Specialty Lines Markets
Specialty lines outlook: 2012
More of the same? But there could be some hardening
By Dave Willis
For a glimpse into next year's specialty lines insurance environment, just look at this year. This advice isn't valid every time December rolls around, but, according to industry leaders, it is this time.
"What we've seen this year is probably a good indicator of what to expect in 2012," says Jeremy Hitzig, CPCU, CFA, chief executive officer of Distinguished Programs and president of Target Markets Program Administrators Association. "In our book of business, we have seen, for the first time since the soft market began, a firming of rates."
He calls the firming "very modest in the grand scheme of things," with rates rising 3% to 5%. "At the beginning of the year it was three, and now it's around five," he adds. "So it's both up and trending upwards."
"For next year, I expect a continuation of the same trends we've seen this year," says Carl Sadler, CPCU, ASLI, president of Transportation Insurance Consultants LLC and chair of the CPCU Society's Excess/Surplus/Specialty Lines Interest Group. "The number-one trend affecting the business is it appears that the market has flattened out. Prices are no longer dropping. In some areas, prices are starting to move upward. Perhaps as we get into next year, they'll rise a little more rapidly."
Of course, notes Robert Sargent, CPCU, RPLU, ARM, president and CEO of Tennant Risk Services, terms like "continuation of the same trends" and "modest" could go out the window if the industry encounters some sort of outside shock. "The industry is more vulnerable to such an impact than it was a few years ago," says Sargent, who also is president of the National Association of Professional Surplus Lines Offices Ltd. (NAPSLO).
According to Sadler, a number of factors are driving change. "Clearly, companies on the property side got clobbered by catastrophes," he says. "We'll learn soon enough about reinsurance pricing, but I suspect property reinsurers will begin to increase pricing. They can't be very happy with results."Some casualty classes have experienced catastrophic losses, too. "Charter buses is one," he adds. "A number of large losses have caused prices in that area, even on the primary level, to increase quite a bit."
Political issues also come into play. "I suspect European problems would almost have to spill over to the major European insurers, especially since some appear to be as much bank as they are insurer," he notes. "If they're writing off half the value of Greek bonds, that will have to have an effect."
Domestic economic factors will also affect the market. "A lot rides on what happens leading up to November 2012—until it becomes clear what's likely to happen in the election," he says. "It's less of an economic issue and more of a business confidence issue. Once the confidence issue gets resolved, you may see the economy improve."
According to Hitzig, a rebound could lead to new opportunities. "The U.S. and global economic environment has depressed growth and growth in exposures and has been restricting budgets," he explains. "Where new risks have emerged, there may have been a lower use of insurance to mitigate those risks. Funding wasn't there. Getting the economy back on track could help overall premium growth."
Continued depressed interest rates will also affect the business. "With interest rates at historic lows," Sadler observes, "insurer investment income has to be drifting downward. If you have positive cash flows, where do you put them today to get a decent return? Back in the 1970s and early '80s, you could get a much higher return, which reduced the pressure on underwriting profit."
Underwriting & pricing
In the midst of myriad economic factors and an apparent market shift, tighter underwriting is expected.
"We have had many years of price decreases and we have had a number of years of prior year reserve releases," Sargent observes. "So the table is set for some difficult times in the underwriting end of the business. Certain segments—whether you define that by class, by territory or by line of business—are going to see some changes," he adds. "Even some of the more competitive lines are going through some changes in the midst of competition."
Citing his own specialty—professional liability—as an example, Sargent explains, "In that, the cyber and data breach segment has been very competitive. It's a relatively new segment, and the underwriting continues to change." He adds, "Some underwriters are being much more careful about exposures from lack of encryption on portable media devices. That's just one small example, but as such tightening increases in the specialty lines business, agents and brokers will need to pay attention to coverages and the competitiveness of what they deliver to clients."
Territory-based tightening could affect specialty lines, too. "That's always an issue," Sargent notes. "It comes into play in different ways. In terms of CAT property, people continue to pay close attention to aggregate exposures. Obviously, Florida and the Gulf Coast are focus areas, as are others. But in professional liability, territory can come into play in other ways, too. With medical malpractice, for instance, territory can be state-specific. Some states are more difficult than others are, and underwriters are tending to pay closer attention to that.
"Underwriters are also looking at professional liability catastrophic exposure embedded in an insurance agency," Sargent says. "For example, an insurance agency that writes a lot of personal lines business in Florida has a different exposure than one that writes personal lines in, say, Ohio. Where there are a lot of hurricanes, and even in areas with earthquakes, claims frequency for insurance agents tends to increase dramatically out of those events."
Tightened underwriting generally drives increased prices. Specialty lines should see this in 2012. "I recently met with program administrators at Target Markets [Program Administrators Association's annual meeting] and at an insurance company producer council meeting," says Hitzig. "While some segments were outside of the 3% to 5% range, on balance, people are experiencing modest price increases in most lines.
"My instinct says we probably won't see a roaring hard market in 2012," he continues, "but we are likely to see a continuation of increases, perhaps in the 5% to 6% range, maybe a little more. I believe we will also see some insurance companies retreat from entire areas or product lines, and there will be more restrictions and tighter underwriting guidelines in certain classes and certain territories."
Some carriers speak rather definitively about the soft market being over and a hard market being in place. While perhaps technically correct, Hitzig says, "As a practical matter, rates being up in the low single digits is not what people typically think of as a hard market. We'll see whether increases reach the 15% range that has been mentioned as likely for 2012."
Sargent describes current pricing as a "mixed bag. Pricing is variable and underwriters in certain segments have said, 'Enough is enough,' and they have pulled back in one form or another. Other underwriters are saying, 'You know, in this particular segment, we are doing really well,' and they continue to be 'moderately aggressive' in their pricing," he adds.
A major underwriting and pricing shift could take place if the specialty lines business—or the industry as a whole, for that matter—encounters some sort of major event. "Severe external factors have triggered tighter underwriting and increased pricing in the past," Sargent notes, "and will likely in the future. The challenge is that nobody knows when or how it will happen. If one does occur, we will be in a very different environment."
"On the simplest of levels," says Hitzig, "a firming of rates will help the overall economic situation of retailers, program managers and MGAs and wholesalers. On the other hand, I think it remains fairly challenging to invest in the business in the right way. If companies didn't invest in technology and distribution in the last few years because of the rate environment and the economic environment, they need to face that situation."
Hitzig adds, "On the retail side, there has been a fair bit of consolidation in recent years and I imagine that will continue. I had actually expected to see more M&A activity in the program administrator and MGA business over the last couple of years. I'll be curious to see how that unfolds in the next year or two. The continuing need to invest in technology, distribution and people will probably lead to more M&A activity."
Such activity isn't limited to retail agents and MGAs. "We're still in a period of carrier consolidation," says Sadler. "It's hard to see if you look at it year to year, but look back over a 10-year period, and think of all of the companies that used to be around that don't exist anymore.
"The same thing is happening with wholesalers," he adds. "Interestingly, such consolidation opens opportunities at the lower end for new businesses. The barrier to entry for wholesalers is not that great. People who used to work for large wholesalers are hanging out their shingles, and this can have an impact on retailers."
Sargent also has observed such marketplace shifts. "At Tennant Capital Partners," he says, "we have seen increased interest from experienced teams looking to start new specialty brokers and underwriting managers."
Sadler believes market changes will demand greater expertise and more efficient communication. "The business is becoming increasingly complex," he explains. "For instance, coverages like E&O and D&O were interesting little niches 20 years ago. Today, they represent significant sources of premium. There's clearly more to know."
Technology is driving changes in how providers and distributors engage each other—and the public, he adds. "There is much more technology within retailer offices," he says. "That will have an effect. Plus, there are far better communication systems than ever before. Social media is part of that. It has fostered communication but, at the same time, it has made it easier for misinformation to be shared. As a retailer, you need to be paying more attention to technology and interface with your businesses partners," he notes. "And wholesalers, MGAs and insurers need to work with agents to address interface if independent agents are going to maintain their strong role in serving commercial lines business."
The industry needs to work together on social media and client engagement, too, he adds. "We need to understand social media and how it can serve our business and our clients. I'm not sure we know fully where that is going to lead us, but it is certainly the wave of the future."
In a changing marketplace, thought leaders point to the need for retailers to bolster partnerships with insurance providers. "It's important to tap them for coverage guidance, of course," says Sadler.
Sargent agrees. "In specialty lines business, expertise is critical," he says. "Retail agents and brokers need to make use of the expertise their wholesaler can provide in helping them figure out the best combination of types of coverage for a client and which markets can provide that."
Expertise is just part of the reason. "It is more important now than it was in the midst of the soft market for retailers to establish relationships with program managers, wholesalers and general purpose MGAs," Sadler says. "If the market begins to tighten, they're going to need those people. When the market really hardens, insurers and intermediaries will be getting calls from people they've never heard from before. If they don't want to work 120 hours a week, they have a tendency to support those people who supported them when the market was soft."
Hitzig sees the importance of strong program business partnerships, too. "For program administrators, we will see the importance of building market relationships," he says. "The strength of our market relationship will be a key determinant of success over the next few years.
"Some companies will shed marginal programs and some will exit the program space," he adds. "It's typical hard market behavior to see some retrenchment. Program administrators and MGAs who developed and invested in their insurance company partnerships will be positioned to succeed."
Sadler concludes, "Start thinking about strengthening relationships now because you're really going to need them before you know it."