Matthew Power, executive vice president of Lexington Insurance Company, will attend the NAPSLO meeting in Orlando, but he didn't have to view an advance copy of the rating agency report to know where Lexington stands.

He believes that three types of capital distinguish Lexington in the surplus lines segment: financial, intellectual and relationship capital.

Financial capital is evidenced by $6.4 billion policyholder surplus in the Lexington Pool at June 30, 2009, and intellectual capital by “a deep bench of talented people” as well as product innovations such as coverage for loss of business income that hospitals may incur in the event of a pandemic influenza, he said. (See related article, page 19, for more on pandemic coverage, and a related text box with this article for a summary of key financials.)

“Our distribution channels here in the United States, and in Canada, Bermuda and London [together] position the organization virtually everywhere business is conducted. So in each venue where E&S business is transacted, we're there to catch the business,” Mr. Power said, emphasizing the benefit of relationship capital.

“Many of the newer entrants into the E&S space purport as an advantage to be small and nimble,” he continued. “I wonder if they truly understand what it takes to move quickly, to create new markets and to execute through complex market cycles and changing economic conditions,” said Mr. Power, who is also and president of Chartis' Risk Specialists Companies Insurance Agency, a wholly owned brokerage network.

Mr. Power explained that distribution capabilities across the United States and around the globe–as well as a diversified product portfolio in property, casualty, professional liability lines and programs–give E&S veterans an edge over newer competitors that shows up clearly on the bottom line.

He noted, for example, that even though 2008 was a challenging year for property writers–with Hurricanes Ike and Gustav as well as a wave of tornadoes and record fire losses impacting underwriting results–Lexington reported a significant profit.

“We were able to do so because of contributions to our bottom line from our casualty, program and health care groups,” he said. “Our scale combined with that diversity acts as a very important stabilizer in the E&S world.”

According to statutory accounting data retrieved from Highline Data (a data affiliate of National Underwriter), Lexington Insurance Company reported a 96.0 combined ratio in 2008, even though commercial property lines together generated a combined ratio of 143.7. For commercial casualty, the overall combined ratio was 68.6.

Diversification and financial strength also give Lexington “a sustainable competitive advantage” during changing market cycles, Mr. Power said.

“Newer entrants that lack capacity have not been able to participate in what has been a relatively firm property market cycle, when compared to casualty lines, especially in catastrophe-exposed areas. A large number of new entrants are relegated to the sidelines and have to focus on casualty lines,” he said, later characterizing the current E&S property market as a hard one, again, in contrast to soft pricing that continues for casualty lines.

Casualty insurers are also challenged to grow premiums as a direct consequence of an economic downturn, he added. The global economic crisis was the single biggest factor impacting the overall p&c cycle–throwing off course an across-the-board hardening that had been widely anticipated last year, Mr. Powers believes.

“If you have capacity, if you have a strong balance sheet, you can participate, function and make markets in the property arena, and in the property-catastrophe segment, in particular. But if you don't have that scale, your focus becomes casualty lines,” he said, noting that the rating bases for critical casualty niche markets such as trucking and hospitality (trucks on the road, sales and payroll) are all diminished in the current economy.

“Many [casualty] insurers find themselves with a mismatch between earned premium in the current year and prior-year losses. It creates an imbalance,” he said, adding that “escalating expense ratios and a high cost of entry to reinsurance protection are further contributors to deteriorating underwriting results for newer market entrants.”

Asked if the chase for casualty business by newer markets has been a major factor driving the continuation of a soft market, Mr. Power replied that he sees inconsistency. “Earlier in the year, I saw a lot of aggressive pricing on casualty lines. But [now], I see some that are beginning to pull back in terms of capacity and commitment to certain market segments.”

In spite of its unwavering commitment to the E&S market, Lexington experienced a drop in total direct written premiums this year. For the first half, direct premiums fell 11.7 percent to $6.0 billion, with commercial casualty lines premium falling 26 percent, while property premiums remained roughly unchanged.

“That's fewer opportunities for the industry. That's not business moving away from us or to the standard markets,” Mr. Powers said of the casualty drop–noting, for example, that economic conditions driving a slowdown in construction project starts have had an impact on a core segment served by E&S insurers.

INNOVATION IS KEY

Mr. Power noted that the E&S market sector traditionally is “a hypersensitive industry segment,” with large premium inflows during hard markets and outflows to standard markets during soft ones.

Some E&S insurers, however, buck the overall trends by creating new products, he said, noting that Lexington annually generates several hundred million dollars from new products in emerging business areas–”products that simply didn't exist in the market heretofore.”

This year is no different, he said.

Recent innovations include two property extensions covering income losses and expenses of health care facilities–one triggered by a flu pandemic and the other by a “nosocomial” (hospital-acquired) infections, such as MRSA. Such infections can create a potential shutdown of a floor or a ward, which represents a meaningful business income exposure for hospitals, Mr. Power said, confirming that Lexington will be launching this coverage within the next few weeks.

Looking back over two years, in the higher education space, Lexington has created crisis management products that respond in the wake of campus violence.

In the commercial real estate sector, Lexington has modified property forms to respond to green-building and sustainability initiatives, while introducing “down-zoning protection,” also within the past 24 months, he said.

Mr. Power explained the down-zoning coverage, using the example of a 600-room hotel built in Boston before zoning ordinance restrictions were put in place.

If the original building burns down and must be rebuilt with 300 fewer revenue-generating rooms, property owners and lenders can suffer financial consequences, Mr. Power noted.

Commercial real estate mortgages aren't necessarily based on the bricks-and-mortar value of the building, but can be based on the income stream produced by the building, he pointed out. “You may very well end up with a delta [difference] between the insurance recoverable (replacement cost) and the mortgage,” he said.

According to a description of the coverage published in conjunction with the “Zoning Restriction Protector” insurance product launch in August 2008, the policy can insure lenders by paying the difference between the loan balance on the date of property damage and the total property insurance proceeds, or it can insure property owners for the loss of net equity.

In general, Mr. Power said the product launches are all a function of looking at trends–”societal and legal trends, or trends in the purchasing appetites of our constituents.” By analyzing such trends, Lexington doesn't just create meaningful products for customers, he emphasized–they're also a source of differentiation for Lexington and for brokers.

A DIFFERENT ENERGY

While new production development is a mainstay at Lexington, some things have changed during the past year, including the management team, which is now led by Peter Eastwood, who was formerly executive vice president and is now chief executive.

In the months that followed the near-bankruptcy and subsequent government bailout of AIG in September last year, several members of the management team jumped ship to Ironshore in Bermuda, including Lexington's former CEO Kevin Kelley, and Shaun Kelly, the past president.

“What hasn't changed is that our focus as a management team continues to be on the business and our customers and our employees. That's remained consistent over the past 40 years,” Mr. Power said. With respect to the business, “Lexington has posted two record quarters,” he said, noting that policyholders' surplus is now at its highest level, and the company's expense ratio remains well below that of competitors.

According to Highline Data, expense ratios for 2008 and for the first half of 2009 were 15.6 and 14.3, respectively–figures consistent with earlier periods, and significantly lower than industry levels that generally hover in the mid-20 range.

Mr. Power attributed the difference to a cultural proclivity to manage the bottom line and the advantages of insuring customers with some scale.

He said the new CEO has maintained a very careful watch over the key metrics of the organization. In addition, he said he feels Mr. Eastwood has brought with him “a refreshingly collaborative management style that has bonded and energized” Lexington's 1,400 employees around the world.

“When you introduce change within organizations, it creates new energy. In the case of Lexington, it's done just that. The energy level at Lexington has never been higher,” he said, adding that the new collaborative style is viewed positively both internally and externally.

Marshall Kath, the incoming president of NAPSLO, as well as CEO of Colemont Insurance Brokers in Dallas, provided an external view that he characterized as not being either overly positive or negative.

“They are actively taking the steps to make sure they run their business as best and smartly as they can,” he said.

Chartis “is behaving and acting like a normal business, and doing the things that you'd expect them to do, and trying to survive in the same environment that all the rest of us are in,” he added. “They've been dinged, no doubt, but they were a big, big, big franchise to start. And it looks like they're positioning themselves to be in it for the long haul.”

Reflecting on the events of the last year, Mr. Power said he is most proud of the way the team has pulled together and “maintained and enhanced the momentum with which we seek out opportunities, drive new product and really lead the market.”