Moody's: Discipline in E&S Helping Sector Overcome Challenges

While the excess and surplus lines sector is maintaining good profitability and strong balance sheets, challenges from high-catastrophe exposures and low interest rates remain, says a Moody’s Investors Service report.

But the report says that, even with current challenges, E&S insurers are expected to continue to generate top-line growth through product innovation and development. New products launched over the past few years include cyber-liability coverage, environmental liability and renewable-energy liability.

At the same time, low stock valuations will limit mergers-and-acquisition activity, the report says.

The report, by analyst Enrico Leo, attributes the sector’s strength to product innovation, underwriting discipline and risk-management practices, which served the sector well through the soft market.

"Collectively E&S companies reported an underwriting loss in 2011 due to the high level of catastrophes," Leo says, citing last year's earthquakes, tsunami, floods and severe storms.

He says E&S insurers have responded by raising rates, tightening underwriting standards, purchasing additional reinsurance, and, in some cases, reducing line sizes.

At the same time, E&S pricing is stabilizing and beginning to improve in some business lines, Leo says, particularly for catastrophe-exposed property risks.

Companies' strong underwriting discipline and limited appetite for retaining risks at inadequate rates have served them well over time, he says.

"As pricing gains traction and standard carriers shed poorly performing accounts, E&S insurers' revenue and profitability metrics will improve, notwithstanding significant competition, low interest rates and still-difficult economic conditions," Leo says in the report.

Expense ratios are generally higher for E&S carriers than they are for standard property and casualty insurers in part because E&S carriers use wholesale distribution channels, though their loss ratios have tended to be lower over time, Leo says.

New regulations in some states are negatively affecting E&S insurers, however, Leo cautions. He notes that in the past two years, four states have passed laws that define construction defects as commercial general liabilities.

"Such laws affect the freedom of policy form traditionally enjoyed by E&S companies," Leo says, "and the recent change in law could open up existing policies to potentially larger claims."

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