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Understanding Surplus Lines Insurance: Risks, Market Dynamics, and Ratemaking Strategies

The surplus lines market plays a crucial role in accommodating hard-to-place risks that are often overlooked by standard insurers. Covering unique, distressed, and high-capacity risks, surplus lines companies thrive by being innovative and flexible. This piece discusses key risk examples, regulatory aspects, expert underwriting, and claims handling. It further delves into market trends, product lifecycle, and various ratemaking methods, emphasizing the adaptability necessary in the ever-evolving insurance landscape.

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Understanding Surplus Lines Insurance: Risks, Market Dynamics, and Ratemaking Strategies

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  1. Pricing Excess and Surplus Lines(COM-5) Ronald J. Herrig, FCAS Markel Corporation Deerfield, Illinois

  2. What Is the Surplus Lines Market?

  3. The role of the Surplus Lines industry is to provide a market for hard-to-place risks that are not written by the standard market.

  4. Why are these risks not written by the standard market? • Distressed Risks/Markets • Unique Risks • High-Capacity Risks

  5. Examples of Distressed Risks • Newly Incorporated Manufacturer • Newly Practicing Physician • Physician with a History of Drug-Use • Lawyer with Past Disciplinary Problems

  6. Examples of Distressed Markets • OB/GYNs • California Contractors • Nutritional Supplements

  7. Examples of Unique Risks • Architectural Project Policies • Fireworks Accounts • Shamu Transportation

  8. Examples of High-Capacity Risks • High Rise Buildings • Directors & Officers • Aviation Property/Liability

  9. How Can Surplus Lines Companies write this Junk?

  10. By being Fast, Fluid and Flexible!

  11. Regulation • Needn’t file rates/forms • Insurance company licensed in state of domicile only • Many Responsibilities passed to the Surplus Lines Broker

  12. Coverage Limitations • Claims-Made Coverage • ALAE included within Limits • Sublimits • Custom Endorsements/Exclusions

  13. Responsibilities Handled by Broker • Verify Diligent Search Completed • Maintain Policy Files for Audit • Collect and Remit Premium Tax

  14. And more importantly…

  15. Expert Underwriting U/Wers need: • to understand their company’s appetite for risk – and abide by it • knowledge of book’s underlying statistics • to understand each insured and it’s associated risks Art, science, experience

  16. Expert Claims Handling • Smart Claim Handlers • Standardized Approach to Claims Reserving • Consistent Approach to Claims Reserving

  17. Effects of the Market on E&S

  18. Hard Market and E&S • Admitted Companies non-renew any iffy risks. • Surplus Lines Apps increase dramatically. • S.L. Rates Firm, Coverages Contract. • Small Decrease in Admitted Market can increase Non-Admitted Market Substantially.

  19. Change in Applications(Products 2000 Baseline = 100 units)

  20. Soft Market and E&S • Admitted Companies become less selective in their Underwriting. • Fewer Risks are Declined. • E&S companies develop new products to maintain volume.

  21. Life Cycle of New Product • Coverage unavailable in Standard Market. • E&S develops coverage, forms, exclusions, rates. • Rates, Forms change quickly, as needed. • Rates, Forms Stabilize – Profit Grows • Standard Market offers broader product at lower rates.

  22. Examples of New Products • Employment Practices Liability • Tenant Discrimination • Environmental Impairment Liability

  23. EPLI(1994 Baseline = 100 units)

  24. New Product Development • Opportunity identification • Product design • Testing • Product introduction • Life-cycle management

  25. Opportunity Identification • Broker Recommendations • Marketing • New Product Teams • Media

  26. Product Design • Target Market • Coverages • Policy Wording • Rating

  27. Testing • Beta-Test on Select Market • Honest Feedback • Rate, rate, rate

  28. Ratemaking Methods

  29. Pure Premium MethodTreatment of Losses • Trend individual ‘ground-up’ losses; remove base deductible • Develop losses; cap at basic limit • Aggregate all adjusted losses.

  30. Pure Premium MethodTreatment of Exposures • Multiply individual units of exposure by applicable relativity factors (state, class code, claims-made step-rate, etc.) • Aggregate all adjusted exposures

  31. Pure Premium MethodCalculation of Rate Pure Premium = Aggregate Adjusted Losses Aggregate Adjusted Exposures Base Rate = Pure Premium Permissible L/R

  32. Pure Premium Method • Works well for an existing product • Works best for a product with a well-defined exposure base (doctors, employees) • Requires detailed loss and exposure info (claim-by-claim, policy-by-policy) • Actuarially sound

  33. Piggy-back Method • Start with Comparative Product • Adjust Rates for Coverage differences • Adjust for Limits/Deductible differences • Adjust for Expense differences • Others?

  34. Piggy-back Method • Works well for Enhancement of Existing Product • Requires knowledge of Comparable Product • Judgmental • Danger of being too Conservative/Aggressive? • Difficult to Support to Others

  35. The Festus Method

  36. The Festus Method

  37. Ratemaking Tools • Imagination! • Intuition! • Internet!

  38. Useful Sites • www.google.com • www.firstgov.gov - U.S. Government’s Official Web Portal • www.bls.gov - Bureau of Labor Statistics • www.federalreserve.gov - Interest Rates

  39. Other Useful Websites • www.cas.org • www.cnn.com • www.espn.com • www.imdb.com

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