If anyone should wonder which sector of the Property & Casualty industry continues to enjoy some of the most enviable results, they need only consider the Surplus Lines Stamping Office of Texas' 2018 mid-year analysis of the 15 surplus lines service offices in the U.S. As of the 2018 mid-year point, Excess & Surplus (E&S) lines premiums recorded by the 15 managing service offices are up 9.4%. Premiums reported total $15.7 billion (up about $1.4 billion from a year prior), with 2.2 million transactional filings logged during the first two quarters of 2018 (5% growth over 2017). Additionally, premiums among the E&S service & stamping offices have seen a 67% increase in the past seven years. Freedom of rate and form, one might argue, is a key ingredient in the ability to surpass one's contemporaries in a crowded and competitive P&C market. Which is not to say such success is easily earned. Several key hurdles must be traversed. Many E&S executives will tell you that rates still aren't where they should be on several key lines, although some pockets of increases can be seen. Overall it's still a profitable business to be in, but operating in Surplus Lines remains as challenging as ever. "This is an exciting time in the E&S market," says Jude DiBattista, senior vice president/head of E&S Property & Casualty at QBE North America. "It continues to trend in a favorable direction, and has been gaining scale and size over the last few years. While there has been uncertainty with the rates in the market, there has been an increased demand for carriers to provide solutions to complex risks as well as demand for carriers to develop new products to address the emerging issues that our customers are facing." He points out that historically, 50% of U.S. E&S premiums came from five states: California, Florida, New York, Texas and Illinois. But now, other states are seeing their own increases: Seven states saw an uptick in filings of more than 10% in the past year, the largest of which were seen in Washington (18%) and Utah (16%). "It will be interesting to see if this remains regional or will be more of a national expansion," DiBattista adds. But he's sure of one thing: "As the market continues to evolve year-over-year, I anticipate this favorable growth trend will continue." |

'State of frustration'

The E&S sector is not immune to the impact that excess capacity has had on the greater P&C industry. Sean McPhillips, U.S. Head of Primary Casualty at Aspen Insurance, believes the E&S Marketplace is currently experiencing a "state of frustration" when it comes to getting rate. The cataclysmic events of Q3 and Q4 2017, he says, "had everyone hopeful that an overdue market correction would finally be realized. It was the opinion of many that the totality of losses could not be covered by rate increases in the Property segment alone." While the year started out with significant action on rates, he adds, that has abated as months progressed: "Most markets realize that rate improvement is needed, but there is an overabundance of naïve capacity to fill the void." "In the Property and Casualty segment of our market, it is largely as if the wildfires, hurricanes and floods of 2017 did not occur," says Gary Tiepelman, senior vice president of Western World Insurance Group. "The market generally is overcapitalized, further exacerbated by new entrants. This environment will test carriers' resolve and ability to have staying power." Erin Cullen, ProSight Specialty Insurance's customer group president, likewise says that increased amount of capacity in the E&S market will likely result in the continuation of soft-market conditions. Davis Moore, the chairman and CEO of Worldwide Facilities LLC in Los Angeles, adds, "The E&S market continues to be overcapitalized, which is resulting in a competitive marketplace." "Alternative capital continues to play a major role in increasing capacity while generally offsetting any change to increased pricing," says Corinne Jones, executive vice president of operations at AmWINS Access in Redondo Beach, Calif. "Casualty remains flat, with very slight increases of 3% to 4% if any." Although rates typically fluctuate based on class of business and venue, DiBattista points out, "there really has been no consistency either way, and it's tough to predict what needs to happen to spur pricing because a good amount of capacity exists in the market now." A perfect example, he adds, is the Property line: "Even after the weather losses of Q4 2017, rates really haven't changed as most predicted." |

Pockets of (some) hardening

Joel D. Cavaness, president of Risk Placement Services Inc. in Rolling Meadows, Ill., notes that early in the year, cat property was experiencing increases that have subsided back to generally flat. Transportation risks, he says, "continue to see modest increases as demand is high due to the economic conditions and lack of interested capacity, especially in the smaller and start-up accounts." Certain hospitality and contractors' liability classes have seen rate increases over the last six to 12 months, as have some areas of trucking. "The trailing loss performances of the last three to four years are mostly to blame for the withdrawal, and inadequate level of, capacity in these lines, causing rates to rise," says Chris Hardcastle, managing director of Capsicum Delegated Authority, a trading division of Arthur J. Gallagher & Co. Commercial Auto continues to see double digit increases, Western World's Tiepelman says, "and it doesn't seem to be enough as markets continue to exit that space." Commercial Property continues to see small increases (1% to 5%), he adds, while General Liability appears to remain flat. Throughout the Property market, Jones is seeing pockets of hardening, especially in some CAT-exposed areas and accounts that have poor loss experience. "It is anticipated that rate adequacy and increases will continue to be challenged," she says. Eric Koppang, vice president and head of E&S Casualty for Everest Insurance, says that from a Casualty perspective, it's no surprise that New York construction and transportation-related auto continue to see rate increases. This, he notes, is due to the classic hard-market influences of claim pressure and limited capacity. "We are also starting to see some rate increases on habitational and hospitality business," he says. "However, there always seems to be another carrier ready and willing to write these accounts at any mention of a rate increase." Construction, Real Estate, and Energy are three industry segments that continue to experience soft-market conditions, says Cullen. Despite 2017's rash of natural catastrophes, she says, many E&S markets did not see significant reinsurance rate increases in their 2018 reinsurance treaty renewals. Aspen's McPhillips believes the general trend this year has been for markets to monitor pricing levels on their renewal business to demonstrate positive movements in [renewal rate variation] for management, but to be aggressive on new business. "This market tends to cause some swapping of accounts," he explains. "It seems that we have markets that are losing renewals by pushing rate but picking up new business at less desirable rates." In general terms, he continues, Property business has seen rate increases driven by loss activity. "Most of the rate increase has been concentrated on risks that were directly affected by wind and fire," says McPhillips. "The Casualty market has leveled off on rate overall after experiencing many years of softening, year to year. The Casualty market needs rate increases to adjust for this downward trend over time, as well as the natural inflationary trend in an opposite direction." Still, while the rate picture may be "soft" by most definitions, it remains stable. "The E&S property market remains soft, but in many cases is still profitable," says Hardcastle. Catastrophe claims from wind, flood and wildfire have been significant, he adds, but Property pricing has, in the main, remained flat. "It will take another series of catastrophes not dissimilar to the intensity of events in 2017 to turn the market," he adds. McPhillips finds it encouraging to see that many responsible players are holding the line on pricing and not buying business just for the sake of market share. However, for most segments in the marketplace, he adds, "there are a handful of players that prefer beating the market rather significantly on pricing and terms." Koppang believes the only way for the E&S market to harden is by a reduction of capacity in the marketplace. "This can only be achieved when both brokers and insureds see value in the financial strength and underwriting knowledge of established carriers," he says. "Ratings agencies should also take a hard look at some long-tail carriers and adjust their assessments accordingly." |

An ever-evolving market

E&S executives are quick to cite Surplus Lines' continued investment in technology, both to deliver products and to better assess risks, whether catastrophe-exposed or not. "Tools to perform both functions, which are being developed at pace, will define MGAs' and wholesale agents' ability to attract the best capacity partners," says Hardcastle. Patrick Albrecht, senior vice president of business development at Associated Insurance Administrators Inc. in Montgomery, Ala., notes that the transition from human underwriting to automated/artificial intelligence underwriting is a trend that is gaining speed in the E&S lines sector — and one worth watching. Standard-lines carriers, he notes, have made a significant push into E&S lines, utilizing automation and AI to reduce risk on previously unprofitable exposures. However, Albrecht points out, "this is often done by replacing the expertise of a broker and/or retail insurance agent with AI at a lower cost to the risk bearer." This movement within the E&S lines industry to automate underwriting, Albrecht says, could devaluate MGAs. "E&S carriers are opening portals directly to retail agents, providing rate and coverage options in advance of the wholesale underwriter review," he says, adding that those carriers are also automating the rating and qualification of risk at the wholesale level. "Much of this is done to increase efficiencies of data capture/transfer and reduce error, but it also reduces the true binding authority and decision making capability of the wholesale underwriter," adds Albrecht. "As a managing general agent this trend should be followed closely, as it can significantly reduce the value an MGA brings to the distribution channel." Broadly speaking, retail consolidation continues, Worldwide Facilities' Moore notes, most likely fueled by private-equity-backed retailers looking to grow as well as historic high multiples being offered to sellers, he says. "Mergers and acquisitions are an ongoing trend in the industry, driving consolidation within the marketplace across multiple segments," adds Jones. "With a growing effort to prioritize exclusive partnerships, companies are having to reinvent themselves and develop product offerings to find further opportunities." DiBattista has likewise seen a good deal of recent M&A activity and consolidation in the E&S market from both retail and wholesale brokers as well as on the carrier side. This includes retail brokers reducing the number of wholesalers they use, national wholesalers acquiring regional wholesalers, increasing use of MGAs/binding authorities and M&A activity with many carriers, he says: "This is a consistent trend in the marketplace, with carriers looking to control their overall expenses." |

Standard-lines competition

Encroachment by standard-lines carriers in lines previously served primarily by specialized insurers is nothing new. However, in recent years, more of those carriers are developing or acquiring Surplus-Lines divisions to compete more aggressively. Even the most seasoned E&S veterans are keeping a watchful eye. "Considering the growth and profitability of the E&S segment, it doesn't surprise me that carriers are developing or acquiring surplus-lines divisions," says DiBattista. Still, he adds, "It's always a concern when new capacity enters the marketplace." Albrecht believes that encroachment should be a major concern for wholesalers, especially as automation and AI tools gain functionality and become less expensive. "It is much easier and more profitable for a retail agent to place E&S business through their standard-lines carrier's E&S division as long as they can meet the needs of the consumer," he says. "These E&S divisions tend to be more limited in their flexibility with classes, rate and form because they're part of a standard-lines carrier. However, as E&S carriers continue to automate with a byproduct of reduced binding authority, the differences between an independent wholesaler and a standard lines carrier's E&S division become fewer and fewer." "It is a real problem that more and more players are added to a mix that already has oversubscribed capacity," says McPhillips, who adds that standard-lines carriers had better know their craft before trying to deal in specialized lines. For many years, the E&S underwriters worked at standard markets to learn their trade and then moved to the E&S side of the business as savvy, well-trained, knowledgeable insurance professionals, he explains. But the insurance industry has neglected to maintain those training programs, which has created a talent void. "Over the last few years, it is not uncommon to find E&S underwriters who have only worked for the E&S markets and have never had any formal training," he continues. "It is more concerning when standard markets begin aggressively writing business that has been written traditionally as E&S business. When standard markets do this, they are often making the decision to enter a segment based on the success of deals that were written with retentions and terms and conditions not available via admitted platforms." Timothy Turner, chairman and CEO of RT Specialty, RSG's wholesale brokerage operation, doesn't believe such competition will disrupt the E&S market to a significant degree. "Most standard carriers that have complementary E&S divisions are disciplined and dedicated in their wholesale-only distribution models," he says. "They keep wholesale and retail separated, and minimize distribution friction and channel conflict." "I have no issue with healthy competition," says Everest Insurance's Koppang. "Dedicating a separate operating unit is absolutely the correct model for entry. It is those start-ups and floundering competition whose only ability to compete is based on price or ease of transaction that endanger the sustainability of the E&S marketplace." Cavaness at Risk Placement Services isn't too worried, either. "It is not a surprise that more standard-lines carriers want to expand into this space," he says. "Those that allow the specialists to be specialists and focus on the distribution that is really good in our space can do well. Those that are not focused — who open their doors to any distribution method — will get hammered over time." |

Staying focused

Despite the challenges to business, however, E&S players are accustomed to finding solutions to the most complex problems; they've made a career of it. The sentiment among nearly all the executives who spoke for this feature is, we'll still get it done. "Today's marketplace is very robust for wholesalers and MGUs," says RT Specialty's Turner. "The percentage of non-admitted P&C business in the U.S. increased from 10.3% to 11.1% in the second quarter of this year. This is a significant indicator that the market is firming, albeit slightly. The market is now clearly moving in a positive direction." Cavaness concurs that, in the broader sense, the E&S sector continues to perform very well. "The business is stable, growing, continuing to create products and capacity and serving the needs of our customers," he says. "Our segment of the insurance market continues to improve in professionalism, size and scope of our offerings." Koppang adds that although he believes the E&S market is as robust as it has ever been, "it bears no resemblance to the market of 10 years ago. A decade from now, it will likely have reinvented itself again. That is the nature of our business as we seek to provide excess capacity and solutions for the most difficult-to-place risks." Shawn Moynihan ([email protected]) is Editor-in-Chief of National Underwriter Property & Casualty. See also: 'Specialty Treatment': The state of the E&S market 'Domesticating' Surplus Lines across the states