In the February issue of Florida Underwriter, we published an extensive Q&A with three insurance executives who focus on excess and surplus lines: Michael Franzese, CPCU, CIC, CRM, ASLI, CPA, vice president with Burns & Wilcox in Tampa; Ron Gabor, president of Gabor Insurance Services, Inc., in Miami; and Irvin "Skip" Wolf III, a senior vice president at Regional Excess Underwriters, LLC, in Jacksonville. That conversation dealt primarily with legislative issues, and we promised a follow-up dialog on market cycles, capacity, emerging coverages, and the impact of the standard market. We are pleased to continue the conversation in this Florida Surplus Lines Association E&S supplement. Instead of the traditional cycle — a hard market followed in relatively short time by a soft market — it appears that we are caught in a long-term soft market. Do you think this is the "new normal?"
Franzese: When I started in the business in 1985, we were in the midst of my first and only hard casualty market. That lasted only about 18-24 months. With the exception of a few specific classes of business like residential home building and long haul trucking, there really has not been a hard casualty market since. When the casualty hard market ended in 1986–87, we had a prolonged soft market until Hurricane Andrew. That hard property market seemed to only last a year or so. The next catastrophic event was obviously 9/11. This created a specific type of hard market as carriers started becoming concerned with terrorist threats. Then came the eight hurricanes of 2004 and 2005. The property marketplace firmed up dramatically for about a year, but things started to ease quickly.
When speaking with customers or staff today, I generally make the comment that "the market is the market." E&S wholesalers and carriers need to operate in whatever market we have. Soft cycles have always lasted longer than hard ones. Fortunately, there is a high degree of efficiency in today's insurance marketplace. This will allow the market to make adjustments quickly when something occurs to firm the market. Therefore, soft markets will continue to last longer and hard markets — if they occur — will be shorter. Gabor: I don't know that there ever was a normal. The cycles have all taken on different appearances for as long as I have been in this business. The one constant, however, is that the soft market swings of the cycle have been 
getting longer, the hard market swings shorter, and the upward swing is more of a spike up and down. This current cycle seems so much worse because we have also had the impact of the weak U.S. economy. This has had an impact on premiums, driving them down due to insureds' decreasing revenues. Having said that, we will see the market swing upward once again. It is just a matter of when. I have no doubt that it will happen, I just don't have a date in my calendar for when it will occur.
Wolf: No, I do not think this is the new normal, but will allow that the cycles may be longer than in the past. However, premium rates tend to move in 6 to10-year cycles with certain lines of business affected sooner than others and for different reasons. The current soft market cycle for all lines began in 2003. While Florida saw extreme tightening in the property market as a result of the storms in 2004 and 2005, soft market property pricing began to return to Florida in mid-2007 and continues today. To some degree the market cycle has been complicated by the global recession of 2008 and 2009. This has served to prolong the cycle. The industry remains well capitalized, but not over capitalized. The latest reinsurance rate reductions we've all heard and read about of 5 to 10 percent will certainly add fuel to the continuing soft market cycle. What will it take to move us into a hard market? 
Franzese: The obvious response is: A major catastrophe in the United States or possibly Europe. [Edito'rs Note: These conversations took place prior to the disaster in Japan.}The size of the catastrophe would have to be significant, probably in the $100 billion range. There is always the possibility of the next asbestos-type of casualty exposure, although carriers today are quick to respond to control these issues via coverage modifications.
If the economies around the world were stronger, I believe we would already be moving toward a harder market. Combined ratios of many of the top insurance companies have not been good over the past few years.
There is a significant amount of capital in the insurance industry right now due to shrinkage in the economy. These challenging times are causing some insureds to go out of business. Those that continue to operate are exhibiting minimal or no growth. There are not a lot of new businesses forming either. This means that all of the capital in the insurance marketplace is chasing the same business.
Gabor: I think that there are several things that could turn the market. What probably needs to happen is for loss ratios to finally reach the point where there is no denying them, and for capacity to shrink sufficiently so that the market has to turn. This is what has always caused turns in the past and there is no reason to believe that it won't be the answer in the future. When investors feel that they can get a better return elsewhere, you will see a shift.
The other possibility is a series of major catastrophes. A major storm hitting Florida probably would not turn the market, although it could do so for us locally. However, multiple major catastrophe losses might have a bigger effect. The other possibility from a catastrophe standpoint is if we had a major storm that greatly exceeded anyone's expectations. With all of the dependence that has been placed on modeling today, one has to wonder what will happen if they really don't have it right and we get a force five storm hitting Miami head-on or a Tampa storm following I-4 across the state. Wolf: Many industry observers believe the market should have turned by now or is on the cusp of turning. Accident-year combined ratios are projected to be in the 110 to 115 percent range for many insurers. Extremely low interest rates 
provide lower investment returns. Reserve releases and redundancy can quickly turn into deficiencies. Underwriting cash flow has been negative for the industry for the past two years. Rate levels generally are back to the same level as year 2000. In addressing the 2010 NAPSLO Conference in October, William R. Berkley, chairman and CEO of W.R. Berkley Corp., stated, "We believe the industry as a whole is losing money. We believe the market is about to change. Companies do not continue to write business knowingly at an operating loss."
There is much pressure on the ability to underwrite successfully. One would think these financial benchmarks would serve to tighten the market on their own. Certainly a major storm or other catastrophe will help hasten the return of a hard market. Possibly the current issues in the municipal bond market will influence the market as portfolios begin to be repositioned. But in the end, there is no substitute for profitable, responsible underwriting and pricing. Where do you see opportunities in new coverages or services?
Franzese: Technology is a driving force for our customers and for us. Things are moving at breakneck speeds. With all of these changes come opportunities in service and coverages.
On the service side, our industry has to be the best at delivering real-time responses to our customers. There are tremendous opportunities to interface with our carrier and agent partners. Many of our carriers are working with us to come up with solutions that will allow us to operate even faster.
Coverage needs in the coming years will be significantly different from what we have dealt with in the past. Technological advances continue to create new exposures to loss. This is a perfect set-up for the E&S industry. We have always thrived on finding solutions to unique coverage issues.
Wolf: We see opportunities for 2011 in the cyber liability and health care-related fields and the environmental arena. While cyber liability coverage tends to be an option purchase (as do some environmental products), these areas will increase as the economy improves and begins to grow again. Cyber needs will be magnified as more firms become at risk to computer hacking. We also see this line of coverage moving rapidly to the smaller insured that now increasingly deals with private and personal information and is subject to the same identity theft as its larger counterparts. Is the standard market still moving into the traditional E&S areas?
Franzese: When the industry is soft, the standard carriers start getting into areas they traditionally avoid. We started to see more of this in the past year or so as standard carriers started writing more property business. They are generally looking for the best-in-class business, but in recent months we have heard some stories of them writing very traditional E&S business.
Standard carriers have been impacted by our economy just like everyone else. Many of their insureds' exposures are down dramatically. With exposure reductions and rate decreases over the past few years the top line production for these carriers has been dropping. In order to grow or at least maintain their position in the industry, they have to start getting into things they may have gotten away from years ago.
Gabor: By standard markets, I assume you are referring to admitted carriers. I don't think that E&S carriers have been writing traditional E&S business; what we really have is a case of the admitted carriers taking back some of their traditional business. E&S was traditionally a small segment of the marketplace that was there to write the unusual risk, the problem risk, and those risks or classes of risk which, due to differing conditions, the admitted market was walking away from. In the 1990s this started to shift and E&S became a major writer of many classes of business.
What really has changed is that the lines between admitted and non-admitted have blurred. If you look at the large non-admitted carriers, you will find major admitted carriers behind or affiliated with them. The days of the small, entrepreneurial E&S carrier that only sought out the small niches are over. E&S is no longer just the "safety-valve" for the admitted carriers and the industry. E&S companies today are large, well-financed insurance companies, writing risks that are anything but non-standard. They write risks that the admitted market does not see as desirable, does not have the capacity for, or cannot write due to the structure of required rate and form filing requirements. E&S also is writing those risks that might be written admitted, and it is those risks that are moving back to the admitted side.
The admitted market is writing more risks that it had walked away from. We certainly see it in general liability. Professional liability is now primarily the domain of the admitted carriers, with the non-admitted market in more of a traditional role for troubled risks and troubled classes. Property, at least in Florida, is more of a mixed bag, but I believe we could see more of the admitted market in property this year as its need for volume grows.
Wolf: This continues to be an issue for the surplus lines industry. Initially, this intrusion was based on the need to generate top line growth during soft market cycles. E&S "light" business provides an excellent opportunity for the standard market to increase its volume. Standard markets are now openly asking to quote E&S business for most classes. The lines of demarcation will blur even further as states move to deregulate various commercial and personal lines of insurance primarily through freedom of rate. Yet at the same time the states continue to maintain the due diligence requirement for surplus lines. While there are definite pros and cons to this issue, the need to attract additional capital may well trump the E&S due diligence requirement. Closing thoughts?
Wolf: The consensus is that the soft market cycle will continue throughout 2011. Of course, a major storm or catastrophe could shift the market. Yet it seems the financial practicalities of the industry cannot move the market alone. Historically, the Southeast is a very competitive geographic region.
The industry seems well capitalized, with some prognosticators looking at 2012 before the market will begin to show signs of tightening. It's been a good thing that 2009 and 2010 have been hurricane-free for the Southeast; it has given the industry time to recoup and rebuild its financial resources
Franzese: It's going to be a great year!
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