One of Best E&S Markets in 50 Years, Industry Veteran Says

The chair of W.R. Berkley Corporation has been observing
conditions in the excess and surplus and specialty markets for more
than five decades, and views the current environment as just about
the best in that time span.

Speaking at the Keefe, Bruyette & Woods Virtual Insurance
Conference last Thursday morning, William R. Berkley said that
there have only been "two, or possibly three opportunities that
have looked like this" that he has witnessed during the course of
his career—opportunities where "demand for [insurance] products
outstripped the supply of reasoned and intelligent suppliers."

The specialty insurance group's chairman gave the historical
perspective just before W. Robert Berkley, Jr., president and chief
executive officer, reviewed some of the familiar drivers of the
current firming market in commercial lines—the realities of a low
interest rate environment, social inflation and financial
inflation. In contrast to other speakers opining on trends in the
insurance and reinsurance markets at the KBW event, and at various
other virtual Reinsurance Rendez-Vous de Septembre events last
week, the Berkleys stood out from the pack because they don't yet
see an end to hardening conditions in sight. Most others put 18
months or shorter timeframes on their favorable market forecasts,
and talked about decreasing levels of increasing prices.

"We think this will continue for longer than usual because of
the enormous amount of uncertainty in the economy and in the
financial markets. When people are unsure, that increases the
likelihood of this opportunity extending for a longer period of
time," said Chairman Berkley.

He noted that economic conditions have created an especially
strong environment for the growth of E&S business volumes.
Because there are many businesses that have dramatically slowed
down or closed, "there are new businesses starting or giving new
birth to the old businesses, which automatically means they go into
the E&S marketplace," he said, underscoring the opportunity for
surplus lines carriers. "We think it is one of the best chances we
have had to get great returns," he said.

"We think this will continue for longer than usual because
of the enormous amount of uncertainty in the economy and in the
financial markets."

William R. Berkley, W.R. Berkley
Corporation

"Brokers only have a limited amount of time," he added,
suggesting that seasoned E&S markets like W.R. Berkley Corp.
are best positioned to profit in the current market. "They have to
find someone they have confidence in who can analyze, underwrite
and place the business. It's not just supply and demand, but it's
knowledgeable markets that can respond promptly to brokers—because
the brokers don't want to miss the opportunity," he said.

CEO Rob Berkley noted that economic drivers, coupled with the
fact that some insurers have been revisiting their appetites in a
more disciplined manner, have been the catalysts for hard market
conditions in commercial lines. Observing that "all product lines
do not march together in perfect lockstep," however, the younger
Berkley said there are "micro-cycles," meaning that different
product lines are at different points of the hardening phase of the
cycle.

But the industry is cyclical, he stressed. "There are some
fundamental drivers that, from our perspective, have led to the
hardening in the market that we're experiencing today, [and] we do
not see them eroding. In fact, we see them continuing to persist,
and in some cases strengthen, which will likely lead to further
firming in parts of the overall marketplace."

"In a cyclical industry, there are moments in time when you may
need to shrink. There are also moments in time, like the one we're
in now, where when the opportunity presents itself, you want to
maximize that opportunity and grow as much as you responsibly can,"
he said.

Inflation—and Hard Market—Continues

The specialty carrier CEO went on to debunk the idea that
financial inflation is transitory—a term he said is popular in
Washington, D.C. and with the media. "Financial inflation is real
….I'm not sure what the definition of transitory is, but
[inflation] certainly has been going on for quarters, and there is
nothing at this stage that leads us to believe this is not going to
be a reality that we are going to grapple with for some period of
time going forward," he said.

"We need to appropriately take that into consideration in how we
thing about our loss costs—what that means for our trends going
forward .…It's one of the reasons that we as, an organization, were
out pushing for rate, earlier than some of our peers, and it's one
of the reasons why we have not wanted to move loss picks down
prematurely in spite of the rate increases because those rate
increases are going to get gobbled up by certain types of
inflation—financial or social ….

"Our assumption is Inflation is real. It rears its head in a
variety of different ways. There is no question that, quite
frankly, the costs of products, good, services today are by and
large more today than they were yesterday. And we expect that trend
will continue. And we need to obviously be responding to what does
that mean for our claims costs and other costs and how we assess
that in our pricing."

"In truth, we have not made a nickel of property
underwriting profits on a cumulative basis in the last five
years."

Joseph Brandon, Alleghany
Corporation

At a later KBW conference session, Peter Zaffino, president and
CEO of AIG, talked about the
transformation of AIG's E&S unit Lexington Insurance, and
what he views as AIG's leadership in driving rate. But at the same
time, he cautioned KBW Analyst Meyer Shield against assuming that
decelerating rate hikes—being reported by some market players now,
and projected by others on the near-term horizon—are necessarily a
signal of eroding E&S profit margins. The key to continued
underwriting profit is that rate jumps outpace loss cost inflation,
he said.

"If you call decelerating rates—meaning I'm getting less of an
absolute rate increase this year compared to last year—a bad thing,
then I want to reshape that [view]. I think it's a good thing
because we want to shape the portfolio we want. If you just chase
absolute rate in a market that starts to go down, you end up
getting a less-than-desirable portfolio….

"We want to make sure that we're retaining clients, we're
getting rate above loss cost inflation, social inflation. We're
repositioning the book because we're constantly pruning. And we're
also using [our] lead underwriting capabilities to drive
outcomes.

"If you call decelerating rates—meaning I'm getting less of
an absolute rate increase this year compared to last year—a bad
thing, then I want to reshape that [view]. If you just chase
absolute rate in a market that starts to go down, you end up
getting a less-than-desirable portfolio."

Peter Zaffino, American International
Group

"We weren't relying on others to shape the rate environment that
we wanted to drive for our portfolio" transformation, he said,
noting that the repositioned AIG E&S book is now growing.
"We're not a capacity player that just follows other leads …We want
to shape the direction of terms and conditions. We want to shape
the direction of how we're underwriting. And I think that
leadership has yielded rate increases, but equally repositioning of
the underwriting portfolio," Zaffino said.

Later, referring to AIG's market position competing with a small
field of large global lead underwriters rather than new capacity
players entering the market to fill in "some of the commoditized
layers," Zaffino concluded: "I think the market we're in is the
market that needs to continue for a while. And we are comfortable
that we will continue to lead in driving rate above loss cost,
driving margin."

E&S Property: Searching For Profit

At an earlier session, Joseph Brandon, president of Alleghany
Corporation, assessed the state of the market, viewed from the
perspectives of Alleghany's RSUI, a bigger player in the E&S
property than casualty space, and CapSpecialty, a writer of
professional liability, health care and specialty casualty.

"There are some fundamental drivers that, from our
perspective, have led to the hardening in the market that we're
experiencing today, [and] we do not see them eroding. In fact, we
see them continuing to persist, and in some cases strengthen, which
will likely lead to further firming in parts of the overall
marketplace."

Robert Berkley, Jr., W.R. Berkley
Corporation

Questioned by KBW Analyst Richard Gagney about the impact of the
pandemic on specialty lines premium volumes, Brandon noted an
influx of submissions. "RSUI and CapSpecialty have not missed a
beat in the transition work from office to work from office. We did
not see a noticeable dip in production trends," he said. For RSUI,
"the feedback has been very positive in terms of speed of response,
quoting, being helpful thru a period of time when the wholesale
market has received a substantial increase in submissions as
standard markets have pulled back and reunderwritten certain
risks."

"Some of RSUI's lines of business are in the 16 or 17th quarter
of rate increase, obviously starting out much slower and ramping up
to double-digits," he said, reporting strong flows of business in
management liability, professionally liability, umbrella and
property.

"Now, some of the rate increases are off their peak but I think
it would have been silly to assume they would go up at an
increasing rate of speed forever. They've kind of rolled over but
the rate increases that we're getting, we believe are in excess of
trend and we're adding to the margin of the book of business."

The Commercial Lines Outlier—Workers Comp

In addition to weighing in on opportunities in the
E&S/specialty lines market segment where prices have been
firming, executives speaking at last week's KBW Virtual Insurance
Conference offered views on the one standard commercial line that
remains an outlier to the current hard market—workers
compensation.

"There is no headline. There isn't anything new" to report, Christopher Swift, Chair and CEO of The Hartford. "The line
continues to perform well," he said, noting that frequencies
declined markedly during COVID but The Hartford remained
conservative in its loss cost picks anyway.

Pointing to the carrier's deep expertise across small
commercial, middle and even large risks with deductibles, which
Swift believes gives The Hartford a data advantage, he reported
that the company was able to manage to a good outcome event during
a declining price environment over multiple years. "It's still a
highly profitable business for us. We have been able to manage to
strong ROEs well in excess of our cost of capital. We have able to
perform during a robust rate environment and when rate environments
were challenged," he said. "There is no breaking news here."

Still, Swift did refer twice to a benefit to comp and other
employment-centric business lines—the tailwind of wage
inflation.

W.R. Berkley Corporation has been shrinking its book in recent
years—and remains cautious. "From our perspective, it is possible
that tempered benign frequency may have glossed over some other
challenges around severity," said Robert Berkley, Jr., president
and CEO. "We, as organization, have been beating the severity drum
for some period of time, [and] we're concerned that others are not
focused on that severity trend. We think it's going to come back
and bite them because they are busy celebrating the short-term
benefit of [lower] frequency during COVID," he said.

Pointing to the impact wage inflation as "the one big wild card"
for workers comp carriers, he conceded that "if all other [loss
cost] assumptions…are spot on, and wage inflation is significantly
above what people had anticipated," that could be a benefit for the
workers comp insurance industry. "We'll have to see how wage
inflation matches up with other components of the equation for loss
costs," he said.

"That all having been said, from our perspective, the industry,
overall is not paying enough attention to severity trend in the
workers comp line." In addition, he said, carriers need to keep a
potential impact to loss frequency in the back of their minds—the
tight labor market.

"It is real challenge for employers to get talent. And as they
are stretched on that from a staffing perspective, oftentimes, you
get less well trained, less qualified people in roles where as a
result of that lack of training, they are more susceptible to
injury," he said, noting that another consequence of the tight
labor market is more people working overtime—any possible
contributor to rising claims frequency.

In the prerecorded session, which Brandon revealed actually took
place within eight hours of landfall of Hurricane Ida, he focused
in on the property line. "In truth, we have not made a nickel of
property underwriting profits on a cumulative basis in the last
five years. So, despite everybody talking about favorable property
rates, we don't have the underwriting profits that show it. That's
true at the reinsurance level, and that's true at the E&S
level."

"Anybody who thinks rate increases the industry is getting
aren't justified, I think doesn't have an appreciation of what the
industry has gone through in the last five years in terms of
losses. And I don't think we're the exception. I don't think
there's any smart money in the property business these days. I
think anybody who has been writing this business for five years has
probably lost money, and at best, they made a little money but the
returns on capital are unattractive for this risk. And it doesn't
matter if you're alternative capital, traditional capital, E&S,
London, U.S. ….It's just been a very rough patch.

We're now coming up on the fifth year of frequency of $10-20
billion events around the world. Maybe it's climate change. Maybe
it's just a tough patch. But the industry has got to charge more
for these risks," he said.

In fact, Fitch Ratings, in a recent report reviewing the state
of the E&S market, noting that the E&S market recorded its
second worst full-year underwriting result in the most recent
decade in 2020, and its fifth consecutive year of underperformance
compared to the overall P/C industry, highlighting the impact of
heavy catastrophe losses. "Property lines led the decline with a
[year-over-year] unfavorable impact of 25 percentage points on the
combined ratio. Higher loss ratios associated with inland marine,
allied and fire lines were the most affected by the worsening
results," Fitch analysts reported in the rating agency's U.S.
Excess and Surplus Lines Market Review published in late
August.

"Prior to 2020, heavy catastrophe losses caused by storms in
2017 and 2018 began the downward trend in E&S results relative
to the overall industry….Property risks are highly sensitive to
major catastrophe events and the 2020 direct combined ratio of 115
was the second highest of recent record. Property lines' combined
ratios of 144 and 113 in 2017 and 2018, comparably, were far
outside of historical norms," the report said.

Fitch expects strong rate increases to fuel an E&S profit
recovery in 2021 from an overall combined ratio of 107 across the
E&S business in 2020.