Inferior Results Will Force Admitted Carriers Out of the E&S World, Eventually

The loss of market share in the surplus lines sector of the property/casualty insurance industry will turn around when standard carriers begin to experience negative results from the non-standard business they’ve taken on in the past few years.

The reason? They don’t know how to write the risks, say a trio of surplus lines professionals.

Standard companies are writing business that normally would go into the surplus lines market and are writing those risks as admitted business, said Alan Kaufmann, president and CEO of Burns & Wilcox. He believes that practice “will come back to haunt them because the business requires a different type of underwriting skill and experience, talent and creativity, that the standard markets do not have. They’re good at writing standard business. They’re not proficient and accustomed to writing non-admitted business.”

In an A.M. Best report released last fall, a comparison between underwriting results for surplus lines carriers versus admitted insurers showed a more favorable overall combined ratio for excess and surplus insurers.

That’s because surplus lines underwriters generally “are more attuned to the risk on their desk at the time that it’s priced, and for good reason. We have to be,” said Chris Timm, president of Century Insurance Group and executive vice-president of Meadowbrook Insurance Group. “We tend to be more focused on risk and less focused on just building market share, right? And so I think that naturally that business is going to produce, over time, superior results,” Timm said.

Rob Lala, senior vice president, Liberty International Underwriters, pointed out that because of the specialty nature of the excess and surplus (E&S) business, surplus line carriers don’t “need to write all things and be all things to all people. … We can specialize and be in a segment of the class of business that we particularly like, that we’re good at, that our claims professionals are better at adjusting claims, and all of that added together results in a more favorable loss ratio.”

Kaufmann said as the underwriting performance of standard companies begins to suffer from the non-admitted business they are writing now, they will return to the standard business for which they have expertise. “That will be a sign of a change in the market,” he said. When the standard companies pull back from writing non-standard risks, “that business will come back to the companies that have the experience and talent — with that know-how — to write the true non-admitted business,” Kaufmann said.

He believes that won’t happen right away as the underwriting experience is not mature enough for standard companies to see the consequences of writing policies in markets where they lack expertise. It will take about another year for the results to work their way through the system, he said.

Timm agreed it will take a while for the turnaround to occur for surplus lines carriers, through 2011 at least and probably into 2012. In the meantime, traditional E&S business will continue to flow “into the admitted market, because the admitted market is the first choice of most retail agents who are placing business. They don’t have a first choice of going to the non-admitted market,” he said.

Other Influences

In addition to the encroachment of standard insurance companies into the E&S market, a big challenge for E&S insurers “has just been the level of exposure basis — the receipts, the payrolls,” said Liberty International’s Lala. That exposure base has “been declining as the economy has declined, so you could literally write the same number of accounts that you had previously written, and you’re going to be down 20 or 25 percent because the size of the companies have declined,” he said.

One way his company has dealt with that challenge is to reduce the cost of doing business. “We particularly have looked at more automation, which we’ve implemented. I think a lot of our peer companies have done that as well. So you try to do more with less and more efficiently.”

Kaufmann said that decline in what Lala calls the “exposure base” is one reason why standard insurers are writing business that normally would be non-admitted business. Like E&S carriers, standard insurers have less business to write because there are fewer businesses to insure.

Another reason is that standard companies have a “substantial amount of capital that they want to utilize to provide returns to their shareholders,” Kaufmann said. So, until the appetite of the standard companies “has dried up because of their poor experience, underwriting experience, we won’t see that business come back,” he said.

Innovation Matters

One counterweight to the pressure placed by standard carriers on E&S market share is innovation, a well-established practice in the surplus lines industry. “Creativity has always been the backbone of the non-admitted world,” said Kaufmann. There’s always innovation in surplus lines, he said, and a difficult economy makes it all the more essential.

“We try to have a good brain trust in our company,” Kaufmann said. “We encourage people to think well out of the box, to come up with ideas, to put together products and programs.”

You have to innovate, Timm said. “If you are content with the status quo, you’re content to fade obscurity,” he added. “The companies that are trying to hold to the current status quo and not trying to innovate, I think that they will become insignificant.”

He said Meadowbrook devotes a considerable amount of resources to innovation. While he wouldn’t detail specific products or niches his company has in development, Timm said his company is definitely looking at new business areas that are beginning to “evolve and thrive.”

Kaufmann, meanwhile, believes there are areas that present opportunities for the non-admitted market. In the property sector, locations that routinely experience natural catastrophes — floods, wind, earthquakes, mud slides, etc. — are favorable markets for the non-admitted world, he said. “Though the rates are low because of the economy and other factors,” that business will stay in the non-admitted market, he said.

On the casualty side, professional liability continues to be an expanding area in which wholesalers can write business, he said. There are specific niches and small program areas that may not be attractive to standard markets because they don’t provide enough premium volume, Kaufmann said. For instance, there are lots of “tanning salons but not enough that the standard companies are interested to a great extent. So our company writes tanning salons.”

He also cited particular niches in health care related industries as having potential, such as day spas and plastic surgery centers. Those are growth industries because of the mass of aging baby boomers. “That’s a growing area of business that we write, for instance, and I think will be appropriately placed in the non-admitted world.”