Surplus Lines Industry Continues to Play its Role

Since it’s inception in the early 19th century, the surplus lines industry has played a significant role in the insurance world: providing the buyer with insurance not available in the standard, admitted markets. As noted by William R. Feldhaus in “Surplus Lines Insurance Principles and Issues,” in the late 1800’s no established insurance laws existed to guarantee insurance buyers that payment would follow the filing of a claim. Insurance companies were chartered but not licensed by state legislatures, resulting in a relatively free economic insurance market. Concentrated fires in large cities such as Boston, New York and Chicago caused the financial ruin, and in some cases elimination, of many property insurance companies. Bankruptcies and loss of capital inevitably resulted in the lack of adequate coverage from chartered insurers.

That lack of available fire coverage caused insureds to seek fire insurance from those companies that would provide it, regardless of whether those firms were chartered in their states. Historically, capital constraints have been linked with increased underwriting scrutiny as insurers rejected non standard, specialty, or distressed business routinely. This loss of capital, coupled with tighter underwriting, caused more buyers to seek coverage from non-traditional methods.

The question for regulators in the 1800’s, as it is now, was how to protect the policyholder from insurer insolvency, while still allowing market access. In 1890, New York recognized the need for an excess and surplus lines market as a supplement for the admitted market. Instead of passing laws aimed at eliminating surplus lines business, New York sought to recognize and regulate the use of non-admitted carriers. The NCIC (National Convention of Insurance Commissioners), formed approximately 20 years earlier, was instrumental in recognizing this critical need in New York. At the turn of the century, the U.S. property and casualty insurance industry did not have the capacity to handle the commercial and industrial growth the country was experiencing. Particularly vulnerable were the insurance buyers in New York’s garment district. Lloyd’s of London was interested in writing non-admitted business and became one of the first excess and surplus lines providers in the U. S. The New York law functions today very closely to the way it was originally enacted, placing much of the regulatory responsibility on the licensed insurance producer.

The Great Depression ushered in the first significant growth for non-admitted alien or foreign insurance companies in the U.S. As the stock market crash and poor underwriting performance limited the capital available to many licensed property and liability insurers, they severely restricted coverage. Lloyd’s of London flourished in the states, writing as many policies as they could. A change in attitude by some regulators regarding the need for a non-admitted market to fill the gaps in coverage created by the admitted market also occurred. Although it took several decades, most states eventually recognized the need for surplus lines insurance and revised or developed comprehensive non-admitted insurance laws.

After World War II the surplus lines industry experienced another growth spurt, as the admitted property-liability insurance companies were unable to meet the growing needs of large industrial and commercial insurance buyers, brought on by the country’s dynamic economic post-war expansion. By the 1950’s domestic carriers had recovered enough capital to write the new coverages needed by a growing industrial nation, but they did not have the appetite or expertise to profitably entertain these specialty risks. This resulted in one of largest growth periods for Lloyds and other specialty companies.

In Texas the surplus line business grew due to the heavy demand for energy and off shore marine coverage. Again, many domestic insurers did not have, or could not economically develop, the expertise to handle this specialty business. The surplus and specialty carriers provided the much-needed coverage.

In 1956, the Texas Surplus Lines Association formed, in part to educate its agent members and protect the public from unsound excess and surplus lines insurance businesses. The organization incorporated in 1966 and in 1971 became a licensed advisory entity to what was then the State Board of Insurance. It also helped establish the Texas Surplus Lines Stamping Office, which was created by the Texas Legislature in 1987.

The 1970’s saw the surplus lines premium in the U.S. double to $2 billion by 1978. In response regulators strengthened their control over this industry during the decade and minimum surplus requirements were increased for alien insurers. By the 1980’s domestic surplus lines insurers accounted for the majority of the surplus lines premium. Intense competition in the admitted sector resulted in declining profitability and surplus, so regulators once again focused on insurer solvency. Most states favored competition that benefited the consumer, so rate and coverage flexibility were encouraged, creating a more open market. Yet Texas continued with strict rate and form regulation. The inability of admitted carriers in Texas to quickly respond to market changes by modifying rates and coverage further emphasized the need for a strong surplus lines market. The use of County Mutuals and Texas Lloyds companies proved invaluable in providing insurance to those that could not find it in the standard marketplace.

According to a 1989 report, “An Economic Overview of the Market for Excess & Surplus Lines Insurance,” by University of Texas professors Patrick L. Brockett, Robert C. Witt and Paul R. Aird, during the period between 1978 and 1988 the percentage of the total Texas property and casualty insurance market held by E&S businesses grew from around 2.5 percent to more than 3.3 percent. That percentage had peaked at around 3.75 percent in 1987, but that year the legislature passed legislation raising the minimum capital and surplus requirements for surplus lines insurers. The University of Texas researchers speculated that the new capital requirements could have been a “possible explanation of why E&S premium volume fell by over 26 percent from 1987 to 1988,” compared to 7.2 percent drop in the country as a whole during the same period.

The insurance business is a dynamic environment, constantly evolving. Carriers change their target accounts or their underwriting appetite frequently. A highly desirable account today can be become undesirable at next years renewal due to the myriad of external factors that govern the profitability of business. For instance, conditions in the Texas homeowners market, not a traditional E&S line, have resulted in a 29 percent increase in the number of homeowners policies written in the surplus lines market. However, as Philip R. Ballinger, general manager of the Surplus Lines Stamping Office of Texas, points out, even with the increase in policies, the E&S market holds less than a two percent share of the overall homeowners market in the state.

Monte Stringer is executive VP, Marketing, for U.S. Risk Insurance Group.

Topics USA Carriers Texas New York Legislation Excess Surplus Property Market