Underwrite With Discipline or Suffer the Consequences

Editor's note: The following are excerpts from a report on the annual state of the surplus lines market published by A.M. Best & Co. The report was released last September.

"Despite rising costs, slowed price momentum, benign investment yields, and the potential for adverse loss reserve development and rising reinsurance costs, near-term profit opportunities within the surplus lines market continue to exist into 2005.

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"In addition, in order to sustain these profit opportunities over the long term, A.M. Best feels the industry must adhere to sound underwriting and reserving disciplines. One thing that is more certain, however, is that the low- interest-rate environment has placed more dependence on underwriting results as the principal driver of operating profits. Incremental increases in the Federal funds rate through 2004 indicate relatively flat yields through 2005.

Standard market insurers should remain in a conservative overall mode until they are producing returns on equity that are at or above the 10.9 percent level produced in 2003. Rising claim costs and the potential for further reserve increases, particularly asbestos and environmental reserves, will hold off any challenge from standard market companies in the short-term.

Such 'reserve cushions' have not been restored and are insufficient to sustain the industry through another soft market cycle. Surplus lines carriers have suffered from this phenomenon alongside their standard market brethren."

A SURPLUS OF THREATS

"With the possible exception being noncatastrophe-exposed property risks, pricing and the overall property and casualty market is most likely to remain firm, particularly for casualty lines such as workers' compensation, medical malpractice and directors and officers liability. This is expected to continue until carriers can produce more robust returns on equity and all material prior year issues are resolved."

"Despite noted market and results-oriented improvement through the first half of 2004, several factors could hamper the standard market and surplus lines results alike going forward. These factors include increases in natural and man-made catastrophes; the continuation of adverse loss reserve development; and additional asbestos and environmental reserves.

The possibility of additional terrorist attacks or another Enron or WorldCom-like accounting scandal also could greatly impact results throughout the entire insurance industry. Standard markets and surplus lines carriers must also evaluate loss cost trends properly and refrain from prematurely taking credit for the benefits of pricing and reunderwriting initiatives, as actual results will not be known for some time."

January 1, 2005

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