A Challenging Environment
The excess and surplus (E&S) lines market is at a critical point in its development, according to industry experts.
The industry has reversed a five-year decline in direct written premiums between 2007 and 2011, with premiums up 7.6 percent during 2014, according to the latest figures from SNL Financial.
The sector has also more than doubled its share of direct written premiums for the property/casualty (P&C) market, from 3.3 percent in 1993 to 6.9 percent in 2013, as well as its share of total commercial lines premiums (13.7 percent), said A.M. Best.
However, with increasing competition from new entrants and more capital than ever flowing into the market, rates — particularly in P&C — are starting to slow. Subsequently, profit margins have been hit.
A.M. Best currently views the surplus lines market as “stable,” but warned that profit margins may shrink in the near term as average rate increases diminish on various lines of coverage.
“Accident year reserve development for surplus lines companies has been slightly more favorable than the overall P&C industry, but the gap has been shrinking as the markets wrestle with excess capacity, low interest rates and capital outlays to enhance operational efficiencies,” said the ratings agency in a recent report. Added to that, the industry faces a constant battle to attract and retain new talent and to keep up with emerging risks and regulations, or risk getting left behind.
All of these issues will be at the top of the agenda when the National Association of Professional Surplus Lines Offices (NAPSLO) meets at its annual convention in San Diego this month, where 4,000 E&S brokers and wholesalers are expected.
“For NAPSLO members and the market in general, it is an extremely challenging environment right now, particularly in property and casualty,” said Scott Culler, regional president at Markel.
“The biggest question on people’s minds is whether the amount of capacity currently available in the market is sustainable.
“Everybody is scrambling just to maintain market share and to stay one step ahead of the competition. So we are constantly having to come up with new and innovative ways to write business in order to remain viable.”
The recent clamor for market share has seen several big players enter the space, most notably Berkshire Hathaway Specialty Insurance (BHSI), and Tokio Marine Holdings, following its acquisition of HCC Insurance Holdings for $7.5 billion.
Other companies such as XL and Catlin have also merged for greater scale and efficiency, and ultimately to increase market share.
BHSI’s Executive Vice President David Bresnahan said that the trend of consolidation would continue as long as there was excess capital available.
“We see evidence that customers are trying to get in front of those trends, and they are beginning to award larger participations to those carriers with a long-term focus and strong balance sheets who can control their own destiny,” he said.
An adverse effect of increased competition, added Culler, has been to squeeze prices further. For rates in a line such as property, he said, “it’s 10 percent off just to start the conversation.”
“Last year, I thought we were at a point where the prices couldn’t go much lower, but every deal is under pressure now — there’s no such thing as a normal renewal.”
Henry Witmer, assistant vice president at A.M. Best, said that competition from the primary market for risks typically covered by E&S has also accentuated market cycles. As a result, insurers need to be prepared to scale up or down their operations and to adjust their prices accordingly.
“As products offered by the E&S insurers gain recognition and are imitated by others, the true innovators within the market need to study, evaluate and develop replacement products in order to stay on the forefront of the market,” he said.
Despite these challenges, Culler said, insurers are increasingly finding ways to differentiate themselves in a competitive market, while brokers are developing specialist niches.
“As the economy starts to recover, more entrepreneurs are entering the market and new cutting-edge ideas and products are being developed all the time, as well as opportunities being created in lines that the traditional market doesn’t want to write,” he said.
James Drinkwater, president of AmWINS brokerage and one of NAPSLO’s wholesale broker directors, is also bullish about the prospects for companies willing to take on such risks.
“As products offered by the E&S insurers gain recognition and are imitated by others, the true innovators within the market need to study, evaluate and develop replacement products in order to stay on the forefront of the market.” — Henry Witmer, assistant vice president, A.M. Best
“Prices are, on average, declining steadily, due to the amount of capital coming into the market and at the same time the market has become very competitive,” he said.
“However, there are still some hard pockets if you are willing to look, such as the New York City construction and transportation sectors.”
Investment in Technology
Going forward, Drinkwater said, companies need to focus more on improving their technology, and the training and development of their staff.
“Everybody will naturally be focused on the rate environment, but I think there are more important factors at play — for example, keeping an eye on what’s happening with regulation and improving the delivery of our product through greater investment in technology and personnel.”
The greater use of technology and analytics has enabled companies to price more accurately, identify new lines of business and, ultimately, to deliver better cost efficiencies to the customer.
It has also spawned a host of new industries such as unmanned aerial vehicles or drones.
“Everything is revolving around technology right now,” said Wyeth Coburn, associate broker at CRC Insurance Services.
“A lot of companies are sitting and waiting to see what happens, particularly with the drone industry, but as soon as the new regulations come in I would expect there to be a big take-up from carriers.”
Culler added that cyber liability has now overtaken energy as the No. 1 risk for the E&S industry following the rise in cyber attacks.
“I think we are just scratching the surface with cyber, trying to understand the exposures companies face because they change almost on a daily basis,” he said.
Drinkwater added: “The cyber marketplace is one that is evolving quickly and with the recent spate of high profile breaches, insureds are steadily realizing that this is an exposure that they must protect themselves against.”
Amid all these new developments, Bryan Salvatore, president of Zurich North America Commercial’s specialty products business unit, warned that it is important for companies not to lose sight of their core value of customer service.
“I prefer to focus on how we can differentiate ourselves in terms of the value proposition that we offer,” he said.
“In that respect, the whole market needs to think about what it can bring to the table.”
That involves a heavier investment in technology to help both the company and the customer better understand their pricing and exposures, he said.
“At the end of the day, we have to remind ourselves that we’re providing an important end solution to the customer for complex and hard to place risks rather than thinking of ourselves simply as a commodity,” he said.
There are also a host of key regulatory hurdles that the market has to overcome in the short- and long-term if it is to maintain its recent growth.
“I think we are just scratching the surface with cyber, trying to understand the exposures companies face because they change almost on a daily basis.” — Scott Culler, regional president, Markel
Brady Kelley, executive director at NAPSLO, said that the main piece of legislation currently impacting the industry is the Terrorism Risk Insurance Program Reauthorization Act 2015 (TRIA), enacted at the start of this year.
TRIA, which was first enacted in 2002 to provide a federal backstop for terrorism claims, was reauthorized at the start of this year and remains in effect until 2020 to cover new policies that run beyond 2014.
Kelley said that the most important part of the bill is the enactment of the National Association of Registered Agents and Brokers Reform Act 2015 (NARAB II), providing a one-stop licensing system for agents and brokers operating in multiple states.
“That will be a tremendous opportunity for us because it will put in place a national set of standards and a new national electronic system for the processing of insurance licenses, meaning that everything is much more consistent and efficient going forward,” said Kelley.
Fight for Talent
“Many of the veterans in our business are starting to retire now and need to put in place a succession plan for the next generation,” he said.
“That means equipping themselves with the best standards and professional talent available and to prepare them so that they are ready to take on those top leadership roles.”
Despite all the challenges it faces, the industry is well placed to capitalize on the new opportunities and risks, such as cyber liability, that the traditional market doesn’t typically extend to.
Markel’s Culler concluded: “I’m bullish about the E&S market — it’s true, there are a lot of new competitors out there, but there’s also a lot of room for growth.”