London market contributor Paul Lawrence, head of the propertydivision at Hiscox Global Markets, gave as succinct a descriptionof the insurance market cycle as any we have heard. “High profitsattract new capacity,” he said. “Without a significant increase indemand, the new capacity drives down price. Eventually profits turnto losses, capacity leaves the market, demand remains constant,prices go up, profits return, and we start all over again!”

Where is the insurance market — and more specifically, theE&S Florida insurance market — in that cycle today, and whatdoes the near future hold? From E&S brokers to retail agents,domestic carriers and the London market syndicate, there isuniversal agreement that the current market is soft, has been softfor some time, and will remain soft through at least a portion of2010. The only minor debates center on how we got here and whatneeds to happen to firm things up. Parties cite as contributingfactors the historical cyclical factors such as excess capacity,increased competition, and declining premiums, along with thestruggling economy, the lack of a catastrophic event, and Florida'svolatile regulatory environment.

“Each market cycle is different, with its own unique set ofchallenges,” said E&S executive Kathy Colangelo, a senior vicepresident with Hull & Company. “The current cycle came with thechallenges of declining interest rates, the sub-prime debacle andSarbanes Oxley, where companies had to release redundant reservesmore quickly than in the past. Also, 2009 was an extremely lightcatastrophe year, so insurers were left with capacity to write morebusiness. These challenges collided with a full-blown recession andunemployment at levels not seen in some 30-plus years.

“In the past, Florida has been more resilient than most states,”Colangelo added. “Historically, our booming tourism industry andstrong housing market and job growth enabled Florida to outperformthe average. This has not been the case during this market cycle.The housing market has crumbled in Florida, causing many people tolose their homes. Those who kept their homes lost 30 to 50 percentof their home value depending on their location. This had an impacton almost every industry that buys insurance. New home andcommercial construction was drastically reduced. The hospitalityand tourism industries were down. People held on to their money,took fewer trips, ate out less.”

Lawmakers and Regulators

E&S broker Thomas Enright, president of Enright & Wilsonin Hollywood, called 2009 a “disappointment,” and holds the actionsof the federal government and financial institutions accountable.“The huge amount of money made available to society by ourgovernment and financial system has not come close to achieving theintent,” Enright said. “Only a small percentage of those funds havebeen aggressively used to get our economy going. Banks have themoney but are failing in the process of using it. Until the banksstart to use it, our (insurance) cycle will go no further than itis now. We are trying hard to be flat (no decreases in rates orpremiums). It is close but not there yet. Most insurance leaderswanted, but really did not see, a 2009 market that would tighten upand result in premium growth. That did not happen, so we arelooking for and hoping for those changes in 2010.” Enright alsoacknowledged the over-arching challenges that continue to confrontthe state's property markets, noting that, “Real estate must takeoff, and even when it does, I don't see any quick recovery.”

In any discussion of homeowners' coverage and Florida realestate, Citizens Property Insurance Corp. inevitably comes intoplay. “A key difference in the Florida property market is thatCitizens holds the price down by providing 'public' capacity, whichin turn causes private capacity to exit Florida due to lack ofprofit,” said Hiscox's Lawrence. Wide consensus says this problemis surely exasperated by the irresponsible “good riddance” attitudeperpetuated by Florida's governor.

John Handel, chairman of John Handel & Associates, Inc., ofSt. Petersburg, a 40-plus year E&S market veteran, faultsFlorida's regulatory environment. “In 2009, insurance regulatorswere more interested in the preservation and expansion of theirpolitical and bureaucratic ideology,” he said. “Their recent answerhas been to 'invent' insurance companies of their own and to allowthe 'invention' of other companies that lack management andbusiness abilities.”

Economic factors obviously play a key role across all lines. Inthe past, one would expect that low interest rates and poorinvestment results would lead to a hardening of the market. This isthe situation we face now. However, because of the dismal economicconditions nationwide, increased pricing is difficult. Raisingrates during the current economic turmoil would be a criticalmistake for carriers. It would just lend more negative attention tothe industry. The underwriting results of the carriers also play akey role. Over the past 18 months there has been a minimal amountof catastrophic events around the country, which adds to thecontinuation of the soft market. This, along with the increasedcapacity of the insurance markets and the regulatory andgovernmental factors stated above, all intensify and continue todrive our current soft market.

Precarious Positions

Some market observers note that if conditions are assessed froma more technical perspective, the industry today hovers on thebrink of profitability. In many instances, a number of participantsmay have already crossed the line into the red, knowingly ornot.

While published combined ratios paint a far more optimisticpicture, underlying non-catastrophic loss cost trends continuetheir historical pattern of persistent year-over-year increase. Thetraditional counterbalances to loss cost trends, such as investmentincome and release of IBNR reserves, are unavailable at this pointin the cycle. Investment income dwells in the low single digits.Reserves accumulated in the heady days of 2001 through 2003 havelargely been exhausted over the balance of the decade. The assetside of the equation (earned premium) has failed to keep pace withits liability counterpart (loss cost and expenses), and there isfaint hope of help on the horizon.

Senior insurer executives will ultimately be confronted by adeteriorating balance sheet as the finality of claims paymentsreveals the deficiency of under-reserved claims. The rational cureis an increase in rates. Identical to the last cycle, whichbottomed out shortly before the events of Sept. 11, 2001, it willtake a painful rate correction to offset the cumulative effect ofloss cost trend increases over the last decade.

The absence of major catastrophic events in Florida over thelast few years further contribute to a false sense of security. Asingle major catastrophic event could push a number of insurersinto the red and force corrective action overnight. Seen from thatperspective, the industry is rapidly approaching the tipping pointwhere senior management will have no choice but to act to restoretheir balance sheets. It may come slowly, in the form ofdeteriorating results, or quickly, in the wake of a catastrophe.However it happens, it will come, in much the same fashion as ithas at the end of prior cycles.

London market contributor Lawrence said, “After the storms of2004 and 2005, the insurance market prepared itself for an increasein frequency of hurricane events. However, since then there havebeen no significant land-falling hurricanes in Florida. Profitshave surged and capacity has flooded in. Theoretically, the creditcrisis and near-collapse of AIG should have reduced capacity andpushed prices upwards in all areas of insurance, but this did nothappen. I think that the capacity was at least maintained inFlorida over and above other catastrophe-exposed states due to thelarge potential profits, and this kept rates flat in the early partof 2009, and saw them falling by year-end.”

More of the Same in 2010

While there seems to be consensus on why 2009 “was what it was,”the looming question for many remains, what now? When is the softmarket going to end? “I believe most people feel we are near thebottom of the cycle, but are uncertain when we will begin to seethe graph move up again,” said Colangelo of Hull & Company.“Many economists say recovery will begin to be felt in the summerof 2010. Much of what happens here will be driven by outsidefactors. The economic recovery is the main driver, but in Florida,the political climate will also impact what happens. If there isgovernment intervention, the natural cycle of recovery will bedelayed.”

Michael J. Riordan III, president & CEO of Hull & Co.,commented, “I think most of the experts feel that the insurancesoft market has another year to play as the combined ratiosmanifest themselves slowly and the admitted markets begin tojettison business. The same experts are saying that the economy hasbottomed out, so we may have more opportunity in 2010.”

Lawrence added, “If Florida is hit by a Category 5 hurricane ineither Miami or the Tampa Bay area, I believe that Citizens will betechnically bankrupt. The outcome of an event such as this couldwell be a federal catastrophe plan similar to the National FloodInsurance Program. This could lead to the end of the large profitsthat Florida has provided to both the direct and reinsurancemarkets!”

Lorna Palmer, president of John Handel & Associates, said,“With the market as soft as I think it can get, we are hoping for2010 to be a bit more realistic with regard to rates, underwritingpractices, and plain and simple common sense. Realistically, commonsense (or the lack thereof) is possibly the most under-rated factorin the whole equation.”

The weather/wind is the heavy hand that has the finaldetermination on how wild the swings are in the Florida market.This is what causes our tight markets (especially property) to bemore severe than the rest of the country. This is also a largefactor in why we sometimes face such roller coaster market swingswhen we go without a storm for some time. The insurance industryjust cannot resist the premium dollars that can come from thisarea.

Florida is an intriguing market. One never knows what to expect.Especially now, the homeowners' market is in flux, plagued by thelimited number of good standard carriers willing to write here.Regulatory and legislative involvement has kept the pricingdepressed. Florida is too big for the insurance market to ignore,but one hopes that the environment becomes friendlier to thecarriers so that they are willing to expand their presencehere.

As for the future, we appear to be in the bottom quarter of asoft market that most expect will continue through mid-2010. Theremay be an attempt to increase rates prior to the start of the 2010hurricane season, but if there is no activity, this soft marketcould continue indefinitely — or until a major catastrophic eventsomewhere else in the country leads to a change.

“The economy is trying to get better, but I do not see anyentities, individuals or corporations willing at this time to takean aggressive approach, which requires a good size investment,”Enright said. “I am waiting for the first big steps, which Ibelieve will come our way in 2010. However, even when it happens,it will be with less energy and expectations than in past similarsituations. I feel that the industry in Florida, which in the pasthas handled its growth aggressively and fast, will not do so thistime. Unfortunately, it will take longer and be a more cautiousprocess.”

Mark Riordan is with the commercial lines teamat John Handel & Associates of St. Petersburg. He may becontacted at 727-576-1536 or [email protected].