Best’s Special Report: Hard Reinsurance Market Makes Surplus Notes Attractive for Some Insurers

As more companies seek greater financial flexibility amid a hard reinsurance market with higher interest rates, the U.S. property/casualty and health segments have increased their use of surplus notes over the past two years, according to a new AM Best report.

The Best’s Special Report, “Hard Reinsurance Market Makes Surplus Notes Attractive for Some,” states that while the growth in surplus notes has been somewhat muted since 2022, through third-quarter 2024, the property/casualty and health segments have seen an increase of 8-9%, or approximately twice that of the life/annuity segment. In addition, more than 30% of the companies that have seen notable growth in surplus notes outstanding since 2022 are in the personal property and standard personal auto and homeowners’ composites, which have been significantly challenges in recent years. Although surplus notes outstanding is the highest for life insurers—$51 billion as of third-quarter 2024—the ratio of surplus notes to capital and surplus is lower than that of the other two major segments.

“Operating losses since 2022 have created a need for insurers to bolster capital cushions,” said Jason Hopper, associate director, Industry Research and Analytics, AM Best. “Loss-affected insurers are most likely to face increases in reinsurance rates and attachment points, which then causes the need for them to raise even more capital.”

According to the report, interest rates on surplus notes can be partially offset by investing proceeds in investment-grade fixed income as yields on new issuances are relatively high. Writing more business due to surplus notes issuance also can bring additional earnings, further offsetting the cost of the notes-related interest expense. As a result, some companies may find that surplus notes provide a better economic solution when compared with additional reinsurance as companies seek to support growth. “Beyond the more-traditional results of increasing capital and enhancing financial flexibility by way of issuing surplus notes, the higher capital can also reduce the need for reinsurance,” said Hopper.

However, AM Best believes that surplus notes are not a replacement for reinsurance and insurers need to perform appropriate risk-reward analysis to find optimal capital raising strategies. “The ability of a company to issue surplus notes is viewed as a sign of financial flexibility, but excessive reliance on surplus notes may result in negative assessment of capital quality,” said Doniella Pliss, director, AM Best.

To access the full copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=352304.

To view a related video on the report featuring Jason Hopper, please visit http://www.ambest.com/v.asp?v=ambsurplusnotes225.

AM Best is a global credit rating agency, news publisher and data analytics provider specializing in the insurance industry. Headquartered in the United States, the company does business in over 100 countries with regional offices in London, Amsterdam, Dubai, Hong Kong, Singapore and Mexico City. For more information, visit www.ambest.com.

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