“It is interesting,” says Gary Tiepelman, senior vice president-contract underwriting at Scottsdale Insurance Co. of Scottsdale, Ariz. “It's certainly not a hard market, but it is a firming market.”

“To call it a hard market is a bit of a stretch,” says Linc Trimble, the Jersey City, N.J.-based head of eCommerce at Torus Insurance Holdings Ltd., which operates a U.S. surplus lines insurer.

Wholesalers in much of the country, meanwhile, are placing risks more efficiently as a result of the 2011 non-admitted market reforms, executives say. But there is still room for improvement.

The consensus that the surplus line market is hardening is a departure from market assessments the previous two years, when insurers and brokers says only pockets of risks faced tougher renewals.

“The market has strengthened since then,” says Marla L. Donovan, a Farmington Hills, Mich.-based executive in the office of the chairman at wholesaler Burns & Wilcox.

Now, underwriters are seeking rate increases for nearly all risks, market executives say. They estimate that rate hikes typically range from 3% to 10%, depending on various factors, including location and how low expiring rates were.

Jeremy Johnson, the Boston-based president and chief executive officer of Lexington Insurance Co., the surplus lines unit of American International Group Inc., says property rates generally are higher by mid-single-digit percentages. Meanwhile, in the insurer's casualty portfolio, rates have increased by double-digit percentages on average, although somewhat less than half of the risks in the portfolio represent the toughest classes of business thathave faced that steep of an increase, he adds.

And unlike last year, insurers are applying those increases equally to new as well as existing accounts, Scottsdale's Tiepelman says. Last year, insurers competed on rates for new business. “This year, I'm not seeing that,” he says.

Still, with insurers raising rates only modestly from their low expiring levels, the surplus lines market cannot be considered hard, Tiepelman explains. “It's not a hard market because rates are still lower than they were in 2000.”

Given the long-term drag on interest rates, across-the-board rate hikes are necessary to ensure insurer profitability, Lexington's Johnson says.

But the market is turning gradually rather than an abruptly for a couple reasons. One is the market's strong financial health.

The “tons of capacity” in the market are holding rates down, and that is positive for the industry's reputation, Tiepelman says. “It makes our industry a lot more credible when we don't have those significant changes in rates.”

The overall steady but moderate rate strengthening is “healthy for the industry,” adds Donovan.

The rate hikes mean the domestic surplus lines industry marked only its second year of premium gains over the past six years, according to A.M. Best, which recently released its 20^th annual report on the industry. The 2013 report, which covered the industry's financials through year-end 2012, found that domestic surplus lines insurers last year generated a robust 12.9% increase in direct premiums written, following a far weaker 3.2% gain in 2011 and four consecutive years of decrease from 2007 through 2010. The overall surplus lines industry reported an 11.8% increase in direct written premiums in 2012 on the heels of five consecutive annual decreases.

And for the ninth consecutive year, no surplus lines insurers became financially impaired in 2012, Best reported. The admitted property/casualty industry disclosed 21 impairments.

Another reason for the gradual turn is the availability of better underwriting data that insurers have been able to capture over the past decade, says Trimble at Torus. It's based “more on data than on emotion.”

“Short of something that would be a significant hit to industry capital, I'd be surprised to see the market go into the more volatile, hard part of the cycle,” Trimble says.

And with the economy beginning to recover, “the demand side of the curve is strengthening,” which will only further fortify the surplus lines industry's financial wherewithal, Donovan observes.

Property risks

Standard-lines insurers began dropping property catastrophe risks after numerous major losses pounded the industry in 2011 and a wind-loss model released early that same year indicated that insurers were far more exposed than they understood. Jettisoned from the admitted market, those risks flowed into the surplus lines market, which charged significantly higher rates.

“I would have thought a good portion of that already had moved” by the fall of 2012, says Barnaby Rugge-Price, a director at London broker R.K. Harrison and the head of its Property/Casualty Division. But losses arising from Superstorm Sandy last October hit admitted markets with “a big surprise” about their property catastrophe aggregation levels.

The storm cause total insured losses of about $25 billion.

“I think (the admitted market) is continuing to shed that business,” especially in coastal wind-prone regions but also in the country's interior where hailstorms and tornadoes are prevalent, Scottsdale's Tiepelman says.

The storm losses' impact on rates, however, was not dramatic, market executives says, even though Best reports the surplus lines industry's loss ratio during the fourth quarter last year surged more than 12 points to 64.9 from 52.8. The spike indicates that the storm hit non-admitted insurers as well as the standard lines market, Best concluded.

“Sandy should have had a much bigger effect than it did,” says Donovan at Burns & Wilcox. “But oddly enough, there's so much capacity out there—and alternative capacity like CAT bonds and sidecars for reinsurers—which reduces the need for higher rates,” she says. The alternative capacity as a percentage of global property catastrophe capacity has nearly doubled from 8% to 15% over the last five years, she noted.

“So Sandy really didn't change the course (of property catastrophe rates) one way or another,” she says.

Nichols of All Risks says that is one of the “biggest changes” in the market. “There are no major rate increases, but there are no major decreases” in property catastrophe rates.

“To me that's shocking,” especially considering the storm hit New Jersey and New York, where the industry's decision-makers live, Donovan says.

Moreover, if insurers this year escape a second consecutive hurricane season with no major losses, “we could be in for a period of softening rates,” Nichols says.

Lexington's former president said last year that inadequate rates might force the insurer to “re-think” its plans for 2013. But Johnson, who was appointed president and CEO this spring, says: “We are very committed to the markets we're in. We won't wholesale pull out of a book of business of we don't achieve X, although that book of business may shrink if the rates are not adequate. We don't try to time the market cycle.

“We're very focused on account-specific underwriting,” he adds.

Johnson also noted that in lieu of additional rate, insurers are seeking larger deductibles, especially in the Northeast. “Sandy demonstrated to us the vulnerability of highly urbanized areas to extreme weather,” he says.

Among smaller risks, “we continue to see [small] construction move into our world” from the admitted market, says wholesaler Matthew D. Nichols, referring to frame residential properties and small joint and masonry commercial construction.

Rates for those properties are quite disparate, says Nichols president of Hunt Valley, Md.-based All Risks Ltd. and outgoing president of the National Assn. of Professional Surplus Lines Offices Ltd. In some cases, rates are 10% to 15% higher, and in other cases rates are flat. “I think it's just a matter of how aggressively they were charged the year before,” Nichols says.

At the extreme ends of the insuring spectrum for those properties, buyers with recent losses could face a doubled rate, while those in the Pacific Northwest likely will find the admitted market still wants their business, Nichols says.

RKH's Rugge-Price also noted that there is “a greater willingness of London underwriters to write middle-market business,” particularly property risks, in the U.S. market. To put themselves in better position to write that business, London underwriters paying higher commissions to managing general agents to produce the business for them.

Casualty risks

Insurers are boosting rates for casualty risks by varying percentages, depending on various factors.

Lexington's Johnson, who says most casualty rates are rising by double-digit percentages, noted that high-hazard product liability risks and energy sector accounts “is where we're seeing particular hardening” because of poor experience and insufficient expiring rates.

However, he noted that a buyer occasionally will negotiate a larger deductible in exchange for a lower rate increase. “But for the most part, we're getting rate for the portfolio,” Johnson says.

Casualty risks flowing into the surplus lines market include habitational coverage and liquor liability, says Nichols of All Risks. Rate increases for those risks generally are around 5%, he says.

Trimble at Torus says rates for small-business casualty risks are increasing by high single-digit percentages “on top of their modestly increasing exposure base.”

“It's the same as it's been the last two full years,” he says.

The surplus lines market also continues to write “a fair portion” of the construction casualty business in New York, Rugge-Price says.

Admitted markets have lost their appetite for that risk in recent years because poor loss experience, much of it driven by New York's law holding contractors liable for third-party losses in scaffolding accidents regardless of fault, executives explained.

“Loss ratios are running somewhere between 200% and 1,000%, depending on whom you talk to, on the back of a spate of claims arising from the NY labor laws and the Scaffold Act,” Rugge-Price noted. As a result, insurers are seeking significant rate hikes, he says.

In addition, Torus' Trimble noted, contractors face rate hikes in four states that either legislatively or through case law have established that faulty workmanship is an occurrence under insurance contract language: Arkansas, Colorado, Hawaii and South Carolina.

As a result of the Affordable Care Act, more casualty business from health care companies has moved into the surplus lines market, and the London market is covering some of that risk, RKH's Rugge-Price says.

““The Affordable Care Act has forced health care organizations to change the way they operate and relook at the way they buy insurance. We have seen demand for regulatory billings, E&O, ACO (Accountable Care Organizations) and cyber coverage,” he says.

Donovan at Burns & Wilcox says demand for medical malpractice as well as general liability and property coverage from many types of health care providers already buying coverage from surplus lines insurers has grown as the demand for those services has risen as a result of the ACA. Those providers include doctors, nurse practitioners, dentists, home health care and assisted living facilities.

Employment practices liability insurance rates are rising, as well, particularly for risks in California, because of a spike in loss frequency in recent years, Rugge-Price says. “Private companies are seeing some of the largest percentage increases, albeit from a low base, and 25% is not uncommon,” he says. “But in general, insurers are looking for increases of perhaps 5% to 15%.”

Rugge-Price noted that insurers are increasing directors and officers liability rates by 10% or more in general.

Surplus lines insurers are seeking single- to double-digit rates for transportation risks, including private passenger, long-haul delivery and livery risks, Nichols says.

Conversely, Nichols says: “Anything that's six figures or larger in premium is under pricing pressure. We expect to lose a certain percentage of those to the standard lines market every year,” because of the lower rates admitted markets are willing to offer those risks, he says.

The only other loss business the surplus lines market is losing is the result of merger and acquisition activity, especially in the health care industry, Rugge-Price adds.