April 1, 2004 by Craig Harris
The wholesale market is a “bellwether” of changing conditions in the property and casualty insurance industry. If there is intense price competition in the standard market and regular carriers are focused on growth, the flow of business slows. When mainstream insurers narrow their scope of targeted risks and focus on underwriting profitability, as has certainly been the case in recent years, the floodgates open.
And open they did for a range of specialty lines providers – from traditional managing general agencies (MGAs) to wholesalers and underwriting managers. The somewhat elastic definition of what constitutes a “standard risk” for regular carriers became much tighter during this period, with clients ranging from homeowners to various retail operations to small contractors winding up on the wrong side of the underwriting line. The wholesale market offered a much-needed safety valve.
“We’ve seen double digit growth over the last three years,” observes David Eastaugh, president of Elliott Special Risks, which focuses on umbrella liability and other casualty lines of business. “It has been a great run.”
This view is supported by Jean Laurin, president of ENCON Insurance Group, in commenting, “I would characterize the past three years as a period of extreme growth.” ENCON operates as a professional liability and course of construction specialist. “Our firm essentially doubled in size. We did not develop specialty products or add in little extras to our policies, but rather absorbed a lot of business from the regular markets.”
ENCON and Elliott Special Risks represent two of the largest and oldest players in the specialty risk market, particularly in liability. ENCON itself, at about $250 million in net premiums, would rank in the top 20 of insurers, but it is not licensed as an insurance company. Instead, it is an intermediary that places risks with a pool of insurers in return for commission and other fee arrangements.
The difference between an MGA, wholesaler and underwriting manager is at least partially a matter of semantics, as the essential purpose of all three is to act as an intermediary in placing “substandard” or unique risks. Larger insurance managers do, however, tend to offer a wider range of underwriting and claims services.
The actual size of the specialty (or surplus lines) market in Canada is difficult to gauge, especially with the amount of business placed in the London markets. But, Ross Totten, a veteran wholesaler, says this segment has grown from 10% of the industry five years ago to about 20% of the $31 billion p&c insurance market today. This is equal to around $6.2 billion in premiums. While this is a rough estimate, Totten, who branched out on his own to start up Totten Insurance Group 15 months ago, sees Canada going the way of the U.S. insurance market, where approximately 35% of premiums are placed in excess and surplus (E&S) lines.
In the mid-range of the Canadian wholesale market, several substantial firms such as The Wholesale Insurance Group (TWIG), South Western Group and Genmark (there are many others) tend more towards special property risks. These groups have also experienced a marked increase in net premiums. “There was a time about a year or two ago when it was difficult to get to the phone and the fax machine couldn’t get the pages through fast enough,” says Frank Muscat, vice president of underwriting at Genmark.
Tom Talbot, president of TWIG, points out “last year alone, we grew by 87% [year-on-year], but with good profitability and solid loss ratios. In the wholesale business, you need to make money when you can.”
Michael Harrison, president of South Western Group, notes brokers have learned what kinds of business specialty firms are looking for. “Certainly over the last two years, the growth in submissions has been substantial,” he notes. “But, that included business we weren’t interested in or didn’t want to write. Today, the submissions have become more related to what we write.”
Several newer firms, such as Summit Underwriting and Totten, have rounded out the wholesale market, adding to the many regional players in specialty lines. “We are here to act as an auxiliary market for brokers who can’t place the business elsewhere,” says Dave Sokol, vice president of Summit Underwriting. “We are picking up the drippings from the trough, and in the hard market there has been more than enough to go around,”
Niche players like Media/Professional Insurance (E&O for “fringe” professional risks, such as publishers, software developers and travel agents ) have also found a lucrative place in the market, offering specialized underwriting services. “We stick to what we know,” says Alice Ergovich, vice president of underwriting for Media/Professional Insurance. “We often see standard markets come into this line of business, and some tend to exit just as quickly. We say we are in this for the long-haul.”
The extreme growth in the surplus lines market does have limits, and some firms, such as Elliott, have recently either slowed or restricted new business. “This is done for one of two reasons – one, either your carriers impose limits on how much you can grow, or two, you don’t have the staff to write the business,” says Eastaugh. “We ramped up at the start of the hard market by hiring employees, particularly in 2002 and 2003. Right now, everyone is looking for qualified underwriting staff. This may act as the biggest obstacle to insurer growth targets.”
While an increased flow of business has characterized the wholesale market over the last three years, several sources say this trend is slowing. “We anticipated that the market would soften a bit, but we have been surprised how fast it is turning,” observes Talbot. “There has bean a real trend to standard markets aggressively pricing and moving on certain kinds of business. more on the property than casualty side.”
Even liability specialists like ENCON are starting to see signs of change. “I know of several standard insurer CEOs actively telling brokers and line underwriters that they are open for business, that they want to grow,” says Laurin. “There are only two ways to do that – increase rates on your current client base or seek out new clients. Most insurers are finding they cannot increase rates much higher than current levels, so they will start to chase business, usually by discounting rates. And that is when the cycle can begin all over again.”
Laurin adds that the difficulty for brokers will be communicating price discrepancies for renewal versus new clients. “Brokers have had a hard time explaining huge rate increases to their customers over the last three years. What do they tell renewal clients when a company CEO says ‘we are looking for new business at competitive rates’? It will leave a lot of people scratching their heads.”
Totten says increased price competition could result because of the uniformity of marketing strategies among several standard markets. “If you look at the mid-market business targeted by the mainstream insurance companies, it’s like one guy designed all the marketing strategies,” he notes. “My concern is that they are all looking for the same small-to-medium sized business accounts and this could lead to an emphasis on market share. We could be right back to the foolish underwriting that took place in the late 1990s.”
The standard markets need to continue their focus on underwriting profitability, according to Eastaugh. “All of the CEOs we talk to say, having got to a disciplined stage, they don’t want to give that up. The truth is whether they can manage that process. Some have gone so far as to say that this is the end of the cycle as we know it, but I’m not sure about that. If you talk to people in London in the marine or aviation market, you can see that those lines have become cyclical again, even after 9/11.”
“I think in London at least we are starting to see some overcapacity, which hasn’t been the case in some time,” says Sokol. “The basic laws of supply and demand w
ill likely dictate some premium reductions.” And, Harrison says he has seen “more stable pricing and a bit more competition returning to the market. But I think we will have to wait and see what happens with the reinsurance contracts later this year.”
The issue for many specialty markets may be precisely what kinds of business will flow back to standard carriers. The list of “untouchables” that mainstream insurers wanted nothing to do with during the height of the hard market was expansive – vacant property, rental dwellings, licensed establishments and hospitality risks. The gray areas of business are E&O exposures like consultants, various trade contractors (especially start-ups), any manufacturing operations with U.S. exposures and even homeowners with claim frequency problems. Some of these risks will certainly move back into the standard market as competition heats up.
“The industry has changed its definition of what a standard risk is,” says Muscat. “If you go back five years, it was likely that the standard insurers covered rental dwellings. Now, that same 50-year old dwelling has no standard markets, trying to make rhyme or reason out of the insurance industry is difficult. We can create our own problems sometimes.”
“The big question is: is all the business in the specialty market really substandard risks or is some of it a lost standard piece of business?” asks Eastaugh. The best example may be high-risk homeowners, which sources say have been an increasing part of the specialty lines client base. Selective underwriting and higher rates for homeowners have become more visible issues recently, with examples of companies like Allstate Insurance Co. denying coverage to people with certain breeds of dogs. “I think insurers are giving all sorts of reasons for denying coverage, and some of these are pretty flimsy,” says Totten. “It is likely that they don’t want to write business in a certain area and they are using other reasons in these politically sensitive times,” he adds.
For Totten, homeowner headaches are caused by other factors. “The biggest problem is that deductibles have been too low for too long. I think we have to see more effective risk management. Certainly a customer has the right to make claims for $200 or $300, but if there are two or three claims in a short time period, then they deal with me. And they don’t want that. In fact, homeowners’ [coverage] has become a ‘cookie cutter’ product for standard insurers. They don’t have the time or resources to do exception-based underwriting. So if there are claims, they just kick it out to the intermediary market.”
While many wholesalers anticipate a return of standard homeowner and general liability (GL) risks to the mainstream market, the same may not be true for other exposures. “If you look at product liability in the U.S., many insurers got out of this completely, mainly because it requires a lot of underwriting expertise,” notes Eastaugh. “We are not expecting Canadian companies to go back into these kinds of markets.”
“I believe mainstream insurers have defined their core competencies and what they should be doing,” says Totten. “For example, if a large property management company has 10 risks on an account and one is vacant, today the standard market will write nine and place the vacant property in the specialty market. Five years ago, it would have been buried in the regular account. I think standard insurers have seen their loss ratios improving as a result of this, and they don’t want to go back to the old days of underwriting. I say that today, but all bets could be off if investment results improve two years down the road.”
Specialty lines players are well aware of how quickly the standard market can change. That is why many are defining niche areas and developing unique programs to ward off competition and buttress business in a potential soft market. “What we have tried to do is create specialty, niche products that are still needed when the market hardens,” says Talbot. For a wide range of wholesalers, these programs range from roofing contractors to clients with U.S. liability exposures to hospitality risks.
Wholesalers are also feeling more secure today because of their growing role as markets of choice for smaller brokers. “Many of the standard markets can’t handle the business coming to them, so they have made choices in terms of the size of broker they want to deal with,” Totten comments. “Instead of having 800 to 1000 brokers, they are looking for 500 brokers, with a minimum of $3 million in premium volume. Even though smaller brokers may have profitable business, the regular markets are still saying they don’t want them. That is good for us.”
Many express confidence that there will always be a place for wholesalers in Canada, “Today, a broker needs to have a wholesale facility, even if it is for just three or four policies,” say Harrison. “It may also be necessary for an otherwise standard client who has some special risks.” Several sources say the entrenched position and solid reputation of wholesalers in the Canadian insurance industry is at least partially due to the rare use of unlicensed insurers, particularly when compared to the U.S. E&S market. There was no marked increase in the use of unlicensed markets over the past three years, according to sources. This is likely attributable to several factors, including self-regulatory requirements for brokers in Ontario and Quebec to get insured sign-off on use of unlicensed carriers and the growing awareness among brokers of potential E&O exposures in using unlicensed markets for general business.
After a period of extreme growth, many specialty lines firms are closely watching movements in the standard market. There seems to be a collective desire among wholesalers for regular carriers to maintain underwriting discipline at a time when rates and terms are softening at the edges of the market. Continuing low investment returns, the high cost of reinsurance for certain lines of business, a shortage of qualified underwriters and dangerous trends in frequency and severity of claims in casualty should act as a brake on overzealous pricing and the drive for marketshare, several specialty lines sources say. But all it takes is one or two carriers to set the ball of price slashing rolling. How short is the industry’s memory?