E&S stress points to hardening US P&C market

After close to half a decade of weakness it seems the soft market in P&C may be finally breaking. 

Although it is too early to make a definitive call, there are clear signs of momentum building for a broader improving US market, albeit with continuing uncertainty around magnitude and duration.

The clearest indicator is the current stress in excess and surplus lines (E&S) markets. 

Widely viewed as the industry’s “safety valve”, the market serves as the leading indicator of a hardening market due to its role in absorbing business from admitted markets when risk appetite among admitted carriers contracts.

Multiple conversations with executives across the specialty admitted and E&S market in recent weeks have made clear the E&S market is in rapid expansion-mode, with each passing month showing an acceleration of momentum.

Executives describe the market as among the most stressed observed in recent history – well beyond the modest incremental rate movements in late 2017 and throughout 2018.

Broking sources confirm consistent challenges placing business, with some even comparing pockets of the market as comparable to the monster hard market at the turn of the millennium.

Though many others are far more circumspect, and there is clearly still ample capacity in many areas, there is a clear consensus that discipline is increasing, with underwriters becoming less willing to deploy their capital on marginal or loss-making business.

Importantly, exacerbating the stress in E&S markets is the fact that the flood of new submissions is happening concurrently with major re-underwriting exercises at leading E&S firms. This has left segments of the market in a state close to disarray.

Importantly, much of the stress does not appear to be due to recent catastrophe losses. Though many industry observers have framed the nascent signs of hardening as a delayed response to 2017 and 2018 cats, in reality much of the stress appears linked with chronic underpricing and loss inflation trends now manifesting in reserving problems in longer tailed lines.

This matters. A price hardening in response to already reported losses is a good signal for the market. Pricing power in response to yet-to-be reported balance sheet problems is another beast altogether.

As such, these developments suggest the coming months are likely to lead to a market bifurcated between winners and losers.

For those with a clean balance sheet, capacity to spare, and an appetite to grow there is clearly opportunity.

However, though many will frame it this way, in reality this group is likely to be a privileged minority. Many others will attempt to “trade through” by pretending-and-extending on reserves, with pay-as-you go additions to older accident years offset by improving reserve strength in newer business.

For others, the improving market may just be an invitation-only party observed from afar.

The Insurance Insider’s four key points are:

  • Submission flow to the E&S market has surged as admitted carriers tighten underwriting standards, with the pace of submission increase accelerating as the year has progressed.
  • The stress of new business flow has been exacerbated by a simultaneous pullback of risk appetite by multiple carriers in the E&S market that have traditionally played an outsized role, including Lexington, Lloyd’s, FM Global and Swiss Re Corporate Solutions.
  • Multiple classes and lines of business are described as distressed, including southeast wind, excess trucking, habitational, agribusiness, healthcare, excess casualty, and New York construction.
  • Though admitted markets appear much more orderly, there is an acknowledgement of a reduction of excess capacity. D&O appears to be the most notable market with rapidly changing conditions, with carriers describing double-digit increases in primary D&O with exposure to public market securities class actions.

Increased E&S flow

Submission activity for E&S business has increased significantly in 2019, according to market sources, continuing signs of growth that emerged in 2018.

The pace of this increase has been accelerating, with every month showing more significant growth, according to wholesale broking sources. 

These sources describe a “dump” of business from admitted markets, a classic cyclical phenomenon in prior hard markets indicative of tighter underwriting standards and lower risk appetites.

Wholesale broking sources describe organic growth in the first quarter as mid-teens or better – with new business production up at levels not seen in years.

Notably, even these numbers appear to not tell of the magnitude of the flow of new business, as broking sources suggest an acceleration of organic growth.

March levels were reported as well above January and continued acceleration was seen into April. If current trends continue, Q2 will look even more dramatic than Q1.

Although pricing comparisons are harder for less standardised business, market participants described renewal rate increases in wholesale markets of mid-single digits or marginally better, though with a wide range depending on the business.

Again, this likely understates the magnitude of overall pricing power.

Renewal premium changes only capture data on business renewing in wholesale markets.

In reality, much of the significant opportunity for E&S carriers comes from the flow of new submission activity where clients are unable to renew in admitted markets. Experienced E&S underwriters with the freedom of rate and form can turn the screw with a combination of deductibles, terms and conditions, and pure price increases from prior admitted forms.

E&S giants retrenching

Concurrent with this flow of new business has been a significant recalibration of the E&S market, with numerous major participants either pulling back or radically re-shaping their risk appetites, target classes and businesses.

Market sources describe the significant underwriting changes at AIG’s E&S business Lexington, as the biggest single driver of this phenomenon, with the retrenchment of Lloyd's seen as a close second. The two businesses are the largest writers of E&S premium.

AIG pullback

As reported last year, AIG’s new management has undertaken a radical overhaul at Lexington, including rationalising its distribution to wholesale only and cutting 50 percent of its programme business.

It has also significantly redefined the type of business it wants to be. Much of this strategy could be defined as a reduced dependence on large and complex risk that had been a hallmark of prior management’s “Go large” strategy, which involved offering gross property limits of up to $2.5bn.

Speaking on a Q4 conference call, CEO Brian Duperreault said it was “impossible to get value for that kind of additional limit”.

“And, rather than cornering a market by being the only company willing to write it, you risk creating an environment where you are adversely selected against. This leads to a situation where “you go large on risk you shouldn't be writing,” he explained.

“It just exacerbates everything”, he said, adding that the challenge of reserving for this type of tail risk and volatility “is impossible”.

As The Insurances Insider revealed last October, AIG has reduced its gross property prior limits offered from up to $2.5bn to $750mn or $1bn in some cases. Through additional reinsurance purchases, net limits have been reduced to a range of $5mn to $50mn.  

Market sources suggest the firm is also cutting its sub-limits for flood and earthquake.

In excess casualty, limits have been reduced to $100mn globally from $250mn for international and $150mn in the US.

The firm also signalled its intent to push for higher attachment points for excess business, and a greater willingness to deploy limits in ventilated layers throughout programmes rather than in single stretches.

These underwriting changes have been accompanied by an increased appetite for other business, with the firm targeting expansion in middle markets business. The goal is to reduce its dependence on large-limit business but still find growth in the aggregate.

Nevertheless, the impact on the markets where it has traditionally been the most important market has been significant.

Lloyd’s Decile 10

The other most significant contributor to market conditions has been the pullback of capacity from Lloyd’s syndicates. This has been driven by the Corporation’s significant performance management initiatives, particularly the remediation it has asked for in the Decile 10 portfolio.

This mandates the rapid remediation of syndicates’ “perennially worst-performing 10 percent of classes”.

While such an approach can have a quick uplift on reported underwriting results, it typically leads to a broad-based approach rather than laser focused re-underwriting by account.

Exacerbating this, the disciplinarian approach from Lloyd’s and the emphasis on shrinking rather than growing has restricted some of the opportunistic and counter-cyclical underwriting Lloyd’s has historically been famous for.

Market sources suggest few syndicates have yet made pitches to the Corporation to pre-empt mid-year in order to seize the growth opportunity in a turning market.

“Simultaneously, Lloyd’s has restricted the amount of growth companies could have in that market,” one market source noted.

“It’s unfortunate timing.”

These two strategic shifts have exacerbated the challenges facing wholesale brokers already struggling with an influx of business, particularly in large-limit and layered property.

Lexington and Lloyd’s combined may only account for around 20-25 percent of the E&S market by premium volume. However, their share of the large complex risk and layered parts of the market is likely much higher.

Similarly, their historic role as market leaders willing to step in and problem-solve for clients cannot be understated.

Brokers describe significant stretches that were once written by exclusively by AIG now being broken into multiple placements, sometimes by as many as 10-15 markets.

Other market pull-back

The marketplace is also being shaped by changes in appetite from FM Global, which has withdrawn capacity following a year of elevated large loss activity.

FM Global has traditionally been known as a large-limit writer in property D&F, and often would write large quota shares and 100 percent of large excess of loss (XoL) layers on D&F placements.

However, FM’s losses, which included a $500mn New Jersey paper mill and a $100mn London warehouse, contributed to the company racking up a combined ratio of 139 percent last year.

The carrier is scaling back from writing certain 100 percent property lines while pushing for meaningful rate rises and asking brokers to syndicate some programmes.

Market sources also point to the impact of Swiss Re Corporate Solution re-calibrating its risk appetite for large limit risks adding to the fallout from the remediation work of AIG and Lloyd’s.

Due to the challenges acquiring capacity, some Fortune 200-500 clients are buying less limit.

“This is extremely risky for the client, but it’s becoming more common,” one executive told The Insurance Insider.

In February, this publication revealed that Swiss Re Corporate Solutions’ head of excess casualty, Bill McDaid, and the head of casualty for its central US region, Christine Harman, were leaving the business, according to market sources.

These departures come at the same time as the insurer told the market it will not renew the majority of US excess casualty and lead umbrella risks where the insured's annual revenue exceeds $10bn. 

According to broking market sources, the exceptions to the rule are those clients operating in the rail and government contractor industries, as well as various specific automotive sectors.

As one source explained, Swiss Re Corporate Solutions made the move after being hit by a series of large claims. These come after a period of significant expansion during what has been a lengthy soft market.

Market sources describe Zurich’s behaviour as somewhat less clear, with some evidence of retrenchment, but also other pockets of more aggressive behaviour. The firm’s recent results have been among the worst of its peers.

‘Poster boys for reckless underwriting’

Other underwriters in the space have largely welcomed the moves. In particular, the changes at AIG cannot be understated, with rivals hoping a rational AIG will lead to a structural change to the P&C market given its long-term role under previous management as a destroyer of hard markets through under-pricing risk.

“What’s encouraging after many years of people not paying attention to underwriting fundamentals, the trading environment is marginally improved,” said one senior E&S executive, who called AIG and Lloyd’s the “poster boys for reckless underwriting” in the past.

“This is therapeutic for the rest of the market,” the executive said.

No successors emerging

Despite the pullback from many leading carriers, one conspicuous absence is the arrival of a clear successor seeking to fill the void and dramatically increase market share.

Obvious candidates for this role include Berkshire Hathaway and Chubb. 

Berkshire and Chubb appear best placed to offer an alternative for a buyer looking for stable markets with big balance sheets and large risk appetites.

In particular, Berkshire specialty appears almost purpose built for this moment with its ex-Lexington leadership team and colossal balance sheet and tolerance for volatility for well-priced business.

Arch Capital is another name apparently well-positioned after a decade of careful exposure management and willingness to shrink rather than write unprofitable business.

However, this represents little more than speculation based on competitive positioning at this stage as market sources said they had not noticed any particular market moving in to fill the void.

Underwriting sources suggested that there is a need for careful evaluation of the growth opportunity when competitors look to “take out their trash”, as even big rate rises can leave business well short of true rate adequacy.

"If you're seeing people bragging about getting big price increases it's only because the product was underpriced to begin with," said one senior source.

Multiple pockets of stress emerging

With so much change from leading carriers, it is unsurprising that significant pockets of stress have emerged where capacity is extremely tight, leading to much improved pricing and terms and conditions.

Property wholesalers say the drawback in capacity from AIG, Lloyd’s and FM Global is one of the main drivers of double-digit E&S property rate increases.

The pullback is tending to affect the lower working layers more than the upper risk-remote layers, sources said.

Wholesale brokers are seeing rate rises of 10-15 percent rate rises on big layered property placements.

Following the 1 April renewal, the sector is “creeping into the double digits” for accounts that have not had losses, one source said.

Non-cat property business is seeing more benign rate increases of 2.5-7.5 percent.

However, on challenged lines, such as hospitality, increases of over 25 percent are common.

Frame habitational is in particular trouble, according to several E&S carriers. Few markets are operating in this space, which is seeing major rate rises, but many – including the Lloyd’s market – do not feel comfortable touching the business, sources said.

“Capacity in the London market for habitational is non-existent and it’s tougher to place here as well,” said one executive.

Other distressed lines include southeastern and coastal property.

Forget property

Despite all this positive momentum, both broking and underwriting sources remain sceptical that the property hard market will have legs if accounts run clean for even a single year. A benign loss experience is likely to return the market rapidly to its prior dynamics.

However, sources appear much more confident in a sustained pricing response outside of property, where signs of stress are spreading.

Excess trucking is perhaps the most obvious area. Last week, this publication revealed Markel was significantly retreating from the space, leaving just four participants.

Excess casualty is also seeing significant rate increases of 5-15 percent. This has been driven by the uncertainty in the legal environment, specifically in New York and Florida, where carriers are taking full-limit losses, according to sources.

Other lines and classes described as distressed include anything touching agribusiness, healthcare, and New York construction, with the latter also witnessing multiple withdrawals.

D&O: A market to watch

Outside of E&S, the most significant development appears to be a nascent hardening of rates in directors’ and officers’ (D&O) insurance, particularly for public market exposures.

This market has long been a sore spot for many executives, with soft pricing for many years despite a range of factors negatively impacting the loss picture.

These include rapidly growing exposures due to the rising equity market, higher frequency due to a proliferation of securities class action cases, and some severity driven as much by higher average legal costs as large settlements.

Underwriters in the space suggest primary D&O policies – those most exposed to the rising frequency – are pricing up 10-15 percent in recent months, an acceleration from the modest single digit rate increases reported in recent months after years of softening.

One trend to watch will be the potential for the dynamics in primary and excess layers to bifurcate. Excess layers typically get a “free ride” off higher pricing in primary by demanding commensurate rate increases.

However, with loss trends most significantly impacting the primary layers, this may be a hard sell for excess layers, with brokers forced to try and offset higher costs on primary layers.

Against that, some market participants describe a growing trend of carriers in excess layers revisiting prior accident years and discovering claims they had assumed would run clean are now facing a full-limit loss.

Notably, TransRe North America CUO Paul McKeon predicted a $3-5bn reserve hole for the industry for other liability claims made business, driven by D&O, while speaking at The Insurance Insider US event last month in New York.

This may lead to commensurate pressure on excess D&O layers over time.