There is a special segment of the insurance industry that can be maligned at times because of how it operates, but it is critically important to a healthy insurance marketplace. That industry segment is the excess and surplus (E&S) market.
In Florida, when the state legislature was considering approving creating a homeowners’ insurance marketplace, it debated allowing surplus lines insurers access to it. Advocates believed that a marketplace would allow homeowners access to more carriers, while those who opposed it felt like consumers could suffer greatly due to the unregulated (or looser regulation) nature of the E&S market.
In truth, the E&S market would likely have served homeowners well by entering that marketplace.
What were those detractors really concerned about?
E&S companies are loosely regulated. However, given that insurance is so heavily regulated, we can’t really say that they are unregulated — they are regulated differently than admitted companies.
E&S companies don’t have to file their rules, rates or forms with the state where they are transacting business. This means that the state doesn’t approve companies’ risk selection criteria. This means that they can choose whatever risks they believe fit them best at the time. They don’t have to choose what risks they want in advance and stick to those criteria.
E&S companies can also charge the premium that they want to charge for the risks that they select. The state doesn’t oversee their rate selection and doesn’t guarantee that those rates will be sufficient to maintain their solvency without being so high as to not be affordable.
The companies don’t file their forms, which means that insurance agents and consumers have a higher responsibility to read the policies that they receive.
E&S policy forms may look like admitted forms, but they may have exclusions that a standard market carrier couldn’t have. They may also contain policy provisions that make it more difficult for the customer to make a claim against the policy.
In the end, the biggest problem that regulators saw was that the loosely regulated nature could create problems for consumers. With loose underwriting rules, no pricing guidance and unregulated forms, consumers could be in a world of trouble.
That’s what the detractors say. However here’s the other side of the story.
Why E&S Makes the Overall Market Better
A strong E&S market makes the admitted market and residual market stronger.
Consider what risks the E&S market is going to write. These are the risks that the admitted market won’t write. There are many risks that admitted markets just can’t write. They either didn’t file to write that business, or their underwriting rules won’t allow them to write it. It may be a business with a risk profile that the carrier isn’t comfortable with. It could be the location of the buildings that are a problem (high flood risk or high hurricane risk).
Without a strong E&S market, many of those risks would be forced into a residual market. The residual market is designed to provide coverage for those risks that should be able to buy insurance, but because of certain factors, they can’t find coverage in the admitted market. This might be risks with buildings in coastal areas or in flood prone areas. Expanding the residual market is a problem because in many cases, if losses exceed the financial ability of the residual market to pay, the claims get paid but customers in the admitted market may be required to pay fees or assessments to make up the difference.
The E&S market relieves some of the strain from the admitted and residual market by providing coverage for those risks that neither market wants to cover. This includes the admitted market, because of the rules carriers must abide by, and the residual market, because of the weight of their burden.
A strong E&S market can be a bed of innovation for the admitted market.
There are risks that the admitted market is not prepared to write for many reasons. Going back to required filings, admitted markets do not generally respond quickly to emerging risks. When carriers identify a new risk that they might be interested in writing, they have a process to follow.
Consider the cyber liability market. A carrier would have to discern what the actual risks are, including the likelihood of those events happening. They would be faced with more questions than answers. They would have to research potential risks and then identify the risk exposures that they want to write and the exposures that they want to exclude.
Once they identify those exposures, they have to work to determine how price those risks. Without actual data to confirm pricing, carriers would struggle to justify their pricing with insurance departments, some of which can be strict on pricing. Without data to come up with a rating structure, many admitted insurance companies would just as soon pass on the opportunity.
The E&S market doesn’t have the constraints that the admitted market does. If a risk is submitted, they can make a decision about whether they have the capacity to write it.
They can gather information about the risk and make their decision. They can learn by trial and error which exposures to exclude, and which exposures are critical to write (even if they are of a higher risk).
They can experiment with the pricing until they find the price that the provides the coverage that the risk needs while allowing them to make a profit. They can learn what price the market will bear. They can innovate on the fly and create some consistency over time. Once they learn about the risk, including the rules, rates and forms that are appropriate, it’s only a matter of time before the risk gets the attention of some enterprising admitted carrier, who will dip its toes into the market.
Strong E&S Market
A strong E&S market specializes in fringe insurance. The quarterback with insurance on his throwing arm. The soccer player with insurance on her legs. The golfer with insurance on his arm. The singer with insurance on her voice.
We have heard the stories. Some are real, and usually the most unbelievable stories are true in this space. These risks are so unique that no admitted market would be able to properly insure them, but it’s what the E&S market excels at.
The insurance industry owes much to the E&S market. This segment allows the standard market to continue to provide coverage for the risks that it anticipates, while it provides coverage for the risks that the rest can’t think about.
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