Last January separate panels of analysts who follow the insurance industry and CEO’s of insurance companies predicted a “foreshortened” cycle, a brief hard market that would give insurers little relief from the woes brought on by their own lack of underwriting discipline (Insurance Journal, February 25, 2002). In retrospect some of that winter day’s predictions seem almost laughable. The market shows no signs of softening, a mixed blessing for excess and surplus lines insurers and the brokers who represent them. The current avalanche of submissions promises healthy profits and a chance to recoup past losses, but it puts a strain on the resources available to manage the business. It also raises questions in some minds about the capacity of the E&S market to absorb all the premium policyholders are throwing at it.
Although the hard market has created challenges for E&S carriers, managing general agents and wholesale brokers alike, as a group they remain optimistic. They are more than content to wait out the storm of the hard market and reap the benefits it is bringing to E&S professionals. “This is when we do our best work,” said Max Williamson, president and COO of Scottsdale Insurance Company. “The market is tight so we need to respond to the needs of the buyer, and we’re doing it. This is our opportunity to demonstrate our ability to perform.”
Financial capacity is one of the biggest concerns generated by a seller’s market. Insurance companies that grow too fast inevitably find themselves in financial trouble, and the growth of E&S writings has been nothing less than spectacular. Richard M. Bouhan, executive director of the National Association of Professional Surplus Lines Offices (NAPSLO), reports that premium flowing to E&S insurers is up substantially, with stamping offices reporting growth rates in the neighborhood of 60 percent. Hard data from the Surplus Lines Association of California paints a similar picture of spectacular growth. For the most popular coverages, E&S premium during the first five months of 2002 reached 64 percent of 12 month premiums for 2001. That represents an annual growth rate of 53 percent, more than enough to raise red flags for an individual insurance company or even for the industry as a whole.
Excess and surplus lines professionals, however, do not view the explosion in written premium as a threat to the financial solidity of E&S carriers, and they are offering sound reasons to support their conclusions. E&S insurers, they point out, are fundamentally stronger than they have been in the past. This hard market also started at a time when insurers generally had more of their capacity available than during previous cycles. Finally, reinsurance support is more available than in earlier market constrictions.
Leverage helps explain both why E&S carriers went into this hard market from position of strength and the amount of capacity they bring to the fray. The soft market drew to a close at a time when the ratio of written premium to surplus for the insurance industry was in the neighborhood of 1:1. The higher written to surplus ratios typical of hard markets in the past constrained the ability of insurance companies to put more premium on the books. That ingredient is missing in the recipe for the current market constriction. Gilbert Hine, president of McLelland & Hine Inc., believes that the lower ratios make a difference. “I just think there is more capacity this time,” he commented. “If you go back and look at the premium to surplus ratios the past few years, they’re well below historical averages.”
|Highest Premium Volume by Coverage 2001 (Top 15)|
|Environmental Impairment Remediation||$171,866,880|
|Errors & Omissions All Other||$166,421,113|
|Commercial DIC/Stand Alone EQ||$153,810,673|
|Directors & Officers||$93,684,033|
|Special Multi Peril||$82,352,377|
|Contractors Engaged in New Tract Homes||$49,978,993|
|Employment Practice Liability||$46,194,158|
|Excess Liability/Underlying Nonadmitted||$38,752,414|
|Individual Insured w/Large Schedule TV||$34,215,980|
|Source: Surplus Lines Association of California|
|Highest Premium Volume by Coverage Jan.-May 2002 (Top 15)|
|Commericial DIC/Stand Alone EQ||$123,309,180|
|Errors & Omissions All Other||$117,576,913|
|Directors & Officers||$78,894,837|
|Special Multi Peril||$50,332,550|
|Contractors Engaged in New Tract Homes||$29,349,096|
|Employment Practice Liability||$29,166,340|
|Environmental Impairment Remediation||$28,016,329|
|Excess Liability/Underlying Nonadmitted||$23,985,559|
|Individual Insured W/Large Schedule TIV||$17,097,892|
|Source: Surplus Lines Association of California|
Changes in ownership among the leaders of the E&S market are also making a difference, putting more capital into the market to create capacity. “I think this time around the ownership of surplus lines companies is in much stronger hands than it was back in the early to mid ’80s,” explained Andrew S. Frazier, president of Western World Insurance Group. “If you go through the list of the top 25 surplus lines companies, most of them are owned by larger organizations that have a lot of money. I’m sure that if they felt this was the sweet spot of their business they would add to capital or do intercompany pooling or whatever is necessary to fill the bill.”
Having a parent with deep pockets, however, is not a prerequisite to a marriage between sound financial condition and effective response to a rapidly expanding market. Although it has remained independent, Western World has the financial resources to meet the demand facing it. “We have a very strong capital position,” Frazier pointed out. “We always have, and we have an immense amount of financial capacity to write business.”
Adequate financial capacity for the industry, however, does not mean that every E&S carrier is plunging full speed ahead into the market. Some E&S insurers are holding back, making a conscious effort to limit the amount of premium they put on the books. “I think you’ve got a mixed bag there,” commented Stephen Conner, president of Crump Insurance Services. “You’ve got some that are holding their premium writings down and others that are taking all they can get.”
There are two possible explanations for this distinctly different response to what many would see as an unqualified opportunity to rake in new business and turn a healthy profit. Some E&S insurers that are part of a larger organization have received instructions from their parent companies to hold down growth in their written premium. Others have stretched their physical and human resources to the limit and have made a strategic decision that some restraint on premium growth is essential to maintaining the quality of the services they provide.
Limitations imposed by a parent do not necessarily reflect a weakness in capital structure or lack of financial capacity, not even the extreme response of shutting down an E&S operation just when the market offers the promise of maximum profits. These organizations perceive their core competencies as offering the best use of their capital, and the E&S market is outside their core. Reining in E&S underwriting, or getting completely out of the business, is purely a question of capital allocation by organizations that are not committed to the E&S market.
The capacity of personnel and physical resources to process business without sacrificing quality introduces a nontraditional measure of capacity. Frazier dubbed it administrative capacity. He suggested that the financial strain that premium growth is causing does not explain why some E&S carriers have put on the brakes. Their concern lies with boundaries on nonfinancial resources, the people who work for them, the places where they work and tools of their trade. These insurers have determined that continued expansion of premium volume demands sacrificing the quality of their services. With no short-term opportunity to expand their staff and facilities, they have made the painful decision to limit the premium they will write.
Underwriting capacity, the ability to offer high limits of liability, is a somewhat different story. NAPSLO’s Bouhan made the point that providing underwriting capacity has never been a strong point of the E&S market. He identified the hallmarks of the E&S business as higher premium, lower limits and more restricted coverage, an appropriate response to the distressed business that is the E&S insurer’s bread and butter.
Some E&S carriers are, nonetheless, being drawn into the underwriting capacity game. Like their counterparts in the standard market, they are declining to go it alone on property accounts with high total insured values or liability exposures with high limits of liability. They are, instead, offering to take a piece of a large account. If figures from the Surplus Lines Association of California are any indication, however, providing underwriting capacity is declining in importance among E&S carriers, at least for property accounts. Over the first five months of 2002, the growth in premium for accounts with total insured value over $500 million has lagged behind other classes and the E&S market as a whole. Despite a healthy annual growth rate of 20 percent, providing underwriting capacity for property accounts has taken on the appearance of a neglected stepchild.
Adequate capacity in the E&S market does not by any means imply that wholesalers and managing general agents are pushing against an open door when they set out to place an account. Markets have dried up for isolated classifications and coverages, and some E&S brokers find that they have fewer choices today than they did a year ago. Bouhan reports that E&S brokers are encountering placement problems with selected classes, notably nursing homes and certain contractor classifications. Others support his conclusion. “We do not see a lack of capacity or appetite for business in general,” Hine said. “There are specific areas that have some problems. Overall there appears to be plenty of capacity, but there are classes where capacity is a problem.”
Scottsdale’s Williamson is among those who believe that the lack of markets for tough classes is transitory, a temporary condition that prevails only for the time it takes the market to adjust to changing conditions. “There are some areas that are difficult for anybody, he asserted, “but there are also in these areas markets trying to respond to them in some way, trying to provide some relief.”
Despite the rosy picture E&S professionals paint of the market, some brokers are facing a real loss of capacity. “We have less companies that we can go to right now and that has been a capacity problem,” said Jim Hippard, president of California-based Yates & Associates Insurance Services. He reported that his experience reflects overall market conditions. The shortage of capacity is more acute for MGA operations than for wholesale brokerage activities. Although he acknowledges that there is adequate financial capacity in the market, Hippard reported en-countering difficulty in placing business. He described the problem as more a matter of fewer choices and a lack of any basis for comparison than an outright inability to find a home for the business.
As they look to the future, E&S underwriters and brokers alike are optimistic. They predict changes, but view them as positive developments rather than a deterioration in the marketplace.
Conner identified building relationships as one key to success. “Overall it’s better for the wholesalers who have strong relationships with their markets than it has been over the past thirteen years,” he asserted. “Those wholesalers that have worked to develop strong market relationships are doing extremely well in this market. That doesn’t mean they’re not having a difficult time, but they’re doing well. On the other hand those wholesalers that do not have strong market relationships are struggling.”
Despite the problems he describes, Hippard also remains confident about the future. He anticipates consolidation within the industry, leaving fewer brokers with about the same premium volume, but says that the E&S broker is not on the verge of extinction. “I really think that we’re not a dinosaur,” he said, “at least not in the foreseeable future.”
The expectation that there will be fewer players in the future is widely-held among E&S professionals, but they generally do not see that as either a negative development or a consequence of the market cycle. They view mergers and acquisitions as a natural development, and regard the hard market as less of a cause than an occasion or an opportunity.
Inherent weaknesses that move to the forefront during a market constriction will motivate some mergers and acquisitions. It will strengthen wholesalers and MGAs whose relationships and staff are not up to the demands of an increasingly demanding market. They will look for larger buyers who have solid relationships.
A capable staff and strong relationships, however, provide no guarantee of survival. A hard market drives up the value of wholesalers and MGAs. Conner believes that this may be sufficient inducement for smaller and mid-sized E&S brokers to join a larger organization. “I think that there will be mid-sized wholesale brokers that see this as an opportunity to sell out,” he said.”
Underwriters and brokers agree that consolidation can be a positive development. “It’s probably good for the industry,” Hine offered. “What we see happening is that E&S brokers, like agents, will have larger commitments with fewer markets. Good E&S agents will be able to cope with that and get by and do well. This has been a tremendous opportunity for us.”
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