Surplus Premiums Slide But Underwriting Results Are Positive

A special report from A.M. Best Co. confirms what is being heard from the U.S. surplus lines insurance industry: the standard market remains a source of pricing pressure.

The admitted market is competing for risks traditionally insured in the surplus lines market, driving a decline in direct premiums written (DPW) for the third straight year, according to the report, "Surplus Lines Drained, Not Dry, From Soft Market and Economy."

However, A.M. Best said it believes surplus carriers' solid underwriting and relationships with agents and brokers should allow them to keep hold of core business.

Surplus lines DPW decreased 4.1 percent in 2009, higher than the 3.3 percent decline in the overall property and casualty industry but better than the 6.2 percent drop felt by the surplus industry in 2008, according to A.M. Best.

Underwriting profits were about $789.2 million in 2009 compared with $857.1 million in 2008. In 2007, profits from underwriting were $2.67 billion.

The soft market is not likely to reverse in the second half of 2010, the A.M. Best report predicted. Disciplined underwriting achieved from using enhanced modeling and other tools should keep surplus carriers underwriting profitably.

Declining payrolls and lower sales were also behind drops in DPW in 2009, the rating agency said. "Other market forces such as volatile financial markets, competition from Bermuda-based carriers with substantial capital and a desire for top-line growth are adding to the challenges facing surplus lines insurers over the near term," the report said.

Catastrophe losses improved performance in 2009, which was a relatively quiet year in comparison to losses in 2008 from hurricanes Ike and Dolly as well as tornadoes in the Midwest. The reduction in catastrophe losses led to the surplus lines posting a loss and loss-adjustment expense ratio for 2009 of 65.4 compared with 68.3 in 2008. The combined ratio in 2009 for surplus lines was 103.3. The combined ratio of surplus lines has outperformed the p&c industry for five years by nearly 13 points, assisted by the surplus industry's freedom to set pricing and coverage terms, A.M. Best said.

Also in 2009, surplus carriers released a significant percent of prior-year loss reserves to offset the soft market, improve underwriting performance and create a better overall combined ratio. However, A.M. Best said "these reserve takedowns on more recent accident years were likely to be premature."

Reserve development for surplus carriers has been more favorable than that of the p&c industry overall, but the gap is closing. That means insurers must emphasize conservative and accurate loss picks, especially in the current soft market.

"If successful, reserve development should be a positive, not negative, factor affecting the surplus lines market during the near term," according to A.M. Best.

In the report, published on Sept. 27, A.M. Best said surplus carriers should see solid results in 2010 if they focus on bottom-line profits, not top-line growth.

American International Group Inc. (AIG) remains the leader in the surplus market, primarily because of subsidiaries Lexington Insurance Company and Chartis Specialty Insurance Company. AIG produced nearly 4.5 times more DPW than Zurich Financial Services Group, the next highest domestic surplus lines insurance group.

AIG and Lloyd's of London account for about 37 percent of the total surplus lines market share in the U.S.

Nine of the top 10 U.S. surplus lines groups in 2009 were the same as 2008. The exception was Berkshire Hathaway Insurance, which fell to thirteenth after reporting a 27.2 percent drop in surplus DPW.

QBE Americas Group, Munich-American Group and Endurance Specialty Group were the only three out of the top 25 to see an increase in DPW in 2009, A.M. Best said.

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