By Wallace L. Clapp, Jr., CPCU
As the property-casualty market rolls into 1997, specialty and excess and surplus lines brokers find it more difficult to detect a hardening in the market. Softness is expected to continue not only in the casualty market, but also in property areas.
The latest third-quarter results from the Insurance Services Office and the National Association of Independent Insurers report that although the experience for the first nine months of 1996 showed a $13.3 billion underwriting loss, net investment income was $27.2 billion, more than offsetting the underwriting loss. The net investment income, combined with a $6.9 billion increase in realized capital, brought the industry's total pre-tax net investment gain to $34.1 billion, up from $31.3 billion for the first three quarters of 1996.
Net written premium for the first nine months of 1996 totaled $203.2 billion, three percent more than in the first nine months of 1995. The industry's consolidated surplus--assets minus liabilities--increased $13.4 billion to $234.4 billion.
The industry recorded a pre-tax operating income of $5.3 billion. Net investment income led the underwriting loss which amounted to $4 billion. This loss compares with a loss of $3.3 billion for the same quarter last year. In terms of written premiums for the third quarter, the growth rate of 3.2% is about the same as last year.
According to Sean Mooney, senior vice president and economist for the Insurance Information Institute, the results in the third quarter were all bad. In his analysis he reported that underwriting losses rose by over $700 million, investment income declined and realized capital gains were down. Return on capital fell to 8.4% from 10.4% in the third quarter of 1995.
The decline in profits reflected deterioration in both underwriting and investment results. Incurred losses increased at a faster pace than premiums. The decline in investment income reflects a combination of lower interest rates and slower growth in assets.
Mooney predicted little change in the industry's finances in 1997. Growth in claims will continue to marginally outpace growth in premiums. This will lead to a further mild deterioration in underwriting results which will be offset by investment increases. Barring any major shocks such as a stock market crash or a major natural catastrophe, the industry's finances in 1997 will be a mirror image of 1996.
Market trends
Competition within the surplus lines market itself is so fierce that some observers are reminded of the 1970s, when cash flow underwriting was the key to business. In this type of market it is very difficult for underwriters to maintain premium volume and underwriting integrity at the same time.
Surplus lines insurers are facing more competition from London, the admitted market and other surplus lines insurers. They feel that the conservative approach is the prudent way to assure financial stability needed to stay in business. Pricing for smaller accounts is more stable, with competition toughest for large accounts, according to one executive of a leading surplus line insurer.
The only tight conditions cited by insurers is in the California residential contracting field and for some professional liability coverages. It was expected that the casualty market would stabilize, but casualty rates have dropped substantially into 1997. The standard market is writing risks that normally would have been written by excess and surplus lines insurers. Umbrella coverage pricing is mostly in the control of the standards.
Rates have continued to drop for directors and officers liability coverage. More capacity in the surplus lines market and increasing competition from the standard market are determining factors. Rates will continue to drop as more insurers enter the market. Product liability also has softened, with higher limits easier to obtain.
Property rates that had shown signs of stabilizing several years ago softened earlier in the year and later dropped even more substantially. Even the commercial earthquake insurance market has softened. Prices had been high with high deductibles, but renewals are lower and more capacity is coming on.
There now has been almost a decade of soft market conditions in the commercial property-casualty insurance field. The challenge to the insurers and brokers is to find new areas in which to grow.
One of the principal growth areas has been "niche" marketing or program business. Further growth in this area will continue into 1997, with many special risk and standard companies offering programs for many categories of businesses. (A more detailed analysis of this development was discussed in the November 1996 issue of Rough Notes.)
Another way insurers are responding to the soft market is by introducing new products. Among the new products offered are multi-year, multi-line policies. Often such policies enforce the idea of a longer term relationship and more stability with one insurer over an extended period of time.
Other areas of growth and emphasis in the 1997 market include:
* Further increases in developing and selling employment practices liability insurance. Developed just about five years ago, the coverage often was quoted but not sold until the seriousness of the exposures of sexual harassment and discrimination hit home in the corporate executive board rooms. EPL products appear to be much in demand now. Prices have softened, coverage has been broadened and limits of liability have been increased. EPL is available both on a monoline basis and in business packages combined with D&O and E&O coverages.
* Environmental coverages continue to be developed. The market is open for environmental contractors, consultants, organizations which do remedial work, testing laboratories, transportation risks, manufacturers and businesses that work with pesticides, fertilizer and fungicides or herbicides. Lead contamination, EMF (electromagnetic field) and "sick building" syndrome, a form of environmental exposure caused by indoor air quantity (IAQ) risks, are being studied as possible new insurance products dealing with the quality of life.
* Coverages dealing with all types of miscellaneous professional liability insurance for businesses continue to proliferate. Any type of risk which has a real exposure of financial loss to customers can qualify under some professional liability programs set up by specialty insurers.
* We are just seeing the beginning of the use of the World Wide Web as a vehicle to promote the resources and products of insurers on home pages on the Internet. Some special risk and surplus lines insurers and managing underwriters have created home pages to guide their agents and customers to their products and underwriters. Soon some of these companies will be able to download applications to agents who then will be able to submit risks to the underwriters.
Experts we contacted believe that insurance transactions on the Internet are not suited to the field of specialty and surplus lines business, but that those in the specialty market need to make their presence known. We believe that within the next few years most companies will have a home page on the Web.
A few questions still remain that can be potential trouble spots presenting a challenge to the insurance industry in the last few years of this century. Among the most serious problems are:
* The need to find a permanent solution to potential hazards of pollution cleanup under Superfund legislation. At the beginning of last year, the insurance industry believed that they had organized a unified drive for legislation to put a cap on most of the retroactive liability incurred by environmental cleanup. Once again Congress did little to address this problem. The industry will try again in 1997 to come up with a workable solution.
* The development of legislation that would establish federal reinsurance contracts to back up state-based catastrophe homeowners insurance programs.
* How to deal effectively with market changes when there are large consolidations of companies or acquisitions of smaller brokers by larger ones.
* Development of a protocol for doing business on the Internet. A new set of intellectual property infringement laws needs to be devised to fit the use of home pages by insurers who are promoting their products and services.
Survey questions
We conducted an informal survey among several brokers and managing general agents to get their opinions on a few hot questions concerning the condition of the 1997 marketplace.
We our indebted to the following for their assistance in the survey: Jerry Roush, Roush Insurance Services, Noblesville, Indiana; Victor D. Giordano, Pennock Insurance, Wayne, Pennsylvania; Maitland S. Dimock, Dimock/PenEx, San Francisco, California; Joe Weckerle, Sr., ARIS Insurance Services, Calabasas, California; and Roger D. Teese, Smith Bell & Thompson, Burlington, Vermont.
What factors do you see directing the trends of the specialty market?
The specialty market is to a large degree driven by the aggressive marketing of standard carriers. As long as the standards can generate enough investment income from cash flow underwriting to offset losses, the market will continue to stay soft. A Midwestern E&S broker observed that large brokers may dominate the niche specialty programs, but smaller brokers will continue to survive due to their ability to provide quicker response time and greater flexibility over a broad range of products.
The role of the specialty market is to fill gaps in coverage left by the standard carriers. Also, there are still classes of business, such as products liability, D&O, certain professional liability coverages, transportation business, contractors and large umbrellas in which the standard underwriters still have less expertise.
A West Coast broker said that the soft market will force more mergers of smaller independent brokers into large houses in an effort to retain markets and retail clients. However, there always will be the need for the wholesale broker doing individual brokerage. The growth is in the area of programs that can be clearly defined and tightly controlled.
Is adequate capacity being provided for your office? What are some specific coverages that are more difficult to place than others?
Capacity is not a problem in any of the offices that contacted us. One broker said that there is more of a problem spreading writings in order to give each insurer a share of the premiums. One East Coast broker added that it is difficult to specify coverages which are hardest to place. A risk with a loss frequency is just as difficult to place now as always.
One California broker stated that most casualty lines, including professional liability and D&O, have enough capacity. On the property side, CAT exposures are still costly, but there is more capacity. Earthquake pricing has softened a bit. The most difficult risks on the West Coast are residential construction for town houses, condos and home builders. The problem with contracting risks is because of numerous lawsuits over alleged building defects, especially in condo construction.
What classes of business are being seen most frequently?
Classes in general remain unchanged from previous years. In the casualty area a Midwest broker reports seeing submissions on restaurants, taverns, apartment house packages, day care, halfway houses, tree trimmers and exterminators There are also frequent submissions for garage, tow trucks and sand and gravel haulers. Some offices are seeing greater growth in the area of D&O and professional liability coverages.
Employment practices liability is the hottest product for the next year. Accounts that were quoted in the last 18 months are now buying. This is reflected in broader terms, better pricing and a legitimate serious concern about a potentially serious risk to corporate assets.
A New England office reports seeing a number of professional liability and medical related submissions.
Will alternative markets, such as risk retention groups, off-shore excess captives and self-insurance programs gain a greater share of the insurance premium dollar?
In contrast with last year's survey results, when the correspondents' feeling was that alternative markets would not be a major challenge to traditional insurance coverage, most of our correspondents this year feel that the use of alternative markets is gaining acceptance.
An East Coast broker reports seeing a trend toward the alternative markets. The firm's offices have been inundated with information, and telephone calls and personal visits from companies wanting to put together programs in the alternative market.
Another specialty broker said that most new risk retention groups and self-insurance programs are established and stable. Certain niche markets that are new and not yet into captive modes will increase. The traditional market has adapted to working with the alternative market, and there will be more of a hybrid type of business done.
Do you find niche marketing an advantage in your marketing strategies?
Our correspondents are almost unanimous in saying that niche marketing is advantageous. One eastern wholesaler did point out certain pitfalls in niche marketing that should not be overlooked. For instance, if an office becomes overly niche oriented, there can be trouble if that niche shows poor experience, or is pirated by a larger market willing to throw in a few more bells and whistles.
Do you plan to establish a Web site on the Internet?
All of those offices answering our survey either have or are planning to have a home page on the Internet. An eastern broker observed that the E&S business does not lend itself to being done online. Their office has a Web site for advertising purposes and will also participate in Web sites being contemplated by the firm's carriers and organizations to which it belongs.
A West Coast broker commented that the personal approach to marketing specialty lines will be with us for the foreseeable future. Purchase of insurance through the Internet may lend itself to "cookie cutter" type insurance policies but not specialty coverages. This does not mean that the specialty market does not have to address the continuing need to streamline the distribution system.
The nature of insurance regulation may change due to rapid developments in cyberspace. What pitfalls do you see in the licensing and regulation of property and casualty business?
A midwestern agent told us that while cyberspace marketing may increase, regulators can still control the issuing company or general agent at the state level. He points out the need to guard against federal controls and intervention, permitting federal control only insofar as requiring proof of state approval for those states accessed.
The major problem in regulation will be with unauthorized carriers. Another broker believes that the licensing and regulatory community is facing a tough time in keeping up with the technological advances to monitor activities that are done online.
Lloyd's appears to be recovering from its hard times. Capacity is up and the corporate capital is replacing individual members. How will the changes in Lloyd's affect the property, liability and reinsurance markets in the U.S.?
Many agents are convinced that the mutual trust and respect inherent in our industry between agents and companies no longer exists in English markets. Domestic companies have filled the gap and have shown themselves to be more reliable and responsible. It will take some years for Lloyd's to regain its former prestige, according to one broker.
Other brokers believe that although Lloyd's current capacity may not be as great as before, even with corporate investors, Lloyd's will deliver more capacity to further lead to market softening. Underwriters at Lloyd's will be very creative and will add new products to the marketplace over time.
What are your predictions for writing an increased volume in 1997? Do you anticipate any marketing changes affecting your volume?
Most of the offices we heard from anticipated some growth in 1997. They do not anticipate any major changes affecting the marketplace. One West Coast broker is hoping to grow by targeting new producers and products. In California their specialty market will continue to turn toward admitted facilities. However, it will always need the nonadmitted market, where there is greater flexibility and needed products for insureds to cope with our changing society.
Sale and consolidation of insurance carriers could have an effect on volume of business, according to a New England broker.
What do you consider when adding on new specialty companies or facilities?
The primary consideration in choosing new markets is financial stability with flexible underwriting and quick response time for policy issuance and claim handling. Most offices review financial reports such as Bests' in their offices on an annual basis. Keeping an ear to the ground to pick up what others are experiencing with their companies is another method used to determine whether companies can handle business you submit.
Trouble signs may show up in the way the insurer pays claims, downsizing of the company, letting experienced underwriters go and operating with lower-paid inexperienced employees. It is important to know on any new venture, whether the company knows anything about the market they are getting into.
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