The hardening of the conventional property/casualty market has created a boom in surplus lines business, according to a report from AM Best.

It is often cited that the insurance industry is, fundamentally, a people business. Whether this is a shield that some shelter behind to protect their positions from the onset of technological solutions is disputable, but nonetheless, strong relationships help grease the re/insurance wheel.

This is particularly the case in the excess and surplus lines industry. One of the major functions of the surplus lines writers is to provide capacity quickly for risks which cannot be covered by conventional, admitted carriers. Here in particular, the relationships between intermediaries and surplus lines carriers - whose numbers are dwindling - is of paramount importance, and more so since the market has been hardening. "The prevailing hard market has impacted not only rates but has affected the transaction of business as well," said AM Best in its recent annual review of the excess and surplus lines industry. "Diminished overall capital and surplus of property/casualty carriers has reduced the amount and scope of available coverage. As a result, many agents are turning to wholesalers to help place business in the excess and surplus lines market." This market hardened considerably after September 11 - more than admitted lines - and intermediaries faced the triple deck problem of limited resources, increased submissions and reduced commission rates.

This increased flow of business into the market "has made it more complicated for surplus lines intermediaries to cultivate relationships with new or previously underutilised insurers," the report identified. "Carriers are able to generate desired production from their core producers because of the higher premiums and are primarily focusing on conducting business with those agents and brokers that stood by them during the soft market." This means that some intermediaries are now finding that placing business is getting increasingly difficult. "For many, they can truly count on only those carriers with whom they maintained solid, productive relationships through the soft market years."

The surplus lines sector was not as affected by M&A activity in the market downturn as carriers in the property/casualty business, partly because the smaller players within the surplus lines arena tended to be aligned with larger organisations. "Surplus lines intermediaries, despite numbering slightly over 450 compared to the more than 100 surplus lines carriers, have also not experienced a high level of M&A activity in recent years. The primary reason is that there are so few barriers to entry in forming an intermediary. Industry observers, however, forecast that there will be fewer players in the future, as the reality of a contracting market will induce some mergers and acquisitions. Hard markets have historically enhanced the value of wholesale brokers and MGAs (managing general agencies), providing sufficient motivation for some smaller and mid-sized E&S brokers to join larger organisations."

State of the market
So, how has the excess and surplus lines industry been faring overall? According to the report - the ninth year that AM Best has issued the review - the market has been going from strength to strength. In the mid-1980s, the surplus lines sector became more established for several reasons including:

  • large standard carriers decided to shed non-core books of business;
  • increased frequency and severity of weather-related claims, particularly in catastrophe-prone areas;
  • legal and regulatory issues in certain states which created a difficult underwriting environment for admitted carriers; and
  • increased expertise in difficult to write lines of business on the part of the surplus lines companies.
  • Last year's uplift in premium rates and conditions across the board was a boost for the surplus lines carriers. AM Best estimates direct premium volumes for the sector were up 35% on the previous year, partly as a result of increased premium levels, but also because of the increasing difficulty in finding standard market capacity. "This compares very favourably to the 11% growth experienced by the property/casualty industry during 2001," it noted in the report. This was on top of a "firming of the pricing environment" in both the surplus lines and the property/casualty sectors in 2000. "As expected, this has been followed by greater premium volume and, at least initially, reporting of more robust operating margins," AM Best observed. "The migration of business into the surplus lines market is largely attributable to a reduction in capacity from the standard market and increasing pressure from reinsurers concerning increased rates and reductions in capacity, particularly for quota share arrangements."

    The second and third quarters of 2001 were also impacted by pricing pressure from reinsurers, as they responded to "bearish" equity markets and an increase in catastrophic losses. September 11 had a dramatic impact on the business, accelerating the changes already apparent in the reinsurance sector, and "exacerbated the lessened capacity that was already affecting commercial lines such as aviation, energy and ocean marine, that are among the traditionally predominant lines," AM Best identified. "Opportunities for surplus lines insurers to increase premium volume at decidedly higher average rates are plentiful." At the same time, however, loss cost inflation and higher reinsurance rates are tempering the upside for the surplus lines markets.

    As with other parts of the re/insurance business, recent times have seen a flight to quality and gravitation towards the largest surplus lines carriers. According to AM Best, the top 25 surplus lines carriers have an 86% share of the market, and "many mid-sized surplus lines carriers will continue to align with larger diversified organisations that provide greater operating and financial flexibility."

    In order to come out on top, surplus lines carriers will need to offer customised products and value added services, commented AM Best. "As policyholders seek ample yet affordable coverage options in today's tighter market, offering valuable risk and claim management services may elevate one market over another in the eyes of the insured. Over the long term, this can combat the tendencies of policyholders to gravitate to the cheaper admitted market when the cycle turns softer."

    Over the past couple of years, the surplus lines carriers have been reaping the rewards of the property/casualty market retreating to its core books of business, though AM Best believes that, despite the current opportunities, the surplus lines players cannot afford to become too self-important. "While these trends are expected to have a favourable impact on results, companies that can establish and maintain a competitive advantage through cultivating value-added relationships with policyholders stand a greater chance of sustaining favourable underwriting margins."

    As ever with the re/insurance business, the good relationship helps keep the business.