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 Many reinsurers have become particularly allergic to this kind of cat and have withdrawn from its haunts as far as they can.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

For the E&S industry, cats present opportunity as well as risk. There is money to be made in Big Cat country by those who have capacity and the confidence to use it. And the freedom of rate and form that characterizes the E&S market theoretically should provide these players with the nimbleness they need to avoid a mauling. I recently spoke with several executives of E&S insurers to get their perspectives on the marketplace. While there was plenty of talk about cats, the executives also commented on a range of other issues.

Kevin Kelley, President
Lexington Insurance Co.

Kelley said Lexington, the nation's largest E&S insurer, had a good first and second quarter and expects production to remain strong through the next six to 12 months. Whatever softness there may be for some lines, he said, will be more than offset by the performance of the company's book of property insurance, which accounts for about 30% of the carrier's business.

Kelley said the insurance market for property subject to such catastrophe exposures as hurricanes, earthquakes and terrorism “is tightening 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 have tightened. “That's forcing a lot of companies to exit the cat-prone property business,” he said.

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

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

In regard to property insurance, Lexington recently increased its capacity for non-catastrophe risks to $250 million, from $100 million. Kelley said Lexington obtained the additional capacity the “traditional way”; i.e., via reinsurance. For non-cat property, he said, reinsurers are quite willing to step up to the plate “at terms 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 too cold, for the so-called average business.”

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

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

While Kelley said the company is happy with its current distribution system, it's open to additional relationships. “It all depends on what happens with the market,” he said. “We are always looking at it and encouraging quality producers to show us business.”

Thomas Kuzma, President
Nautilus Insurance Co.

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

Nowhere is that need more apparent than in the hurricane-prone Southeast. About 15% of Nautilus' business consists of commercial property insurance, and Kuzma said the company is not shunning the area. “We see opportunities, certainly with the controls that we have put in place, with property on the coast,” he said. “We are continuing to write business there.”

Kuzma added, however, that with the build-up of property values in coastal areas, the exposure “is just beyond the capacity of the E&S marketplace to cover in its entirety,” unless state or federal authorities do something to somehow mitigate the risks. Otherwise, he said, with hurricane activity up in the last few years, the market is unlikely to draw additional capacity. “If there is a way that risks can be managed and returns can be reasonably expected, money will flow,” he said, “but that has been very problematic.”

A tightening market for facultative and treaty property reinsurance has reduced capacity at some E&S carriers, but Kuzma said it has not significantly affected Nautilus. “We have our cat(astrophe) reinsurance handled through W.R. Berkley (which owns Nautilus and other E&S insurers, as well as several reinsurers),” he said. “We're in a very good position, as far as still being able to write business in a controlled manner.”

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

Nautilus gets about 85% of its business from general liability insurance, Kuzma said, mainly from small to midsize accounts. It writes per-occurrence limits up to $5 million. While rates have been softening for some risks, they have not for many classes of contractors or for risks that have “difficult legal environments,” he said. Where pricing becomes too soft, Kuzma said, Nautilus is prepared to give up business to competitors rather than settle for an unacceptable rate of return.

Nautilus writes insurance nationwide. Most of its business comes from general agents exercising binding authority on the carrier's behalf. “I don't say managing general agent,” Kuzma said, “because we have control over things like claims and reinsurance.” Perhaps 15% of its business is written on a broker basis, he said, but that tends to be placed by GAs as well.

Kuzma said Nautilus might appoint a few additional general agents in the coming year. “First we have to have a need in the area for a new appointment,” he said in explaining the company's procedures. “Then we look at how long they've been in business. Who are their people? What are their qualifications? How long have they been handling an underwriting desk? Have they been doing business with other E&S companies, and who are they? Have they made underwriting profits for their companies? We want to know what their (underwriters') educational background is. What insurance-related courses have they taken? We want to be able to look at them and say they are company underwriters out in the field, not just salespersons. We want to know they can be trusted with a binding-authority contract and understand the responsibilities that go with it.”

Kuzma said Nautilus also is emphasizing to GAs that they must collaborate with the insurance company on its efforts to operate more efficiently via technology. Nautilus has established a Web site where its GAs can get current information about the carrier's underwriting requirements by class of business, which Kuzma said he would like to see more widely used. “A lot of it is just changing habits,” he said. “Some of them (the GAs) haven't looked at the latest upgrades to the Web site.”

“We are putting together a rate, quote, bind, issue platform that is going to be released this year,” he added. “We're trying to make their (the GAs') jobs as easy as possible; and if we can do that, 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 move primarily because of the growth it had observed in the nonadmitted market, according to John M. DiBiasi, CPCU, president. He pointed out that in the 20-year period ending in 2004, the size of the E&S marketplace increased roughly tenfold, to more than $30 billion in annual written premium. XL decided it needed to form a business unit to tap into that growth, DiBiasi said, as well as to complement its 20 or so other business units, which underwrite various specialty risks and coverages. “In fact,” he added, “most people involved in the decision at XL probably would have said the move was overdue.”

DiBiasi, who had been executive vice president of underwriting at Nautilus Insurance Co., joined XL in December to run the new unit. Its office in Exton, Pa., which covers the market from Pennsylvania to Florida, began quoting business around April 1, DiBiasi said. A recently opened office in New York writes risks from New Jersey to Maine, he said, while a branch in Scottsdale, Ariz., has two managers, one of whom is responsible for California and the 15 westernmost states, and the other for Texas and the Midwest. When this was written, the New York and Scottsdale offices were not fully operational but were expected to be at “75% or 80% capacity” by Aug. 1, DiBiasi said. Together, the three offices will cover 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 property coverage. About 90% of its business is placed with XL's Indian Harbor Insurance Co., he said, with the rest going to two other XL carriers.

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

DiBiasi said the market for the sort of general liability business on which his unit focuses is soft and likely to get softer, but not “outrageously competitive.” The unit's strategy for countering falling rates is four-fold, he said. The first is to leverage the expertise of the unit's underwriters, most of whom have more than 20 years' experience with E&S risks, he said. The second is to leverage the relationships those underwriters have with wholesale brokers. Together, DiBiasi said, these two factors make it possible to achieve an underwriting profit regardless of market conditions.

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

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

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

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

As he looks ahead, DiBiasi said his greatest concern is that new capacity could come into the E&S market and then compete irresponsibly. He emphasized that he's not worried about existing E&S insurance companies, the great majority of which he called solid citizens. “What I worry about is capital that comes into the marketplace that is uncontrolled, unrestricted or undisciplined.”

Ralph Palmieri
First State Management Group

First State Management Group writes nothing but commercial property insurance, almost all of it on a surplus-lines basis. That puts Ralph Palmieri, First State's president and COO, front and center on the most pressing concern of the day: the availability of coverage in catastrophe-prone areas.

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

First State Management Group is owned by The Hartford Financial Group, of which Palmieri is a senior vice president. It underwrites insurance nationwide, primarily on behalf of The Hartford's Pacific Insurance Co. Ltd., an E&S carrier. It does the great majority of its business with surplus-lines brokers, said Palmieri, who approach First State on a risk-by-risk basis. First State writes coverage for a broad array of commercial risks and provides per-risk limits up to $10 million.

Palmieri cited a number of factors that are affecting coverage for hurricanes, earthquakes and other catastrophic perils. They include the losses that occurred in 2004 and 2005, and the capital expended on them. Then there is the cost of catastrophe property reinsurance, which he said has increased over the first six months of this year in a “stunning” manner. “More recently,” he added, “the catastrophe models that we all use have been recalibrated” for much higher loss estimates.

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

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

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

Meanwhile, in the interior of the country, the property market looks calm, Palmieri said, despite such catastrophe exposures as tornadoes and the New Madrid earthquake fault. “They just don't seem to drive the emotion and fears at either the reinsurance or insurance end of things at this time,” he said. “We're seeing very flattish pricing in that business, and there is not yet a hint that rates 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 wood workers, plastics workers, vacant properties and frame apartment complexes–”those sort of things that have their own consideration from a fire standpoint but that certainly would not be exposed to a hurricane or even an earthquake.”

Rupert Hall
Golden Bear Insurance Co.

The E&S marketplace is home not only to large national insurers, but also to many smaller, regional carriers. One is Golden Bear, a California-based carrier that does business on an admitted basis in the Golden State and on a nonadmitted basis in Oregon, Washington, Idaho, Montana and Wyoming, according to Rupert Hall, president and CEO. The company, which was started by Hall's father, is owned by M.J. Hall & Co., a California wholesaler.

Hall said one of the company's main products is commercial earthquake insurance, and right now the market is rumbling. “The California 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, as carriers began to realize that capacity was drying up. While Hall said Golden Bear has reinsurance and capacity in place, a number of other carriers have cut back on earthquake coverage or have stopped writing it altogether. The tightness is likely to continue for some time, he said, as national insurers buy as much catastrophe reinsurance as they can.

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

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

In addition to earthquake, the carrier writes property and casualty 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 a good-sized book of excess and umbrella business,” he added.

Golden Bear does business with about 60 wholesalers in California and another 60 outside the state, he said. It has an A.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're keeping it.” He said he thinks the company's Best's Capital Adequacy Ratio (BCAR) score, warrants a higher rating but surmises that the company's relatively small size and book of catastrophe business keeps it from getting one.

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

Hall said there has been quite a bit of consolidation in the wholesalers market lately. Often, the wholesalers are bought by large national retail brokers, he said. In that regard, the carrier's B+ rating can be a drawback, Hall said, since those retailers' security requirements typically mandate the use of an insurance 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 at evaluating retail agents and building relationships with them. Hall said that's important to Golden Bear. “A wholesaler is only as good as his retailer,” he said.

Special Reports /

Are E&S carriers nimble enough to bell the 'cat'?

Related Stories

Recommended For You