Specialty Players Shrug Off Dips In Prices

By flying under the radar to take business that's not in full view of large standard carriers, executives of specialty lines insurance companies predict they'll continue to grow profits in 2007.

While admitting that they don't expect to grow their top lines by leaps and bounds this year, publicly traded companies that reported to Wall Street analysts this month described an array of strategies they say will carry them through a softening market.

Some said they simply won't grow premiums very much at all as they strive to exercise underwriting discipline and maintain profit margins. But many said they planned to put just a little more heft into this year's premium figures--articulating strategies that include developing new products, cross-selling across existing product segments, retaining more business rather than passing it to reinsurers, and outright acquisition of books and teams of specialty underwriters.

That task will be easier for the smallest players in the group--a message that became clear during a presentation by American Safety Insurance Holdings at the New York Society of Security Analysts' conference in mid-February.

"There's no question that the market is softening. Anybody who doesn't admit that is fooling themselves," said Joseph Scollo, executive vice president and chief operating officer of Atlanta-based American Safety, noting that rates in the lines of business that his company writes are down anywhere from 5-to-10 percent.

"The difference is we're a small company. We write $200-plus million of premiums" in a year, he said. "For us to grow 5-to-10 percent is very minimal in overall premiums--$10-to-$15 million. We can start up a new product line--write $5-to-$10 million, which has virtually no impact on the market, and for us that's growth. For most companies, that's meaningless."

Such figures would do little for the largest specialty insurers--such as W.R. Berkley, Markel Corp., Argonaut Group and RLI Corp.--yet executives at those firms were equally unruffled by declining prices.

William Berkley, chairman and CEO of W.R. Berkley in Greenwich, Conn., reporting a 28 percent jump in net income for 2006, admitted to being a little disappointed that net premiums grew just about 5 percent. But he predicted during an earnings call that his company's premium would grow 5-to-8 percent in 2007.

"Business is good," he said, noting that the fourth quarter is always more competitive than the rest of the year. "We see lots of opportunities."

"Prices are going down. No question," he said, noting price drops of 5 percent on average across the company's various business units--which include specialty operations and regional subsidiaries. The figure is lower than those reported in various industry surveys, he added--chalking the difference up to the fact that "they're produced by agents frequently with self-fulfilling prophecies in mind."

The surveys are "directionally accurate," but there's reason for optimism in the specialty lines sector, he said. "We think we have lots of [profit] margin in the business," he noted, recalling the "worst mistake" he ever made in running W.R. Berkley Corp.--halting growth in 1988 when prices started to come down 10-to-12 percent.

"We printed cards that said: 'Volume is vanity; profit is sanity.' And I believed it," he said. "I still believe it."

But the question is whether there is profit in the business. "And we think there's still a lot of profit as it's priced today," in "some business," but "not in all business," he said--noting that he expects not only to expand opportunistically, but also to produce a comfortable 20 percent return this year.

The accompanying tables of earnings for a group of publicly traded specialty insurers are a testament to the profitability of the business. Even in the fourth quarter of 2006, underwriting profits were at record levels, with only one company--Toronto-based Kingsway--reporting a combined ratio over 100, which it attributed to prior-year development on program business at its Lincoln General subsidiary.

While Mr. Berkley did not provide hints as to where opportunities for expansion exist, the company started up five new operations in 2005 and 2006--including an aviation unit and a Web-based workers' compensation unit--that put roughly $86 million of premiums on the books last year.

New products fueled some of the growth at Markel Corp., according to Chief Financial Officer Richard Whitt, who identified a lumber program at Markel Insurance Company, specialized alternative risk-transfer programs at Markel Re, and higher rates for marine and energy lines (added in 2005) as contributors to a 6 percent increase in gross written premiums.

During the company's earnings conference, CEO Tony Markel outlined a formalized process for growing business in any phase of the market, which included the promotion of Senior Vice President John Latham to work with Mr. Markel to focus on that task and to head up a new Office of Business Development that will look at opportunities to make acquisitions, enhance existing products and develop new ones.

"We don't go in setting any growth targets," he said. "We are basically doing everything we can to increase submission flow," identifying the December acquisition of the Prairie States agency from Aon as another step that's been taken to assure growth.

"But we don't force growth. We try to increase deal flow--price every one the way we think it should be priced to achieve our underwriting results and, at end of the day, add them up," he said.

Assessing current market conditions, Mr. Markel said that strong property-reinsurance treaty rates for Jan. 1 indicated to him "a probable continuation of the justifiably higher [primary] rate levels achieved on cat- exposed properties" following the 2004 and 2005 wind seasons.

"Tempering that, however, I am concerned about pressure on rates in other sectors. We are seeing casualty rates continue to moderately erode as well as property rates in non-cat prone areas," he added. "That said, the bottom is certainly not falling out of the market. And suffice it to say that we've been here before."

Michael Stone, president and chief operating officer of RLI Insurance Company, had a more negative view of market conditions, but was equally confident of his company's ability to weather changes.

"Any reinsurers out there, your cedents aren't being as disciplined as they have represented to you," Mr. Stone said during a conference call, highlighting eroding market discipline that extended to the property-catastrophe insurance market during the fourth quarter of 2006.

Peoria, Ill.-based RLI Corp., with net earnings of $134.6 million in 2006, also recorded its 11th consecutive underwriting profit, with a combined ratio of 84.1 for the year. But while gross premiums rose 5.6 percent to $799 million overall for 2006, they slipped 7.7 percent in the fourth quarter. And for the property segment alone, Mr. Stone reported gross premiums jumped 28 percent for the full year, while shrinking 19 percent in the last quarter, with rates returning to 2004 pre-hurricane levels.

Still, he said the outlook is positive for growth at RLI in 2007. "If you look back over the past couple of years, rates have weakened a bit in casualty and we've pretty well held our own," he noted, adding that the firm has some new initiatives to enter geographic areas that it is not currently in.

At the analysts' conference, CEO Jonathan Michael agreed, noting that RLI will expand niche products by "recruiting proven underwriting talent--people that have a following"--and by going out and acquiring underwriting teams.

As an example, he noted that RLI started a marine office in 2005 through the acquisition of a team of employees that wrote nearly $30 million of that business for the company last year.

While there was some difference of opinion about how soft the market is getting, it's certainly not hard, which is a cue for executives at Kingsway Financial to put the brakes on, according CFO Shaun Jackson.

Also speaking at NYSSA, Mr. Jackson said that "our view is that the time to grow is in a hard market. The time to stay pat and really just preserve margins" is in a soft one. He noted that while Kingsway's premiums doubled in 2002 as the company seized hard market opportunities in its niches--trucking and nonstandard auto--in the United States, since 2003, gross premiums have hovered between $1.9 billion and $2.0 billion.

Kingsway, which has a history of acquisitions, will continue to selectively pursue them, Mr. Jackson said. "In this market, we think this is one of the best uses of our capital," he added, highlighting the recently announced deal for Mendota, a nonstandard auto writer, from Travelers--a deal that should add about $175 million of premium annually.

"Also important for us is they're very strong in several states where we have very little presence," such as California and Colorado--one of the nation's most profitable nonstandard auto states. Even in states where there's overlap, he said Mendota is strong in parts where Kingsway is not--noting, for example, that Kingsway writes business in Miami but not the rest of Florida where Mendota has a presence.

Growing casualty business in Florida and neighboring states is also part of a growth plan at Southfield, Mich.-based North Pointe, which was forced to cancel 40 percent of its commercial property policies in the state in June 2006, protecting the company's income stream from volatility.

Explaining the situation at NYSSA, CEO James Petcoff said: "We couldn't buy enough reinsurance. And it sure occurred to me that if we don't think we can pay a claim in the event of a hurricane, then we probably shouldn't take anybody's money."

North Pointe--which has built its franchise around claims handling and writes specialty admitted products mainly through independent agents in liability niches such as liquor liability and bowling centers--will seek to expand geographically and through new product offerings in 2007.

To expand specialty commercial lines beyond the Midwest, North Pointe added an office in Sacramento, for example, Mr. Petcoff said, adding that new products could include workers' comp coverage for bars and restaurants, which is not offered today.

Mr. Petcoff said North Pointe will also seek to expand its presence in the broad area of hospitality and entertainment, giving the example of a move to write roller skating centers in April 2006 as the type of natural evolution he envisions.

Roller skating centers are a similar type of risk to bowling centers, he noted, adding that the expansion exemplified the company's philosophy when adding a new line. While the total market for roughly 4,000 skating centers nationwide is about $30 million, "if we write one-third of that market, the $10 million is meaningful to us."

CFO Brian Roney said such a figure "may seem very small to a middle manager at Chubb," but to North Pointe, "it's that proverbial fly below the radar" that can insulate the specialty insurer in a softening market. He added that skilled claims handling can make such small segments very profitable for small specialty insurers.

At San Antonio-based Argonaut, CEO Mark Watson has seen a similar evolution at his firm--which, among other distinctions, is the largest writer of grocery stores and coal mines. "Our expertise is in mining, not just coal mining," he said at NYSSA, noting that the Select Markets division of the group, which targets specific industries, is focusing now on a gravel mine opportunity in Florida.

Similarly, when the grocery industry began consolidating, the management team of Argonaut's Grocers subsidiary repositioned the company "as not just an insurer of grocery stores, but retail business." Last November, the company carved out a new niche among furniture stores that sit within the same strip centers as the grocery stores it already writes, he said, noting that their proximity means similar risk profiles.

"That isn't going to shoot the lights out and generate $300 million of premium, but it might generate $30-to-$100 million," he said. "It's all those base hits that we just keep connecting."

He also highlighted cross-selling opportunities between the group's largest segment--E&S--and admitted segments.

For example, he noted that an E&S employment practices liability product is now available to grocery store accounts, while a dry cleaning program came from the E&S platform, which wrote only environmental exposure, opening an opportunity to offer remaining coverages in another unit of the company.

Like almost every other executive reporting to investment analysts, Mr. Watson said acquisitions were a possibility for his firm, reporting that some potential targets that were rejected last year--because they had overly ambitious expectations about the value of their businesses--are now back to talk again.

Frank Bramanti, CEO of Houston-based HCC Holdings, which has been an active acquirer of specialty insurers and agencies over the years, said his company continues to be on the hunt for deals, and that some small ones are in the pipeline.

"We're going to look at larger acquisitions which the company really hasn't done in the past. We can make great use of a $30-, $40-, $50 million acquisition, but it's probably not going to move the needle very much," he said.

"If we're truly in the beginning of a soft market, there are going to be public companies out there whose shares are going to be coming under pressure," he added.

HCC is one of several specialty companies that reported higher net premium growth than gross premium gains in 2006, by retaining more business rather than passing it on to reinsurers. Others pursuing such strategies included Richmond-based Markel; Chapel Hill, N.C.-based James River; and Atlanta-based American Safety.

While American Safety has yet to report its full-year 2006 results, the company was probably the most aggressive in terms of reducing reliance on reinsurance--with a net-to-gross ratio of 68 percent through nine months compared to 58 percent for the same period in 2005.

In addition, CEO Stephen Crim said 43 percent growth in gross premiums through nine months was mainly attributable to existing environmental and construction businesses, but that product diversification is also part of the plan. In 2006, for example, the company added nonconstruction liability and umbrella products to its lineup.

Like others, Mr. Crim said his company would selectively pursue acquisitions, adding that specific targets will be MGAs that give the company the ability to produce some fee income as well as get them into new product lines, in addition to specialty insurance companies, books of business and underwriting teams.

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