Covid temporarily halts E&S market’s profitability push: Fitch

The Covid-19 outbreak will forestall the E&S market’s expected return to underwriting profitability this year, with the pandemic set to put a pause on the sector posting a sub-100 percent combined ratio for the first time since 2016, according to Fitch Ratings.

In 2019, despite the significant moves made to improve the sector’s profitability, the E&S market still posted a combined ratio of 100 percent, according to analysis of a group of carriers compiled by Fitch. In 2018, the sector recorded a combined ratio of 106.5 percent, while in 2017 it was 115.8 percent.

The last time the E&S market posted a sub-100 percent combined ratio was in 2016 when it recorded 97.9 percent for the year.

Fitch’s assessment of the E&S market’s 2019 combined ratio contrasts the findings published last week by a report on the sector from AM Best.

As this publication reported, AM Best’s research showed that domestic professional surplus lines insurers - which includes those that write more than 50 percent of their business on a non-admitted basis - recorded an average combined ratio of 99.4 percent in 2019, a 5.1 percentage point improvement over 2018.

According to Fitch’s study, the E&S space was expected to report a marked improvement in its combined ratio in 2020.

“Barring inordinate catastrophe losses, E&S was positioned for significant profit improvement in 2020,” Fitch said in its US Excess and Surplus Lines Market Review.

This improvement would have been driven by rising E&S coverage demand which has been spurred by the admitted markets shedding risk, as well as accelerated premium rates and tighter underwriting terms.

However, Fitch said that “losses from the onset of the coronavirus pandemic in 2020 are likely to forestall this advance”.

These losses will likely creep into 2021 as well. Market fears and uncertainty about the potential scale of Covid-19 related losses are driving further price increases and growth in the E&S market which, Fitch said, “will likely foster greater underlying profit improvement post-pandemic”.

US property and casualty (P&C) insurers have already booked substantial insured losses related to the pandemic this year. While uncertainty remains over what the final quantum of losses will be to the E&S sector, Fitch said the market “will likely bear a disproportionate share of these losses relative to its size, given its specialty nature and product mix”.

“E&S policies for business interruption and contingent business interruption may generate losses from pandemic-related events due to broader coverage terms and fewer instances of virus exclusions,” Fitch said.

Accelerated growth

There are around 40 unique insurance groups that each wrote more than $200mn of E&S premiums in 2019, according to the firm’s analysis. The two largest writers of E&S business are Lloyd’s and AIG which together accounted for 30 percent of the segment’s direct written premiums (DWP) in 2019. The top 15 E&S writers generated greater than two-thirds of all the market’s DWP last year.

AIG has retained a strong position in the market despite dropping approximately a quarter of its E&S business in the last four years as the company seeks to boost its profitability in the sector.

Berkshire Hathaway continues to grow its share of the E&S market. Back in 2015, its share of the segment was just 2 percent, but by last year that had increased to 5 percent.

“The company is positioned for further long-term growth with multiple specialty underwriting platforms and the industry’s largest capital base,” Fitch explained.

Collectively, the top 15 largest E&S writers generated some $36.6bn of DWP in 2019, according to Fitch. Overall, the entire E&S marketplace increased its DWP by 16 percent year on year to $40.8bn, excluding Lloyd’s, in 2019, Fitch said. Adding in Lloyd’s close-to $12.5bn of E&S DWP, Fitch’s assessment of total E&S DWP for 2019 stands at $53.3bn.

In comparison, AM Best’s report found that the top 15 E&S writers posted $35.8bn of DWP last year. AM Best’s report also pegged the E&S market’s DWP at $55.5bn for 2019, an increase of 11.2 percent when compared with the prior year.

As Fitch highlighted in its own report, the growth seen in 2019 meant that the E&S market recorded double-digit growth in its DWP for the second straight year after posting an increase of 11 percent between 2017 and 2018. Expectations are that this recent trend of expansion will continue, with rates and exposure both again showing strong growth during the first six months of 2020, Fitch said.

In comparison, the overall P&C industry saw its DWP increase by 5 percent between 2018 and 2019.

E&S market DWP has now increased for nine years in a row.

And, as the ratings agency highlighted, all of the major E&S lines of business reported year on year growth, which helped to fuel a close-to doubling of the overall P&C industry’s rate for 2019.

Casualty business represents approximately two-thirds of the E&S market’s DWP, with property accounting for the final third.

In 2019, all E&S lines exhibited some degree of DWP growth. Commercial multiperil liability business saw the lowest level of DWP growth, according to Fitch, although that still increased by 5 percent year on year. Conversely, the E&S casualty line which saw the greatest level of growth was commercial auto liability.

E&S market’s size belies its importance

“The E&S market’s modest size relative to the standard admitted market belies its importance to the US insurance industry,” Fitch said.

The E&S segment has shown a greater rate of growth in the past couple of years, and equated to almost 6 percent of the overall P&C industry’s total DWP in 2019.

The growth in 2020, Fitch explained, is tied to insurers in the admitted market cutting unprofitable risks from their books as well as significant premium rate increases across multiple lines of business.

Looking ahead to the future growth of the E&S market, Fitch said the expansion of specialty underwriters in the segment continues to attract interest through acquisitions as well as new entrants.

However, better organic growth opportunities as well as a limited number of willing sellers reduce the likelihood of widespread merger activity taking place.

“Near-term acquisition activity is more likely concentrated within specialty managing general agents and other distribution sources to gain access to new books of business,” Fitch predicted.

E&S pricing to continue rising

E&S property lines will outperform casualty segments in the long-term, albeit with greater variability in loss experience owing to the impact of catastrophe losses, Fitch said.

Property accounts for more than one-third of the E&S market’s premium volume, and in the near-term is expected to witness above-average growth due to both price increases and the influx of business to the non-admitted markets.

Over the past decade, the property E&S market’s direct combined ratio has averaged out at 89 percent.

On the casualty side of the market, the segment posted a combined ratio of 107 percent in 2019 – the worst result in over a decade and well above the 10-year average of 100 percent. Growing loss cost trends have adversely impacted results in recent years, Fitch explained.