Surplus Lines Premiums Fall Flat In 2004

Executives say Katrina will harden property nationally, as wellas liability

San Francisco

In spite of the fact that premium growth in the surplus linesindustry is now absolutely flat, insurance company executives whosecompanies participate in the market say they're not standingstill.

Speaking to National Underwriter here during the annual meetingof the Kansas City, Mo.-based National Association of ProfessionalSurplus Lines Offices, Ltd., some said new initiatives at theircompanies are aimed at putting more premiums on the books. Othersare directing efforts toward enhancing relationships withwholesalers.

Still others speculated that Hurricane Katrina will harden amarket where slow growth is no longer confined to large propertyrisks.

"All of us casualty guys are saying we don't see how it [thehurricane] can not affect the casualty business," said Brian Evans,vice president for the E&S Individual Risk unit of GE InsuranceSolutions.

Joseph Morris, chief executive officer of Hatboro, Pa.-basedPenn-America, said, "What I've heard at this convention from myagents" is that property markets "are already informing them toexpect rate increases--even outside the Gulf."

The comments came as rating agency A.M. Best, as it has for adozen years, released its annual report on the excess and surpluslines market. In the report, the Oldwick, N.J.-based rating agencysaid that in 2004, direct written surplus lines premiums of $33.0billion were just 0.65 percent higher than comparable 2003premiums. In contrast, direct premiums for the entire industry rose4.5 percent.

The report reveals that 2004 was the first year since 1997 thatgrowth in total p-c industry premiums eclipsed surplus lines. Themeager 2004 surplus lines growth rate followed three years ofextraordinary jumps--35.7 percent in 2001, 61.7 percent in 2002,and 28.3 percent in 2003.

Individually, growth was uneven among E&S players. Acomparison of premiums for the top-25 surplus lines writers withthose listed in the prior Best reports reveals that while many ofthe biggest U.S. surplus lines insurers posted declines in 2004,second-ranked Lloyd's saw its E&S premiums rise 2.3 percent to$4.5 billion. (At top-ranked American International Group, E&Spremiums fell 12.1 percent to $7.0 billion.)

Mr. Morris observed that Lloyd's has been a formidablecompetitor for risks that small-risk specialist Penn-America oncewrote in its package book. "We're now seeing the monoline propertyput in Lloyd's, and we write the liability," he said.

As a group, insurers that are part of Bermuda-basedorganizations had the largest E&S growth rates. They includeArch Insurance, rising 23.6 percent to $824 million; XL America,jumping 32.7 percent to $396 million; and Axis, up more than 50percent and making its first top-25 appearance with $383million.

"I don't think they've moved to any kind of a first-tierposition in agents' offices. But they're out there," Mr. Morrissaid.

Standard Markets Back In the Game

At GE Insurance Solutions, Mr. Evans said some habitational,products and service risks are flowing back into the standardmarket, while contractors' opportunities remain in the E&Sliability market.

Liability pricing has been flat or decreasing, he said. "We haveaccounts where we've gotten increases, but across our book, we're abit negative," he noted. In spite of declines, he said pricesremain at levels needed to meet return targets.

Scott Bayer, senior vice president in the general liabilitydivision of Liberty International Underwriters in New York, agreed."Our typical account is being shopped for a decrease, but rates arestill adequate," he said, noting that most opportunities for LIUare in the middle market. "There's a market perception that thelarger the account, the greater the price flexibility, which is whywe don't write a lot of that."

Mr. Morris said Penn-America, whose average account premium is$2,000, is still getting "a few points of rate" on smallcontracting and habitational risks that remain beyond the reach ofstandard markets. But standard insurers are stepping up in retailstores and restaurants, he reported.

Mr. Bayer said that among three broad target classes for hiscompany--owners, landlords and tenants, commercial contractors, andproducts--OLT had the most movement back to standard carriers,adding that price didn't explain the shift. Instead, standardmarkets offer to write at lower attachment points, or evenfirst-dollar. That's an approach "we can't, or won't, competewith," he said.

Although Mr. Bayer and Mr. Evans both said there are stillopportunities for E&S insurers to write tough classes ofproducts liability, standard insurers now have broader appetitesfor products also. "That business never really hardened," Mr. Bayeradded.

Katrina's E&S Impact Predicted

Looking ahead, most of the predictions voiced at NAPSLO centeredaround the impact that Hurricane Katrina might have on E&Sbusiness, even in liability lines.

Mr. Evans, noting industrywide loss estimates as high as $60billion, reasoned that liability prices would have to rise withininsurers' portfolios "to supplement returns that are missing" inproperty lines, he said.

"It's like an investment portfolio. If you have some stocks thatare performing poorer than others, then you want to try to balancethat. If something is performing poorly over here, you're going tohave to get some more dollars over here," he said, gesturingalternatively with his left and right hands.

As for the prospect of direct exposure to liability insurers,carrier representatives agreed that environmental/mold issues andcertain professional liability exposures (such as that evidenced bya lawsuit against a nursing home operator in Louisiana for failingto evacuate residents) were among the most likely to produce lossesfor liability insurers.

On the property side, Mr. Morris said areas outside theGulf--specifically Florida and Texas catastrophe-exposed risks--arealready being impacted with price hikes. He added that with Floridamarket rates back up to levels his company has been charging, thereare now opportunities to put unused capacity to work in a statewhere it lost one-half of its insured property value tolower-priced competitors in recent years.

Changes In A Static Market

For LIU, new opportunities are mainly coming as a result ofopening two new offices--one in San Francisco in March 2004, andone in Chicago last September. "From our standpoint, [existingoffices in] Boston and New York are flat offices that have reachedcritical mass," Mr. Bayer said.

While opportunities in new offices still come from the same 150wholesalers the company had been dealing with, they're controlledregionally. That made them unlikely to be sent to the East Coastbefore.

An even newer LIU initiative is a recently established casualtyprograms unit--an initiative that will further diversify the bookof business, he said. Liberty will consider primary casualtyprograms within niches not entertained on the brokerage side.

"It could be a class we entertain but a smaller account," hesaid, clarifying the guideline, and adding that only existingprograms will be considered. "We prefer not to hitch our bets togood ideas," preferring to stick with proven programs.

At Hartford Steam Boiler, Vice President David Schraederreported progress with his company's initiative to add equipmentbreakdown coverage to surplus lines policies. In-force counts areup 45 percent, he said, referring to a program in which specialtyinsurers can automatically add equipment coverage to policies,while ceding premiums and losses for the coverage back to HSB. (SeeNU, Sept 20, 2004 for a complete description of the program.)

He chalked up increasing interest in this new business source torecent efforts to attract wholesalers--not just E&Sinsurers--to the concept.

Noting that United National has now joined AIG's Lexington amongE&S insurers offering the coverage, he said: "United Nationalcan't just go to its wholesalers and say, 'Do this.' So...we'llprice United National's business, but we then go wholesaler towholesaler and ask if they want to include equipment breakdown intheir United National packages," he explained. If they say yes,"then we flip the switch on."

A seemingly more dramatic change took place at UnitedNational--and Penn-America--in January of this year, when the twoE&S insurers completed a merger. Mr. Morris explained that thedeal was initiated when Penn Independent Corp., a 30 percentshareholder in Penn-America, decided to sell for estate-planningpurposes. What was once a business with a rich family historybecame one of the operating units of United America Indemnity, aCayman Islands-based holding company. (See NU, June 11, 2004 formore on the history.)

However, according to Mr. Morris, the core tenets of eachcompany remain unchanged. "We run the businesses separately," hesaid, noting that the combination wasn't driven by goals of addingrevenues or cutting expenses. "We rarely competed before and werarely compete now. We don't appoint each other's agents or quoteeach other's renewals."

Currently, Mr. Morris said Penn-America is focused on improvingrelationships with 66 general agency partners. For example, an"overhaul" of an automated underwriting manual is nearingcompletion. The result will be an automated database, allowingagents to easily identify eligible risks, rates and exclusions.

The reworking comes in response to agency feedback, he noted."They said our manual was no better or worse than anyone else's."Being "easiest to do business with," he added, "will facilitategetting more business."

Mr. Morris also said there is "room for more appointments" atPenn-America. While the company limits appointments in each state,he said, "ultimately we could be at 80 or 85 agents" withoutinterfering with that strategy.

Flag: Best Reports

Head: E&S Market Still Strong

As it has for more than a decade, A.M. Best compared thefinancial strength of the E&S market with the rest of theindustry.

The Best report, distributed at National Association ofProfessional Surplus Lines Offices annual meeting, was commissionedby the Derek Hughes/NAPSLO Educational Foundation--set up in 1991to improve education about surplus lines. Best found:

o With $33 billion in direct premiums, the E&S market sharewas 6.9 percent of p-c industry premium last year, and 14.1 percentof commercial lines.

o Surplus lines insurers had a higher average rating--an "A"rating--than the p-c industry in total, which has a median ratingof "A-minus" as of July 2005.

o Since 1976, the failure rate for surplus lines carriers (1.09percent) has been slightly higher than the overall industry (0.90percent). Best attributes some of the difference to higher E&Sfailure rates in 1999 to 2003, related to the demise of someprogram writers that afforded too much underwriting authority toMGAs.

o In 2004, the combined ratio for 65 surplus lines companies was92.7 versus 98.1 for the industry. On average, surplus lineswriters bested the industry's combined ratio by 10 points over fiveyears.

o Outside of Bermuda, top E&S growers on Best's top-25 listwere Greenwich, Conn.-based W.R. Berkley, where E&S premiumsrose 15.1 percent to nearly $1.1 billion, and Los Angeles-basedArgonaut, which reported 11.5 percent growth to $421 million.

Massive Katrina property losses are likely to spur price hikesin liability lines to help bolster multi-line insurer incomestatements

Flag: Growth Slumps

Growth rates of direct written surplus lines premiums for thelast four years, according to A.M. Best, were:

o 35.7 percent in 2001

o 61.7 percent in 2002

o 28.3 percent in 2003

o 0.65 percent in 2004