As you have no doubt heard by now, this hard market is not just longer; it is fundamentally different. It is by all reports the most moderate in memory, characterized by fewer and less dramatic disruptions of normal market mechanisms. One result of this moderation is that the transition from a buyer’s to a seller’s market has inflicted considerably less pain on businesses that buy insurance, along with the agents and brokers who guide those purchases.
That is diametrically opposed to the outcome events would have led an informed observer to expect of a hard market that comes hard on the heels of the longest and deepest soft market the property and casualty insurance industry has ever experienced. Both logic and history suggest that the disruption of a hard market ought to be in direct proportion to the length and depth of the pricing trough it follows. Underwriters ought to withdraw wholesale from entire lines or classes of business, sometimes leaving entire industries no choice but to scramble for whatever coverage they can find. Insurance companies should be closing their doors to new business early in the year, as they have during past cycle changes, because their rapidly shrinking surplus will not allow them to write any more premium. Those kinds of disruptions have not happened on a large scale this time around.
The kinder and gentler hard market that appeared with the dawn of a new millennium is certainly different, but it is hardly a random occurrence. There are good reasons why the insurance industry has not responded to this cycle change the way it has reacted to every similar event in the past. One of the principal root causes is the performance of a market segment that comes into its own when the going gets tough. This time around the nonadmitted insurers who make up the excess and surplus lines market, as well as the professional surplus lines brokers who represent them, have filled in some of the lowest valleys and leveled some of the highest hills. This has produced a ride that is hardly smooth, but has not been as jarring as most anticipated.
Stepping up to the plate for agents
“I think the excess and surplus lines industry has been excellent in terms of their responsiveness overall since this crisis began in the market,” commented Jim Griffith, president of Princeton Risk Managers and president of the National Association of Surplus Lines Offices (NAPSLO). “I can tell you they have filled the breach. We have seen people stepping in and stepping up to the plate, acquainting themselves with the risk and deciding to get into it.”
Professionals point to both conditions internal to the E&S market and external factors that have extended the hard market while tempering the knee-jerk reaction that has been the hallmark of so many past cycles. Within the E&S marketplace they point to superior management and planning. External influences include consolidation within the P/C industry, reserve adjustments in response to pending asbestos claims and inadequate prices in the years leading up to 2000, and the security of reinsurance recoverables that primary insurers are carrying on their balance sheets.
Sophistication and anticipation
One of the most important drivers of the E&S market’s performance during this cycle has been a more sophisticated management style that saw what was coming and prepared for it. “The CEOs who run the companies in the wholesale industry are by and large pretty enlightened,” offered Richard L. Polizzi, president of Western Security Surplus Insurance, a surplus lines brokerage in Pasadena, Calif. “It’s clear certainly from the A.M. Best study of the surplus lines industry over a number of years that the surplus lines industry has outperformed the standard industry on average.”
The high quality of its management, Polizzi continued, allowed E&S insurers to enter this hard market much better prepared than they have been in the past. “We don’t see the chaos in the surplus lines industry that we probably saw in the last cycle, where markets were closing early in the calendar year because of capacity problems,” he added. “The E&S markets by and large are pretty sophisticated today. They are well managed, and they know what’s going on. They’re much more careful in terms of appointments and who they do business with. They’re much more secure in the classes of business they’re comfortable in. You don’t see them jumping in and out of certain classes of business where they have no expertise and are just trying to make a buck.”
The added stability the E&S market exhibited this time around has eased the pain that customarily comes with the transition to a hard market, but many question whether that hard market is behind us. They point to lower rates and greater capacity in the property reinsurance market as a sure sign that we are entering a new soft market and that rampant competition is just around the corner. If that is true, we can expect to see the standard market expand as carriers pursue market share at any price and the E&S shrink as its more disciplined underwriters walk away from business that they can no longer write at a rate adequate to generate a reasonable profit.
Perspective, perspective, perspective
How you view the market at this moment depends very much on where you stand and what lines of business you are trying to place. In some regions of the country early signs of competitive pricing and coverage appear to be returning like the first robin of early Spring. Reports from elsewhere, on the other hand, seem to suggest the prices, terms and conditions are holding firm, or even that rate increases have abates but continue to be the rule. Overall, property coverage has assumed its customary leadership role, with prices stable or even starting to decline. Casualty coverages are, as usual, bringing up the rear and prices tend to be holding steady or still increasing. Being in the right place will, nonetheless, allow you to find rising property prices and emerging competition for casualty business. Account size is also sometimes a factor in the direction prices are moving and the availability of coverage.
E&S markets in the Southeast mirror national trends reported for the property and casualty industry generally. Property pricing is no longer increasing across the board, but they are not yet declining either. “We’re seeing that property is now flat,” said Jill Jinks, CEO of the Insurance House in Atlanta. “There’s no more rate in it. We’re still able to get 10 to 15 percent on GL, more in certain classes [basically contractors]. Commercial auto remains a disaster.” She attributed conditions in the commercial auto market to a lack of players, which has produced substantial price increases and “a lot of confusion.”
In the Midwest Leatha Heaton, senior vice president, sales and marketing for Shand/Evanston Group, gets a different view. She too has heard that property prices are softening but has not seen any evidence to support that contention. “My expectation is that it will soften because it always has,” she commented. “We just don’t have evidence of that in our book of business today. I think it’s because we really write the tough stuff and there seems to be plenty of need for a strong market.”
Market conditions as seen from the Northeast are remarkably calm. Princeton Risk Managers’ Jim Griffith does not see changes that meet the traditional criteria of a softening market, but instead sees stability coming home after a long road trip. “I don’t know if I could really call it softening in the classic sense of a soft market; kind of softening,” he explained. “I don’t think we’re seeing that, but I think it’s stabilizing. There’s a little more sanity in the underwriting and you are seeing some competition. There’s no question about that. Companies are cherry picking right now. Both the standard and the E&S carriers are looking for that better quality risk and they’re willing to negotiate on those. Those that are more difficult to place are still having a hard time getting attractive terms, but they’re getting terms. There are very few risks that totally go begging in the property field. Casualty is another matter, but property wise there is market for most of the challenging risks.”
Looking at the E&S market from the Southwest the picture is a little less clear. Mac Wesson, president and chief operating officer at U.S. Risk Insurance Group Inc., has been picking up signs of a turn toward a buyer’s market. That would put the Southwest in the unaccustomed position of market, a role the industry has traditionally regarded to states with a seacoast like New York and California. “The general trend is toward a softening, although that doesn’t really describe every aspect of the market,” he said. “You really have to look at it by division or by line of business to answer the question properly.”
Wesson perceives the same dichotomy between property and casualty lines of business that is apparent in other parts of the country. Property coverages are taking the lead and dragging casualty along with them. “Casualty, if you were to describe it in simple terms, it’s more or less flat,” he continued. Property, on the other hand, is much more susceptible to price reductions. I think there’s more or less of an anticipation on the part of our producers that property is going to be decreased by 10 or 15 percent just because.”
On the West Coast the cycle has not progressed nearly that far, at least in the traditional sense of a change that is born in the property market and sweeps through casualty lines as it matures. Property pricing has not reached the stage of automatic rate cuts, according to Polizzi, but there does appear to be a higher level of early competition. “The market is still favorable to us in the wholesale industry, still good,” he said. “I would say that the changes that we’re seeing tend to be in the property market and also in large general liability accounts. Clearly property prices are starting to level if not drop.”
Developments in the market are also presenting agents and brokers with a whole new set of challenges. Consolidation means that there will be fewer choices when it comes time to shop accounts, and rating downgrades are going to make some of those options less attractive. The wholesale side of the E&S market is in a position to offer agents additional alternatives that will become more valuable as the pool of highly rated insurers shrinks.
Insurers are disappearing from the market, especially on the commercial lines side, Griffith said, and that is a genuine concern to agents and brokers. “The retail agents are very concerned,” he explained. “If a smaller retailer has the wrong mix of companies they can find themselves in some difficulty writing certain classes of business for their clientele.” Agents and brokers, he points out, are already talking about the problem and talking publicly.
Downgrades by rating agencies put additional limits on the outlets available to producers. “A lot of agents,” Griffith commented, “don’t want to deal with carriers that have less than an A rating, or certainly less than a B+ rating. There are a number of them now that had to this point been filling an important role, and lot of agents feel they can’t deal with them.”
Identifying the tough classes
Conditions in the market generally do not necessarily predict the conditions individual accounts may face. Some classes are harder to place than others, and what is tough in one part of the country is not necessarily that way from coast to coast.
E&S wholesalers are, for instance, handling a lot of personal lines in the Southeast and Southwest, but that does not appear to be a national trend. California homeowners submissions to wholesalers, Polizzi reports, are also growing, but perhaps not at the rate that you might expect in the wake of the Southern California wildfires. He has not yet seen a reaction to this catastrophe loss, but has heard that markets do not anticipate a change in pricing. Underwriting in brush areas is, on the other hand, receiving additional attention.
Competition for commercial general liability business has started to appear in the Southwest and on the West Coast, but has not showed up in other parts of the country. Loss history and account size are important determinants of which accounts catch the underwriters eye, with higher premiums attracting more attention.
Medical malpractice may give the appearance of being a crisis of national scale, but the evidence suggests that it is a collection of smaller problems that change every time you cross another state line.
Despite evidence that a softening of the market is just over the horizon, the evidence points to an E&S market that is in strong condition and ready to spend another prosperous year tackling the seemingly intractable problems of the insurance industry. As Richard Polizzi put it: “I think that 2004 is going to be another good year for the wholesale industry. The things you read in the trades, various reports from various segments of the industry, still say there’s a lot of work to be done.”
Joseph F. Mangan is an author, editor and consultant with more than 25 years of experience in property/casualty underwriting. He has authored four textbooks on commercial lines underwriting, and has contributed to textbooks on personal lines insurance and operations.
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