The surplus line industry is stable, but profit margins may shrink in the near term as average rate increases diminish on various lines of coverage, says A.M. Best Co. Inc. in a report.

In addition, a separate report issued by Chicago-based Fitch Ratings Inc. also predicts that the segment's profitability is likely to weaken in 2015 as pricing pressure and diminishing favorable loss reserves reduce underwriting performance, and continued low asset yields adversely affect investment income.

Professional lines insurers' balance sheets, which have “endured many challenges” in recent years, have maintained “considerable strength to support future operating plans,” says the report issued Monday by Oldwick, New Jersey-based A.M. Best.

It was produced with the support of the Kansas City, Missouri-based National Association of Professional Surplus Lines Offices Ltd.'s Derek Hughes/NAPSLO Educational Foundation. The report, which is dated Sept. 15, was distributed to NAPSLO members Monday with Best's special permission.

According to the report, surplus lines insurers benefited in 2013 from a relatively benign catastrophe year, which was “welcome relief, given the devastating impact that Superstorm Sandy had on this segment and indeed the entire insurance industry just one year earlier.”

But the Best report says while surplus lines companies' accident-year reserve development has been slightly more favorable than that of the overall property/casualty insurance industry, “the gap has been shrinking as the markets wrestle with excess capacity, low interest rates and capital outlays to enhance operational efficiencies. A.M. Best expects surplus lines insurers' underwriting to remain disciplined,” says the report, however.

The report also says surplus lines insurers' percentage of commercial lines direct premiums written has more than doubled to a 13.7% share in 2013, compared with a 6.1% share in 1993.

The Fitch report states excess and surplus lines market direct written premiums increased 8%, to $28 billion in 2013 over the prior-year period.

“Higher E&S premiums were driven by rising rates in various lines, increased exposure due to a continued, albeit slow, economic recovery and a reduced appetite from standard carriers to write nonstandard risks,” says the Fitch report. “However, rate increases have slowed and turned negative in some segments, particularly commercial property.”

The Fitch report says ample market capacity “will promote persistent competition and restrict future price movement” in the segment. It says Omaha, Nebraska-based Berkshire Hathaway Inc.'s effort to increase participation in the E&S market has added $3.2 billion in capacity “to an already competitive market,” although its premium growth “has been measured to date.”

The report also predicts further market consolidation in 2014-2015 “as scale operations become more essential to manage expenses in an increasingly underwriting-focused environment.”