Non-admitted underwriters are seeking across-the-board rate hikes for property & casualty risks—and are covering more risks as standard lines insurers continue to shed unwanted business. Yet the surplus lines market has not entered the “hard” phase of the market cycle. Not even the massive insured property catastrophe losses stemming from Superstorm Sandy last fall could push the market into truly hard conditions.

Instead, insurers are taking measured steps to generate the revenue they believe they need to realize underwriting profits while not unnerving buyers with the jarring rate hikes and coverage restrictions that have marked some previous market turns. Even so, some risks face rougher market conditions than others, market executives note.

“It is interesting,” says Gary Tiepelman, senior vice president-contract underwriting at Scottsdale Insurance Co. of Scottsdale, Ariz. “It's certainly not a hard market, but it is a firming market.”

“To call it a hard market is a bit of a stretch,” says Linc Trimble, the Jersey City, N.J.-based head of eCommerce at Torus Insurance Holdings Ltd., which operates a U.S. surplus lines insurer.

Wholesalers in much of the country, meanwhile, are placing risks more efficiently as a result of the 2011 non-admitted market reforms, executives say. But there is still room for improvement.

The consensus that the surplus line market is hardening is a departure from market assessments the previous two years, when insurers and brokers said only pockets of risks faced tougher renewals.

“The market has strengthened since then,” says Marla L. Donovan, a Farmington Hills, Mich.-based executive in the office of the chairman at wholesaler Burns & Wilcox.

Now, underwriters are seeking rate increases for nearly all risks. Market executives estimate that rate hikes typically range from 3% to 10%, depending on various factors, including location and how low expiring rates were.

Jeremy Johnson, the Boston-based president and chief executive officer of Lexington Insurance Co., the surplus lines unit of American International Group Inc., says property rates generally are higher by mid-single-digit percentages. Meanwhile, in the insurer's casualty portfolio, rates have increased by double-digit percentages on average, although somewhat less than half of the risks in the portfolio represent the toughest classes of business that have faced that steep of an increase.

And unlike last year, insurers are applying those increases equally to new as well as existing accounts, Scottsdale's Tiepelman says. Last year, insurers competed on rates for new business; “This year, I'm not seeing that,” he says.

Still, with insurers raising rates only modestly from their low expiring levels, the surplus lines market cannot be considered hard, Tiepelman explains. “It's not a hard market because rates are still lower than they were in 2000.”

Given the long-term drag on interest rates, across-the-board rate hikes are necessary to ensure insurer profitability, Lexington's Johnson says.

But the market is turning gradually rather than an abruptly for a couple reasons. One is the market's strong financial health.

The “tons of capacity” in the market is holding rates down, and that is positive for the industry's reputation, Tiepelman says. “It makes our industry a lot more credible when we don't have those significant changes in rates.”

The overall steady but moderate rate strengthening is “healthy for the industry,” adds Donovan.

The rate hikes mean the domestic surplus lines industry marked only its second year of premium gains over the past six years, according to A.M. Best, which recently released its 20th annual report on the industry. The 2013 report, which covered the industry's financials through year-end 2012, found that domestic surplus lines insurers last year generated a robust 12.9% increase in direct premiums written, following a far weaker 3.2% gain in 2011 and four consecutive years of decrease from 2007 through 2010. The overall surplus lines industry reported an 11.8% increase in direct written premiums in 2012 on the heels of five consecutive annual decreases.

And for the ninth consecutive year, no surplus lines insurers became financially impaired in 2012, Best reported. The admitted property & casualty industry disclosed 21 impairments.

Another reason for the gradual turn is the availability of better underwriting data that insurers have been able to capture over the past decade, says Trimble at Torus. It's based “more on data than on emotion.”

“Short of something that would be a significant hit to industry capital, I'd be surprised to see the market go into the more volatile, hard part of the cycle,” Trimble says.

And with the economy beginning to recover, “the demand side of the curve is strengthening,” which will only further fortify the surplus lines industry's financial wherewithal, Donovan observes.

Property risks

Standard-lines insurers began dropping property catastrophe risks after numerous major losses pounded the industry in 2011 and a wind-loss model released early that same year indicated that insurers were far more exposed than they understood. Jettisoned from the admitted market, those risks flowed into the surplus lines market, which charged significantly higher rates.

“I would have thought a good portion of that already had moved” by the fall of 2012, says Barnaby Rugge-Price, a director at London broker R.K. Harrison and the head of its Property & Casualty Division. But losses arising from Superstorm Sandy last October hit admitted markets with “a big surprise” about their property catastrophe aggregation levels.

The storm caused total insured losses of about $25 billion.

“I think [the admitted market] is continuing to shed that business,” especially in coastal wind-prone regions but also in the country's interior where hailstorms and tornadoes are prevalent, Scottsdale's Tiepelman says.

The storm losses' impact on rates, however, was not dramatic, market executives say, even though Best reports the surplus lines industry's loss ratio during the fourth quarter last year surged more than 12 points to 64.9 from 52.8. The spike indicates that the storm hit non-admitted insurers as well as the standard lines market, Best concluded.

“Sandy should have had a much bigger effect than it did,” says Donovan at Burns & Wilcox. “But oddly enough, there's so much capacity out there—and alternative capacity like CAT bonds and sidecars for reinsurers—which reduces the need for higher rates,” she says. The alternative capacity as a percentage of global property catastrophe capacity has nearly doubled from 8% to 15% over the last five years.

“So Sandy really didn't change the course (of property catastrophe rates) one way or another,” Donovan adds.

Nichols at All Risks says that is one of the “biggest changes” in the market. “There are no major rate increases, but there are no major decreases” in property catastrophe rates.

“To me, that's shocking,” especially considering the storm hit New Jersey and New York where the industry's decision-makers live, Donovan says.

Moreover, if insurers this year escape a second consecutive hurricane season with no major losses, “we could be in for a period of softening rates,” Nichols says.

Lexington's former president said last year that inadequate rates might force the insurer to “re-think” its plans for 2013. But Johnson, who was appointed president and CEO this spring, says: “We are very committed to the markets we're in. We won't wholesale pull out of a book of business of we don't achieve X, although that book of business may shrink if the rates are not adequate. We don't try to time the market cycle.

“We're very focused on account-specific underwriting,” he adds.

Johnson also noted that in lieu of additional rate, insurers are seeking larger deductibles, especially in the Northeast. “Sandy demonstrated to us the vulnerability of highly urbanized areas to extreme weather,” he says.

Among smaller risks, “we continue to see [small] construction move into our world” from the admitted market, says wholesaler Matthew D. Nichols, referring to frame residential properties and small joint and masonry commercial construction.

Rates for those properties are quite disparate, says Nichols, president of Hunt Valley, Md.-based All Risks Ltd. and outgoing president of the National Association of Professional Surplus Lines Offices Ltd. (NAPSLO). In some cases, rates are 10% to 15% higher, and in other cases rates are flat. “I think it's just a matter of how aggressively they were charged the year before,” he adds.

At the extreme ends of the insuring spectrum for those properties, buyers with recent losses could face a doubled rate, while those in the Pacific Northwest likely will find the admitted market still wants their business, says Nichols.

RKH's Rugge-Price also notes that there is “a greater willingness of London underwriters to write middle-market business,” particularly property risks, in the U.S. market. To put themselves in better position to write that business, London underwriters paying higher commissions to managing general agents to produce the business for them.

Casualty Risks

Insurers are boosting rates for casualty risks by varying percentages, depending on various factors.

Lexington's Johnson, who says most casualty rates are rising by double-digit percentages, noted that high-hazard product liability risks and energy-sector accounts “is where we're seeing particular hardening” because of poor experience and insufficient expiring rates.

However, he noted that a buyer occasionally will negotiate a larger deductible in exchange for a lower rate increase. “But for the most part, we're getting rate for the portfolio,” Johnson says.