While the excess-and-surplus-lines sector is maintaining goodprofitability and strong balance sheets, challenges from highcatastrophe exposures and low interest rates remain, says a reportfrom Moody's Investors Service.

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“Collectively, E&S companies reported an underwriting lossin 2011 due to the high level of catastrophes,” says the report,citing last year's earthquakes, tsunamis, floods and severestorms.

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But Moody's says that even with current challenges, E&Sinsurers are expected to continue to generate top-line growththrough product innovation and development.

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In addition to the sector's success in creating new products,the report, authored by analyst Enrico Leo, attributes the sector'sstrength to underwriting discipline and risk-management practices,which served the sector well through the soft market.

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Leo says E&S insurers have responded to a changedenvironment by raising rates, tightening underwriting standards,purchasing additional reinsurance and, in some cases, reducing linesizes.

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In further good news for carriers, E&S pricing isstabilizing and beginning to improve in some business lines, Leosays, particularly for catastrophe-exposed property risks.

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“As pricing gains traction and standard carriers shed poorlyperforming accounts, E&S insurers' revenue and profitabilitymetrics will improve, notwithstanding significant competition, lowinterest rates and still-difficult economic conditions,” Leowrites.

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Expense ratios are generally higher for E&S carriers becausethey use wholesale-distribution channels, though their loss ratioshave tended to be lower over time than standard carriers, Leosays.

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New regulations in some states are negatively affecting E&Sinsurers, Leo cautions, noting that in the past two years, fourstates have passed laws that define construction defects ascommercial general liabilities.

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