Canadian Underwriter

Wolves in Sheeps’ Clothing

April 1, 2004   by Mark Ram

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To general insurers, niche lines are often seen as just another new market opportunity. Some specialty lines may even appear simple, but looks can be deceiving. The hidden exposures and need for specialized resources can profoundly set them apart.

Clearly, few are tempted to jump into obvious high-risk lines like aviation or nuclear power plants. But other lines that may look safe enough are actually wolves in sheeps’ clothing. Long-haul trucking, for example, is far tougher than general commercial auto, despite its surface similarities. Without the right arsenal of specialized resources, you could easily experience developed combined ratios of 150% or more, as so many have in the past.

One of the first mistakes general insurers make in entering a specialty line is to rely on the public “numbers”. Picking up the statistical issue of CU and checking results does not constitute proper due diligence. Real statistics on niches are rarely publicly available, so many insurers rely on the market leader’s results as a proxy. But, this can be tremendously misleading – even if you are looking at the combined ratios of mono-line companies. Their numbers are often as much as 20% to 30% better than their competition’s as a result of experience and specialized infrastructure. So you can imagine how a new, inexperienced player in the line will often fare.


As counter-intuitive as it may seem, if you want to do some effective due diligence, talk to the specialist insurers themselves. You would be amazed to find that some niche market leaders would consider it in their own best interests to help you (within the constraints of the law of course) actually understand the requirements, traps and true exposures you will face in the line. And, as always, reinsurers are another good bet when it comes to due diligence.

Unfortunately, in the race to grow, too many insurers have historically failed to heed the call of proper due diligence and have been doomed to the fortunes of the many fallen players. In long-haul trucking, almost every company that has jumped in has experienced the “death spiral”. It goes like this: An insurer enters the line without the proper knowledge, claims data or exposure information. So, not having the proper pricing information, they set rates using general commercial automobile loss experience plus some vague assumptions in lieu of actual long-haul trucking exposure data. As they do not have the long-haul claims expertise or data, when the claims start to roll in, they end up dramatically under-reserving. The line also has a tail, so the problems do not show up for a few years. As a result, after year-one, some companies believe they are very profitable, and therefore drop their rates further and write even more business. They believe they have found the “magic formula” that the market leaders have missed for decades. However, after a few years, the losses start developing hard and fast. Open claims begin settling for as much as ten times their original estimates.

Suddenly insurers in such circumstances realize their combined ratio is not running at 92%, but rather at around 152%. Some carriers withdraw immediately, while others try to “fix it”. But, without the tools and experience to remedy the situation, these companies find themselves in trouble.


If you are entering a tough niche, you of course need the key data, but you also need the specialized processes, controls, and niche-specific systems. That often means investing millions of dollars and many years of intensive infrastructure implementation. For example, a specialized long-haul trucking system combined with years of hard data ensures much greater segmentation is tied into the rate adequacy process, making pricing a distinct science rather than a never-ending guessing game.

Infrastructure, however, is more than just bricks, mortar and computer systems: it is also about knowledge. “Sure, we’ve painstakingly built our custom programs and systems…but for us it’s a multi-pronged approach – one of the crucial keys is having the experience in the class of business,” observes Tim Davies, vice president of the Canadian property division of Commonwealth Insurance. “We have the systems, but more importantly, we know what we’re doing.” Davies also notes, “we’ve seen nave capacity enter our lines of business, and then pay dearly for it. They think it’s just another simple line, similar to something they’re already doing. The problem is that they don’t truly understand the business.”


Just as a line of business can seem innocuous, so can a commodity. Take chocolate. What could be simpler? Well, on one occasion at Markel, we were asked by an insured to endorse chocolate cargo coverage, a new line for him, carte blanche. Our underwriting team knew from experience that chocolate companies could never have their name associated with contamination.

Even a minor accident where one box is mildly dented could instantly be considered a total loss, in this case almost $5 million. Worse still, we would not be permitted to sell the undamaged goods for salvage because of stringent food laws. In response, our team worked with the insured, helping him renegotiate contract terms with his client to cover the additional insurance cost required. “The information we rely on is not just the things you can look at on a computer”, says Davies. “It’s engrained from decades of experience looking at the same classes of risks. We regularly see what others miss.”

Tim Ius, senior vice president at Common-wealth’s casualty division, also points out, “you don’t make money jumping in and out of the market, trying to time it. Our operating philosophy hasn’t changed since day-one. We’re in it for the long-term because in our book of business, we need to build up many years of premiums to cover the big losses. We won’t undercut the pricing we need.”


According to a 2003 Towers Perrin study, the U.S. tort system cost US$233 billion in 2002, up a staggering 30% from 2000 alone. Just one glance at these rising U.S. tort costs tells you how dangerous it can be to take on high risk lines with U.S. exposures, and how important it is to be working with current, accurate data.

At the end of the day, specialty lines may be exciting but many are far more dangerous than they may appear on the surface. As the market softens and insurers once again look for new lines to grow in, one can only hope that they will look carefully before they leap. And, if they still choose to jump in, that these new players will do so with the right data, expertise and infrastructure – and their eyes wide open.