London market contributor Paul Lawrence, head of the property division at Hiscox Global Markets, gave as succinct a description of the insurance market cycle as any we have heard. “High profits attract new capacity,” he said. “Without a significant increase in demand, the new capacity drives down price. Eventually profits turn to losses, capacity leaves the market, demand remains constant, prices go up, profits return, and we start all over again!”

Where is the insurance market — and more specifically, the E&S Florida insurance market — in that cycle today, and what does the near future hold? From E&S brokers to retail agents, domestic carriers and the London market syndicate, there is universal agreement that the current market is soft, has been soft for some time, and will remain soft through at least a portion of 2010. The only minor debates center on how we got here and what needs to happen to firm things up. Parties cite as contributing factors the historical cyclical factors such as excess capacity, increased competition, and declining premiums, along with the struggling economy, the lack of a catastrophic event, and Florida's volatile regulatory environment.

“Each market cycle is different, with its own unique set of challenges,” said E&S executive Kathy Colangelo, a senior vice president with Hull & Company. “The current cycle came with the challenges of declining interest rates, the sub-prime debacle and Sarbanes Oxley, where companies had to release redundant reserves more quickly than in the past. Also, 2009 was an extremely light catastrophe year, so insurers were left with capacity to write more business. These challenges collided with a full-blown recession and unemployment at levels not seen in some 30-plus years.

“In the past, Florida has been more resilient than most states,” Colangelo added. “Historically, our booming tourism industry and strong housing market and job growth enabled Florida to outperform the average. This has not been the case during this market cycle. The housing market has crumbled in Florida, causing many people to lose their homes. Those who kept their homes lost 30 to 50 percent of their home value depending on their location. This had an impact on almost every industry that buys insurance. New home and commercial construction was drastically reduced. The hospitality and tourism industries were down. People held on to their money, took fewer trips, ate out less.”

Lawmakers and Regulators

E&S broker Thomas Enright, president of Enright & Wilson in Hollywood, called 2009 a “disappointment,” and holds the actions of the federal government and financial institutions accountable. “The huge amount of money made available to society by our government and financial system has not come close to achieving the intent,” Enright said. “Only a small percentage of those funds have been aggressively used to get our economy going. Banks have the money but are failing in the process of using it. Until the banks start to use it, our (insurance) cycle will go no further than it is now. We are trying hard to be flat (no decreases in rates or premiums). It is close but not there yet. Most insurance leaders wanted, but really did not see, a 2009 market that would tighten up and result in premium growth. That did not happen, so we are looking for and hoping for those changes in 2010.” Enright also acknowledged the over-arching challenges that continue to confront the state's property markets, noting that, “Real estate must take off, and even when it does, I don't see any quick recovery.”

In any discussion of homeowners' coverage and Florida real estate, Citizens Property Insurance Corp. inevitably comes into play. “A key difference in the Florida property market is that Citizens holds the price down by providing 'public' capacity, which in turn causes private capacity to exit Florida due to lack of profit,” said Hiscox's Lawrence. Wide consensus says this problem is surely exasperated by the irresponsible “good riddance” attitude perpetuated by Florida's governor.

John Handel, chairman of John Handel & Associates, Inc., of St. Petersburg, a 40-plus year E&S market veteran, faults Florida's regulatory environment. “In 2009, insurance regulators were more interested in the preservation and expansion of their political and bureaucratic ideology,” he said. “Their recent answer has been to 'invent' insurance companies of their own and to allow the 'invention' of other companies that lack management and business abilities.”

Economic factors obviously play a key role across all lines. In the past, one would expect that low interest rates and poor investment results would lead to a hardening of the market. This is the situation we face now. However, because of the dismal economic conditions nationwide, increased pricing is difficult. Raising rates during the current economic turmoil would be a critical mistake for carriers. It would just lend more negative attention to the industry. The underwriting results of the carriers also play a key role. Over the past 18 months there has been a minimal amount of catastrophic events around the country, which adds to the continuation of the soft market. This, along with the increased capacity of the insurance markets and the regulatory and governmental factors stated above, all intensify and continue to drive our current soft market.

Precarious Positions

Some market observers note that if conditions are assessed from a more technical perspective, the industry today hovers on the brink of profitability. In many instances, a number of participants may have already crossed the line into the red, knowingly or not.

While published combined ratios paint a far more optimistic picture, underlying non-catastrophic loss cost trends continue their historical pattern of persistent year-over-year increase. The traditional counterbalances to loss cost trends, such as investment income and release of IBNR reserves, are unavailable at this point in the cycle. Investment income dwells in the low single digits. Reserves accumulated in the heady days of 2001 through 2003 have largely been exhausted over the balance of the decade. The asset side of the equation (earned premium) has failed to keep pace with its liability counterpart (loss cost and expenses), and there is faint hope of help on the horizon.

Senior insurer executives will ultimately be confronted by a deteriorating balance sheet as the finality of claims payments reveals the deficiency of under-reserved claims. The rational cure is an increase in rates. Identical to the last cycle, which bottomed out shortly before the events of Sept. 11, 2001, it will take a painful rate correction to offset the cumulative effect of loss cost trend increases over the last decade.

The absence of major catastrophic events in Florida over the last few years further contribute to a false sense of security. A single major catastrophic event could push a number of insurers into the red and force corrective action overnight. Seen from that perspective, the industry is rapidly approaching the tipping point where senior management will have no choice but to act to restore their balance sheets. It may come slowly, in the form of deteriorating results, or quickly, in the wake of a catastrophe. However it happens, it will come, in much the same fashion as it has at the end of prior cycles.

London market contributor Lawrence said, “After the storms of 2004 and 2005, the insurance market prepared itself for an increase in frequency of hurricane events. However, since then there have been no significant land-falling hurricanes in Florida. Profits have surged and capacity has flooded in. Theoretically, the credit crisis and near-collapse of AIG should have reduced capacity and pushed prices upwards in all areas of insurance, but this did not happen. I think that the capacity was at least maintained in Florida over and above other catastrophe-exposed states due to the large potential profits, and this kept rates flat in the early part of 2009, and saw them falling by year-end.”

More of the Same in 2010

While there seems to be consensus on why 2009 “was what it was,” the looming question for many remains, what now? When is the soft market going to end? “I believe most people feel we are near the bottom of the cycle, but are uncertain when we will begin to see the graph move up again,” said Colangelo of Hull & Company. “Many economists say recovery will begin to be felt in the summer of 2010. Much of what happens here will be driven by outside factors. The economic recovery is the main driver, but in Florida, the political climate will also impact what happens. If there is government intervention, the natural cycle of recovery will be delayed.”

Michael J. Riordan III, president & CEO of Hull & Co., commented, “I think most of the experts feel that the insurance soft market has another year to play as the combined ratios manifest themselves slowly and the admitted markets begin to jettison business. The same experts are saying that the economy has bottomed out, so we may have more opportunity in 2010.”

Lawrence added, “If Florida is hit by a Category 5 hurricane in either Miami or the Tampa Bay area, I believe that Citizens will be technically bankrupt. The outcome of an event such as this could well be a federal catastrophe plan similar to the National Flood Insurance Program. This could lead to the end of the large profits that Florida has provided to both the direct and reinsurance markets!”

Lorna Palmer, president of John Handel & Associates, said, “With the market as soft as I think it can get, we are hoping for 2010 to be a bit more realistic with regard to rates, underwriting practices, and plain and simple common sense. Realistically, common sense (or the lack thereof) is possibly the most under-rated factor in the whole equation.”

The weather/wind is the heavy hand that has the final determination on how wild the swings are in the Florida market. This is what causes our tight markets (especially property) to be more severe than the rest of the country. This is also a large factor in why we sometimes face such roller coaster market swings when we go without a storm for some time. The insurance industry just cannot resist the premium dollars that can come from this area.

Florida is an intriguing market. One never knows what to expect. Especially now, the homeowners' market is in flux, plagued by the limited number of good standard carriers willing to write here. Regulatory and legislative involvement has kept the pricing depressed. Florida is too big for the insurance market to ignore, but one hopes that the environment becomes friendlier to the carriers so that they are willing to expand their presence here.

As for the future, we appear to be in the bottom quarter of a soft market that most expect will continue through mid-2010. There may be an attempt to increase rates prior to the start of the 2010 hurricane season, but if there is no activity, this soft market could continue indefinitely — or until a major catastrophic event somewhere else in the country leads to a change.

“The economy is trying to get better, but I do not see any entities, individuals or corporations willing at this time to take an aggressive approach, which requires a good size investment,” Enright said. “I am waiting for the first big steps, which I believe will come our way in 2010. However, even when it happens, it will be with less energy and expectations than in past similar situations. I feel that the industry in Florida, which in the past has handled its growth aggressively and fast, will not do so this time. Unfortunately, it will take longer and be a more cautious process.”

Mark Riordan is with the commercial lines team at John Handel & Associates of St. Petersburg. He may be contacted at 727-576-1536 or mriordan@jhassoc.com.

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