E&S: Growth Opportunities Available, But Distribution Channel Under Pressure

While executives attending the National Association of Professional Surplus Lines Offices Ltd. (NAPSLO) Mid-Year Leadership Forum, held this past week in Naples, Fla., do not expect a hard market to arrive anytime soon, they have identified growth areas in some segments and have developed strategies to survive now while preparing to seize opportunities that will materialize when the market does turn.

But as the soft market wears on, E&S/specialty insurers and wholesalers are also forced to deal with challenges to their traditional distribution system and pressure from the admitted markets. While executives have affirmed their commitment to the surplus-lines space and the wholesale-distribution system, they recognize the need for continued innovation and product development to distinguish themselves.

When interviewed at the conference, Stan Galanski, president and CEO of New York-based specialty insurer the Navigators Group, said that with respect to the soft-market cycle, there is still plenty of excess capital chasing stable opportunities. He added that from a pure competitive standpoint, he does not expect improvement soon. He mentioned, though, that increasing commodity prices arising from revolutions in the Middle East could be a wild card. The impact of runaway inflation could impact the market over time and may not be reflected in companies' plans, he said.

Mr. Galanski also said there is nothing to suggest that companies are acting with greater discipline in this soft market compared to previous ones, despite better underwriting tools and, in many cases, new leadership throughout the industry.

“It would be great to say that because of things like the Securities and Exchange Commission, increased disclosure requirements and changes in the leadership of the industry, that things are different this time, but I think we'd be kidding ourselves if we really believed that,” he said. “I think the business is still driven by capital and greed and by people motivated to hit their numbers and achieve whatever financial objectives—even if that's simply keeping their jobs.”

Alan Kaufman, president and CEO of wholesale brokerage and underwriting manager Burns & Wilcox, also expressed doubts about an imminent market change, saying that he expects 2011 to be a repeat of 2010. “I don't think [conditions] will get worse in most areas,” he said, but added that property rates continue to decline, there is still too much capacity, and the industry has not experienced a market-changing catastrophe. “And the overall economy is still weak,” he said.

GETTING ENERGIZED

Despite the soft market and weak economy, Mr. Galanski pointed to some segments where growth opportunities exist. The energy segment, for example, has shown improvement since the Deepwater Horizon rig explosion and resulting oil spill into the Gulf of Mexico.

Mr. Galanski cautioned, however, that another Deepwater-type platform loss would likely total around $500 million for the industry. “So there's clearly the importance for pricing discipline and rate in the energy sector, and, encouragingly, [the sector] seems to be getting [adequate rates].”

Another area of growth, Mr. Galanski said, is the excess casualty business. He said Navigators was selective in this sector, writing just 7 percent of the risks the company saw—and still business was up. Mr. Galanski noted his firm is still a “relatively small player in a large pond” in this sector, but he said it has doubled the number of underwriters focusing on excess casualty around the country.

Environmental risk is another potential growth area, according to Mr. Galanski. Many of the buyers of these insurance products—such as pollution coverage—are first-time buyers, and there is “great growth opportunity” when a product can be sold to a large number of newcomers, he said.

Some aspects of the professional liability and health care markets are expanding for wholesalers, according to Mr. Kaufman. In his view, the reason there are pockets of opportunity here is because the government has “attacked certain businesses” with more regulation, which has invited more litigation, which in turn has driven up insurance rates. Mr. Kaufman said he looks for future growth in the areas under the government's increased scrutiny.

PROFIT, NOT PRODUCTION

Speaking to overall business strategies in the continuing soft market and weak economy, Mr. Galanski said insurers must be prepared to walk away from risks and cannot “fall in love with numbers geared toward production and not profit.”

He noted that Navigators has shrunk its business and that if renewal retention on a given product line happens to be 50 percent or 60 percent, “that's OK for us.”

To illustrate this point, Navigators shows its underwriters a chart displaying the “modest impact” on the company's estimated stock price and earnings if the underwriters miss their budget by 1 percent or 2 percent. The chart shows a slightly larger impact if the underwriters miss their expense ratio. But, Mr. Galanski said, there is a far more dramatic impact if the underwriters miss their loss ratios.

The message: “Don't get yourself in trouble,” Mr. Galanski said. “Don't destroy capital in a soft market, because when those market conditions change, you want to be poised to jump on them and hit the accelerator, and not be spending a lot of time fixing problems.”

He said companies should develop a bonus plan that “rewards profit and not production.”

GOOD TIME FOR TECH, RECRUITING

For wholesalers, both Mr. Galanski and Mr. Kaufman noted that investment in technology has been a key strategy for survival in the soft market. Mr. Kaufman said he saw heightened interest in investing in technology from fellow wholesalers at the conference.

Mr. Kaufman added that, for Burns & Wilcox, the weak economy has also created hiring opportunities. “This is a great time to recruit from universities,” he said, noting that with fewer businesses hiring it is easier now to attract top talent.

Burns & Wilcox has “increased the bar of what we're looking for [in candidates],” he said, noting that the firm is turning to the best business schools in the country for prospective employees.

Mr. Kaufman said he has not seen recruiting competition from others in the industry. With so much available talent, he'd like to see others follow suit. “Why not get the best talent you can get now?” he said, noting that there has been a shortage of talent, particularly young talent, in the industry.

WHOLESALE WORRIES, SURVIVAL STRATEGIES

While there are definite opportunities for insurers and wholesalers in the current market and economy, the conditions have also created some significant challenges, not the least of which is pressure on the wholesale-distribution system as a concept.

Speaking at the conference's Executive Session, Kevin Westrope, president and CEO of Kansas City, Mo.-based wholesale brokerage Westrope, said the erosion of the wholesale-distribution system is a concern for him, noting that some E&S and specialty companies have expanded recently and have decided to deal directly with retail outlets rather than wholesalers. “I'm not sure if that's a good thing,” he said.

The wholesale-distribution system has other pressures as well. Tony Markel, vice chairman, Markel Corp., said consolidation among retail agencies means wholesalers and E&S and specialty insurers must jointly adjust to find out how to add value to much more sophisticated and leveraged channel partners below the wholesalers. The business is still out there, Mr. Markel noted, but it is concentrated in less personal and more process-oriented larger retail agencies.

He said that the estimated number of retail agencies in the U.S. has dropped from 39,000 in 2000 to 19,000 in 2010. Further consolidation is expected by 2015, Mr. Markel said, with an estimated 7,000 to 8,000 additional agencies being acquired or going out of business.

In order to survive and succeed, the professionals at NAPSLO agreed wholesalers need to get creative and deliver expertise that others cannot provide.

Joel Cavaness, president of national wholesale brokerage Risk Placement Services, said, “For us to continue to be a factor, we must continue to innovate new products.” As an example, he noted that 15 years ago, no one had ever heard of cyber-liability products. Rolling out such products that serve critical needs will be how wholesalers “continue to be a force,” he said.

“If I own an idea or a product, I'll get my fair share,” Mr. Cavaness said.

Mr. Markel said specialty insurers, along with the wholesalers, must continue to look for coverages and approaches that answer societal needs. Key to this, he said, is relying on wholesalers to inform insurers about clients' needs. “You, the wholesalers, are the eyes and ears on the ground,” Mr. Markel said. He added that insurers like his firm are willing to listen to any wholesaler proposal that makes sense and provides a distinctive approach.

He noted that Markel is committed to its wholesaler relationships and guards those relationships “zealously.”

Speaking to NU, Mr. Galanski also affirmed his company's commitment to the wholesale-distribution channel. He noted that Navigators recently completed a renewal-rights transaction to sell the rights to some commercial multiperil business to Tower Group. “We never quite got scale in that business, which was generated by smaller retail insurance agents,” he said. He added, “We found it's much more efficient for us to work with the wholesale community for that.”

He said Navigators continues to focus on what works for the company. “And one of the things that does work for us is our wholesale distribution in our E&S business.”

Mr. Markel also warned the industry about moving away from the surplus-lines space and to the admitted market too readily. He said the need to provide admitted products is growing, and those in the E&S space have to act. “But we should be more grudging to give up the surplus-lines space,” he said. Surplus lines, he noted, allow for more flexibility. He said insurers can move faster to respond to market needs on the nonadmitted side compared to admitted.

“I'm concerned with the movement to the admitted side,” Mr. Markel said.