AM Best takes E&S segment off negative outlook citing profitability and growth

AM Best has revised its outlook for the excess and surplus lines (E&S) market to stable from negative, stating that the segment’s ongoing profitability and premium growth signal opportunities for carriers to successfully operate.

The ratings agency said the change of outlook captures insurance industry dynamics that provide benefits specific to surplus lines carriers, despite the widespread impact of Covid-19 on the US economy and uncertainty about the length of the pandemic.

“Surplus lines carriers are not immune to the worldwide declines in economic activity. Still, the segment’s profitability and growth highlight the subdued impact of the pandemic on the surplus lines companies,” AM Best said.

The ratings agency had revised the outlook on the segment to negative in April 2020, noting the disruption from the Covid-19 outbreak had resulted in a contraction of the US economy.

However, today AM Best stated: “Since we last updated our outlook, the surplus lines carriers have generated consistent underwriting cash flow, experienced stability in claims activity, and successfully managed the challenges of investment market conditions. These factors have moderated concerns about the cohesion of the surplus lines market.”

The ratings agency noted that economic ingenuity has “minimised the decline in demand for customised coverage for new, unique, high capacity, or distressed risks”. Businesses pivoted to strategies to remain open while, surprisingly, a fair number of new businesses have been formed in the past year. This has led to a persistent need for insurance capacity.

In addition, AM Best said the market has a layer of insulation against pandemic claims because its ability to structure bespoke terms and conditions favours clearly defined coverage exclusions.

The adequate rate-setting ability under the rate freedoms provided by the surplus lines markets also provides a pricing advantage, a fact AM Best said is demonstrated by the premium volume reported through surplus lines stamping offices across the country.

The surplus lines premium in 2020 in stamping office states exceeded $41.7bn, up 14.9 percent over 2019, according to the 2020 annual report of the US Surplus Lines Service and Stamping Offices released earlier this month. The stamping offices account for around 63 percent of overall E&S premiums.

“The ability to align rates charged with insured risks has favoured this market since 2019,” AM Best commented. “Even in the pandemic environment, accounts continue to go to market as both standard and non-standard carriers look to improve underwriting performance.”

The ratings agency added that the apparent incongruence of the stable outlook with the negative outlooks that it has for other commercial lines is largely offset by the intricacies of the surplus lines market, notably its position as a relief valve for the standard markets.

It also said that market participant growth is an encouraging sign for the segment.

“Newcomers, along with a recommitment from existing participants, show a healthy interest in the specialty commercial market. That capacity will remain stable and could even expand in the short term,” it said.

AM Best believes the surplus lines segment will continue to record stable results this year.

However, it noted that potential headwinds for the market include the impact of social inflation on casualty claims, as well as the possibility of a sudden increase in market capacity to disrupt currently favourable market conditions.

In a report on the E&S market released in September 2020, AM Best reported that its composite of domestic professional surplus lines insurers – which includes those that write more than 50 percent of their business on a non-admitted basis – recorded a combined ratio of 99.4 percent in 2019, which was a 5.1-point improvement over 2018.

This improvement reflected the positive impact of recent average pricing increases in most lines, along with lower catastrophe losses in 2019.

The surplus lines market has been more profitable than the overall property casualty industry historically, with a five-year pure direct loss ratio average of 58.2 percent versus 61.1 percent for 2015-2019. AM Best noted that excluding AIG the difference in favour of the composite is much starker, with a 52.8 five-year average loss ratio.

As previously reported and as noted by AM Best, the surge in business coming into the E&S market and hard pricing across most lines has created an attractive opportunity for new players entering the market.

This trend has continued into this year. January saw the launch of Upland Capital Group, led by Todd Hart, James Damonte and Mark Morrison with up to $200mn of backing from Newlight Partners and additional investment from management.

And The Insurer revealed that plans are advancing for the launch of specialty carrier LIO Insurance by former Guy Carpenter executive John Ehinger and several alumni from Philadelphia Insurance Company.