Soft market sends E&S underwriters back into the field

THE E&S marketplace has had a heady run in the last decade, growing to nearly $38.7 billion in premium in 2006 from $9.2 billion in 1996, according to A.M. Best. Over the same period, its share of the commercial-lines market rose to 14.37%

To assess the state of the E&S marketplace at the start of 2008, we recently contacted a half-dozen managing general agents and surplus-lines brokers, as well as a couple of E&S insurers. All reported rapidly softening conditions that are forcing the E&S marketplace back into its traditional role as an insurer of volatile risks, niche business or standard accounts with adverse loss histories.

One thing that all of the intermediaries contacted for this special report agree on is that they cannot wait for business to come to them. All are ramping up their efforts to get in front of retail insurance agents and brokers, so prepare to be wooed.

Mary Ellen Rozzell

Continental Marmorstein & Melone

Paramas, N.J.

When it comes to describing the effect of the soft market on her E&S firm, Mary Ellen Rozzell doesn't mince words. "It's very tough right now," she said, adding that January was quite challenging.

Rozell, who is the current president of the National Association of Professional Surplus Lines Offices, is also president of Continental Marmorstein & Malone, which does business in New Jersey and the New York metro area. The brokerage does most of its business on a nonadmitted basis, and its split of binding authority to brokerage business is roughly 75/25, she said.

Rozzell said she and her associates write the sort of E&S business customarily found in older urban areas, including frame buildings with mixed mercantile and habitational use. "Two years ago, the standard markets hated such business," she said, but now "they're absolutely eating it up." She said there's also stiff competition from standard markets for other types of business Continental Marmorstein & Malone writes, including property accounts, and artisan and general contractors. The professional classes are about the only stable area, she said.

With standard markets broadening their appetite, it's tough to write new business, she said. Meanwhile, there's plenty of pressure on existing accounts too. To keep clients, you might have to renew them for as much as 10% less in premium, she said.

Rozzell said E&S insurers want to retain their renewals as much as brokers and MGAs do. "They're starting to put on more standard-company endorsements," she said. For example, a carrier might enhance its E&S policies with equipment breakdown, and hired and nonowned auto insurance, or with BOP-like endorsements. They also are increasing limits and lowering deductibles.

E&S carriers are eager to provide marketing assistance too. "We have one market that would absolutely hold our hands with clients," Rozzell said. "If we think we can put together a group of agents and sell a certain coverage, they will do a seminar for us. They're doing everything possible to make it easy for people to do business with us."

Rozzell said carriers will go only so far, however, particularly on rates. She said they all seem to have a good idea of where they need to price risks for an acceptable profit and won't go below that point. "And I hope they all stick to that," she added, emphasizing the need for underwriting discipline, despite softening conditions.

In a market like this, Rozzell said, she believes it is important to remain loyal to the E&S carriers that in the hard market stuck with her. "There's not enough business out there to share at the moment," she said. "We had a market in recently that's trying to offer us a binding authority, but we just don't want it at the moment."

Rozzell writes coastal homeowners business in New Jersey, where she said some markets have been competing more aggressively for business. Where such business typically has been written with a 1% or 2% windstorm deductible, "we're starting to see some markets come in with $500 on wind," she said.

Rozzell said one of her main strategies for getting through this market is simply getting out of the office as much as possible. "Our underwriters go out at least once a week to visit brokers," she said. "You've got to keep reminding people what you do-and ask for the business."

She said some E&S companies, mainly on the brokerage side, are starting to implement volume commitments, much as standard carriers often do with retail insurance agents. "To me that doesn't make any sense." Rozzell said. "In this kind of market, business gets tougher and tougher to place. So are they trying to weed out the small guy?"

Like others contacted for this report, Rozzell said the brokerage carriers also are moving toward MGA business. "That always happens," she said. "If you've been a brokerage market, you're going to then go into the binding-authority market when the market gets soft. Then when the cycle turns, you're going to drop your binding and go into brokerage."

Rozzell said she is getting mixed forecasts from E&S insurers in regard to their individual growth projections. "There's no consensus," she said, "but I think realistically there's going to be a downturn."

Business was down at her own firm in 2007, she said. This year, "we're hoping for flat."

Tom Albrecht

Southern Insurance Underwriters

Montgomery, Ala.

Tom Albrecht, who is the current president of the American Association of Managing General Agents, as well as vice president of product development at Southern Insurance Underwriters, said the changing market conditions don't alter the fundamentals for MGAs.

"It's not that we haven't seen this before," he said, "We are innovators, so we figure out ways to continue to bring products to our producers. We get in front of them with marketing efforts and concentrate more on the niche side of the business."

SIU has its headquarters in Atlanta and does business in Georgia, Florida, South Carolina and Alabama. Its split of binding-authority to brokerage business is 87/13, Albrecht said, and roughly 50% of its business is admitted, reflecting among other things a large book of nonstandard auto insurance.

Albrecht said the soft market began gathering momentum about 18 months to two years ago. "It's full speed now," he said, and will not end anytime soon, given the market's current capitalization. Current conditions will continue through 2008," he said, "with 2009 also being an extremely difficult year," barring major catastrophes that could reduce industry surplus.

Albrecht said he experienced such market cycles several times while heading up his family's business, the Barclay Agency, in Montgomery, Ala., before it was sold to SIU a couple of years ago and became its Montgomery branch office.

"My dad always said this market can't stand prosperity," he said.

Albrecht said SIU so far has weathered the increased competition fairly well in regard to the nonadmitted business it writes for its small to midsize commercial accounts. "Where we have lost some ground is in the commercial auto area," he said, where he said he has seen a big influx of standard insurers.

Like many MGAs, SIU is responding to the soft market by increasing its contact with retail producers, Albrecht said. SIU's marketing and underwriting people are making "blitzes" to different parts of states, he said, calling on key retail agents and brokers in those regions. They also conduct "town meetings" in larger metropolitan areas-e.g., Huntsville, Birmingham, Montgomery and Mobile in Alabama.

"We invite just about everybody who represents us in the particular area to come by for a breakfast and a presentation," he said. By having underwriters in the field, SIU not only can answer agents' questions about a particular class of business but also, for a specific risk, "give them a feel for how it would be underwritten and maybe a ballpark ... price." While in the field, Albrecht said, SIU's staff also is giving retail agents demonstrations of an online rating system for selected commercial E&S classes that the MGA introduced last year.

In this market, a few E&S carriers may be tempted to approach retail agents more directly, Albrecht said, "but for the most part they are staying loyal to this distribution system. Overall I feel like they are working with us to help us maintain as much business as we can."

Albrecht said different E&S carriers are responding to the soft market in different ways. "Some of them refuse to follow the market down and are content with the status quo, or will offer some help on renewals," he said. "Others want to play a little stronger" and will be more aggressive on price. "But when I say aggressive, they are not anything close to standard markets," he added. "They are still maintaining the integrity of their rates, so as to not affect their underwriting profit."

Like MGAs and surplus-lines brokers, E&S insurers are putting more emphasis on specialization these days, he said; e.g., long-haul trucking. Some go so far as to acquire wholesalers to gain underwriting expertise in a given niche, he said. They also are asking MGAs whether "you have some ideas about programs or niches that they can help you with."

The soft market has implications beyond guaranteed-cost insurance programs, Albrecht said. MGAs involved in alternative markets also could see their business change as a result of the continued softening, he said. "We are seeing a decrease in the number of captives that are being brought online because of the marketplace," he said.

Albrecht said that besides the soft market, fellow AAMGA members have told him they are keeping an eye on the economy. Should a recession materialize, MGAs could experience a claims uptick in certain books of business. "You always have the possibility of the moral hazard increasing," Albrecht said. The effect of the subprime meltdown on D&O insurance is another concern, he added.

Indeed, the emphasis in 2008 is likely to be on careful monitoring of conditions and alert underwriting, Albrecht said, as well as on an acknowledgement that business may fall off in a market like this.

"Last year was the transition," he said. "I don't think E&S insurers made the goals they had set" and that consequently their 2008 objectives likely will be "less ambitious."

Leonard T. LoVullo

LoVullo Associates Inc.

Buffalo, N.Y.

Len LoVullo, president of LoVullo Associates, said he thought 2007 was going to be another big growth year for the E&S market and so projected an 8.5% increase in his business, which is mainly written in New York. Instead, his MGA ended up growing only about 3%, he said, with business falling off noticeably toward the end of the year. Now, he said he thinks 2008 could turn out to be one of the toughest years he's ever experienced.

He said the adjustment for LoVullo Associates' underwriters, in particular, could be difficult, even more so than at the outset of the hard market. It's very frustrating, he said, for underwriters to do things right, "then find out that you have to cut a $25,000 renewal to $15,000. They know it doesn't make sense, but that is the nature of what is going on out there."

LoVullo said the E&S industry "came of age" in the last hard market, from roughly 2001 through 2005, when it more than doubled its premium volume to $33 billion. It also began to get respect from regulators, he said, thanks in part to the annual reviews of the surplus-lines marketplace that A.M. Best began conducting in the 1990s. The reports "proved that we outperformed the rest of the industry," LoVullo said.

Also, "retailers really learned how to use us," he said. A big reason was that the standard insurance companies they represented sharply restricted the business those agents could write. "There was a period of time ... where for a large percentage of our retailers, we were their largest market," he said.

"It got to a point that they knew our payment terms cold," LoVullo continued. "They knew what applications to use. They knew what lines we wrote. They knew what people to call here.... It is amazing how much less time you waste when you know which application to use and when affidavits have to be completed."

Ironically, retailers' knowledge of how E&S intermediaries do business could work against them now, he said. "We are being asked to quote on a lot of business, but our hit ratios are dropping off." Consequently, he said, underwriters have to ask themselves how realistic their chances of writing a piece of business really are. "We don't need to just practice quote," he said.

Rather than stay in the office and wait for calls, LoVullo said his underwriters are visiting retail agents and brokers to tell them face-to-face what they can do for them. Unlike marketing reps, he added, the underwriters have authority to make decisions on the spot. "Part of their job is to visit at least 50 agents during the year," LoVullo said. "We have more than a dozen underwriters, so that is a lot of visits."

LoVullo said that in this market, MGAs are going back to "bread and butter" E&S risks: businesses with bad loss experience, new ventures and high-exposure specialty business, like daycare centers. He said LoVullo Associates is telling retailers to "never turn down a piece of business because a standard company won't write it.... We are always going to be here for those kinds of things."

LoVullo said he has spoken to executives at many E&S insurers. "I think the majority will be happy if they end the year flat," he said. "There is no doubt that dropping pricing and relaxed underwriting are going to have a negative effect on the bottom line, and they all know it."

He added that he is concerned that if E&S companies give in to the temptation to compete too aggressively with standard insurers, they could jeopardize the E&S market's recent gain in stature. "I think that A.M. Best has done something wonderful for us by recognizing our performance and bringing up our level of respect," he said, "but with that, comes an enormous responsibility. All you need is one failure and all that respect is going to go into the dumper."

Back in the 1980s, a string of companies failed, including Mission Insurance Co., Transit Casualty and Ambassador Insurance Co., and the E&S market's image was set back for years. "All those carriers ... went down the same way," LoVullo said. "They got in the areas that they shouldn't have and they appointed people that they shouldn't have."

David Stevoff

Colemont Insurance Brokers

Dallas, Texas

At Colemont Insurance Brokers, David Stevoff is not only the chief operating officer but also a broker with his own book of business, so he feels the effects of the soft market firsthand. "It's difficult to retain business in this marketplace," he said. "When you lose a piece of business, sometimes you have to write two or three new accounts to make up for it, and doing that is made even more difficult in this soft insurance cycle."

Colemont, which has headquarters in Dallas and six major offices around the country, operates almost exclusively as a surplus-lines wholesale broker. While it writes a broad range of coverage, its book varies somewhat by region. For example, Stevoff said California business tends to be more construction-driven, while the Atlanta office sees a lot of coastal property placements.

The broker was formerly part of the Heath Group, a British holding company, and did business as Heath Insurance Brokers. "Back in 1992, they provided us the opportunity to launch a wholesale insurance operation in the midst of the last soft market," he said.

"We had a great relationship with the Heath Group," he continued, "but when we were presented the opportunity to purchase ourselves outright a few years ago, we took it." When the buyout was complete, the company thought it was important to establish a new identity, so it coined a new name based on the intersection of two streets outside its home office, Cole and Monticello.

Stevoff said E&S insurers typically lower rates in an effort to retain business, but they are also looking at other strategies. "Some E&S companies that we deal with are focusing on some smaller MGA-type programs in an effort to make up for the loss of larger open-brokerage accounts," he said. Colemont, which currently derives less than 10% of its revenue from binding-authority business, has been examining opportunities for growth in that area as well, Stevoff said.

Other considerations that E&S companies are offering in the soft market include higher limits, and better terms and conditions, Stevoff said. Multiyear policies with guaranteed rates also are making a comeback. On some auditable policies, carriers have been waiving additional premiums owed in exchange for a renewal.

Stevoff said E&S carriers have accepted the fact that 2008 is not going to be a banner year and will focus on protecting their margins. "I think the industry is going to be happy with flat growth," he said.

Unlike a couple of years ago, catastrophe property coverage is now more widely available in coastal areas, Stevoff said. Barring any potential disasters, he said rates are likely to decrease as much as 10% to 20%.

"It is a buyer's market right now," Stevoff said. "Instead of a $5 million umbrella, we can easily negotiate twice the limits for the same price. It might sound crazy, but that is typical in today's market."

In a soft market, E&S brokers must look harder for business, Stevoff said. Consequently, Colemont continues to aggressively hire young producers, whom Stevoff called "brokers in training." He said that although experienced salespeople don't like to admit it, it can be hard for them to make the transition back to a soft market, with its demands for intense prospecting and travel. He said the "younger producers in the pipeline" are more willing to take on the aggressive travel schedule necessary to grow today.

While maintaining an emphasis on prospecting in a soft market, E&S brokers have to pare expenses where possible, Stevoff said. With more accounts moving back to the standard markets, brokers may need to reassess their support-staff needs. "If we do lose people through attrition, we need to closely evaluate if there is an immediate need to find a replacement," he said. Reasonable sales-expense guidelines are needed too.

"Our sales folks have to be out on the road building relationships with our customers, and that involves spending money," Stevoff said. "What we are telling our people is: Use common sense. Spend money when necessary, but be smart about it."

John Klag

West rope

Kansas City, Mo.

John Klag, executive vice president and COO of Westrope, said he expects 2008 to resemble 2007-and pretty much every other year of the specialty wholesale broker's 16-year existence, for that matter. "All but a handful of our years have been in a soft market," he said. "This is nothing unusual to us."

The marketplace is extremely competitive, "literally across all classes of business," Klag said. Carriers' top lines may be down, and thus little growth is expected for the coming year, yet profitability remains high. Meanwhile, E&S brokers are "really fighting hard" for new-business opportunities, since standard markets are swooping back in to reclaim former business, Klag said.

Westrope has specialties in healthcare, transportation, executive and professional, construction, workers comp and agribusiness lines. It also does a "significant" amount of property-cat business, which may become a comparative island of stability in a churning sea. Property-cat business has dropped by as much as 30% over the last couple of years, Klag said, but now he thinks a "line in the sand" has been drawn. There will still be some pricing pressure, but "not at the same level as you'll see in some other lines." Another light hurricane season, however, could bring further reductions, he said.

Approximately 60% of Westrope's business is nonadmitted, a ratio Klag expects to maintain in 2008. In response to standard-market competition, he said some E&S carriers are trying to modestly increase the business written by their admitted affiliates, "especially on the umbrella side."

Klag said he's seen a few new E&S carriers enter the market in the past couple of years, but the big influx of capital that followed Katrina is a thing of the past. "Quite honestly, we have an abundance of capital in this market right now," he said.

Klag said Westrope will respond to the changing market by maintaining its specialties in certain fields, providing service and searching for "those retailers that really value what a wholesaler brings to the table." Despite the increased competition from standard markets, he said Westrope will continue to put new brokers out on the street as they complete a regimen of three or four years of training. "It's a long-term strategy for us," he said. "Westrope continues to see opportunity in the Southeast, Texas and certainly on the West Coast, which are the classic E&S bastions."

Lisa Ryan

Heartland Specialty Insurance

Dallas, Texas

At a time when many E&S intermediaries are scaling back their growth projections, Heartland Specialty Insurance expects its premium volume to climb-primarily by building business with clients of its sister organization, Heartland Marketing Group.

According to broker Lisa Ryan, Heartland Specialty Insurance began doing business in 1994 as Construction Equipment Insurance Services. As its name implied, CEIS mainly insured contractors' cranes, bulldozers and other heavy equipment. A couple of year ago, CEIS was renamed and its mission was expanded to include the provision of E&S products to the retail agents served by Heartland Marketing Group.

"On the brokerage side, we have about 225 agents; our sister company has ... about 750 agents," Ryan said. "So our emphasis is going to be on co-branding."

In Texas and the central states in which most of Heartland Marketing Group's agents are concentrated, construction and oil and gas operations are two of the major risks for which E&S markets are needed, Ryan said. Heartland Specialty Insurance also is placing more general products, habitational and premises exposures with E&S companies, she said, including hotel and motel accounts.

Ryan said that in the soft market, E&S companies appear to be making greater use of admitted paper-even for oil and gas risks. "I've seen a big switch from nonadmitted monoline writings in energy to an all-lines program based on admitted paper," she said. In other cases, E&S carriers writing CGL policies on a nonadmitted basis for energy companies are combining them with admitted workers compensation insurance. E&S carriers also are loosening coverage restrictions for some classes of business, Ryan said, including residential contractors and condo developers.

In the Florida market, E&S carriers had been restricting Heartland Specialty's property writings, which mainly takes the form of inland marine coverage on contractors equipment, Ryan said. Now such restrictions have been greatly relaxed, she said.

Thomas M. Kuzma

Nautilus Insurance Co.

Scottsdale, Ariz.

For E&S insurers, "2007 was not an easy year," said Thomas M. Kuzma, president and chief executive officer of Nautilus Insurance Co., a member company of W. R. Berkley Corp. While not downplaying the significance of the California wildfires, he said the relatively benign year for catastrophe losses only made the market more competitive.

Despite competitive pressure from standard insurance companies, Kuzma said Nautilus had a "very positive" year. He said the company ended 2007 in "basically a flat position on written premiums-but given the market conditions, we believe flat wasn't bad in the E&S world."

Kuzma said that standard-market competition has been particularly noticeable in the contractors niche, where licensed insurers are writing some of the more difficult classes they've shunned in recent years. But he said he believes E&S carriers will continue to be competitive for a number of tougher classes of business, such as coastal property. Nautilus has remained a market for commercial property business in coastal areas, Kuzma said, and he stressed the company's commitment to it. "We never withdrew from any of the (affected) states after the hurricanes of '04 and '05," he said, and the company expects to be a player in this market in the years ahead.

Cat-exposed property is not the only opportunity for E&S insurers in 2008, Kuzma said. "The standard markets continue to not write certain exposures like restaurants and bars. Kuzma believes that businesses with adverse loss experience or other coverage problems also will continue to turn to the surplus-lines market.

Vacant property historically has been insured by E&S carriers, Kuzma said, and because of the crisis in the subprime market, such business undoubtedly will increase in 2008. He said Nautilus writes a significant amount of both property and liability coverage for vacant property, whether repossessed or otherwise, and that the book has been growing.

Nautilus obtains about 80% of its business from liability lines but on its Web site at www.nautilusinsgroup.com it is currently stressing its interest in property submissions, which can then be packaged with the liability coverage in one policy. "We are trying to make sure that our agents understand that we have the capacity to write midsize to large property risks, for a price that we feel is adequate," he said.

In 2008, Kuzma said Nautilus will continue to emphasize the importance of technology and customer service to its general agents. Nautilus has an online platform its general agents can use to rate, quote, bind and issue policies for certain types of risks. "That was something that we rolled out in 2007," he said, "and we want to get more agents queued up to utilize our online capabilities."

Vacant property is one class of business that can be underwritten well electronically, Kuzma said. Others include such classes as daycare centers, exercise facilities and some apartment buildings. By using technology to evaluate these risks, Kuzma said, Nautilus and its general agents can devote their underwriting talent to more complicated-and potentially more rewarding-businesses, like manufacturers and accounts with tougher hazards or new ventures.

"Working with our general agents who really understand the importance of technology and efficiency in the underwriting and risk placement process-that's what we want to do more of," he said.

Tom Mulligan

Western World Insurance Group

Franklin Lakes, N.J.

In the early part of the decade, the hard market brought a surge of business to E&S insurers, but according to Tom Mulligan, Western World's executive vice president of underwriting and marketing, the party's over.

"Our peak was probably back in 2004," he said. Other markets, particularly those with significant books of wind-exposed property or tougher contractor classes, held on a little longer, he said, "but I think by 2007 just about everybody was past the peak of the hard market."

But to look on the bright side, he said the market at least has not softened as rapidly as it did following the previous hard market, in the 1980s, although he noted the pace accelerated in 2007.

"I think the business that does get through to our distribution system is still fairly well-priced," he said. "It's certainly off the peak, but it's not necessarily bad business yet. We're not in the trough of the soft market."

Competition is coming not only from standard insurers slashing rates but also from other E&S carriers, Mulligan said. But it takes the form of competition for relationships with MGAs and wholesale brokers, he said, rather than overt price competition. "Certainly we see some of that," he said, "but the E&S industry at large is attempting to exercise pricing discipline."

Western World does business nationwide. Its split of binding-authority to broker business is about 80/20, Mulligan said, and the carrier tends to focus on relatively small commercial risks, "everything from apartments to petting zoos." The company does not have much property catastrophe exposure on its books, he said, but does look for opportunities in other difficult-to-write classes, including tougher contractor accounts, and miscellaneous malpractice and professional liability risks.

Like many E&S insurers, Western World has an admitted facility, Stratford Insurance Co., which it uses for a specific purpose: to write commercial auto insurance, which Mulligan said must be written on an admitted basis in most, but not all, states. He said Western World plans to keep things that way. In a soft market, the temptation for E&S carriers to open up their admitted facilities to a broader range of risks can be great, he said, and brokers and MGAs may request as much. "But it's a lot easier said than done."

"We don't have the infrastructure in place to quickly file the necessary rates and forms," he said. Of course, there are regulatory considerations too. "Once you accept business in the admitted market within your group," he said, "it's often difficult to show good reason why it should be eligible for the nonadmitted side when the market is a bit firmer."

In 2008, Mulligan said Western World's strategy would be to continue to stress its commitment to long-term relationships with MGAs and brokers. The company also plans significant investments in technology, not only in Web sites and online transactional capabilities that will be apparent to its business partners but also in "behind the scenes" improvements that will enable the insurer to operate more efficiently and render better service.

When contacted, Mulligan said he'd seen some preliminary numbers for 2007 indicating that, compared with 2006, the year was flat for E&S premium. He said in 2008, barring a severe hurricane season or some other catastrophe, "I wouldn't be surprised to see some decline."