DUAEs and surplus lines: Clear winners in the hard market

David Blades, associate director, industry research and analytics at AM Best, examines the relationship between the rapidly growing DUAE and E&S markets…

The hard market conditions of the past couple years have harmonised the relationship between MGAs and the E&S insurance market, with the number of MGAs increasing as surplus lines underwriters see higher top-line growth.

New distribution platforms and geographic or product line diversification have played an integral role in allowing the leading E&S groups to defend or increase their market positions. These new distribution partnerships, particularly ones where they delegate authority to MGAs or similar delegated underwriting authority enterprises (DUAEs), have helped fuel the growth of newer surplus lines entities as well.

Some of the lines of business being eschewed by admitted carriers and finding their way to the E&S market include commercial auto/trucking and D&O liability exposures. Cyber liability and coverage for the expanding legal cannabis industry also continue to leverage the capabilities of DUAEs and E&S insurers. With new and evolving technologies presenting emerging and more complex risks to businesses – requiring specialised insurance coverage solutions – distributors with the experience and proven acumen to address these issues are becoming increasingly necessary and valued.

The growth of volatile risks such as more frequent and severe US weather-related events has also supported the sizeable premium growth generated by DUAEs over the last few years. Increasing challenges due to secondary perils (such as wildfires and convective storms) allow DUAEs to play a vital role in matching these risks and surplus lines insurers.

In its review of data in Note 19 of insurance companies’ 2022 National Association of Insurance Commissioners (NAIC) statements, AM Best identified 654 MGAs that generated direct premium, and this does not represent the entire universe of MGAs since many MGAs generate annual premiums for insurers that fall below the 5 percent surplus threshold. (NAIC reporting regulations for Note 19 require that companies disclose individual MGA premium data only for those MGAs whose premium constitutes more than 5 percent of the risk-bearing entity’s policyholders’ surplus.)

The DUAE model allows its partners to move more quickly, exploit niche markets, show creativity in coverages and target opportunities moving from the admitted to the surplus lines market. The hard market for most lines of business has offered opportunities for DUAEs to thrive and will allow them to capture more market share. Historically, under hard market conditions, carriers have tended to move away from the DUAE model, but the maturity in the DUAE space, coupled with opportunities that offer carriers access to certain lines of business, suggests value in the partnership. At the same time, tightened underwriting criteria among admitted carriers has led more accounts to seek coverage solutions in the surplus lines market.

As market capacity for admitted carriers becomes more constricted and average premiums rise, the value of MGA-sourced premium grows. Additionally, relative to the continuing challenge of attracting and cultivating new talent to the insurance industry, newer MGAs benefit from generally being less burdened than traditional distributors or carriers with legacy operating systems and norms that younger employees may view as inefficient and disruptive. As the insurance industry becomes more concentrated due to mergers and acquisitions, underwriters, actuaries and data scientists may be looking for new positions, and finding a home with an MGA can present an interesting career option. The surge of expertise in the sector, along with an attractive expense model, continues to benefit the DUAE segment during this hard market.

Premium amounts sourced through MGAs vary by insurer. Some insurers leverage MGAs to source new business but only around the margins, typically for less than 5 percent of their overall premiums. Others, especially insurers focused on specialty commercial insurance, employ distribution strategies where MGAs play a more integral part. Some of the MGAs use a hybrid model, with some programs managed by in-house underwriters and others by MGAs, typically accounting for a higher percentage of overall premiums written. In these relationships, insurance carriers rely on MGAs for most, if not all, of their distribution and underwriting.

Pricing on liability lines, other than commercial auto liability, had a diminishing effect on overall premium growth. However, DUAE-produced market premiums did not decline, because MGAs working with recent start-up specialty commercial carriers helped fuel the top-line revenue growth of these entities.

The use of the surplus lines structure also has expanded with fronting carriers applying the freedom of rate and form to meet the needs of insureds. Insurers with a real interest in the business can be an independent partner of the MGA or a captive risk-bearing insurer created by the MGA. MGA-owned captives are often incorporated outside the US, where the capital requirements are lower and the regulatory environment less stringent. The proliferation of new specialty commercial and surplus lines start-ups using fronting models has been fruitful for MGAs.

Conditions in the global reinsurance market (including the London market) are also leading participants to surplus lines carriers with stability and predictability in their casualty books, amid the quest to diversify away from property exposures subject to natural catastrophe risks. Meanwhile, DUAEs continue to play an increasingly significant role in insurance markets across Europe, again thanks to interest from a broader range of capacity providers, as well as advances in technology.

The DUAE and E&S markets are the only two insurance industry segments in which AM Best has a positive outlook for 2024. AM Best has not witnessed a sector-wide pullback of capacity for DUAE-sourced business in 2023 and does not expect one in the current year. Amid hard-market conditions, DUAEs are under more pressure to demonstrate their value to carriers. Fronting companies have provided access for more reinsurance participation as reinsurers’ appetite for DUAE business remains firm.

However, incidents in the fronting space have yet to completely play out, and these hiccups may have an impact on DUAE capacity. The operating environment also favours E&S writers, alongside their historical viability, and especially in light of their financial impairment rates, which are much lower than those of admitted insurers. The tailwind conditions for surplus lines carriers will remain in place beyond the short term.