Brokerage M&As Expected to Continue for the Near Term; Time’s Almost Up for Congress to Pass Reform Bill
Surplus lines insurers continued to outperform the property/casualty industry in underwriting and operating performance in 2007 despite the softening market and more aggressive competition. Heightened competition along with the turbulent market, however, caused a slight deterioration in underwriting profitability that led to a decline in the industry’s net income, analysts report.
“The market is softer, prices are declining and the admitted market is taking a lot ob business back,” said Dick Bouhan, president of the National Association of Surplus Lines Offices (NAPSLO).
The impact of the softening market caused an 8.7 percent drop in net premiums written in 2007 for professional surplus lines insurers, according to a new report by A.M. Best, “U.S. Surplus Lines – 2007 Market Review.”
The Surplus Lines Stamping Office of Texas tracked similar results, noting that surplus lines premiums of the 14 U.S. stamping offices dropped by 7.6 percent in the first six months of 2008. Overall premiums reported dropped from $12.307 billion in the first six months of 2007 to $11.373 billion in 2008, said the SLSOT.
Of the 14 states with stamping offices, the biggest drops in premium included Montana, New York, Idaho, Arizona, Texas and Washington (see chart below).
U.S. Surplus Lines — Top 10 Groups (2007)
Ranked by 2007 direct premiums written.
|Rank||AMB No.||Group Name||Direct Premiums Written||Total Surplus Lines Market Share||Policyholder Surplus|
|1||18540||American International Group||$8,271,902||22.2%||$32,383,700|
|3||18549||Zurich Financial Svcs. Group||1,647,223||4.4%||6,934,087|
|5||18498||ACE INA Group||1,227,818||3.3%||5,310,345|
|6||04655||W.R. Berkley Group||1,162,112||3.1%||3,700,744|
|7||18468||Markel Corporation Group||1,123,866||3.0%||1,335,447|
|8||18640||Alleghany Insurance Holdings||959,526||2.6%||1,735,944|
|9||00811||Berkshire Hathaway Insurance group||931,300||2.5%||61,939,484|
|10||18313||CNA Insurance Companies||759,053||2.0%||8,612,535|
Bouhan says that NAPSLO members have seen rates for nearly all classes of business hit by decreases. “The contracting business also has come to a big halt, so there isn’t as much of that business out there,” he said, adding a lot of property business moved back into the admitted market, even some traditional E&S risks.
Absent a catastrophe that curtails the incursion of standard market insurers and the new offshore market, the surplus lines industry’s market share is expected to continue decreasing over the near term, according to the A.M. Best report. (The annual special report on the surplus lines market was made possible by a grant provided by the Derek Hughes/NAPSLO Educational Foundation. This is the 15th year the foundation sponsored the report.)
E&S Outperforms Overall P/C Market
The underwriting and operating performance of surplus lines companies, both domestic professional and domestic specialty, continued to outpace that of the total P/C industry in 2007, the analysts said.
“While direct premiums written (DPW) for surplus lines insurers, overall, decreased due to heightened competition, some of the top companies and groups in terms of DPW that specialize in surplus lines or specialty business still generated excellent underwriting results,” according to the report.
The top three surplus lines groups were unchanged from 2006: American International Group, Lloyd’s and Zurich Financial Services Group.Rounding out the top 10 surplus lines groups are: 4) Nationwide Group; 5) ACE INA Group; 6) W.R. Berkley Group; 7) Markel Corp. Group; 8) Alleghany Insurance Holdings; 9) Berkshire Hathaway Insurance Group; and 10) CNA Insurance Cos.
After-tax return on equity, which measures after-tax profitability from underwriting and investment activity, slipped slightly to a still solid 12.4 percent from 15.05 percent at year-end 2006.
“The accumulation of excess capital in combination with premium erosion, deteriorating underwriting results and intensifying competition caused the decline in profitability,” analysts wrote.
For the fourth consecutive year, in 2007, surplus lines recorded no financial impairments, compared with the four impairments for the admitted P/C industry.
Merger and acquisition activity has been high among surplus lines companies and wholesale brokers through midyear 2008, and is expected to continue over the near term.
“Interest in mergers and acquisitions (M&A) in the brokerage market picked up considerably through 2007, even considering the soft market conditions that generally depress premium volumes and profits and keep down sale prices based on multiples of earnings,” analysts wrote.
The American Association of Managing General Agents (AAMGA) reported this year that it continues to receive three to five inquiries a month on MGAs that may be interested in a sale or other transaction.
Several factors appear to be driving consolidation for wholesale brokers, including soft market conditions, aging brokerage owners, and economic factors such as the cost of technology and higher staffing costs.
For wholesalers seeking growth, one way to do so during the soft market is through a merger or acquisition.
“The largest wholesalers are private equity backed,” said John Kraska, managing partner for Hales & Co. Inc. based in New York. “They have been acquisitive and I believe they will continue to be,” he said.
But Kraska believes that buyers today have become a little more cautious in their selection. “Capital isn’t as cheap and readily available,” a big change from just a year ago when buyers were more inclined to buy what they wanted.
Even so, Kraska says he continues to see an abundance of buyers in the marketplace.
“The firms that have a great franchise and are able to show organic growth, or past organic growth, are profitable, and have a good niche or area of expertise — those firms will have a lot of choices,” he said. “I think it’s the next tier firms that are not growing, or marginally profitable, and less focused — those are seeing a reduction in value because there’s few places for them to go.”
Time’s Almost Up
An interstate compact designed to solve the surplus lines industry’s multistate tax and compliance problems was finalized in 2008, as Congress considered the Non-admitted and Reinsurance Reform Act (NRRA), also supported by the surplus lines industry.
NRRA denotes that multi-state commercial risks written in the surplus lines market will no longer require agents to pay the state surplus lines taxes to the each state in which the proportionate share of the premium for that risk resides.
Bernd Heinze, executive director of the AAMGA, says that NRRA “is an important step in sustaining the non-admitted insurance market’s effective, efficient and economical services to the public and private sector, while streamlining the processing, licensing and compliance components of insurance transactions.” Most importantly, he added, the legislation will create a uniform and consistent foundation on which essential state based regulation can continue without restraining the creativity, investment and security provided by the surplus lines market.
The U.S. Senate Banking Committee held a hearing in late July to discuss various proposals on insurance regulation reform, including NRRA. NAPSLO’s Bouhan says he remains hopeful that Congress will take further action on NRRA this session, but time is running out.
“The difficulty that we face is time,” Bouhan says. “I do think if it gets into the next Congress it will get passed.” He added that the surplus lines industry, including NAPSLO and AAMGA members, remain “optimistic” the legislation will pass this year.