NAPSLO 2017

Surplus Lines Growth Slows

Attendees at the NAPSLO convention in San Diego need to find ways to compete, yet avoid falling victim to price wars.
By: | August 29, 2017 • 5 min read

The excess and surplus (E&S) lines market is between a rock and a hard place.

Depressed interest rates and a soft market driven by fierce competition, lack of a big catastrophic event and unprecedented levels of available capital have combined to squeeze margins further and have forced some players to pull back or exit the sector altogether.

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Total surplus lines direct written premiums increased by the smallest amount in five years, up 2.5 percent in 2015, ending two straight years of underwriting gains, according to analysts. However, the market as a whole has more than doubled over the last 20 years from 3.4 percent of total property/casualty (P&C) direct written premiums in 1995 to seven percent in 2015.

As a percentage of commercial lines direct written premiums, surplus lines insurers also increased their share from 6.3 percent to 14.2 percent over the same period.

“With the demonstrated capability to effectively assess new exposures and the flexibility to tailor terms and limits to meet coverage standards, we believe that the surplus lines market will continue to assert its value in the property/casualty insurance marketplace,” an analyst said.

And with a planned merger between the National Association of Professional Surplus Lines Offices (NAPSLO) and the American Association of Managing General Agents (AAMGA), due to come into force before this month’s annual NAPSLO convention in San Diego, there has arguably never been a more opportune yet challenging time to be in the E&S market.

“An abundance of capital, low interest rates and a super competitive marketplace have all conspired to create a challenging set of headwinds,” said Jeremy Johnson, president, U.S. Commercial, AIG.

“Although we believe that the $40 billion E&S market will likely outperform the standard market in 2017, it’s certainly a market beset with a host of familiar challenges.”

Key Challenges

Property was worst hit, with rates falling between 10 and 12 percent, said David Bresnahan, executive vice president, Berkshire Hathaway Specialty Insurance.

David Bresnahan, executive vice president, Berkshire Hathaway Specialty Insurance

“Property remains the softest category by far with the most competition and as a result it has suffered continued rate reductions for several years now,” he said. “In financial lines, primary and lead lines are stable, but excess executive lines are under very heavy competition, while med mal and casualty are the most stable.”

Jim Auden, managing director of Fitch Ratings, said that pricing and competition, particularly from the wider P&C market, were the two biggest challenges facing the E&S industry.

“Profitable avenues of business growth are getting harder to find in E&S,” he said.

“In this part of the market underwriting cycle, admitted carriers’ efforts to maintain premium volume lead them to creep further into what was previously considered E&S space, further pressuring the E&S market.”

Consolidation

E&S market leader Lexington pulled back last year as its direct written premiums fell to $3.76 billion from $4.66 billion in 2015, resulting in its market share shrinking to 12.6 percent from 15.6 percent over the same period.

It is expected to continue to reduce its net written premiums because of unsatisfactory rates.

There has also been an increase in M&A activity led by Japanese insurer Sompo Holdings’ $6.3 billion takeover of Endurance Specialty Holdings.

Allied World Assurance Co. Holdings AG also announced its pending sale to an investor group led by Fairfax Financial Holdings for $4.9 billion, and Liberty Mutual agreed to a $3 billion deal to buy Ironshore from Fosun International Holdings.

“In financial lines, primary and lead lines are stable, but excess executive lines are under very heavy competition, while med mal and casualty are the most stable.” — David Bresnahan, executive vice president, Berkshire Hathaway Specialty Insurance

“I think more capital is and will continue to find its way into E&S, especially in the short tail lines and property,” said AIG’s Johnson.

Despite all of the challenges faced by the E&S market, there are still pockets of opportunity.

Among the biggest growth areas are private flood, drones, the service economy and robotics. But the biggest opportunity is cyber, said Terry Leone, manager, insurance research at S&P Global Market Intelligence.

“Standalone insurance almost doubled in 2016 from $488 million to $911million,” he said. “The more cyber attacks there are, the more demand there will be for protection.”

James Drinkwater, president, AmWINS

James Drinkwater, president of AmWINS brokerage and one of NAPSLO’s wholesale broker directors, added: “People are now starting to buy whereas last year they were just getting quotes.”

Innovation brings opportunity, but Bresnahan said that companies need to concentrate on getting the basics right.

“Carriers need to spend more time on the basics like getting policies issued quickly, paying claims without reservation and generally being a little bit more responsive,” he said.

“That has certainly been the feedback from customers who would prefer the industry gets the basics of service and claims right first.”

NAPSLO/AAMGA Merger

One of the key developments in the E&S market this year was the proposed merger between NAPSLO and AAMGA to form the Wholesale and Specialty Insurance Association (WSIA).

It was a no-brainer, said AAMGA president Corinne Jones, given that 76 percent of AAMGA members also have a NAPSLO membership and 48 percent of NAPSLO members are affiliated with AAMGA.

“The potential synergies of merging the AAMGA and NAPSLO, together serving the entirety of the wholesale, specialty and surplus lines insurance marketplace, became a common sense opportunity the organizations had to explore,” she said.

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“WSIA will be highly effective in promoting the value of wholesale distribution with a stronger, unified voice on behalf of its members.”

Jones said that WSIA will provide a simplified menu of programs and services, a stronger, unified voice in its legislative and regulatory advocacy and improved synergy in committee and volunteer work.

Among the biggest regulatory hurdles yet to be overcome by the new organization is the Flood Insurance Market Parity and Modernization Act of 2017, which is awaiting approval.

Brady Kelley, executive director at NAPSLO, said that NAPSLO continued to focus on lobbying Congress about the Act, enabling the E&S market to continue providing coverage for unique and complex flood risks not available through the National Flood Insurance Program or on the standard market.

Another issue, he said, is lobbying Congress to reform provisions from the Dodd Frank Act in order to maintain the Nonadmitted and Reinsurance Reform Act in its current form.

“We have encouraged members to support H.R. 871, which eliminates unnecessary FATCA (Foreign Account Tax Compliance Act) reporting for the property and casualty industry, and we are asking senators for help in quickly confirming any nominees to the board of the National Association of Registered Agents and Brokers and to allow it to begin the implementation process,” he said. &

Alex Wright is a U.K.-based business journalist, who previously was deputy business editor at The Royal Gazette in Bermuda. You can reach him at [email protected]

More from Risk & Insurance

More from Risk & Insurance

Alternative Energy

A Shift in the Wind

As warranties run out on wind turbines, underwriters gain insight into their long-term costs.
By: | September 12, 2017 • 6 min read

Wind energy is all grown up. It is no longer an alternative, but in some wholesale markets has set the incremental cost of generation.

As the industry has grown, turbine towers have as well. And as the older ones roll out of their warranty periods, there are more claims.

This is a bit of a pinch in a soft market, but it gives underwriters new insight into performance over time — insight not available while manufacturers were repairing or replacing components.

Charles Long, area SVP, renewable energy, Arthur J. Gallagher

“There is a lot of capacity in the wind market,” said Charles Long, area senior vice president for renewable energy at broker Arthur J. Gallagher.

“The segment is still very soft. What we are not seeing is any major change in forms from the major underwriters. They still have 280-page forms. The specialty underwriters have a 48-page form. The larger carriers need to get away from a standard form with multiple endorsements and move to a form designed for wind, or solar, or storage. It is starting to become apparent to the clients that the firms have not kept up with construction or operations,” at renewable energy facilities, he said.

Third-party liability also remains competitive, Long noted.

“The traditional markets are doing liability very well. There are opportunities for us to market to multiple carriers. There is a lot of generation out there, but the bulk of the writing is by a handful of insurers.”

Broadly the market is “still softish,” said Jatin Sharma, head of business development for specialty underwriter G-Cube.

“There has been an increase in some distressed areas, but there has also been some regional firming. Our focus is very much on the technical underwriting. We are also emphasizing standardization, clean contracts. That extends to business interruption, marine transit, and other covers.”

The Blade Problem

“Gear-box maintenance has been a significant issue for a long time, and now with bigger and bigger blades, leading-edge erosion has become a big topic,” said Sharma. “Others include cracking and lightning and even catastrophic blade loss.”

Long, at Gallagher, noted that operationally, gear boxes have been getting significantly better. “Now it is blades that have become a concern,” he said. “Problems include cracking, fraying, splitting.

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“In response, operators are using more sophisticated inspection techniques, including flying drones. Those reduce the amount of climbing necessary, reducing risk to personnel as well.”

Underwriters certainly like that, and it is a huge cost saver to the owners, however, “we are not yet seeing that credited in the underwriting,” said Long.

He added that insurance is playing an important role in the development of renewable energy beyond the traditional property, casualty, and liability coverages.

“Most projects operate at lower capacity than anticipated. But they can purchase coverage for when the wind won’t blow or the sun won’t shine. Weather risk coverage can be done in multiple ways, or there can be an actual put, up to a fixed portion of capacity, plus or minus 20 percent, like a collar; a straight over/under.”

As useful as those financial instruments are, the first priority is to get power into the grid. And for that, Long anticipates “aggressive forward moves around storage. Spikes into the system are not good. Grid storage is not just a way of providing power when the wind is not blowing; it also acts as a shock absorber for times when the wind blows too hard. There are ebbs and flows in wind and solar so we really need that surge capacity.”

Long noted that there are some companies that are storage only.

“That is really what the utilities are seeking. The storage company becomes, in effect, just another generator. It has its own [power purchase agreement] and its own interconnect.”

“Most projects operate at lower capacity than anticipated. But they can purchase coverage for when the wind won’t blow or the sun won’t shine.”  —Charles Long, area senior vice president for renewable energy, Arthur J. Gallagher

Another trend is co-location, with wind and solar, as well as grid-storage or auxiliary generation, on the same site.

“Investors like it because it boosts internal rates of return on the equity side,” said Sharma. “But while it increases revenue, it also increases exposure. … You may have a $400 million wind farm, plus a $150 million solar array on the same substation.”

In the beginning, wind turbines did not generate much power, explained Rob Battenfield, senior vice president and head of downstream at JLT Specialty USA.

“As turbines developed, they got higher and higher, with bigger blades. They became more economically viable. There are still subsidies, and at present those subsidies drive the investment decisions.”

For example, some non-tax paying utilities are not eligible for the tax credits, so they don’t invest in new wind power. But once smaller companies or private investors have made use of the credits, the big utilities are likely to provide a ready secondary market for the builders to recoup their capital.

That structure also affects insurance. More PPAs mandate grid storage for intermittent generators such as wind and solar. State of the art for such storage is lithium-ion batteries, which have been prone to fires if damaged or if they malfunction.

“Grid storage is getting larger,” said Battenfield. “If you have variable generation you need to balance that. Most underwriters insure generation and storage together. Project leaders may need to have that because of non-recourse debt financing. On the other side, insurers may be syndicating the battery risk, but to the insured it is all together.”

“Grid storage is getting larger. If you have variable generation you need to balance that.” — Rob Battenfield, senior vice president, head of downstream, JLT Specialty USA

There has also been a mechanical and maintenance evolution along the way. “The early-generation short turbines were throwing gears all the time,” said Battenfield.

But now, he said, with fewer manufacturers in play, “the blades, gears, nacelles, and generators are much more mechanically sound and much more standardized. Carriers are more willing to write that risk.”

There is also more operational and maintenance data now as warranties roll off. Battenfield suggested that the door started to open on that data three or four years ago, but it won’t stay open forever.

“When the equipment was under warranty, it would just be repaired or replaced by the manufacturer,” he said.

“Now there’s more equipment out of warranty, there are more claims. However, if the big utilities start to aggregate wind farms, claims are likely to drop again. That is because the utilities have large retentions, often about $5 million. Claims and premiums are likely to go down for wind equipment.”

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Repair costs are also dropping, said Battenfield.

“An out-of-warranty blade set replacement can cost $300,000. But if it is repairable by a third party, it could cost as little as $30,000 to have a specialist in fiberglass do it in a few days.”

As that approach becomes more prevalent, business interruption (BI) coverage comes to the fore. Battenfield stressed that it is important for owners to understand their PPA obligations, as well as BI triggers and waiting periods.

“The BI challenge can be bigger than the property loss,” said Battenfield. “It is important that coverage dovetails into the operator’s contractual obligations.” &

Gregory DL Morris is an independent business journalist based in New York with 25 years’ experience in industry, energy, finance and transportation. He can be reached at [email protected]