AM Best: Surplus lines grew 17.5% in 2020 but UW profitability “elusive”

The US surplus lines market saw direct premiums written (DPW) grow 17.5 percent in 2020, the largest year-over-year increase since 2003, while operating performance deteriorated from 2019 and the segment is set to stay “tight” in 2022 with continued pricing momentum, according to a new AM Best report.

The 17.5 percent premium growth last year was up from 11.2 percent growth in both 2020 and 2019.

Underwriting results for AM Best’s domestic professional surplus lines (DPSL) composite worsened slightly in 2020, but it still generated $1.3bn in pre-tax operating income, down from $1.5bn in 2019.

The composite recorded a combined ratio of 99.7 percent in 2020, a 0.3 percentage point deterioration from 2019. This compared with combined ratios of over 100 percent in each year from 2015 to 2018.

“Despite excellent growth, the underwriting profitability of the surplus lines segment has been elusive in recent years due to losses driven by secondary perils such as wildfires and convective storms,” the report said.

Surplus lines insurers have been able to offset modest underwriting losses with net investment gains and other income to generate both pre-tax and net operating profits.

Only 2.8% growth for Lloyd’s

The segment’s overall expansion was driven by 20 percent growth for AM Best’s DPSL composite, which comprises companies writing more than 50 percent of their direct business on a surplus lines basis.

The US domestic specialty companies – those writing less than 50 percent of their overall business on a surplus lines basis – also experienced overall DPW growth of more than 20 percent. But this group has lost market share to the domestic professionals in recent years.

Lloyd’s syndicates account for almost 20 percent of surplus lines annual premium, but their premium grew only 2.8 percent in 2020 despite the opportunistic market conditions. Syndicates have been implementing more conservative underwriting strategies since mid-2018 as part of a strategic business review implemented by Lloyd’s.

“Lloyd’s made a strategic decision in mid-2020 to focus even more on the US surplus lines and reinsurance business so its syndicates will continue to have a meaningful impact on the market,” the report said.

The ratings agency noted that surplus lines and specialty insurance writers continue to report that they are being flooded with submissions as the economy reopens and standard market companies continue to revisit their appetites.

“Ongoing uncertainty about Covid-19 variants – their extent and length – could undo some of the progress made in the second half of 2020, and earlier-than-usual significant catastrophe losses, uncertainty about casualty claims costs as courts reopen and clear their backlogs, and price adequacy concerns will be headwinds in 2021,” the report said.

Tight conditions for 2022

AM Best expects market conditions to remain “tight” in 2022 because of the ongoing impact of Covid-19, with the potential for more economic uncertainty.

“A decline in capacity owing to changes in company risk appetites, along with hardening rates for many commercial lines of coverage, creates an environment with an acute need for creative market and product-oriented solutions – the hallmarks of the surplus lines carriers,” the report said.

Consolidation has been a theme for the surplus lines market in the past few years. This has reshaped the distribution side of the market. In contrast, E&S company consolidations have slowed a bit the past couple of years.

“Over the near term, especially in the aftermath of the pandemic, we may see more strategic acquisitions of specialty niche insurers or of insurers with a well-established market presence or advanced technological capabilities, than mergers of large global multi-line insurers and reinsurers,” AM Best commented.

A number of new E&S companies have launched in recent times.

“Although new entrants and incremental capital raises have had an impact on the edges of the market, pricing momentum is likely to continue, as a multitude of factors, such as low interest rates, elevated natural catastrophe activity, social inflation, and Covid-19 losses, are likely to persist throughout 2021 and affect pricing,” the report commented.

Berkshire overtakes AIG

The top 25 surplus lines groups plus the syndicates that make up the Lloyd’s market dominate the surplus lines market, with 74 percent of DPW in 2020. Excluding the Lloyd’s market, the top 25 groups account for around 55 percent of premium, meaning Lloyd’s accounted for 19 percent of premium.

“Lloyd’s appetite for US surplus lines and the specialty commercial business remains strong, bolstered by the July 2020 decision to give up admitted licences in the US Virgin Islands, Kentucky, and Illinois, and instead focus on the US reinsurance and surplus lines insurance markets,” the report said.

“The decision reflected not only that Lloyd’s underwriters consider the US surplus lines market an excellent one, but also that North America is a key source of income.”

AIG and its surplus lines companies have been the leading US group underwriting surplus lines business for the past two decades. But it has made strategic changes in the past few years to generate more favourable underwriting and operating results.

As a result, Berkshire Hathaway Insurance Group, the third-ranked US surplus lines group in 2019, rose to the top spot in 2020. It recorded 61 percent DPW growth of its main surplus lines insurer/reinsurer National Fire & Marine Insurance Company to almost $3.6bn, surpassing AIG by a very modest $9mn.

“National Fire & Marine’s growth was fuelled, in part, by the decision to put more resources into building its specialty commercial book while de-emphasising property catastrophe reinsurance, whose profitability has been under pressure,” the report noted.

As previously reported, Berkshire Hathaway Specialty Insurance is led by a team of former AIG and Lexington executives under Peter Eastwood.

Third-placed Markel was some way behind the top two, with just under $2.8bn in surplus lines DPW in 2020.

Eight of the top 10 groups by direct premium volume and 14 of the top 20 saw double-digit growth in 2020. Of the top 10, only Markel and XL Reinsurance America Group generated less than 10 percent growth.

Among individual surplus lines companies, there was also a shake-up at the top.

AIG’s main surplus lines insurer, Lexington, had long been the largest US surplus lines company, holding the top spot from when AM Best first published its report in 1994 to 2019.

But in 2020 two companies generated higher DPW than Lexington: Berkshire Hathaway’s National Fire & Marine and Nationwide’s Scottsdale Insurance Company.

“The AIG/Lexington brand maintains considerable market strength, as the group continues its enterprise-wide effort to modernise its operating infrastructure and generate excellent underwriting results, which incorporates de-risking efforts that have decreased its premium volume,” the report said.