View this article online: https://www.insurancejournal.com/magazines/mag-coverstory/2004/09/20/46620.htm
First Responders
Once upon a time, the excess and surplus line market was the safety valve of the insurance industry—the more lightly regulated, more financially shaky little brother to the admitted market. It was said to release the pressure on the admitted carriers during the hard market portion of the cycle.
This may have been true in, say, 1981, when the E&S market accounted for $2.2 billion in direct written premium, compared to the $35.5 billion raked in by surplus line carriers in 2003. The E&S market has grown 16 times larger in just 22 years. More and more often, surplus line insurers are not the industry’s last resort, but its first responders.
Just as in the wake of Sept. 11, 2001, emergency medical personnel and firefighters took on heightened importance as the first responders in the event of a terrorist attack, so has the E&S market’s quick response to crisis become its telltale signature. Thanks to converging ownership structures, eased state regulations, solidified financial backing and product innovation, the E&S market is unlikely to ever see its numbers retreat to 1981 levels, even when adjusted for inflation or as a percentage of total premium volume.
As the market turns
That said, the increase in the E&S market’s premium volume has clearly tapered off recently. While the E&S market’s total premium volume grew by 62 percent in 2002, it grew by less than half that—29 percent—in 2003. Through June 2004, the 14 states with stamping offices reported only a 17.2 percent growth in premium volume since July 2003, with just a 3.8 percent increase the number of policies, or items.
“It’s been a tough year for everybody,” said Simon Bancroft, branch manager of the Swett & Crawford brokerage’s Dallas office. “I think it will continue to be. Property rates started to talk themselves down last year, and we’re starting to see small decreases in casualty rates.”
Whether that property rate decrease will continue in light of the hurricane season remains to be seen. Richard Kerr, the CEO of online brokerage MarketScout.com, said in a statement that $15 billion in insured damages would send property rates back on an upward trajectory, while as little as $5 billion could stop the decreases. Hurricane Charley’s and Frances’s combined losses are estimated at $11 billion. Meanwhile, at press time Hurricane Ivan was barreling toward the Florida Panhandle and west to New Orleans, though early indications were that its toll would not be as great thanks to a less heavily populated path of impact.
“Overall, MarketScout’s composite property/casualty premium calculations resulted in an increase of 4 percent for August, down from 5 percent in July and down 12 percent from one year ago,” Kerr added. “Even D&O insurance renewals are dropping dramatically. Heavy premium volume related to renewals this fall will begin to clearly reflect the market direction for the next six months.”
Joe Hutelmyer, president of the American Association of Managing General Agents (AAMGA) and Burlington, N.C.-based long-haul trucking MGA Seaboard Underwriters, also sees softening ahead, though he cautioned that hurricane news “could change the whole outlook at NAPSLO.”
“We won’t be seeing increases next year,” he said. “Even D&O and E&O prices are starting to soften. Trucking liability is not something where you’d think prices would be falling quickly. In the last two years we were able to get increases. This year, pricing is flat to 10 percent below and we are seeing some softening.”
Maintaining discipline
Indications are, however, that the admitted market has more appetite for volume but does not necessarily want to loosen its underwriting criteria. The property/casualty industry reported its first quarterly underwriting profit in seven years in the first quarter of 2004, according to the financial analysis firm Weiss Ratings.
The industry tallied a $5.5 billion underwriting profit, compared to a $1.1 billion loss during the first quarter of 2003. Insurers might be tempted by their investment returns, which went up 182 percent to $3.2 billion in the first quarter of 2004, compared to $1.1 billion the year before, according to Weiss.
“The strong profitability is the result of several years of rate increases combined with stricter underwriting standards,” Weiss Vice President Melissa Gannon said in a statement. “There is a sense that the industry is trying to level out the swings in the business cycle by maintaining tighter underwriting standards going forward, rather than returning to the lax standards of the soft market. If this continues, premium rates should level off or even decline.”
In casualty lines of business, for instance, it appears that admitted markets are still hesitant to take on tougher risks at low rates.
“There are a number of factors for the P/C industry that will and should hold pricing firm in various professional and casualty lines in the near term,” Michael Rozenberg, the chief operating officer of Markel subsidiary Shand, Morahan & Co., told IJ via e-mail. “These include a decade of past underwriting losses, declining interest rates, poor investment results, and prior year reserve deterioration. If we look at environmental business alone, current estimates indicate a shortfall of $60 billion to $140 billion of reserve deficiencies for the industry.”
Rozenberg cited as evidence the medical malpractice line, from which about 20 carriers have withdrawn in the last several years. Almost 70 percent of those firms “are no longer even in business,” he added. “These types of results have kept large amounts of new capital from entering the market, and accordingly we anticipate rates to remain firm in the near term for carriers who are still able to write these risks for their clients.”
According to Don Urbanciz, the CEO of Insure Vianet, the holding company of online small business risk wholesaler Insurance Noodle, “Markets are expanding, but more on the size of the risk, not the risk characteristics. Five million in revenue was kind of an upper limit on a BOP account. Now it’s $10 million or $12 million. The size of that risk is growing.”
Swett & Crawford’s Bancroft sees the same thing occurring on the much larger scale of property business he typically deals with.
“The harder to place risks are staying in the surplus lines marketplace where they belong,” he said. “Certainly, there are massively increased limits. Insurers are willing to put $10 million or $20 million primary versus the $2.5 to $5 million level they had been at. Extra layers have pretty much disappeared. Insurers who were offering $25 to $50 million in capacity last year are now offering $100 million limits.”
According to Bancroft, residential contractors and professional lines such as architects, doctors, lawyers and nursing homes are “still very tough to find a home for … We’re not anticipating price reductions there. Different markets have different appetites. Some are waiting on the sidelines keeping their powder dry, and some are continuing to compete to keep their business. They’re not chasing rates down indiscriminately. They’re chasing individual accounts where they think it makes sense.”
Max Williamson, the president of leading surplus line carrier Scottsdale Insurance, said things will be different in this year’s version of “as the market turns.”
“I don’t see them acting like they did in the previous emergence from the hard market, wherein appetite increased for all risks,” he said. “There’s discipline going on, which will continue to create opportunities for us in the casualty lines of business and others. Yeah, there’s anecdotally some price-cutting, but for the most part it’s pretty stable, pretty plateaud.”
“Loss experience dictates how companies operate,” Williamson added. “That’s what determines what the underwriting and pricing philosophy will be. If they feel there’s some fat in the rates, they’ll try to return some of that.”
Insuring homeland security
Ultimately, what will keep the E&S market strong is its ability and willingness to underwrite and insure risks the admitted market won’t touch. As Williamson pointed out, most of the major leading domestic surplus line carriers are actually owned or have been acquired by holding companies which also own leading admitted markets. Scottsdale, for example, is owned by Nationwide, the exclusive agent personal lines juggernaut. As such, admitted markets have less reason to compete for tough-to-write business.
“So long as the money’s coming in the door,” Williamson said, “they don’t care how.”
The risks that admitted markets won’t touch could be established lines where insurers have run into losses piled on top of losses, or new risks without a solid track record. Surplus line carriers’ role as first responders means that not only are they the first to respond to hard-to-place risks shed by the standard carriers during a hard market, but they are the first to innovate to meet new risks.
As Shand’s Rozenberg told IJ, “Our market exists to solve problems—even in the softest of markets, our role is to place coverage for risks which the standard market does not have an appetite to write.”
As in Shand’s case, the E&S market may save the day on a long-bedeviled line such as medical malpractice. At other times, something new and different demands the expertise and innovation surplus line carriers are noted for. A good example of this is AIG subsidiary Lexington Insurance Co.’s new program for homeland security providers, called Safety Act Homeland Protector. The program, which was introduced in March, was developed once Lexington became aware of a subset of the legislation that created the Homeland Security Department called the Support Anti-Terrorism by Fostering Effective Technologies Act of 2002 (aka Safety Act).
“We started to take note of the legislation in the latter part of 2003,” according to Peter Eastwood, Lexington senior vice president, who said the company did not lobby for the law’s passage. “We noticed it due to the uniqueness of the Act’s provision that requires companies to purchase insurance and also gives them the opportunity to limit their liability by the amount of insurance they had in place. We felt it was a unique opportunity to come out with a dedicated insurance program to support these technologies and their potential exposures.”
The Safety Act limits the liability of any homeland security service or technology provider certified by the Homeland Security Department by providing the following:
• Exclusive jurisdiction in federal court for suits against the sellers of “qualified anti-terrorism technologies” (aka QATT);
• A limitation on the liability of sellers of qualified ATTs to an amount of liability insurance coverage specified for each technology;
• A prohibition on joint and several liabilities for noneconomic damages, so that sellers can only be liable for that percentage of noneconomic damages proportionate to their responsibility for the harm;
• A complete bar on punitive damages and prejudgment interest;
• A reduction of plaintiffs’ recovery by amounts that plaintiffs received from “collateral sources,” such as insurance benefits or other government benefits;
• And a rebuttable presumption that the Seller is entitled to the “government contractor defense.”
The rationale behind the law was that technologies and services that could help prevent or mitigate a terrorist attack might not be developed or offered due to liability concerns. If there were a terrorist attack and the technology failed, the tort consequences could be disastrous. The Lexington program offers up to $25 million in limits per QATT product. So far, four products have been qualified.
“Our approach to this is to not provide only tailored coverage, but dedicated limits of liability,” Eastwood said. “If you look at the types of technologies being certified and what they’re being designed to respond to—terrorism, which by its nature a very dangerous thing. And in the insurance world, that’s likely to create a severity issue from a loss standpoint. They’re not getting exposure and putting that into their stand-alone products and professional liability package. I think a company needs to avoid a scenario where multiple products and services are all insured under products liability, including QATT-certified products.
“As this is likely to be a very high severity event,” Eastwood added, “companies could find themselves in the position where they no longer have coverage for the other products and services within the corporation. The inverse of that is that they have other products and services, losses there will erode the limits of liability under the program.” Eastwood said that Lexington has not set a cap on the amount of business it would write related to its Homeland Protector product. Other insurers—admitted and surplus lines—may eventually join Lexington in offering this product, but it is precisely this kind of innovation that is likely to keep the E&S market thriving in tough times.
“Our posture is we’re always looking,” said Scottsdale’s Williamson. “That’s an E&S company. Since this business ebbs and flows, we’re always looking for an opportunity. We haven’t designed the next great hula hoop, but we’ll be looking for it.”