Aiming for the Middle.

Some commercial insurers are taking a new look at the middle market because prices are firming, there are more midsize companies and insurers are seeking to diversify their risks.

The number of midsize 13.5. businesses-those with revenues of $5 million to $100 million-has increased to 425,000 and continues to grow. In terms of commercial insurance, this sector is second only to small business in direct premiums written. The insurance industry is experiencing a greater demand for commercial coverages by midsize companies, and industry experts predict that this demand will continue to shape commercial-lines pricing over the next several years.

Nearly one-half of commercial lines exposures' growth over the past five years was generated by the middle market, according to recent data by MarketStance, an analysis service for the U.S. commercial property/casualty insurance market. The data indicate that the number of middle-market risks increased during that time by almost 38,000, a substantial portion of last year's nearly 175,500 middle-market risks.

Much of the growth in the middle market is being caused by smaller businesses that grow to become midsize businesses. "Small-commercial [companies] tick along in a more uniform pace of growth, whereas a middle market has a more cyclical factor," said Frederick Yohn, president of MarketStance.

While insurers are optimistic about the middle market, that wasn't always the case. According to a 2000 Conning & Co. study called "Middle Commercial Insurance Markets: It's Tough to Be in the Middle," three-fourths of the study's respondents concurred that middle-market business is typically unprofitable. However, the respondents, which included 28 of the largest commercial-lines insurers, said their companies were committed to the business. Today, the middle market has reached nearly $35 billion in written premiums.

Defining the Middle Market

Definitions of the middle market range from annual premium accounts between $25,000 and $1 million to various limits of total revenue to a certain number of employees. For its research, MarketStance used U.S. government census data as its standard in defining the market, including companies with 50 to 999 employees.

The middle market has been a preferred domain of many carriers for several years, although it has had a rocky history over the last two decades. "The middle market was going great guns during the last hard market in the late 1980s through the recession of the 1990s," Yohn said. However, the mid-'90s soft market together with the middle market's emphasis on longer-tailed lines-where a risk takes time to become known and claims are paid years later, such as asbestos exposure--took a heavy toll on the segment's underwriting results. Carriers then began to shift their attention to the small-commercial segment. "Eventually, the luster of focusing chiefly on small commercials wore off, and insurers started to once again become more serious about the middle market," Yohn said. During the last several years, many insurers have reaffirmed their focus on midsize companies as prospects for firmer pricing improved.

St. Paul Cos., which characterizes its middle market as companies with $50,000 to $1 million in annual premium accounts, has always had a central focus on the market. Due to its large number of midsize customers, St. Paul recently segmented its market into a variety of specialized businesses, including construction, technology, financial and professional, public, health care anti ocean marine. Anything outside of these areas falls into the company's general middle-market accounts, said Jim Lewis, senior vice president of U.S. insurance operations. St. Paul's middle market represents nearly 40% of the insurer's overall revenue.

USI Insurance Services Corp. has also been actively involved in the middle market since the company's inception in 1994. Viewing it as an under-served market, USI's business model provides all forms of risk and asset management to the middle-market sector, including property and casualty life and estate planning, employee benefits and 401(k) planning.

A few insurers, however, have taken a different approach. Erie Insurance Group is one such company that does not segment its markets, but, rather, takes a holistic approach. "Compared to other insurers that target specific market segments, underwrite products for those sectors alone and treat each unit of business separately, our approach is much different. We look at our book and overall loss ratio as a whole, not just by segments," said David Miller, senior vice president and division officer, commercial underwriting. In comparison to other middle-market commercial insurers, Erie is unusual in that it underwrites all its policies from one central location, Miller said.

The strength of several economic sectors has contributed to middle-market growth during the past five years. During that time, the influx of midsize customers traditionally came from the construction and manufacturing sectors--two of the most cyclical industries. As the economy came out of a recession in 1991-92, these industries grew the fastest, which contributed a lot to middle-market business, Yohn said.

Manufacturing continues to boast the highest share of the middle market, with nearly 60% of property exposures and nearly 60% of written premiums in all lines. For many insurers, such as Zurich North America and USI Florida, the state subsidiary of USI Insurance Services Corp., manufacturers top their list as the largest middle-market client base.

However, construction and manufacturing are beginning to give way to new industries moving into the market, the majority of which include knowledge-based and technology businesses. "For example, computer software and real-estate investment trusts are among the fastest-growing business classes that will shift the middle market's focus away from manufacturing and construction and more toward service and knowledge-based industries," Yohn said. In examining forecasted growth in the number of accounts and exposures within the middle market, MarketStance predicts that the service industry will be this year's leader. "With the growth of business-service classes, the service industry is anticipated to provide some of the strongest support for middle markets in the near future," Yohn said.

Demand for Coverages

Standard commercial coverages continue to account for the preponderance of middle-market companies' coverages. Workers' compensation, a central part of these packages, is the leading specialty segment within the commercial market for midsize businesses, with nearly $11.7 billion in written premiums in 2000. Liability coverages follow close behind with $10.5 billion in written premiums, said Yohn. Other commercial-lines specialty segments in demand by middle-market companies include commercial auto, medical malpractice, excess and surplus lines and umbrella.

"Although Royal & SunAlliance USA is moving aggressively toward a multi-line middle-market approach, we recognize that workers' compensation remains the central factor in many of our clients' insurance purchase decisions," said Ray Jacobsen, middle-market president and chief operating officer, Royal & SunAlliance USA. "As a result, workers' compensation will continue to be a critical part of our middle-market success." The company focuses much of its workers' compensation emphasis and expertise on a differentiated underwriting, accident prevention and claims approach, with the goal of eliminating accidents and reducing costs for customers.

However, the growth of new industries, such as service and facility-support management, may change the focus on what types of coverages will be sought by midsize companies. "The shift in terms of client base does underscore a shift of premium base, because those industries tend to have much less workers' compensation premiums associated with them than do manufacturing and construction," Yohn said, adding that workers' comp probably will lose its place as the largest line sometime in the future. In business services, for example, workers' comp accounts for only about 23% of total written premium, which is substantially less than its more than 40% share in construction and manufacturing.

New technological advancements also may contribute to the rise of new coverages in the coming years. MarketStance data projects that between 2000 and 2004, more than half of middle market's fastest-growing classes will include information-related businesses. "As a result of the Internet, there are new product needs where standard commercial products possibly will not necessarily meet the emerging trend," said Rita Nowak, assistant vice president of the Alliance of American Insurers. While standard commercial coverages were originally developed for the traditional business approach, there now may be a shift in need for more specific products, such as Internet liability products, to cover potential exposures, she said.

Insurers currently involved in the middle market are reaping many of the benefits the sector provides. "If done correctly, profit and earnings opportunities in this market are very attractive," said Peter Higgins, senior vice president and chief underwriting officer of commercial lines and chief executive officer of the commercial accounts group for Travelers Insurance. Travelers, which defines its middle market as companies with $25,000 to $1 million in annual premiums, insures more than 20,000 middle-market companies, with an average account size greater than $100,000.

St. Paul Cos. also is finding the market to be a profitable entity, particularly after changing the way it targets this sector. In 1998, St. Paul began a property improvement program for its midsize customers. "We strategically decided we were going to be smaller in the middle market in order to become profitable," Lewis said. At that time, the company shed premium, giving it the opportunity to review staffing and reorganize its field structure. "The market has clearly now fired up from a pricing perspective. We are more encouraged about middle-market business, and we are taking a very opportunistic approach as we look at writing new middle-market business. We will entertain coverage, and our philosophy is really to try to look at writing the entire account," he said.

Not only does the market's size play into the decision-making about targeting to the middle market, but its diversification of products and new technologies also make it attractive to insurers. "With this segment you have an array of industries to deal with, from contractors to municipalities, whereas in the small market, products are geared more to the commodity perspective. There is a definite diversification in the types of risks found in the middle market," Nowak said.

In addition, an influx of premium volume is making the middle market an attractive sector. While the small market is seeing countrywide growth and jumbo accounts are relying on alternative-risk mechanisms, insurers are focusing heavily on the middle market where the premium volume lies, Nowak said.

Each day, new technologies are making their way into the industry, aiding insurers in their efforts to better target customers, including middle-market customers. "The industry has a renewed interest in this area now because of some of the Internet technology and Web-based methods that we can use through the independent agents...to target that part of the marketplace and make it more expense efficient to handle," said David Thompson, vice president of underwriting for Peerless Insurance Co., a member of Liberty Mutual Insurance Co.'s regional agency markets.

For insurers already on the middle-market bandwagon, or for potential marketers, timing and a clear understanding of the market can aid in achieving profitable results. Don Hurzeler, president and CEO of Zurich North America Middle Markets, said insurers should consider the following steps:

* Be selective in what you write, particularly writing insurance where you know your customers well enough to add value to the proposition via services or products being offered.

* Be wise in realizing that you can't write everything for everybody.

* Be extremely responsible in your pricing year in and year out.

* Keep all promises you make to customers.

Characterizing Middle Markets

While size and premium account dollars set middle markets apart from other sectors, additional characteristics such as loyalty and stability are being linked to midsize companies. In addition, these companies, for the most part, are less hazardous in exposure, Thompson said. "From past experience, it has usually been the expense part of the equation that hurt profitability on that market more than actual hazard associated with the risk," he said. Once the expense aspect of the equation is surpassed to transact business efficiently, the hazards help to play into its desirability, he said.

Middle-market companies now have more sophisticated needs than in the past. "[The middle market] requires a great deal of infrastructure. We have the depth to work with this, because it tends to be the most risk-bearing segment of commercial insurance," Travelers' Higgins said. In addition, middle-market infrastructure requires strong surplus and financial ratings to gain success.

The middle market is a price-sensitive sector, although purchasing decisions may be influenced by coverage options, value-added services and ease of doing business. But insurers vary in their views about defining midsize companies as a price-sensitive market. It is very much a competitive market, and prices have been going up steadily for some time now, Hurzeler said, adding that price is always a consideration in the market.

St. Paul's Lewis said that after closely following the insurance market for many years, he believes every part of it is price sensitive, including small accounts. "Price firming occurs in all areas, including the middle market. This sector is not any more price sensitive than any of the other [markets]," he said.

Price runs through the gamut of all markets, Higgins agreed. "The agent/broker who acts as the client's buyer watches quality for price very carefully," he said. Rather than classifying the middle market as price sensitive, Higgins defines it as a sophisticated distribution system seeking the best quality for the best price for clients.

Michael Karp, president and CEO of USI Florida, has a different perspective of the market. "The middle market is underserved. It has, in many cases, less infrastructure than the Fortune 500 companies and requires more in terms of human-resources support as well as financial-services analysis than larger companies," he said.

"I see that there is a lot of fragmentation in the middle market. A lot of carriers are confused about what they are going to do with their middle-market approach. Some are just indiscriminately nonrenewing clients," said Jacobsen of Royal & SunAlliance USA. And, several insurers are canceling agents or withdrawing from various product lines. Jacobsen summarized the middle market as being somewhat in a state of chaos, although holding significant opportunity for committed carriers with a strong portfolio of multiline and differentiated risk-improvement offerings.

What will occur in the middle market remains uncertain, but most insurers are optimistic. "We are going to continue to see a very competitive middle market in the future," said Nowak of the Alliance of American Insurers, adding that the key to success is a continued strong customer focus. Insurers must do more than just issue policies and provide claims service. They must work with middle-market clients on an individual basis to ascertain their needs so tailored products and services, including strong loss-control programs, can be developed to support their business needs, she said.

With the anticipated continued growth of midsize companies, new trends are being predicted to find a stronghold in the market in the coming years. One phenomenon found in national accounts is beginning to trickle down into middle markets and will eventually be accelerated by hard markets. "Companies are beginning to rely on the use of alternative markets rather than carriers to insure risks, set up risk-retention pools and retain higher exposures internally," Yohn said. Up to 40% of national-account workers' comp premiums are handled through alternative markets, Yohn said.

As new middle-market companies emerge, the possibility exists that these midsize businesses will one day be part of a merger or acquisition. "Middle markets, more than anything, look to sophisticated brokerages to provide service ancillary to singular distribution of insurance products," said USI's Karp. Such services include employer-assistance programs and sophisticated analysis of conventionally insured and alternative risk-transfer property and casualty and benefit programs. "These companies look to us due to the ongoing convergence within the P/C industry, and their need to be proactive and stay ahead of the curve vis-a-vis their competitors," Karp said.

As a decline in the number of manufacturing companies produces less competition and a stronger focus on larger accounts, it works against middle-market companies. The result is less preferable terms and conditions and premium structures, Karp said. "After a 10-year soft cycle, the market is now beginning to harden," he said.

The hardening of the market will also impact how heavily insurers will target midsize companies in the future. "Insurers are starting to be able to get more price for products, and they now really have the opportunity to make money in this market," said St. Paul's Lewis.

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