THE INSURANCE industry is obsessed with cats–as in catastrophes.Hurricane cats–especially “Kat-rina”–have raked insurers forbillions of dollars in the last couple of years. Many reinsurershave become particularly allergic to this kind of cat and havewithdrawn from its haunts as far as they can. The market appears tobe edgy about other cats as well, including earthquake cats inCalifornia. Right now, it's cat season in the Gulf and on theEastern Seaboard, and you can almost sense the industry holding itscollective breath and hoping to ride out the next couple of monthsrelatively unscathed.

For the E&S industry, cats present opportunity as well asrisk. There is money to be made in Big Cat country by those whohave capacity and the confidence to use it. And the freedom of rateand form that characterizes the E&S market theoretically shouldprovide these players with the nimbleness they need to avoid amauling. I recently spoke with several executives of E&Sinsurers to get their perspectives on the marketplace. While therewas plenty of talk about cats, the executives also commented on arange of other issues.

Kevin Kelley, President
Lexington Insurance Co.

Kelley said Lexington, the nation's largest E&S insurer, hada good first and second quarter and expects production to remainstrong through the next six to 12 months. Whatever softness theremay be for some lines, he said, will be more than offset by theperformance of the company's book of property insurance, whichaccounts for about 30% of the carrier's business.

Kelley said the insurance market for property subject to suchcatastrophe exposures as hurricanes, earthquakes and terrorism “istightening as we speak, and I think it will continue to tighten,almost regardless of what happens during the hurricane season.”

The demand for reinsurance for such property far exceeds supply,Kelley added, so the cost of coverage has gone up and terms havetightened. “That's forcing a lot of companies to exit the cat-proneproperty business,” he said.

Lexington remains a player in that market, Kelley said. Thecompany offers limits up to $25 million for catastrophe-exposedbusiness, the same as last year, he said. Wind deductibles haveincreased, however, to 5% from “about 3%.”

In addition to opportunities in the property market, Kelley saidhe sees them in meeting the demand for increased capacity in alllines. “Some of the areas where we offer high-limit casualty lineshad a very strong (second) quarter,” Kelley said. “I think thatdemand for capacity is going to be strong throughout the year.”

In regard to property insurance, Lexington recently increasedits capacity for non-catastrophe risks to $250 million, from $100million. Kelley said Lexington obtained the additional capacity the“traditional way”; i.e., via reinsurance. For non-cat property, hesaid, reinsurers are quite willing to step up to the plate “atterms that are fair.”

“I think the reinsurance market right now is kind of a'Goldilocks' insurance market,” he said. “It's not too hot, not toocold, for the so-called average business.”

Other than conditions in the reinsurance markets, the factormost likely to affect the E&S marketplace in the short term isthe severity of this year's hurricane season, Kelley said. “Whileit may not have a direct, immediate impact on catastrophe resultsif it's benign, if it's worse than expected, I think it will have amajor impact on the market,” he said. “The third quarter, I think,is going to be a very, very important quarter for theindustry.”

Lexington obtains about 10% of its business from programadministrators with the rest coming largely from surplus-linesbrokers. In evaluating program administrators, Kelley said the No.1 factor the company looks for is “a continued emphasis onquality–the quality of their management team, the quality of theirunderwriting performance over the last several years, the depth oftheir staff, and the quality of their business experience in theirtargeted areas.”

While Kelley said the company is happy with its currentdistribution system, it's open to additional relationships. “It alldepends on what happens with the market,” he said. “We are alwayslooking at it and encouraging quality producers to show usbusiness.”

Thomas Kuzma, President
Nautilus Insurance Co.

As Thomas Kuzma surveys the E&S landscape, he says he likeswhat he sees. “I'm positive about what's going in the E&Smarketplace,” he said. “There absolutely is a need for our segmentof the industry.”

Nowhere is that need more apparent than in the hurricane-proneSoutheast. About 15% of Nautilus' business consists of commercialproperty insurance, and Kuzma said the company is not shunning thearea. “We see opportunities, certainly with the controls that wehave put in place, with property on the coast,” he said. “We arecontinuing to write business there.”

Kuzma added, however, that with the build-up of property valuesin coastal areas, the exposure “is just beyond the capacity of theE&S marketplace to cover in its entirety,” unless state orfederal authorities do something to somehow mitigate the risks.Otherwise, he said, with hurricane activity up in the last fewyears, the market is unlikely to draw additional capacity. “Ifthere is a way that risks can be managed and returns can bereasonably expected, money will flow,” he said, “but that has beenvery problematic.”

A tightening market for facultative and treaty propertyreinsurance has reduced capacity at some E&S carriers, butKuzma said it has not significantly affected Nautilus. “We have ourcat(astrophe) reinsurance handled through W.R. Berkley (which ownsNautilus and other E&S insurers, as well as severalreinsurers),” he said. “We're in a very good position, as far asstill being able to write business in a controlled manner.”

Nautilus gives its general agents authority to write up to $2million of property coverage on any one risk, Kuzma said. Withinthe Berkley Group, he added, Nautilus can arrange per-risk limitsup to $7.5 million.

Nautilus gets about 85% of its business from general liabilityinsurance, Kuzma said, mainly from small to midsize accounts. Itwrites per-occurrence limits up to $5 million. While rates havebeen softening for some risks, they have not for many classes ofcontractors or for risks that have “difficult legal environments,”he said. Where pricing becomes too soft, Kuzma said, Nautilus isprepared to give up business to competitors rather than settle foran unacceptable rate of return.

Nautilus writes insurance nationwide. Most of its business comesfrom general agents exercising binding authority on the carrier'sbehalf. “I don't say managing general agent,” Kuzma said, “becausewe have control over things like claims and reinsurance.” Perhaps15% of its business is written on a broker basis, he said, but thattends to be placed by GAs as well.

Kuzma said Nautilus might appoint a few additional generalagents in the coming year. “First we have to have a need in thearea for a new appointment,” he said in explaining the company'sprocedures. “Then we look at how long they've been in business. Whoare their people? What are their qualifications? How long have theybeen handling an underwriting desk? Have they been doing businesswith other E&S companies, and who are they? Have they madeunderwriting profits for their companies? We want to know whattheir (underwriters') educational background is. Whatinsurance-related courses have they taken? We want to be able tolook at them and say they are company underwriters out in thefield, not just salespersons. We want to know they can be trustedwith a binding-authority contract and understand theresponsibilities that go with it.”

Kuzma said Nautilus also is emphasizing to GAs that they mustcollaborate with the insurance company on its efforts to operatemore efficiently via technology. Nautilus has established a Website where its GAs can get current information about the carrier'sunderwriting requirements by class of business, which Kuzma said hewould like to see more widely used. “A lot of it is just changinghabits,” he said. “Some of them (the GAs) haven't looked at thelatest upgrades to the Web site.”

“We are putting together a rate, quote, bind, issue platformthat is going to be released this year,” he added. “We're trying tomake their (the GAs') jobs as easy as possible; and if we can dothat, we feel we can get more business from them.”

John M. DiBiasi, CPCU, President
XL Excess & Surplus Lines

This year has seen a new player enter the E&S marketplace,XL Excess & Surplus Lines. XL decided to make the moveprimarily because of the growth it had observed in the nonadmittedmarket, according to John M. DiBiasi, CPCU, president. He pointedout that in the 20-year period ending in 2004, the size of theE&S marketplace increased roughly tenfold, to more than $30billion in annual written premium. XL decided it needed to form abusiness unit to tap into that growth, DiBiasi said, as well as tocomplement its 20 or so other business units, which underwritevarious specialty risks and coverages. “In fact,” he added, “mostpeople involved in the decision at XL probably would have said themove was overdue.”

DiBiasi, who had been executive vice president of underwritingat Nautilus Insurance Co., joined XL in December to run the newunit. Its office in Exton, Pa., which covers the market fromPennsylvania to Florida, began quoting business around April 1,DiBiasi said. A recently opened office in New York writes risksfrom New Jersey to Maine, he said, while a branch in Scottsdale,Ariz., has two managers, one of whom is responsible for Californiaand the 15 westernmost states, and the other for Texas and theMidwest. When this was written, the New York and Scottsdale officeswere not fully operational but were expected to be at “75% or 80%capacity” by Aug. 1, DiBiasi said. Together, the three offices willcover the entire country, he said.

DiBiasi said XL E&S focuses on general liability insurance;only about 10% of its business will be devoted to propertycoverage. About 90% of its business is placed with XL's IndianHarbor Insurance Co., he said, with the rest going to two other XLcarriers.

XL E&S can offer $5 million limits on an occurrence orclaims-made basis, DiBiasi said, and anticipates having a smallumbrella-insurance facility down the road. He said the unit's“strike zone” consists of businesses paying $20,000 in annualpremium (also the unit's minimum premium) to $250,000, although itwill consider larger risks.

DiBiasi said the market for the sort of general liabilitybusiness on which his unit focuses is soft and likely to getsofter, but not “outrageously competitive.” The unit's strategy forcountering falling rates is four-fold, he said. The first is toleverage the expertise of the unit's underwriters, most of whomhave more than 20 years' experience with E&S risks, he said.The second is to leverage the relationships those underwriters havewith wholesale brokers. Together, DiBiasi said, these two factorsmake it possible to achieve an underwriting profit regardless ofmarket conditions.

“Most business that comes across an underwriter's desk is goingto be pretty decent,” he said. “It's identifying the worst 10% ofthe business. If you have the right brokers, you have a significantleg up on avoiding these risks. Then, with the right underwritingtalent, you're able to carve out the proper underwriting terms andconditions and get the proper pricing in most cases.”

The third piece of the strategy is to leverage the attraction ofthe XL brand, DiBiasi said. “The XL name in the marketplace ispretty potent. Then you add that XL uses A+ XV paper oneverything.”

The final part of the strategy, DiBiasi said, is to have theright number of brokers. “Our goal is to have a small, select groupof wholesale brokers representing us,” he said. “That helps theunderwriting control.”

XL E&S does not hand out the underwriting pen, DiBiasi said,and so does business exclusively with contracted surplus-linesbrokers. In time, it expects to have relationships with about 100such wholesalers, he said, each serving its own geographicterritory. Some will be specific branch offices of large,well-known wholesalers, but XL E&S will not serve all locationsof such entities. “We are not appointing 'organizations,'” DiBiasisaid. “We are appointing individual offices.” Consequently, therealso is a place in the unit's distribution plans for smaller,well-run independent wholesalers located in the right place andhaving the right connections with local business, he said. Forthose offices that XL E&S does appoint, it expects to be theNo.1 or No. 2 market for the kind of business it writes, headded.

As he looks ahead, DiBiasi said his greatest concern is that newcapacity could come into the E&S market and then competeirresponsibly. He emphasized that he's not worried about existingE&S insurance companies, the great majority of which he calledsolid citizens. “What I worry about is capital that comes into themarketplace that is uncontrolled, unrestricted orundisciplined.”

Ralph Palmieri
First State Management Group

First State Management Group writes nothing but commercialproperty insurance, almost all of it on a surplus-lines basis. Thatputs Ralph Palmieri, First State's president and COO, front andcenter on the most pressing concern of the day: the availability ofcoverage in catastrophe-prone areas.

“Underwriting and pricing conditions for any risk that has acatastrophe exposure is going to be challenging … for the next sixto 12 months,” Palmieri said.

First State Management Group is owned by The Hartford FinancialGroup, of which Palmieri is a senior vice president. It underwritesinsurance nationwide, primarily on behalf of The Hartford's PacificInsurance Co. Ltd., an E&S carrier. It does the great majorityof its business with surplus-lines brokers, said Palmieri, whoapproach First State on a risk-by-risk basis. First State writescoverage for a broad array of commercial risks and providesper-risk limits up to $10 million.

Palmieri cited a number of factors that are affecting coveragefor hurricanes, earthquakes and other catastrophic perils. Theyinclude the losses that occurred in 2004 and 2005, and the capitalexpended on them. Then there is the cost of catastrophe propertyreinsurance, which he said has increased over the first six monthsof this year in a “stunning” manner. “More recently,” he added,“the catastrophe models that we all use have been recalibrated” formuch higher loss estimates.

In Florida, “capacity is going to be difficult to find, and ifyou find it, it's going to be very expensive,” Palmieri said. “Bythat I mean anywhere from 100% to 300% more than it might have beena year ago, and probably with higher deductibles and lower limits.”Earthquake coverage in California also is dicey, he said. “Capacityis limited, deductibles are on the increase and pricing is upanywhere from 50% to 100%.”

“We're seeing tightness in the Texas and Gulf Coast areas, whichwould include Houston,” he added, where prices and deductibles areheaded up. It's much the same story in the Northeast, where he saidsome people believe the area is overdue for a major storm.

As for First State, Palmieri said, “We will continue to manageour catastrophe exposures to coincide with what the new models aretelling us and with our own appetite for risk. That probably meanswe will continue to shed, in an organized and responsible way,exposures in those areas.”

Meanwhile, in the interior of the country, the property marketlooks calm, Palmieri said, despite such catastrophe exposures astornadoes and the New Madrid earthquake fault. “They just don'tseem to drive the emotion and fears at either the reinsurance orinsurance end of things at this time,” he said. “We're seeing veryflattish pricing in that business, and there is not yet a hint thatrates will escalate at any sort of a brisk pace.”

Palmieri said First State, like other property markets,undoubtedly will put more emphasis on non-catastrophe prone areas,where it will pursue such typical surplus-lines risks as woodworkers, plastics workers, vacant properties and frame apartmentcomplexes–”those sort of things that have their own considerationfrom a fire standpoint but that certainly would not be exposed to ahurricane or even an earthquake.”

Rupert Hall
Golden Bear Insurance Co.

The E&S marketplace is home not only to large nationalinsurers, but also to many smaller, regional carriers. One isGolden Bear, a California-based carrier that does business on anadmitted basis in the Golden State and on a nonadmitted basis inOregon, Washington, Idaho, Montana and Wyoming, according to RupertHall, president and CEO. The company, which was started by Hall'sfather, is owned by M.J. Hall & Co., a Californiawholesaler.

Hall said one of the company's main products is commercialearthquake insurance, and right now the market is rumbling. “TheCalifornia commercial earthquake market has become extremely tight,the likes of which I don't think anybody has seen–ever,” Hall said.The tightening began to take hold around April 1, he said, ascarriers began to realize that capacity was drying up. While Hallsaid Golden Bear has reinsurance and capacity in place, a number ofother carriers have cut back on earthquake coverage or have stoppedwriting it altogether. The tightness is likely to continue for sometime, he said, as national insurers buy as much catastrophereinsurance as they can.

The contractor's market also remains difficult, Hall said. “Idon't see a lot of new players willing to come into California,” hesaid, although there has been some competition on largewrap-ups.

On the other hand, the fire-insurance market has been gettingmuch softer, he said, leading the carrier to let business go whenrates fall too far. “We've lost 30% of our California fire businessin the last year-and-a-half,” he said.

In addition to earthquake, the carrier writes property andcasualty insurance–all on a monoline basis–for a number of risks,Hall said. They include contractors; bars, taverns and restaurants;special events; truckers; fuel-haulers; and taxis. “Then we write agood-sized book of excess and umbrella business,” he added.

Golden Bear does business with about 60 wholesalers inCalifornia and another 60 outside the state, he said. It has anA.M. Best rating of B+ V. “We've had a B+ rating for 10 years,”Hall said. “It was the very first rating we got, and I guess we'rekeeping it.” He said he thinks the company's Best's CapitalAdequacy Ratio (BCAR) score, warrants a higher rating but surmisesthat the company's relatively small size and book of catastrophebusiness keeps it from getting one.

The lack of an “A” rating hasn't affected the company greatly inCalifornia, Hall said, since it can write business there on anadmitted basis, which gives its clients the protection of the stateguaranty fund. In other states, where it does business on anonadmitted basis, the insurer sees a lot of “distressed” business,Hall said, including risks rejected by higher-rated markets. “We'reactually writing business that's probably already been looked overby four or five E&S carriers,” he said.

Hall said there has been quite a bit of consolidation in thewholesalers market lately. Often, the wholesalers are bought bylarge national retail brokers, he said. In that regard, thecarrier's B+ rating can be a drawback, Hall said, since thoseretailers' security requirements typically mandate the use of aninsurance company rated “A-” or better.

Hall said he finds wholesalers for the most part to be“extremely sophisticated” and adept not only at underwriting but atevaluating retail agents and building relationships with them. Hallsaid that's important to Golden Bear. “A wholesaler is only as goodas his retailer,” he said.