Competition hits Surplus Lines Market
As the surplus lines world turns to another year of soft market conditions, specialists and innovators may be the ones to survive as increasing competition intensifies, according to excess and surplus lines brokers, wholesalers and insurers.
“It’s as competitive as I’ve seen it in a long time,” said Francis Johnson, president of Johnson & Johnson in Charleston, S.C., who is also past-president of the American Association of Managing General Agents.
“The specialists survive” in today’s competitive market, said Alison J. Renner, CEO of Chicago-based Vista Insurance Partners, part of USI Holdings.
Johnson added that except for the coast, which includes the southern Atlantic seaboard, Florida and the Gulf Coast, all lines seem to be softening. “Fifty, maybe even thirty, miles back you see the standard [admitted] carriers starting to come into the market.”
The softer market trend began two years ago. A.M. Best’s E&S report, published in Sept. 2005, notes that in 2004 “after growing significantly for three consecutive calendar years, direct premium volume for the surplus lines industry remained relatively flat.” The hard market between 2001 and 2003 was largely responsible for the growth, which, until Katrina and her sisters hit, was slowing down. But the losses generated by those disasters tended to keep rates high.
That no longer appears to be the case, according to experts. Wendy Baker, Lloyd’s U.S. president, director distribution and development, noted that E&S “was around 6 to 7 percent of all commercial lines 10 years ago, since then it’s doubled. While there may be continued growth in the sector, it’s unlikely to double again in the next 10 [years]. However, most E&S professionals see the current slowdown as a return to a more normal state for the E&S market rather than a sea change.”
Rates are softening
“The market clearly has changed,” said National Association of Professional Surplus Lines Offices’ past-President Richard Polizzi, who is also president of Western Security Surplus Insurance based in Pasadena, Calif. “It’s soft and it’s getting softer. I think we’re in for a normal cycle change that will last for a few more years.”
The return to what historically have been considered normal market conditions highlights the turbulence of the past few years. “The business cycle [faster or slower economic growth] and the insurance cycle never end,” Polizzi continued. “But they do react to outside pressures, such as regulatory changes, terrorism and catastrophe losses.”
The Sept. 11 attacks, followed by the hurricanes of 2004-05, created abnormal market conditions, Polizzi said. “The real condition now is probably a more normal market,” Polizzi said. “It was abnormal, as capacity shrank; now it’s becoming more normal.”
“What we’re seeing now is increased pressure on surplus lines, particularly in casualty,” said Vista’s Renner. “The market is soft and somewhat chaotic,” she continued.
With over 35 years experience in the surplus lines market (she was a co-founder of A.J. Renner & Associates in 1985), Renner has seen a lot of cycles come and go. “A lot of [admitted] carriers are looking for cash flow income, so they become more aggressive in seeking business in surplus lines,” Renner said.
Also, Renner noted, that the hard market periods seem to be getting shorter, while the soft ones are getting longer. “It used to be you could count on around five years for each one, but now the softer ones are longer,” she said. “I expect this one to continue for at least through 2007, and probably until the end of the decade.”
Johnson also sees more standard carriers coming into the market. “As a result there have been minor rate reductions and most other rates are flat,” Johnson said. Although he indicated that he and other managing general agents have lost business to admitted carriers, he said that for his firm, the effect hasn’t been “real bad.” Some rates have fallen as much as 10 percent to 15 percent, but not across the board, he added. “Most of the country has seen rates go down,” he said.
Johnson also noted that in some regions — notably the Midwest, which is far from any coasts, and has somewhat less exposure to natural disasters — rates seem to be softer than in other parts of the country. “You find a lot of regional carriers, who are coming into the market,” he added. Most of those companies didn’t take the hits from the hurricanes that the larger national companies did, so they are in a better position to seek business that has been in the E&S sector, according to Johnson. The risks are manageable and they have the capacity, he said.
Renner pointed out that the standard carriers aren’t the only ones expanding into E&S markets.
“A lot of surplus lines companies are looking for business in some of the tougher areas, as the easier stuff has become more competitive,” she said. Those tougher areas, primarily the riskier portions of the business, are likely to remain in the surplus lines market, she noted, and may include the pharmaceutical and life sciences sectors, medical devices and some professional E&O, especially doctors, lawyers and accountants.
On the other hand Renner said, “D&O is now pretty much a part of the standard market — except for Enron-type situations It came and went quickly.”
“I call it ‘casual capacity,'” she explained. When rates go down and more admitted carriers enter a market, the surplus lines companies and MGAs start looking for business in more lucrative fields. As an example, Renner said some lines have gone down to 80 cents per $1,000 in coverage, whereas in some of the more difficult lines — medical devices, nursing homes, among others — the rates are $7 to $8. Renner added that a lot of new competition has jumped into the more lucrative markets. As a result, MGAs like Renner, who are highly specialized in the coverage they provide, are feeling pressure from other surplus lines companies and MGAs.
Denise Morris, senior vice president, Excess Casualty for Liberty International Underwriters in Chicago, sees an analogous problem on the admitted side. She specializes in umbrella coverage, the high limit type of excess that kicks in to pay casualty claims above primary limits.
“The market is definitely softening,” she said, “with more and more rates going down in all lines, and more people entering the market.” She singled out the loss of profitability in the property sector as a major force driving companies to consider writing umbrella coverage.
The cycle’s invisible hand also plays a role. “We’re sort of like the tail that wags the dog,” Morris said, “the first to soften and the last to go up.”
Coastal chaos
The major carriers have left the affected coastal areas, or are severely curtailing their activities there, most reported.
As John M. DiBiasi, president of XL’s new E&S unit [see sidebar], explained, “80 percent of the E&S market is in casualty, mainly general liability.”
Renner agrees with that figure, but noted that in 2006 there could well be an increase in property coverage in the E&S sector as a result of the situation along the coast.
DiBiasi said XL E&S would in fact begin writing property coverage within the next few weeks, although he made it clear the company would not write business in wind areas.
Thus while a return to more normal pricing and distribution procedures is taking hold in most of the United States, the property sector, particularly in Florida, along the Gulf Coast and up to Virginia, is still in chaos.
Johnson added while the E&Smarket is competitive, that only applies to those companies that “don’t write on the coast.” Nobody, it seems, wants to write on the coast, he added, as the salutary lessons of the last two years are still quite fresh in the minds of brokers, underwriters and MGAs.
The reinsurers have also substantially raised the costs of their protection, when it’s available. They don’t want to increase quota share treaties, much less write new ones, excess of loss coverage has increased substantially, and retrocession coverage has practically disappeared (See IJ Magazine article Aug. 9).
“They’ve [reinsurers] killed their capacity in property,” Renner said, “so now they’re looking to write casualty.” She warned, however, that with the long tail liabilities, they might be in for “some nasty surprises down the road.”
Under these conditions middle and lower income families, as well as smaller businesses, can only turn to state funded alternatives, such as Citizens in Florida, for coverage. For high value property and large commercial risks on the coast, the E&S market may offer a costly alternative.
There are, after all, a lot of people — around 35 million between North Carolina and Texas — and a lot of property that needs to be insured. However, Johnson said, “getting any coverage on the coast is a hit and miss struggle. One minute they’ll write it, the next minute they won’t. Lloyd’s and AIG are offering $2.5 million to $3 million in layer coverage, but it’s pricey,” he said. “It used to be around 80 cents [per $1,000] and now it’s $2 to $3.”
He also pointed out that even though none of the recent storms caused major damage in the Carolinas or along the Georgia coast, those areas are nonetheless being affected by the pricing pressures emanating from their neighbors further south.
But brokers in the region are seeing some competition. “State Farm came in and took away one of our accounts,” Johnson said, “simply because they wanted the business.”
The hurricanes’ aftereffects may have caused many coastal residents to rethink their location. According to a recently released study by the Earth Policy Institute, more than 300,00 people who evacuated their homes in the wake of Hurricanes Katrina, Rita and Wilma may have left permanently. It also concludes: “As rising seas and more powerful hurricanes translate into higher insurance costs in these coastal communities, people are retreating inland. And just as companies migrate to regions with lower wages, they also migrate to regions with lower insurance costs.”
E&S future outlook
Predicting the future is always a risky business, but given the past history of the surplus lines industry it continues to look pretty solid.
“The surplus lines market is 120 years old,” Polizzi said, “but it has really grown to maturity in the last 30 years. It’s now more solid, more sophisticated, and [I’m confident] the wholesale side will figure out ways to grow.”
Looking back over those 30 years, he maintained that in the ’70s, aside from Lloyd’s, “you could count the number of surplus line carriers on one hand. Today, however, it’s a highly sophisticated and well managed market.” He stressed that general agents, specialty agents and MGAs have all played a role in producing a flexible and sustainable market sector.
“Our true calling,” Polizzi continued, “is to underwrite risk selection, using common products that have been developed on our side of the business.”
The E&S industry also develops new products, he added, noting that the two seasons of abnormally destructive hurricanes spurred the surplus lines market to create products that may be less risky and/or more lucrative.
“We need to offer the proper products for what the market needs,” Polizzi said. “We’re championing the freedom of the market, as in many ways we’re closer to the true nature of the real risks we underwrite. We can’t use a ‘one size fits all approach.'”
Renner expressed similar sentiments. “E&S survives because it provides free rates [i.e. unregulated] and forms; it doesn’t fit into the box.”
“In surplus lines you need to see value added to the business; you have to be a problem solver,” Renner said. As the market gets progressively softer, “the general wholesale market will really struggle,” she continued. “In addition the ‘casual capacity factor’ is adding to market instability.”
The surplus lines brokers who are prepared to offer “unique risk management” and tailored programs do bring added value to their clients and will continue to do substantial business, she said. The ones who just take orders will suffer. “We’re like independent agents; we’re both in the same boat.”