NAPSLO Members Brace To Weather Economic Storms Ahead

A few weeks before the NAPSLO Midyear Educational Conference, executives of member firms shared their thoughts on the top stories of 2009 and the potential impacts on the E&S/specialty segment.

o Peter Eastwood, president and chief executive officer of Lexington Insurance in Boston, said: "One does not need a crystal ball to foresee a diminishing demand for property insurance and liability coverage in the areas of construction and architects and engineers, given the dramatic slowdown in construction.

"Clearly, with the economy stagnating so severely, the reduction in commercial activity will continue to impact negatively on a number of other classes of business," he added, identifying lawyers professional liability, transportation, recreation, hospitality and real estate.

Explaining the impact on the lawyers E&O class, Mr. Eastwood said "layoffs among law firms truly are unprecedented as the demand for legal work literally is drying up."

In addition to "obvious victims of an economic slowdown," Mr. Eastwood said industries previously considered recession-proof are being adversely affected by the condition of the equity markets, such as higher education and health care.

This is "exacerbated by the Madoff and mini-Madoff schemes which have come to light, and further diminished the ability of historically reliable philanthropists to support these institutions," he said, also citing "the havoc this could cause to the E&O and D&O sectors claims-wise."

"The mention of claims reminds us that the underwriting is not the only side of the equation that is impacted by a recession," he continued--adding, however, that "the claims side may be somewhat schizophrenic."

Explaining the schizophrenia, he said, "a slowing economy is characterized by a reduction in the sort of commercial activity which gives rise to claims. Put simply, fewer trucks on the road, for example, mean fewer accidents."

Counteracting this is the well-recognized phenomenon known as the moral hazard, he said, explaining that "when times are tough, the first thing to go is maintenance"--adding that maintenance lapses of commercial insurers "logically should result in increased claims activity."

Mr. Eastwood said Lexington is preparing to deal with the challenges of the foregoing developments by focusing on what it can control--underwriting. "Our underwriters must be on their game, recognizing that the deterioration of the exposure bases due to current economic conditions results in a mismatch between current-year premiums and prior-year losses," he said.

o Robert Berkley, executive vice president of W.R. Berkley Corp. in Greenwich, Conn., articulated a similar strategy: "Focus on maintaining discipline, focus on preservation of capital, and do not follow/join competition," he said, summing up his company's plan for dealing with the challenges of the economy in 2009.

Mr. Eastwood added that innovation, which has always been a key part of Lexington's business plan, "will be more important than ever in these difficult times."

Adding revenues from new products to current-year premiums will ease the imbalance that would otherwise result from declining exposures, he said. In the most recent five-year period, Lexington generated $2 billion in gross written premium from new products, he noted.

"Understanding social and economic trends ranging from sustainability, global supply chains and terrorism risks--a particularly undertreated exposure--is a good starting point" for new product development, he said.

"Moreover, the E&S platform allows us to move swiftly to create new products that are meaningful to our clients and to bring them to the market without regulatory delay," he added.

o Christopher Timm, president of Century Insurance and executive vice president of Southfield, Mich.-based Meadowbrook Insurance Group, like Mr. Eastwood highlighted the problem of mismatched premiums and losses, focusing his remarks on the stress that reduced sales will put on classes with products and completed-operations exposures.

"Losses flowing from the products/completed operations hazard on sales made during the more robust years will need more rate on the reduced current-year exposure to produce adequate premiums. By the end of this year, we believe several carriers will see a need for substantial rate increases in such lines," he said.

"Reduction in the exposure base is a problem that will affect all facets of our business," he said. "We need to maintain a vigilant control on expenses and a detailed approach to tracking our performance."

Expressing some optimism about the potential for business to flow back into the surplus lines market, Mr. Timm said that for standard carriers, dropping E&S-type risks from their books "will be a most effective and efficient way to deal with the problems of rate adequacy and capacity, while avoiding the difficulties caused by attempting to raise rates in a down or flat economy."

The migration of risks back to the E&S market will be especially evident in small and midsize hospitality businesses, as well as habitational and contracting business, he predicted.

Still, he said, 2009 will prove to be a tough year for agents as economic activity declines. "We have noticed an increase in shopping activity, while our overall business is flat to slightly down," Mr. Timm reported.

"We believe that carriers that are able to give their agents the tools they need to be the most efficient will do well. We have taken the steps to provide our agents with expense-saving online and local tools. We are focused on helping our general agents and their retail producers maintain profitability on the business placed with us," he added. "Our focus on expense control will allow us to pay commissions needed to adequately compensate our agents for the value added."

Mr. Timm also suggested that as the economy tightens, claims-made coverage will be more acceptable as a risk-financing method for some contractors and product suppliers looking for ways to save money.

"Agents will need to be able to explain the difference in the claims-made and occurrence form as one of timing of payment for the risks assumed. This could be especially helpful for the homebuilding industry," he said.

"We need to be a vehicle for education of our producers and provide the tools for them to help educate the retailers," he said.

Wholesale brokers, like the carrier executives, identified recessionary economic conditions and the meltdown in financial markets as the key developments that will impact the E&S/specialty segment in 2009--and shared similar strategies for dealing with the impacts.

o Robert Owens, president of RPS of Lexington, a unit of Risk Placement Services in Kentucky, said: "Our company, as are many within our business, is closely looking at every expense in order to reduce expenses and preserve people as much as possible as the downturn continues."

"If production talent is lost, it will be very difficult to have the talent and capacity to take full advantage of the upswing if and when it occurs," he added. "The broker industry is in survival mode, however difficult that may be."

o Tap Johnson III, president of TAPCO Underwriters in Burlington, N.C., noted that the general economy has taken a huge toll on MGAs and brokers, with the combination of fewer insureds in business, lower payrolls and receipts for those still in business, and lower rates all working to drop premiums down 40 percent or more from 2006 highs, in his estimation.

"Most firms are just now coming to grips with how to respond," he added.

TAPCO, he said, has always been focused on margins, efficiency, transparency, control and best practices--referring to his firm's process for binding small policies in a five-minute phone call.

Late last year, TAPCO was acquired by Birmingham, Ala.-based wholesale insurance broker CRC Insurance Services, and Mr. Johnson predicts there will be continued--and accelerated--consolidation on all fronts: retail agencies, MGAs, brokers, E&S carriers, standard lines insurers and London brokers.

"The sad news is if [you] didn't already see this coming and don't have a plan well in place, it is likely too late. These consolidations will not be at the benefit of the seller," he said.

o Scott Smith, president of S. H. Smith & Company in Hartford, said his company has been adding to staff, regardless of the market cycle. "We added 15 percent to staff in 2008 and have been adding to staff already in 2009," he reported.

Most additions have strengthened the firm's capabilities in technology-related coverage areas such as privacy and security, he said, noting that other hires are in the firm's fundamental lines of product liability, general liability, health care, construction, manufacturing and financial institutions.

"We have an extremely strong group of brokers and underwriters, as well as market relationships in all of the executive protection lines," he said--also highlighting his firm's very strong property team.

In addition, the company has a program unit that has been able to bring at least one new national program to market in each of the last four years. "We are very bullish in this area and continue to staff here as well," he said.

Turning to the broader industrywide impacts of the meltdown in financial markets, Mr. Smith called the implications "potentially catastrophic."

"The predictable consequence would be insurer insolvencies, which would put additional strain on the surviving carriers," he said. "It would also put a strain on the underwriting results that should result in a property-casualty market that is significantly harder than we have seen in the last two-to-three years."

The hardening market, he added, "of course brings with it higher premiums, a capacity crunch, and a restriction of insurance abilities for the most vital lines of the business as well as newer industries."

However, Mr. Owens also pointed out that a slowing economy will hide the increased pricing impacts of a hardening market. Unlike Mr. Timm and other carrier executives, Mr. Owens believes this will mean that standard companies--which will be "under extreme pressure" to preserve premium volume--"will continue to invade the true E&S marketplace."

In addition, he noted that a number of E&S startups have occurred in the last few years. "The demand by their owners/investors to produce revenues and profits will help keep E&S pricing down even as we experience a hardening market," according to Mr. Owens.