The overall property/casualty insurance market has been showing signs of softening, but insiders in the excess and surplus lines market are cautiously optimistic about the state of the industry for 2007.
In 2005, the surplus lines market remained fairly stable, despite the decline of the bull market the industry had enjoyed since the Sept. 11, 2001, terrorist attacks. According to the 2006 Surplus Lines Market report from A.M. Best Company Inc., that stability has mostly been maintained through 2006, with earned premiums from surplus market drivers buffering much of the loss of declining rate levels due to increased competition from the standard market.
Despite these signs of decline in the industry as a whole, the extreme growth experienced by the surplus lines industry during that hard-market period, coupled with the business driven into the nonadmitted markets by several devastating hurricanes, has left the E&S industry better poised to handle a downward turn in the market.
"Overall, the property/casualty industry results have been very strong in 2006," said Jim Auden, senior director with Fitch Ratings.
The lack of any massive storm losses in 2006, unlike the billions of dollars in claims from the Three Sisters hurricanes in 2005, has helped maintain stronger underwriting results, keeping pricing in both the standard and E&S markets relatively strong.
"Post Sept. 11, 2001, E&S writers had a lot more underwriting opportunities because admitted players were scaling back on what they were writing," Auden said. "Now we're at a point where there's a real slow growth phase in the market, and admitted carriers are looking for new places to write premiums."
Kevin Kelley, CEO of Lexington Insurance Co., the world's largest excess and surplus carrier, said he expects casualty will be "the story in 2007."
"In my view, there are two dynamics here," he said. "One is market discipline, which is extremely important, and the second, which is corollary to that, is loss-cost inflation. These are the two things to watch."
PROFITABILITY A CHALLENGE
So what will the future hold for the E&S market?
"I guess if I had a crystal ball, I could tell you exactly what to expect next year," said Denise Morris, senior vice president of excess casualty at Liberty Insurance Underwriters. "If you had asked the same question last year, I wouldn't have been right either."
What everyone does seem to agree on is that the market is softening and will continue to do so through 2007. But the outlook for the E&S market isn't dire.
David Blades, a senior financial analyst for A.M. Best who served as one of the lead authors of the Surplus Lines Market report, expects an increase in competition from the standard market, yet he also predicts favorable conditions for the E&S market in the coming year.
"In 2007, surplus lines still will enjoy, to some extent, the robust rates from even those parts of the marketplace that are getting more competitive," Blades said.
"I believe rate levels will be adequate, and believe the underwriting discipline on the surplus lines side will be maintained and allow those companies and those groups to produce solid results," he added.
Morris said although the market is softening, it's not yet soft. She believes there is still money to be made in the primary arena, and said excess casualty is continuing to see rate adequacy despite the downward trend of the cycle.
"There are still a lot of opportunities to make money," she said. "If you're pricing responsibly, there is still money to be had in the surplus lines market."
Because hurricanes Katrina, Rita and Wilma forced many coastal property buyers into the E&S market, John Iten, a director in the property/casualty group at Standard & Poor's, expects the biggest profit opportunities in 2007 to come from catastrophe-exposed properties.
"The issue there, though, like every other insurance company, is the appetite is only so much (based on capitalization and risk tolerance)," he said.
Kelley said those changes to the property/casualty market as a result of disasters won't necessarily go away in 2007.
"I think the property side is better able to withstand a shock or a series of shocks similar to what we experienced in 2004, but I think the market could underestimate loss-cost inflation in 2007 on the casualty side," he said. "If it does, that could be the big story and in essence, could even create some market torrent in 2008."
Blades suggested success lies in new product development.
"Those surplus lines carriers that come out with innovative products, typically in the marketplace when the soft cycle sets in, those are the companies that end up doing the best," he said. "Usually, when competition ratchets up, surplus lines get more creative with freedom of rate and form, and a lot of growth opportunities come from surplus lines as well."
As the E&S market forcibly retreats from the gray areas of the standard market, the increased competition from the admitted market will bring opportunities, according to Greg Crouse, president of Crouse & Associates in San Francisco.
"As the market softens and business flows back to the standards, opportunities will be, as always, in writing the true, core E&S business in that region," he said. "Efficiency will also create more opportunity because whoever can handle twice as much business with the same recourses will be able to write twice as much business."
The softening market has already brought plenty of competition into the surplus lines from the admitted carriers.
"The most significant competitive factor is definitely the standard markets coming back and writing tougher risks," said Crouse, who saw as much as a 50 percent decrease in standard-market rate from 2005 to 2006, and a 10 percent to 15 percent reduction in rate from E&S, excluding catastrophe property.
"Some say it only takes 15 percent of the market to create a soft market," he said. "We see very few standard markets that are not being extremely aggressive, especially on new business, so we are probably far past this number already."
Bill Newton, president of Lemac & Associates in Los Angeles and the new president of the National Association of Professional Surplus Lines Offices Ltd., said he wasn't prepared for the standard market to grab his $20,000- to $100,000-accounts this early in the soft-market cycle.
"Normally I would have said that the small- and medium-sized accounts would be a great opportunity, but that has proven not to be the case," Newton said. "I would have thought they would have left that business alone at this stage of the cycle. All I know is that I've lost a number of renewals as of Oct. 1 (2006) in that price range, and I've lost them to the standard market. I think it's going to happen all over the industry."
Blades, too, said he was surprised to find the standard market looking at accounts of less than $50,000--even accounts where premiums are just $10,000 to $15,000--before the end of 2006.
"Generally that size of business has been able to stay out of the competitive fray," he said. "Now on the casualty side, some middle-market accounts and even some smaller surplus lines will see competition increased."
Although the standard market remains wary of coastal properties, industry insiders believe admitted carriers will be competing for errors-and-omissions coverage, noncatastrophe-exposed property, general liability and even umbrella coverage.
Morris at Liberty Insurance Underwriters predicted admitted carriers will be looking at low-to-moderate hazard business as a new writing opportunity. "The standard markets are very hungry for that business," she said.
Newton said he has even seen a resurging interest in construction from the standard market. "Most of the standard carriers lost a lot of money doing construction in the 1990s," he said. "They exited that entire class of business. Now they're getting back into it."
Crouse said this competition is not limited to standard carriers expanding their risk appetite, but can be linked to the ability of carriers to form risk retention groups and specialty programs more easily than ever before.
"Just about every carrier has a program division looking for that niche that will help them consolidate homogenous risks," he said. "As these are created, more difficult classes will leave the current carrier, wholesaler or E&S marketplace altogether."
Despite these challenges, Newton of NAPSLO believes the E&S market will remain flat, with more premium volume coming from the property side than in the past to make up for the decrease in casualty premium volume siphoned off by the admitted market.
He's also confident that the redundancy in reserves created by surplus lines carriers in the hard market will help keep the E&S market profitable even as rates decline.
"If you want to grow your business, there's basically two ways to do it: One is to buy someone else and the other is to expand the appetite of what you write," Newton said. "I think (the admitted market) has noticed how much money the surplus lines industry has made on these classes of business and figured, if the surplus lines business can do it, so can they."
Kelley is confident that success in the market is going to come down to execution. "I think that 2007 is going to be a market where smart execution on the part of insurance carriers will be the key to success," he said. "Those that have more competitive advantages will do much better than those that do not."
lives in Chicago.
January 1, 2007
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