Why would anyone in their right mind choose an insurance market with no state guaranty fund protection? What makes the Excess and Surplus Lines non-admitted insurance market a viable option? Well, I will tell you why I would choose the non-admitted market; and make the case that the non-admitted market is a safer bet every single time.
Buckle your seatbelts and hang on….
Why the Non-Admitted Market, You Ask?
The non-admitted market is not subject to state rate and form regulation. Since there is no rate regulation, these non-admitted carriers can collect the appropriate premium for the risk. Additionally, because there is no form regulation, the non-admitted carrier can more accurately underwrite the risk by providing policy wording to match what is being insured. Freedom from rate and form regulation allows the non-admitted carrier to design and create programs and policies to respond to and meet the changing needs of insureds such as cyber liability, technology liability, environmental liability, professional liability, and even entrepreneurial needs within an ever-changing world. This freedom from rate and form filing also encourages growth, profitability, greater solvency, and a competitive edge not found in the admitted market.
The Problem of Over Regulation
In some states, the admitted market is so overly regulated that these admitted carriers cannot charge appropriate rates and this could ultimately lead to a higher probability of insolvency. Form and rate regulation, if abused, can inhibit accurate underwriting and premium rates, removing flexibility to meet market changes.
Every state's primary goal is to protect the consumer, but state over-regulation defeats this purpose, and in the long term, can actually hurt the consumer. How? Not to pick on any state because state oversight and regulation does protect consumers – I'm not disputing that. On the other hand, overly regulating an industry hurts not only the industry itself but the consumer as well. For example, let's look at the State of California and the Department of Insurance specifically. Due to an influx of natural disasters, wildfires in particular, admitted carriers who write homeowner policies in California have experienced tremendous losses.
Yet, the process to offset losses is hindered by the department of insurance due to convoluted and complex regulatory compliance. In a recent Insurance Journal article Mark Sektnan of the American Property Casualty Insurance Association states, "…California insurance companies are not allowed to use catastrophe models to look into the future."
How can insurance carriers rate homeowner policies accurately if a state forces regulation keeping carriers on a continual reactive cycle instead of a proactive cycle? Plus, the California Department of Insurance has issued bulletin after bulletin restricting non-renewal and cancellations for up to one year after Governor Gavin Newsom declared a State of Emergency in certain zip codes and counties. Right or wrong, I am not here to judge, and California is certainly not the only state. My point is that these admitted carriers are so severely restricted in their ability to properly rate homeowner policies to offset losses that some of these carriers face the possibility of insolvency, which in turn inhibits competition, ultimately leading to higher premiums for insureds. How is that protecting the consumer? It's not.
All carriers in both the admitted and non-admitted markets must meet state-specific minimum financial guidelines and reserves to cover losses. If carriers cannot underwrite and rate risks properly, they will either pull out of the market or state altogether or discontinue writing certain risks or face the possibility of insolvency. This leads to fewer consumer options and higher premiums, which in the end, will only hurt the consumer in the long term.
The insurance industry needs both the admitted and non-admitted markets – they play off each other, promoting competition and greater options for the consumer. Usually, but not always, in a hard market, non-admitted carriers do better, and in softer markets, the admitted carriers do better. These two markets are so important and are needed to maintain a balance in the insurance industry.
But What About Safety?
The admitted market has the State Guaranty Fund to pay losses if a carrier becomes insolvent. However, depending on the cost of the loss and the number of losses, there may not be sufficient funds to cover a loss event in its entirety. The insured could certainly pursue the admitted carrier for the monies to cover losses, but there would not be enough monies in reserves to cover the loss if the carrier is not solvent. In other words, the carrier would not have sufficient assets to cover the loss.
Conversely, with the exception of New Jersey in regards to homeowner policies only, the non-admitted carrier does not have any guaranty fund protection in the event of insolvency. Historically, fewer non-admitted carriers have faced insolvency than admitted carriers. The non-admitted market has proven to be solvent and has more significant reserves to cover losses more efficiently. This is in part due to greater underwriting discipline and rating flexibility.
In A.M. Best's Market Segment Report, Expanding Opportunities Bolster Surplus Lines Growth And Operating Results, A.M. Best designates an insurer as being financially impaired "if it is placed, via court order, into conservation, rehabilitation, or into insolvent liquidation, as of the date of the earliest court action." By using their above designation, A.M. Best found that "From 2000 to 2019, far fewer surplus lines companies became impaired than in 20 years prior, from 1980 to 1999," and "…no surplus lines companies became impaired between 2004 and 2017, in contrast to the admitted companies." A.M. Best attributes this to "…maintaining underwriting discipline, adhering to proven underwriting standards and judicious risk selection, and not yielding to competitive market pressures driving softer markets (which could lead to underpricing). These have been among the consistent qualities of most surplus lines companies and have resulted in positions in the aggregate, minimizing impairments. Dedicating greater financial and strategic resources to improve enterprise risk management may have also had a positive impact." Read that again and let that sink in for a moment. One direct result of freedom from rate and form regulations is non-admitted carriers can create and underwrite risks and have greater flexibility to rate the risk properly, therefore collecting sufficient premiums to offset losses: bottom line, much more solvency.
Not Regulated? Where's the Trust?
Indeed, non-admitted carriers are not subject to form and rate regulations, but the non-admitted market is heavily regulated. In the admitted market, the carrier is the regulated entity. In the non-admitted market, the surplus lines broker is the regulated entity and subject to state audits and the non-admitted carrier is regulated in its state or country of domicile. The non-admitted market is not a free-for-all. There are hefty financial regulations that are more stringent for non-admitted carriers than there are for admitted carriers as a whole. Most states require greater monetary reserves for non-admitted carriers than they do for admitted carriers. And international non-admitted carriers, such as Lloyd's, have even greater regulatory hoops to jump through. So, it is no easy task to become approved in any state as a non-admitted carrier who must comply with state financial minimum guidelines and regulatory requirements.
Then What's Your Point?
My point is this: The non-admitted market is no more or less safe than the admitted market.
In fact, from my perspective, the non-admitted market is a safer bet than the admitted market. Think about it. The non-admitted market writes risks with little to no historical data, higher loss ratios, and more stringent financial requirements, and is heavily regulated by the states. In turn, they have much greater flexibility to create policies with better underwriting forms and more accurate rate pricing.
The non-admitted market takes on more significant risks with greater financial requirements and yet, is more solvent to better cover losses than the admitted market. Even with the Guaranty Fund protection afforded the admitted markets, there is no guarantee a loss will be fully covered in the admitted market depending on the coverage and number of losses. The chances of an admitted carrier facing insolvency as a result of a loss, in addition to over-regulation, are higher than the non-admitted carrier. According to a recent NAIC article discussing the surplus lines market, "Due to the strong and effective state-based solvency monitored framework, the insolvency rate of surplus lines insurers has been historically equivalent to the admitted marketplace."
My Final thoughts
According to a news release by the Wholesale & Specialty Insurance Association (WSIA), "Surplus lines premium in 2020 in stamping office states exceeded $41.7 billion, up 14.9% over 2019 according to the 2020 Annual Report of the U.S. Surplus Lines Service and Stamping Offices." In addition, the NAIC writes in their article, Surplus Lines, "Lloyd's of London is the largest writer of surplus lines insurance. According to A.M. Best, in 2018, the Lloyds market represented 23.6% of the total surplus lines market share and wrote $11.8 billion in surplus lines premium."
Moreover, according to Lloyd's Reports 2020 Full Year Results, "Lloyd's maintains strong capital and solvency positions, with net resources increasing to £33.9bn in 2020 and a central and market-wide solvency ratios of 209% and 147% respectively."
To put this in perspective:
if the insolvency rate of the non-admitted market is historically equivalent to or lower than the admitted market;
if the non-admitted market is increasing premiums written year over year;
if Lloyd's represents close to 25% of the surplus lines market share with a solvency ratio of over 200%; and
if the non-admitted market provides freedom from rate and form regulation and strict financial requirements;
I am placing my bet on the non-admitted market every time.
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Additional sources:
WSIA. (2021, April 21). Spring Surplus Lines Law Group. PDF.
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