For the past decade, the surety market has been profitable and today, competition remains strong. Underwriters come and go while the economy plays a major role in this segment of the industry.
Even with big losses in 1999, the surety market reported another profitable year, posting $3.3 billion in direct premiums written in 1999, according to A.M. Best Co. And it looks as if surety brokers can expect more competition in the year ahead.
In the past, surety underwriters tried to win clients and grow premiums by lowering their underwriting guidelines. “This seems to be abating a bit or at least slowing down,” said Larry Byers, vice president of commercial surety for Contractors Bonding & Insurance Co. (CBIC) in Seattle. “You don’t see as much willingness to come in and chop rates and throw the underwriting manual out the door.”
Skip Baumgarten, CEO of American Contractors Indemnity Company (ACIC) headquartered in Los Angeles, agreed. “There probably was some very loose underwriting for a while…and I believe that is beginning to change,” he said. “Some of the transgressions that may have occurred previously may correct themselves, and overall, if the market stays healthy…there is a lot of market and ample opportunity out there.”
Losses pile up
Not only were more losses reported in 2000, but the severity of those losses was nothing to brag about. “There were big loss problems [as high as] $300 million…and the companies say they’re going to remain profitable, but we’ll see,” said Keith Clements, West Coast bond manager for Allied Group (a member of Nationwide Insurance) and president of the Surety Association of San Diego.
While the surety industry screens and qualifies principals on behalf of obligees, everything else in the business revolves around the philosophical loss ratio expectation of zero losses in the surety line. “In the surety business, we underwrite to a zero or low loss ratio, so if you have losses it takes away your profits,” Clements said.
John Pieprzny, senior vice president and director of contract underwriting for CBIC, was happy to say that CBIC has not experienced any major severity problems as far as losses are concerned. “But as an industry, talking to the reinsurers, it’s our understanding that there are a number of claims out there-some in the $40-$50 million range and even higher,” he said.
Companies that are consistent with their underwriting should be able to weather the possible storm on the horizon, according to Clements. “I think that some of the things that we have seen are young and inexperienced underwriters getting involved in the business that haven’t seen the change in economy, and it’s an infallible situation,” he explained.
ACIC’s Baumgarten expects that the marketplace will experience a slight tightening over the next year from the reinsurers down to the primary carriers. As a result, companies should expect some pressure from reinsurers. “There were some losses last year and the previous years, and the industry is probably starting to tighten up just as the economy probably is,” he said.
Economy takes its toll
Ray Gail, COO for Lou Jones & Associates, feels that the surety industry is in a “plateauing” stage. “We’ve all experienced some premium volume increases over the past few years and I don’t think we’re going to see anything drastic in either direction, which is why I used the word ‘plateau,'” he said. “There are a lot of things happening with the economy right now.”
Gail is referring to the Federal Reserve’s aggressive action on Jan. 3, the day the Feds unexpectedly slashed a short-term interest rate half a percentage point, signaling that the nation’s economy is in tougher shape than previously thought.
This was the first reduction in more than two years. The hope is that lower interest rates will translate into a stronger economy. The cuts are designed to reassure consumers and businesses that the Fed will keep the economy growing and the financial system flush with enough cash to continue lending.
“Ten years ago, when the economy changed a little bit, all of a sudden people started having the hiccups, and it looks like even though the Feds cut interest rates, the economy is changing,” Allied’s Clements said. “Obviously they wouldn’t do that if they didn’t think it was changing.”
“Along with that uncertainty comes caution,” Gail added.
A trickle-down effect
“The past year we saw higher than normal losses and I don’t anticipate that changing much next year,” Gail said. Basically, this is a direct result of what’s going on with the economy today. “[The two] usually go hand in hand-more people begin to struggle,” he explained.
The success of the surety business over the past 12 years brought in additional capacity in the surety reinsurance market. “There was a tremendous amount of capacity in the market, but at this point in time reinsurers are getting hit a little bit,” Clements said. “When you start having bigger losses like we’re hearing out there…premiums start changing.”
CBIC’s Pieprzny agreed that reinsurers, unhappy with the results, are increasing their prices significantly to the companies-especially ones that have not had very good experience. As a result, he foresees changes over the next 18 to 24 months. “I think there may be a hardening, but it’s probably not coming as fast as you’re seeing on the p/c side of the house,” Pierprzny said, explaining how, in general, the surety business usually lags the p/c industry.
Consolidation plays a role
The surety market has witnessed significant consolidation and/or company restructuring in recent years. “One market looks like it’s getting out of the business altogether, or a couple of them seem to be, but there is always somebody else that seems to be stepping in to fill the void-if there was a void to begin with,” CBIC’s Byers said.
According to the Surety Association of America, the top five writers of surety for 1999 controlled roughly 38 percent of the total surety market, compared with 28 percent in 1990.
“There are a couple of companies that either had to sell out or are trying to sell out at this point,” Clements said. “And it’s pretty shocking because some of those companies have been around for some time, but they changed their underwriting approach [which] can really hurt. And you don’t get a second chance in this business…so when you’re at that point, you’re not writing anything and you’re trying to find somebody to buy you.”
Three of the top 15 surety companies, based on direct premiums written in 1999-Reliance National Group Inc. (fourth), Frontier Insurance Group Inc. (ninth) and Amwest Insurance Group (fourteenth)-were hit with major downgrades. The end result: restructurings and/or sell-offs.
In May, Reliance completed the $580-million sale of its surety unit to Travelers Property Casualty, more than doubling the size of Travelers’ surety business. Reliance was downgraded by A.M. Best, first in June to “B++” and then in July to “Vulnerable,” after Leucadia National Corp. backed out of its acquisition agreement on July 13.
Frontier was downgraded to a “C++” by A.M. Best, forcing the insurer to puts its surety business up for sale. On July 20, Gulf Insurance Group and Frontier reached an agreement for Gulf Insurance Co. and its subsidiaries to acquire the renewal rights to Frontier’s environmental, excess and surplus lines casualty businesses and certain classes of surety.
Last month, A.M. Best downgraded the FSR of Calabasas, Calif.-based Amwest Insurance Group from “B” to “C-.” The rating action applies to Amwest Surety Insurance Company and its subsidiary, Far West Insurance Company.
Effective Dec. 11, 2000, Amwest management entered into a co-surety agreement with Lyndon Property Insurance Company. Given the continued slippage in underwriting results through nine months 2000, A.M. Best remains concerned with the group’s elevated leverage and its prospects for improvement going forward.
The outlook also reflects the possibility that the parent company may not be able to refinance its bank debt, which includes a paydown of $5 million in principal due in September 2001. Furthermore, Amwest Surety faces the potential for regulatory review.
Playing the ‘Survivor’ game
Byers said that CBIC has always tried to maintain a steady approach to its underwriting integrity. “It’s always a constant balancing act-trying to be competitive and yet not giving away so much of the store that you put yourself in financial jeopardy,” he said.
Even if the ride starts to get a little bit rougher in the surety industry, Byers is comfortable. “We haven’t lowered rates so low and lowered underwriting standards so much we would feel a need for some kind of knee-jerk reaction where we would suddenly have to start pushing rates way up,” he explained.
As one of the newer surety companies on the block, ACIC is enjoying growth and has two goals for the year ahead: 1) to stay true to the same principles that it started out with, and 2) to remain an alternative market.
“This is only our sixth year in business,” Baumgarten said. “It would be normal even in a downtime [that] we would be growing, because when you start from zero, it’s not hard to go up.”
Allied’s Clements also had some final thoughts on how to stay afloat in the surety market. “Keep your underwriting guidelines intact…try to underwrite the risk with sound underwriting decisions,” he said. “Because you can always get hit with something that’s totally unexpected.”
Lou Jones & Associates has sustained a presence in the surety industry because of its underwriting philosophies, according to Gail. “We’ve been in business since 1971 and we’ve had ups and downs, but that’s the story of the economy-there are high points and there are low points,” he said.
The bottom line is that “quality accounts are quality accounts,” Gail said. “If you feel like you’ve done the proper things when you’ve underwritten the account, then you should feel comfortable even in downtimes that what you’ve done is correct.”
Competition remains fierce in the surety market, according to CBIC’s Pieprzny. “Basically, we’re trying to be competitive on rates and commissions to some degree, and we’re trying to maintain our underwriting integrity,” he said. “Certain companies have gotten out of the business and other companies are experiencing losses, but there are still a lot of major companies out there looking for market share, making it very competitive.”
Was this article valuable?
Here are more articles you may enjoy.
Insurers Hike Rates as Extreme Storms Like Beryl Proliferate 
AIG Files Amended Suit Against Former Execs, Dellwood Insurance 
Marsh McLennan Agency to Acquire The Horton Group 
AT&T Says Data From Around 109M Customer Accounts Illegally Downloaded From This Issue
