2010: A SURPLUS ODYSSEY:
Carriers, Cycles and Performance Five Years Down the Road
Looking ahead to 2010, the easiest prediction is that the fortunes of the surplus lines industry will, as usual, be linked to the behavior of standard lines carriers. The second easiest is that the hard and soft market cycle will still be a defining force, although each leg may not be as extreme or as long as in the recent past.
"This industry is still subject to the same forces and will still suffer the same cycles," noted Daniel Maher, executive director, Excess Lines Association of New York, noting that price competition is now heating up after a few years of strong results.
Most observers do not expect the current softening of the market to be deep or prolonged and by 2010 they see the industry back on solid pricing ground, which should be good news for surplus lines. That's when surplus lines writers regain business lost to standard markets.
"The market is competitive but I don't see us headed the way of the soft market of the late '90s," said David Blades, a property casualty analyst with A.M. Best.
"The industry should be back at the center or in a firm, predictable center," affirmed Marshall Kath, chief executive officer for Colemont Insurance Brokers, based in Dallas, Texas.
Investment prospects
"We're very bullish on the surplus lines business," said Don Urbanciz, chief executive at Insurance Noodle, the online wholesaler, who captured the attitude of other surplus lines executives. But precisely what shape the industry will be in and where in the hard cycle it will be parked in 2010 will depend on what happens on the investment side for insurers, they agreed.
Colemont's Kath is one who believes that insurers will not be able to make up losses on investments and this will keep them disciplined over the next few years. "We will continue in a lower interest rate environment for the foreseeable future. The effect on carriers will force them to continue to be disciplined in their underwriting," predicted Kath.
Blades of A.M. Best agreed that the investment scene will be key to the financial picture of the industry over the next five years. But Blades, who helps produce the annual surplus lines industry report for the National Association of Surplus Lines Offices, also thinks a "catalytic event" could push the cycle. If there is a major event similar to the 9/11 terrorist attacks, the Northridge earthquake or a hurricane season like 2004, prices could harden faster than they might if left simply to carriers looking at their profitability, he noted.
A.M. Best expects to see "continued strong financial underwriting profitability" in the coming years for surplus lines carriers. Since 2002, the surplus lines industry has reported loss ratios between 92 and 93, and Blades thinks loss ratios in the low to mid-90s can be expected in the years ahead as well.
Dick Bouhan, executive director for NAPSLO, along with the other leaders, anticipates that the report on 2004 will again show solid financial performance by surplus lines carriers and be a harbinger of 2010 as well. Why? "Because the factors that A.M. Best puts forth as important--better capitalized companies, individual underwriting, freedom of rating and forms--exist regardless of the market conditions," he explained.
One area where the 2004 and future reports might be down from the recent past is in premium growth. For 2003, premium growth was up about 28 percent over the prior year. For 2002, it jumped a whopping 62 percent. But for 2004, A.M. Best will report that premiums grew barely 1 percent, a slowdown that is consistent with a softer market in which standard lines seek out more business.
Going forward, surplus lines leaders do not anticipate a repeat of the past decade's dramatic double-digit growth in surplus premiums; instead they view single digit growth as likely. As NAPSLO's Bouhan explained, while the annual jumps might be smaller, there will continue to be a steady "ratcheting up" of surplus premium totals during the years ahead.
"Ultimately there will be plenty of opportunity and premiums will continue to grow," said Rick Lindsey, chief executive officer and president for Prime Insurance.
Fewer carriers?
Whether the roster of surplus lines carriers will be noticeably smaller or differently populated in 2010 than it is today is debatable.
Prime's Lindsey believes "insolvencies will always be an issue" and fears a number of smaller carriers may be in trouble. But most agree that insolvencies should not be a major concern in surplus lines because carriers are well capitalized and the lessons of the Reliance, Frontier and Legion failures have been absorbed.
There may be wholesaler mergers ahead, but these leaders don't buy a scenario of multiple or mega mergers.
Bouhan said he sees some consolidation but expects that will be made up for by new entries so that the overall picture will be about the same in 2010 as it is now. Insurance Noodle's Urbanciz said he doesn't see a lot of consolidation between now and 2010 either.
Blades said he could see some larger carriers eyeing certain smaller ones for geographic or products expansion. But a lot of merger activity? These executives do not see it happening. "The major surplus lines players don't need to consolidate. Also, a lot of medium-sized groups have good market share and plenty of capital," ELANY's Maher explained.
While neither insolvencies nor consolidation should significantly reconfigure the carrier ranks, other forces including rating agency scrutiny and quality concerns could.
Lindsey suggested that the insurer rating system is weighted in favor of size and this will continue so that by 2010 there will be fewer, but bigger carriers than there are now. "It doesn't matter if you're good or not or if you're making money," he said. "Smaller companies get a closer look." Lindsey sees opportunity for smaller carriers as bigger carriers shun smaller brokers.
Colemont's Kath firmly believes that the flight-to-quality trend will accelerate and this will continue to alter the profile of players, whether they are big or small carriers. "It's all about quality. The flight to quality becomes the flight to only quality," he maintained, suggesting insurance carriers and brokers will be forced to learn from the Enron, Worldcom and other scandals and meet higher standards.
Kath agrees that rating agencies will have a lot to say about what the marketplace looks like in 2010; he sees them "continuing to get tougher." Aggressive stances by the A.M. Bests and Standard & Poors of the world could prove a deterrent to new entries as well as make "those in the market now be more mindful of bumps in the road," Kath added.
While others predict few major changes by carriers, online broker MarketScout's Richard Kerr sees a dramatic realignment among carriers, both standard and surplus lines. (See related story, "The Invasion of the Insurance Exchanges," page N27.)
New players
By 2010, the biggest news among carriers in the field could be coming from some of the late entries including James River, Maxum, Aspen, Prime, Wellington, Quanta and others.
Blades said new players like these would be closely watched to see how they perform in the softer market but that overall they appear wise to the dangers of grabbing market share at the expense of premium and should be in good shape come 2010.
While Kath and Lindsey think new entries may have a tough time getting past rating agencies, ELANY's Maher wouldn't be surprised if there are even more young players in surplus lines five years from now. These could include some insurers that have traditionally operated in admitted markets only but are now eyeing getting into nonadmitted markets in selected areas.
According to A.M. Best, larger insurers have for years dominated surplus lines, with the top 25 groups capturing 85 percent of direct premium. American International Group (mainly through its Lexington Insurance Co. and American International Specialty Lines subsidiaries) and Lloyd's have been the surplus lines market leaders with about 24 percent and 14 percent respectively.
Five years from now, that market share report might look a shade different, but not much, observers said. The market share of domestic carriers' might be slightly bigger for a variety of reasons including the arrival of several new domestic players, the fact that some alien carriers now have U.S. domiciled companies, and because European insurers are facing tougher regulation.
"There's still plenty of opportunity," said Prime's Lindsey. "It's a huge world out there."
See the Sept. 19 issue for coverage of: "Surplus Lines Products and Regulation in 2010."
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