Cycling back: with the hard market ebbing, excess and surplus carriers continue to grow their business in newly harder-to-place liabilities.

Several new players entered or returned to the excess and surplus market last year, drawn in by a hardening market and the migration of several business classes from standard companies.

Now, rates are softening again. "We're coming off a period in the cycle that the excess and surplus market fives for--a hard market," said Thomas Mulligan, executive vice president of underwriting and marketing for Western World Insurance Group. Despite that, some E&S carriers say it is still an exciting time to be in the market.

"A few years ago we witnessed phenomena that signaled a continued deterioration of the financial stability of P&C companies that had been writing casualty business in the United States since before World War II," said H. James Griffith, president of New Jersey-based Princeton Risk Managers and president of the National Association of Professional Surplus Lines Offices Ltd., a national trade association representing the surplus lines industry and the wholesale insurance marketing system.

"How many of the insurers of the '70s and '80s with household names are still with us? Over the decade preceding this hard market, inadequate pricing, ignorance--both planned or innocent--of the need for reserve strengthening, failure to recognize in balance sheets uncollectible reinsurance and the sacrificing of writing to an underwriting profit were all factors in assessing the standard P&C market's financial integrity" Griffith said.

Prices peaked about a year ago, then leveled off. There's now a reduction of pricing, come renewals, said Griffith. Some property business and most casualty lines have remained hard, however, particularly professional liability, contractors and medical malpractice, he added.

Small retail establishments written in the surplus lines market are seeing flattened or decreasing rates, particularly on the property side, said Joseph Timmons, president of Midwestern General Agency Inc. in Lee's Summit, Mo. "For the most part, pricing we're now seeing is adequate to produce a decent return for carriers and is no longer at the peak it was six to nine months ago."

Direct premium volume for the surplus lines industry continues to rise. At year-end 2002, the volume increased by nearly 62% over the prior year, according to A.M. Best Co.'s Excess and Surplus 2003 report. The increase for 2003 is expected to be about 25.17%.

New Kids on the Block 

Last year was a big year for players entering the market, such as Richmond, Va.-based James River Insurance Co. The company's management team was experienced, and strong profit prospects paved its way into the market segment. "As a company with a bit of a contrarian approach to risk selection, we like our continuing opportunity as an E&S underwriter," said Mike Kehoe, president and chief executive officer.

Early on, James River decided to focus on small to medium-sized accounts written on a brokerage basis. During the first half of 2003, the company raised capital privately, acquired the formerly named Fidelity Excess and Surplus Insurance Co. from American Empire, recruited staff, built and acquired systems and began operations. James River sold its first policy on July 1, 2003, and now writes property and casualty business on both primary and excess bases through 10 underwriting divisions, each organized around a distinct coverage or industry segment. Property and casualty units include general casualty, manufacturers and contractors, excess casualty, primary and excess property; while specialty units include health care, professional liability, and energy and environmental. The company wrote nearly $88 million in gross written premium during its first year of operation.

Also in 2003, Northern Homelands purchased the assets of Caliber One Indemnity Co., a nonadmitted company now authorized in 45 states, changed the name to Maxum Indemnity Co. and recapitalized it. Caliber One's business was being run off by its parent company, PMA Capital, when Maxum became involved in the company. Many of Maxum's management team members are no strangers to the E&S arena, having come from Northland Insurance Cos., which is now part of St. Paul Travelers, and other key specialty companies. "[E&S] is disciplined in its underwriting and has a strong profit-making potential if business is done correctly," said President Randall Jones. Maxum Indemnity distributes through wholesale brokers and general agents and writes a variety of primary and low-layer excess general, product and professional liability. In 2003, the company wrote $28 million in premium, and Jones said it's on track to write nearly $61 million this year.

Boston-based Aspen Specialty, part of Aspen Re, opened for business in September 2003, after purchasing the shell of Dakota Specialty and picking up a North Dakota-domiciled company with surplus line approval in more than 30 states. Aspen Specialty is in the process of opening additional offices this year. The company focuses on midsized accounts in the $25,000 to $100,000 premium range. "That differentiates us from a number of competitors who are more focused on larger accounts, and we can bring our experienced underwriting judgment on this premium segment," said Peter Coghlan, president and chief executive officer. The company was drawn to this segment after discussions with wholesale brokers who said it was underserved, he said, adding that rates in that premium range tend to remain stronger in the market cycle.

Migrating Classes

Another factor in E&S growth is that many classes of business have migrated. "The shift is a result of standard companies trying to comb through their books of business and getting rid of underperforming accounts or classes," said Kehoe of James River.

In the past two to three years, admitted insurers have been dumping the more volatile risks, such as fast-food restaurants, exterminators and various urban risks. Professional liability policies for lawyers, architects and engineers also are increasingly being written by E&S writers.

Rising damage awards have caused the migration of several business classes. "There's a big shift going on now in the physician malpractice market. Some of the regional mutuals are capital constrained and that constraint is being exacerbated by the large rate increases made necessary by the continuing inflation in damage awards," said Kehoe. "It's an interesting dilemma for some of those companies where they raise prices and now need to jettison business."

E&S writers can respond more quickly to changing market conditions because, unlike standard carriers, they aren't slowed by the need to file new rates in a variety of states.

Medical malpractice is fraught with availability and affordability issues. "So many of the insurers whose sole purpose was to provide an insurance market for medical professionals have failed, most notably in the past few years, that many E&S markets have been reluctant to 'jump in where wise ones fear to tread,'" said Griffith. While there are what he calls "brave and resourceful E&S companies" that are writing medical malpractice and hospital professional insurance, they are few. Griffith testified before the National Association of Insurance Commissioners earlier this year that less than 5% of E&S companies approved in New Jersey are now willing to consider writing medical malpractice insurance.

Staggering damage awards also have driven nursing homes and assisted-living facilities into the hands of E&S writers. The two classes, which carriers refer to as "distressed," may be even too much for the E&S market. A growing number of risk-retention groups now are being formed for these liabilities, thus moving these classes into the alternative market.

Some classes, on the other hand, are increasingly making their way back into admitted carriers' hands. Initially, arranging umbrella limits of any significance, for instance, was a challenge, but that is no longer the case, and the E&S market has seen a lot of umbrella business return to the standard P&C companies, said Griffith.

"Although there may be a shock for risks moving from the standard market to the E&S segment in terms of higher rates and more restrictive coverage," said Kehoe, "[the E&S market] is actually quite competitive with many quality companies wing for even the tougher classes of business." The market, he added, is a very viable place for people to craft coverage they need and want.

Trend Watch

Mergers and acquisitions are among other changes occurring within the E&S market, said NAPSLO's Griffith. A byproduct of many of the mergers and acquisitions is that smaller wholesale brokers and managing general agents are becoming more regionalized.

In addition, finding markets willing to write frill terrorism coverage remains a challenge. Not only is available coverage now limited, what is available is expensive, according to the A.M. Best report.

Technology also is now taking a front seat in the E&S market. A survey of NAPSLO members found they are investing a higher average of total retained revenues from the previous year into technology, with much emphasis on data transmission to markets from the intermediary, distribution of forms applications to retailers, and policy issuance.

"The diversity of our industry didn't lend itself well to older technology, but the E&S industry is on the verge of using the Internet and other technologies, such as imaging and rating and policy issuance, that will greatly enhance the efficiencies in our distribution system," said Western World's Mulligan, who expects technology to enhance, rather than replace, the existing distribution system and make more efficient use of wholesale distributors.

The Road Ahead

There's greater sophistication in the market than there was 15 years ago, driven by wholesale broker consolidation that gives the broker access to more resources, said Aspen Specialty's Coghlan. "This allows wholesale brokers to bring more to the submission process." Complementing this, he said, the surplus lines industry has been able to attract the most talented underwriters in the overall P/C industry.

Many expect rates to continue to soften in the near term "as primary carriers are starting to see decent returns with much improved loss ratios," said Timmons of Midwestern General. While premium volume was about $25 billion in 2002 and climbing, Timmons believes there will be a flattening or loss of premium volume in the next three to five years. "But there could be some marked changes predicated to a certain extent on the appetite of the reinsurance market and, of course ... a strong hurricane could turn things back to a hard market in a matter of a few days."

Timmons also believes directors and officers, employment practices, liquor, medical malpractice and nursing homes rates have yet to peak and will fuel growth in surplus lines writings, he said. But, price erosion of some of the less hazardous classes and taking back some of the surplus lines business into the standard market may flatten and perhaps erode some of the growth, he said.

Key Points

* After a period of growth, the excess and surplus lines market is seeing softer rates.

* Many new entrants came into the market in 2003, and several classes of business migrated from standard companies.

* Advances in technology are strengthening distribution channels.

Learn More

Aspen Specialty Insurance Co.

A.M. Best Company # 12630

Distribution: Wholesale surplus lines brokers

James River Insurance Co.

A.M. Best Company # 12604

Distribution: Wholesale brokers, select retail specialists

Maxum Indemnity Co.

A.M. Best Company # 12563

Distribution: Wholesale brokers, general agents

Western World Insurance Group

A.M, Best Company # 02946

Distribution: Contractual relationships (bindinging authority and/or brokerage) with nationwide network of wholesale

general agents

For ratings and other financial strength information about these companies, visit www.ambest.com.