About the time NAPSLO 2014 begins, Atlantic City's newest luxurycasino, “Revel,” will close its doors after only two years inoperation (including two bankruptcies in that time). It's yetanother major loss for Atlantic City, which depends on the casinoindustry for a full 70% of its tax revenue. In August,Moody's cut the rating for the city's $245M in general obligationsto junk, and Atlantic City's already high 13.1% unemployment ratewill increase further with the loss of an estimated 3,100 Reveljobs. There is also a huge potential loss for the lenders,who thought it was a good idea to invest $2.4B – $2.6B to build thestate-of-the-art-facility, not to for mention New Jersey taxpayers(see: me) who pledged $261M in tax incentives to hasten Revel'scompletion. Clearly, some smart people seem to have beenworried about the wrong things when planning this failedcasino.

Are we, as an industry, worrying about the right things? Of allthe risks to which Revel was exposed, its backers at least had theluxury of knowing that risk inside the house, atthe tables, was a lock. They knew that math would guaranteethey'd win, if they got gamers toplay. E&S markets, however, are exposed toboth external factors and therisk inside the house. Carriers should be so lucky as to have thecertainty that Revel had: guaranteed underwriting profit, if onlyenough bets are made.

Reasons for Revel's quick and total loss reportedly includeself-induced hurdles, like a poor layout and an initial“no-smoking” policy. External factors included increasedcompetition from NY and PA casinos and from online gaming. Moreover, Revel's home town had failed to adapt to a changingenvironment. In Atlantic City, gaming accounts for 78% of casinorevenues. Compare that to Las Vegas, which also had arecession-driven decline in gaming revenues but which relies ongaming for only about 34% of revenue. Relying onentertainment, Las Vegas' overall revenues increased every yearsince 2010, while Atlantic City's have declined. Las Vegasdealt with environmental risks and is growing. Atlantic Citytried too late, and appears to have failed with Revel's closingbeing the latest blow.

Unlike the static gaming rules at a casino, the house rules inthe E&S industry change constantly. New variables tounderwriting property, casualty, and professional risk includeclimate change, extreme weather, rapid class action status forinvestors, ever increasing medical costs and jury awards, andcourt rulings challenging long-held truths like what “occurrence”means. Can the E&S industry evolve to meet a changingenvironment while dealing with both internal and external riskfactors?

Consider the fictional ten-year snapshot below on an imaginaryexcess casualty account. Assume the exposure growth kept paceexactly with inflation and that they marketed their business oncein the recession and got a big premium decrease in 2008. Thelimits and attachment points are constant, at $25M and $1Mrespectively. In 2004, the carrier's “bet” started at 223 -1(though the odds were actually longer, considering commissionreduced the premium received and defense-outside-the- limitincreases the maximum possible outlay). By 2013, they reached301-1 (-35%), after having spiked to a high of 385-1 in 2008. Not only is the carrier's payback period now much longer, butattachment point has been halved in real terms, because medicalcosts trends and CPI have eroded the real value of the primarylayer over the past ten years. In short, the bet got a lotworse, but the carrier hasn't really noticed. $1M primaryattachment points have remained standard since the mid 80's for allbut the toughest risks. In this way, the market hasn'tevolved to meet an external challenge.

Here's a list of just some of the ways that our collectivebusiness (the house) is exposed to external, uncontrollable andsystemic risk factors:

Training & Talent

Markets and brokers have skimped on training as bottom linessuffered. It's a natural reaction to rising expenses, anddeteriorating results. Training takes time and money. Most canspare neither. But, will next-generational decision makers beequipped with the tools they need to react quickly to a changingenvironment, like Revel did not?

Casual Capacity

The risk that E&S markets “bet” against is increasing incost, but our response to that trend has not kept pace. Markets continue to casually and easily put up $25M in limits,with “$1,000 per million” pricing readily available in highexcess casualty layers. These “commodity” layers would need a least1,000 similar loss-free accounts to cover any single limits loss,and logically such bets should extremely rare.Currently, the longest odds to win the Super Bowl before the 2014NFL season are the Jacksonville Jaguars who are opening at 250-1. Ateam 4 times as bad as the Jaguars winning the Super Bowl inFebruary 2015 carries those same 1,000-1 odds. Yet, nearlyeveryone at NAPSLO has at least one story where a losswent into the high excess layers unexpectedly.

Bad/Slow/Too Much Data; combined with 1 & 2above

It's true that both markets and brokers are operating with moreaccess to 'big data' than ever. The question remains whether we, asan industry, will be able to translate that data into actionableinformation upon which better decisions are made.

In a famous scene in the 1995 movie Casino, a haplesssupervisor of a section of slot machines (Don Ward) isn't awareuntil it's too late that he has been scammed. Don knew the data andhe knew what was happening wasn't right. But he didn't act fastenough and gets fired for it by his boss, Ace Rothstein (RobertDeNiro):

Ace Rothstein: Four Reels, sevens across on three$15,000 jackpots. Do you have any idea what the odds are?

Don Ward: Shoot, it's gotta be in the millions. Maybemore.

Also notable is the fact that Ol' Don Ward's bad/slow decisionand subsequent firing in the movie ultimately led to the downfallof “the house.

Haphazard Market Underwriting Controls &Oversight

There's and old poker tenet often cited by insurance icon WarrenBuffett: “If you've been in the game for 30 minutes and you don'tknow who the patsy is, you're the patsy.” This adage appliesuniquely and especially to our industry, where a “patsy” can oftenbelieve it has won a round and so proceeds to go on anill-conceived betting binge. Many a program or deal orrelationship has been lost because of a new player who entered themarketplace late, with insufficient experience and/or information. We compete in an industry in which the least informedparticipants are also those most likely to believe they have “won,”if only for that period of innocence until the losses begin tomount.

As compared with price, which is measurable and immediate, greatservice and world-class claims handling are hard to sell, becauseonly a small fraction of our customers will ever really need us. Nomatter how much risk consultation, safety expertise, claimsprofessionalism, or good old fashion long-term relationship amarket or broker can offer, there will always be some customerswilling to move their business for lower premiums – and forrelatively nominal differences. Nevertheless, our industry'schallenge is to continue to diversify our offerings and effectively“de-commoditize” ourselves.

Our ability to grow and thrive as an industry will depend on ourresponse to the changing environmental factors around us, ourability to create a sustainable risk-transfer model driven notmerely by price, but by value as well. We need a model whereboth the market's and the broker's revenue streams can bediversified away from simply trading premium dollars for occasionalloss payouts – where risk-bearing markets are betterincentivized to make reality-based underwriting judgments usingaccurate information and to offer clients risk consultation andsolutions.

Revel faced external, uncontrollable forces like online gamingand the negative effects of its early “no smoking” policy. The E&S industry is similarly exposed to various risks beyondits control, with cat bond markets, judicial re-interpretationswhat an “occurrence” is, runaway jury awards, brokers operatingwith a legitimate fear of losing deals to substandard competitiveproposals, loose authority letters, abundant treaty capacity andcapital, low/no bond yield, and good old fashioned underwritingrisk among them.

Successful markets and brokers will evolve and respond to boththeir internal and external challenges, as Atlantic City and Reveldidn't. Their odds at success will improve if they pay attention toemerging risk and adapt. Better training for their brokers andunderwriters who can access better data and offer clients betterproduct suites beyond simply paying claims, or hunting for quotes,will make it a lock.

Sources:

• Wall Street Journal 8/12 “Closing of RevelCasino Deals Another Blow to Atlantic City
• Star Ledger 8/17 “Revel in Atlantic City will Close inSeptember”
• CPI Data: Bureau of Labor Statistics http://www.bls.gov/cpi/