surplus lines market. “It is the most important market for us in the U.S.,” said Julian James, managing director, Lloyd’s of North America. “According to our analysis—we believe we are the largest single entity that has the largest market share—no U.S. domestic company writes as much business as Lloyd’s.”

In 1999, surplus lines premium for Lloyd’s increased 21 percent to $1.9 billion from $1.6 billion in 1998. “A.M. Best rates that at about 19.9 percent market share,” James said.

According to Lloyd’s, the growth in its surplus lines premiums was a direct result of the following factors: expanded marketing activity, more underwriters out in the field, increased awareness of Lloyd’s security ratings, the hardening market in certain lines, and market withdrawals by certain surplus lines carriers during the year.

Both the Lloyd’s market and other markets experienced large underwriting losses in 1998 and 1999. “Our losses are very much in line with some of the combined ratios that U.S. domestic carriers are seeing,” James said. “And if you look at Lloyd’s results over a five- or 10-year period, what is very clear—and this has been reaffirmed recently by A.M. Best—is that our results tend to be more volatile, but overall—Lloyd’s tends to outperform its competition.”

Keeping up with changes

With technology at the forefront of today’s business, new exposures and new risks are popping up all over the world. “There are different levels of risk within the technology sector, and indeed, some of the exposures that come with a technology company will be risky in different ways,” James said. “So yes, there is a risk attached to it. Do we feel comfortable with it? Yes, we do. We’ve done this all of our lives.”

Lloyd’s has been in the risk business since the late 1800s. “We’ve made an entire history throughout 310 years of taking on risk—and we’re not shy about it,” James said.

A.M. Best believes Lloyd’s is well-placed to service the insurance markets and will exist increasingly for its underwriting of special risks that is not available in local markets. Risks underwritten by Lloyd’s range from unusual risks such as accident cover for the Russian cosmonauts who traveled to the MIR space station on the American space shuttle to new liabilities stemming from e-commerce and the Internet.

“We’re listening very closely to how technology can help us with accessibility and improving customer service,” James said. “And we are very much looking at what the overall level of service needs to be to make sure our underwriting innovation is matched by cutting-edge service innovation.”

California is the most important state for Lloyd’s U.S. surplus lines business, according to James. It accounts for roughly 12 percent of its total surplus lines business ($1.9 billion). Lloyd’s plays a major role in providing coverage for some of the mass transit, airport and other major construction projects that have taken place throughout the Golden State.

“The surplus lines market is the cornerstone of our U.S. activity and I do not see that changing,” James said. “As ways of doing business change, [there are] new exposures being developed within the U.S. economy—and we’re still seeing a great demand for surplus lines carriers—and Lloyd’s still plays a very strong part of that role.”

According to A.M. Best, insurers that leverage technology and employ data mining techniques to target and retain their customers will be market leaders in the future.

Topics Trends Carriers USA Excess Surplus Tech AM Best Lloyd's