Wholesale Growth Is Cycle-Proof; Dual Distribution Has Failed: AIG’s Zaffino

By | September 13, 2022
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Peter Zaffino, president and CEO of American International Group, began a presentation at the Keefe, Bruyette & Woods Insurance conference last week by reviewing changes in AIG’s risk appetite and underwriting culture that turned around its general insurance (property/casualty) business. Later, he spent several minutes discussing equally dramatic changes he’s witnessed in the wholesale market as well.

“I’d have to give a thought, [but] are there parts of the business that have changed more?” he asked rhetorically, when KBW Managing Director Meyers Shields asked the executive to talk about the state of the wholesale market.

Shields informed conference attendees that his interest in Zaffino’s perspective on the wholesale market was prompted by news earlier in the day that Liberty Mutual would change its dual-channel distribution strategy for surplus lines and specialty business. Liberty Mutual announced on Sept. 7 that its Ironshore operation is becoming a wholesale-exclusive brand, while specialty and E&S business placed through retail brokers will carry Liberty Mutual’s brand. (Related article: Liberty Mutual: Ironshore to Become Wholesale-Exclusive Brand)

“The last holdout,” Zaffino quipped. Zaffino was referring to the fact that like Liberty Mutual, AIG refocused its Lexington Insurance brand back in 2019.

A January 2019 announcement that Lexington would concentrate on the excess and surplus lines market, with its core property and casualty products available primarily through wholesale brokers, was a key step in AIG’s turnaround effort. (Related article: “Remaking AIG: CFO Describes Changes in Underwriting, Distribution and More)

Prior to 2019, “AIG in Lexington, and a lot of the executives that [have since] left AIG, had the model where you can do dual distribution, which I think has proven to fail,” said Zaffino, the former CEO of retail broker giant Marsh. “You have to focus on where distribution [is]—the admitted market is more retail; the nonadmitted is much more wholesale.”

“What happened [was] if a wholesale E&S player took both distributions, they’d get the bottom of the barrel of both retail and wholesale,” he asserted. “That’s just the way it works. Retail’s not going to go and advocate for a market that a wholesale broker can go to. And the wholesale broker’s not going to give its best business to an underwriting company that’s going to accept retail.”

“The winners are the ones that have both businesses and both dedicated distributions that are clear.”

Giving his broader perspective on marketwide changes at the KBW conference, Zaffino suggested that the market dynamic in which “very difficult-to-place businesses, if you go back 10, 20 years ago, found their way to wholesale brokers, which found their way into excess and surplus lines,” is a relic of the past.

“That’s the old model.”

During the past five or six years, the wholesale distribution channel has grown three or four times that of retail, he reported. “They’re grabbing market share. They’re growing faster. That’s No. 1. No. 2 is they are creating more delegated authority through their MGUs and MGAs, where the old model would be to get one or two carriers to do a line of business. Now, they’re getting these syndicated. They’re much more sophisticated. They’re getting these placements syndicated—again, grabbing market share. And they’ve become a professional placement arm for agencies of mid-to-small size.”

“All of that is propelling growth” for wholesalers. “And I don’t think it’s cyclical…If you go back 20 years, obviously Ryan [Specialty] didn’t exist, but they [wholesalers] just weren’t that large. And so they became much more an adjacency.”

“Today, the top three wholesale brokers all place $15 billion or more of premium into the market…They [don’t] see, and nor do I, any slowdown in terms of their ability to grow. They have become much more specialized, have much more expertise.”

“So, I think the [insurance] companies that win are ones that dedicate themselves to understanding that market.”

Zaffino suggested that Lexington’s clear distribution strategy is fueling growth in the current market.

“If I look at the rate environment, it’s not something that’s shopped a lot,” he said, referring to E&S business placed with Lexington. In retail, “the traditional placement mechanism is send [a submission] out to multiple carriers [to] figure out the ones you want to align with, get the best pricing and clear the market. On wholesale, it goes to usually one or two markets. You hit the bid, you bind it.”

“It’s less price sensitive.”

“We’ve seen that. We’ve had 16 quarters in a row of double-digit rate increases in property wholesale” throughout the industry. “And Lexington itself has had 13 quarters in a row of greater than 10 percent rate increase,” he said.

Returning to the news of the day, Zaffino said, “I think Ironshore had the playbook of the old AIG when Lexington was bigger than everybody else and had a dual distribution…I don’t know what was behind the decision, but [now] it’s just going to be aligned with the way the rest of the market is.”

In a media statement, Ironshore President Matt Dolan offered this rationale: “Since Liberty Mutual’s acquisition of Ironshore in 2017, we have offered commercial, specialty and E&S products under both the Liberty and Ironshore brands, regardless of channel. [Now], the distinction between Liberty Mutual for retail and Ironshore for wholesale will create a clearer, more consistent experience for customers and partners and demonstrates our dual-channel commitment.”

A day before last week’s KBW Insurance conference, rating agency AM Best published its annual report on the U.S. Surplus Lines market ranking leading production sources of E&S premiums. According to the report, “The Best’s Market Segment Report, titled “Record-High Direct Premiums Written for the U.S. Surplus Lines Segment in 2021,” more than two-thirds of E&S direct premium was placed through wholesalers in 2021—56.8 percent through wholesalers without binding authority and 19.8 percent through wholesalers with binding authority. Retail agents were the next largest production source, responsible for placing 12.6 percent of U.S. E&S direct premiums in 2021, followed by program managers, placing another 10.0 percent.

At the KBW conference, Zaffino told Shields, “Five years ago—you’d have to ask the wholesale brokers for the exact number, but wholesale-only insurance companies, I think you could count them. [There were] probably 10 or less. And today there’s 50 or more that have said, ‘We’re just going wholesale. That’s where we’re dedicated, and that’s where we’re going get our business from.'”

“The market’s changed,” he asserted.

Two days later, another specialty player, AXIS Capital Holdings Ltd., announced that it would launch AXIS Wholesale, a new division dedicated specifically to servicing the wholesale market. (Related article: AXIS Capital Launches Wholesale Division)

“AXIS has operated in the wholesale space since our inception, and with the launch of AXIS Wholesale we’re leaning into what we do best,” said Carlton Maner, who was appointed as CEO, AXIS Wholesale. “Through the new Wholesale division, we’re introducing dedicated teams and resources focused specifically on the wholesale channel. This speaks to our ambition to grow profitably with our customers as we introduce new products and services designed directly to meet their needs.”

AXIS Capital’s latest news followed a June announcement about the company’s intention to exit property reinsurance business to focus instead on casualty, specialty, accident and health, and credit lines.

AIG’s 2019 declaration that most of the business written out of Lexington would be through wholesalers also ushered in an appetite change at Lexington Insurance at the time—away from mega-account business written through retail brokers to today’s focus on smaller account wholesale business. (Related article: Remaking AIG: CFO Describes Changes in Underwriting, Distribution and More)

Last week, AIG announced a continuation down that path, not just positioning Lexington to write smaller accounts but to officially launch a Middle Market Casualty team, a group of dedicated underwriters focused on providing insurance coverage exclusively to small-to-medium-size commercial enterprises. (Lexington Starts Middle Market Casualty Group for SMEs)

Zaffino reviewed the earlier change in Lexington’s appetite along with a host of other steps in AIG turnaround during his introductory remarks kicking off the KBW session last week.

“We needed to address a variety of things. The poor underwriting results. And those were over a prolonged period of time. Our underwriting structure and the team that needed to be overhauled and refocused. We needed to significantly reduce volatility in the portfolio due to large cat and non-cat losses. We needed to establish a more prudent and sustainable reserving philosophy with an overhaul claims and actuarial operations. There were businesses that needed to be exited or totally repositioned.”

“We had a very ineffective reinsurance strategy and needed to establish a new measured strategy for growth that moved away from taking large positions on single risks and instead place significant focus on combined ratio improvement while positioning businesses for better risk-adjusted returns, as well as top-line growth,” he said, before moving on to a high-level overview of AIG’s work to modernize its operating infrastructure and a discussion of major changes in the structure of AIG’s reinsurance program.

Drilling down on some of the underwriting revamp that would ultimately result in AIG achieving its first sub-90 combined ratio since before the financial crisis during second-quarter 2022, Zaffino said “the key change was creating a culture of underwriting excellence, which was largely driven by the hiring of hundreds of experienced underwriters that were not at AIG at the time.”

“Three thousand underwriters had their authority revised, mostly to reflect our risk tolerances and to reposition businesses based on our view and where we thought we could get the best risk-adjusted returns over time,” he said, highlighting portfolio changes involving the reduction of gross limits by over a trillion dollars since 2018 and cumulative rate hikes of over 50 percent from 2018 through the second quarter of 2022. “This includes over 100 percent rate increases in retail property, excess casualty, Lexington casualty and property, and in cyber liability, just to name a few. While rate increases have come down on a nominal basis compared to prior years in certain areas, we’re focused on retention of a high-quality book and maintaining price above lost cost trends and continuing to develop margin,” he said.

Recognizing that the AIG turnaround story was likely somewhat familiar to investment analysts in attendance, Zaffino said he felt it was worth repeating “because the last five years have been about the heavy lift that was required to position AIG for success, today and over the long term, as a global property and casualty company. Most importantly, I want our stakeholders to recognize that AIG is not the same company it was in 2018,” he said.

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