Us surplus lines business by Sutherland Global Services

US Surplus Lines Business November 2013

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Industry Definition Definition •

•

Excess and Surplus lines insurance is a segment of the insurance market that allows consumers to buy Property and Casualty (P&C) insurance through the state regulated insurance market, where policyholders, agents, brokers and insurance companies all have the ability to design specific insurance coverages and negotiate pricing based on the risks to be secured The E&S Insurance originated when those who needed insurance coverage were unable to secure it from the standard carriers (aka admitted carriers) due to a variety of reasons (e.g., new entity or one that does not have a adequate loss history; one that has unique coverage requirements; or a loss record that does not fit the underwriting requirements of a standard carrier)

Typical characteristics of E&S products include high-hazard or extraordinary risks (e.g., earthquake insurance in Beverly Hills), emerging risks (e.g., network security), niche market risks (e.g., celebrity body part coverage), and unique risks (e.g., insuring a contest or pet insurance)

Regulatory Aspects •

An E&S carrier is not required to be licensed by the state, but is allowed to do business in that state. Insurance departments in the states maintain a list of approved surplus lines insurance companies. E&S carriers are at times referred to as non-admitted or unlicensed carriers

•

Most US states require that E&S carriers submit financial information, articles of incorporation, list of officers, and other general details in order to make sure that the companies offering these lines of insurance are financially sound companies; this is especially important given that the policies underwritten by these companies are not protected by State Guarantee Fund

•

E&S Insurers can also not write insurance that is typically available in the admitted market and can only write a policy if it has been rejected by three different admitted carriers

•

Excess and Surplus line carriers are not bound by most of the rate and form regulations imposed on standard market companies, allowing them the flexibility to change the coverage offered and the rate charged without time constraints and financial costs associated with the filing process

Source: AM Best, Secondary Research, American Association of Managing General Agents (AAMGA) SGS Research and Analysis

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For over a decade, Surplus industry has contributed c. 7% of the overall P&C Insurance industry US Surplus Industry vis-Ă -vis P&C Insurance Industry

33.0

33.3

463.0

481.6

491.4

7.1%

6.9%

6.8%

2004

2005

32.8

38.7

36.6

34.8 34.4

33.0

31.7

31.1

25.6 15.8 11.7

6.3

422.7 327.3

211.3 3.0%

1988

367.8

503.9 7.7%

506.2

492.9

481.4

481.1

7.2%

7.0%

6.8%

6.6%

2009

2010

6.0%

501.6

6.2%

523.4

6.7%

4.3% 3.6%

2000

2001

2002

2003

DPW P&C (USD Bn)

2006

DPW E&S (USD Bn)

2007

2008

2011

2012

% Share of E&S

Source: AM Best, Secondary Research, SGS Research and Analysis:

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Commercial lines have been consistently contributing 75-80% of the overall premium written by the Surplus industry Commercial vs. Personal Segregation (2007-2012 Average)

Examples of Commercial Insurance •

Property - Wind and earthquake-exposed commercial properties

•

Product liability for Manufacturers, Distributors and Importers etc.

20-25%

– Coverages for specialty and generic pharmaceutical companies, medical products and medical device manufacturers, as well as industry distributors •

Workers' compensation insurance for small businesses

•

Professional liability coverage for highly specialized professionals

Examples of Personal Insurance •

Homeowners insurance in catastrophe prone areas (coastal risks and tornado belt)

•

Marine - Yachts and other watercraft

•

Recreational vehicles - Motor homes, Travel trailers and other recreational vehicles on the road

75-80%

Commercial Insurance

Personal Insurance

Source: AM Best, Secondary Research, SGS Research and Analysis

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The industry is tightly held as top 25 groups account for c. 87% of the DPW as of 2012, and … US Surplus Lines – Top 25 Groups (2002) Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Company Name

DPW (USD Bn)

American International Group Lloyd's Zurich/Farmers Markel Corporation Nationwide Group Berkshire Hathaway ACE INA Royal & SunAlliance W. R. Berkley Travelers P&C Group United National Group Chubb Group of Insurance Cos Hartford Insurance Group Great American P&C CNA Insurance Cos St. Paul Companies HDI U.S. Group GE Global Insurance Group RLI Group Argonaut Insurance Group Kemper Insurance Cos Arch Capital Group IFG Cos Western World Insurance Group HCC Insurance Group Subtotal Total U.S. Surplus Lines Market

Source: AM Best, Secondary Research, SGS Research and Analysis

6.04 4.08 1.28 1.20 0.98 0.97 0.80 0.70 0.66 0.66 0.51 0.47 0.45 0.44 0.43 0.39 0.33 0.31 0.28 0.24 0.22 0.21 0.21 0.18 0.16 22.21 25.56

US Surplus Lines – Top 25 Groups (2012)

Total Surplus Lines Market Share (%) 18.2% 12.7% 5.2% 3.5% 3.4% 3.3% 2.8% 2.3% 2.2% 2.2% 2.1% 1.9% 1.8% 1.6% 1.4% 1.3% 1.3% 1.2% 1.2% 1.1% 1.0% 0.8% 0.8% 0.8% 0.7% 86.9% 100.0% Improved Ranking

Rank

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Company Name

DPW (USD Bn)

Lloyd's American International Group Nationwide Group Zurich Financial Svcs NA Group W.R. Berkley Group QBE North America Group ACE INA Group Markel Corporation Group CNA Insurance Cos Ironshore Insurance Group Alleghany Insurance Holdings Fairfax Financial (USA) Group California Earthquake Authority AXIS Insurance Group XL America Group Arch Insurance Group Allied World Group Chubb Group of Insurance Cos Argo Group Berkshire Hathaway Liberty Mutual Insurance Cos HCC Insurance Group Assurant P&C Group Great American P&C Group Catlin U.S. Pool Subtotal of Top 25 Total U.S. Surplus Lines Market Deteriorated Ranking

6.27 5.04 1.44 1.18 1.12 1.02 0.89 0.82 0.78 0.67 0.66 0.65 0.57 0.48 0.45 0.45 0.43 0.43 0.41 0.41 0.36 0.34 0.32 0.31 0.31 25.79 34.81

No change in ranking

Total Surplus Lines Market Share (%) 18.0% 14.5% 4.1% 3.4% 3.2% 2.9% 2.5% 2.4% 2.2% 1.9% 1.9% 1.9% 1.6% 1.4% 1.3% 1.3% 1.2% 1.2% 1.2% 1.2% 1.0% 1.0% 1.4% 1.3% 0.9% 74.1% 100.0%

New Entry

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… only one company from the AIG pool holds market share which is > 10% US Surplus Lines – Top 25 Companies (2012) Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Company Name Lexington Insurance Co Scottsdale Insurance Co Steadfast Insurance Co QBE Specialty Insurance Co Chartis Specialty Insurance Co Columbia Casualty Co Ironshore Specialty Ins Co Landmark American Ins Co California Earthquake Authority Nautilus Insurance Co AXIS Surplus Insurance Co Indian Harbor Insurance Co Westchester Surplus Lines Ins Arch Specialty Insurance Co Illinois Union Insurance Co Evanston Insurance Co Colony Insurance Co First Mercury Insurance Co Essex Insurance Co Chubb Custom Insurance Co Liberty Surplus Ins Corp Houston Casualty Co Admiral Insurance Co Catlin Specialty Insurance Co Gemini Insurance Co Subtotal Total U.S. Surplus Lines Market

Group Name

Surplus Lines DPW (USD Bn)

American International Group Nationwide Group Zurich Financial Svcs NA Group QBE North America Group American International Group CNA Insurance Companies Ironshore Insurance Group Alleghany Insurance Holdings California Earthquake Authority W. R. Berkley Insurance Group AXIS Insurance Group XL America Group ACE INA Group Arch Insurance Group ACE INA Group Markel Corporation Group Argo Group Fairfax Financial USA Group Markel Corporation Group Chubb Group of Insurance Cos. Liberty Mutual Insurance Cos. HCC Insurance Group W.R. Berkley Insurance Group Catlin U.S. pool W.R. Berkley Insurance Group

4.23 1.27 1.03 1.02 0.81 0.74 0.67 0.59 0.57 0.49 0.48 0.45 0.45 0.45 0.42 0.41 0.40 0.38 0.37 0.36 0.36 0.32 0.31 0.31 0.28 17.16 34.81

Total Surplus Lines Market Share (%) 12.2% 3.6% 2.9% 2.9% 2.3% 2.1% 1.9% 1.7% 1.6% 1.4% 1.4% 1.3% 1.3% 1.3% 1.2% 1.2% 1.2% 1.1% 1.1% 1.0% 1.0% 0.9% 0.9% 0.9% 0.8% 49.3% 100.0%

Source: AM Best, Secondary Research, SGS Research and Analysis

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Composition of the Surplus Industry has been moving in favor of ‘Domestic Professionals’ US Surplus Industry Composition - 1988 5%

Total: USD 6.3Bn

16%

US Surplus Industry Composition - 2002 Total: USD 25.6Bn

16%

59%

20%

77%

US Surplus Industry Composition - 2007 8%

Total: USD 36.6Bn

17%

US Surplus Industry Composition - 2012 Total: USD 34.8Bn

18%

76%

73%

Domestic professional - U.S.-domiciled insurers that write 50% or more of their total direct premium on a nonadmitted basis Domestic specialty - U.S.-domiciled insurers that operate to some extent on a nonadmitted basis but whose direct nonadmitted premium writings amount to < 50% of their total direct premium written Source: AM Best, Secondary Research, SGS Research and Analysis

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Performance: Domestic Professional Surplus (DPSL) Line vis-à-vis P&C Insurance U.S. DPSL vs. P/C Industry – NPW Growth (1978-2012)

Better Top line

110 100 90 80 2012

2011

2010

2009

2008

2007

2006

2005

2004

DPSL

P/C Industry

U.S. DPSL vs. P/C Industry – Total Returns on Surplus (2000-2012)

U.S. DPSL vs. P/C Industry Pre-tax Returns on Net Premiums Earned (2000-2012)

Higher Profitability

2003

2002

2001

2000

1999

2012

2010

2008

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

1978

DPSL

Higher Profitability

DPSL

P/C Industry

DPSL

2012

2011

2010

2009

2008

2007

2006

2005

2004

2012

2011

2010

2009

2008

2007

2006

2005

2004

-20 2003

-10 2002

-10 2001

2003

2002

2001

2000

Return (%)

2000

Return (%)

Better Combined Ratio

120 Combined Ratio (%)

90 80 70 60 50 40 30 20 10 0 -10 -20 -30

Change in NPW (%)

U.S. DPSL vs. P/C Industry – Combined Ratios (1999-2012)

P/C Industry

Source: AM Best, Secondary Research, SGS Research and Analysis

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Reasons for Superior performance by the Surplus companies Reasons for growth in DPW (over 4.5 times b/n 2002 and 2012)

More flexible regulatory environment

• Surplus line carriers have “freedom of rate and form,” allowing them to write more exclusions, waivers, and riders than a standard policy • Surplus line insurance professionals are able to develop their own unique policy forms and rates, and maintain the rate flexibility to be more responsive to the customers’ needs and react quickly to changes and opportunities in the marketplace • As of 2012, there is no dominant player in the E&S market (except for Lexington of the AIG pool) which has a market share > 10%. Five companies have share > 2% and the rest hold less than 2% each, most even lesser than 1%

Fragmented marketplace

• This kind of market fragmentation increases opportunities for new entrants, and forces the existing companies to attempt to differentiate fiercely. This attempt often leads to the companies serving their unique niches of business segments, further allowing them to price and design their products freely • Hardened market conditions have forced admitted insurers to concentrate more on their core business

Hardened market conditions

• In the last few years, admitted insurers have become less aggressive in retaining some of the “fringe” business in the wake of prevailing low interest rate environment and tighter profit margins. As a result, some additional business found its way back into the surplus lines market • This is a typical cycle seen in the E&S industry, when the standard lines get out of higher-risk accounts, that business swings back to E&S and its market grows

Source: AM Best, Secondary Research, SGS Research and Analysis

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Reasons for Superior performance by the Surplus companies Reasons for better operational performance • While specialty market exposures have higher perceived insurance risks than their standard market counterparts, they seek to manage these risks to achieve higher financial returns. Insurers have traditionally focused on losscontrol and risk management services to add value for the policyholder in identifying key exposures to loss • Moreover, competition in the specialty market tends to focus less on price than in the standard insurance market and more on other value-based considerations, such as availability, service and expertise

Better risk management strategies

• In order to effectively service surplus line risks, insurers have developed extensive knowledge and expertise in their chosen markets. Most of the players consider and manage their accounts on an individual basis where customized forms and tailored solutions are employed • It is critically important for surplus insurers to have expertise in ‘identifying’ and ‘assessing’ risks that it can undertake and making sure it is rewarded suitably via additional premium. In order to achieve this most E&S companies are known to hire the best-in-class risk strategists and underwriters who are paid several times more than the typical payout by the P&C industry •

To achieve their financial and operational goals surplus line insures have looked beyond the better “risk management strategies” and have also focused on putting a curb on cost factors by investing in technology, restructuring distribution strategy and outsourcing their certain business areas

• Many companies have either recently upgraded or are in the process of upgrading their technology platforms and all new entrants are focussing on technology for better operational results

Better operational prudence

– Guy Carpenter which recently launches its Excess & Surplus lines specialty practice aims to leverage powerful technology-enabled analytics through the expertise of its GC Analytics – Berkshire Hathaway Specialty Insurance which is moving into Surplus market in a substantial way aims to leverage technology for specialty success • Many of them also try and keep the costs low by outsourcing certain business areas

– Arch Insurance group outsource its field claims investigation, adjustment services and audit functions • Markel has taken initiatives to restructure its E&S distribution channel as a move to streamline its distribution process and services Source: AM Best, Secondary Research, SGS Research and Analysis

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