Tight Reinsurance Capacity Puts the Squeeze on Program Market

As more and more reinsurers become increasingly timorous in a hard market yet to peak, one of the most acutely affected business lines have been programs. Reinsurance capacity for many standard commercial lines has dropped substantially, especially after Sept. 11, 2001, and the unique structure of program coverages makes them particularly susceptible to such capacity shortages.

In softer markets, reinsurers were more willing to take on additional risks from program business; now, however, the program administrators (usually MGAs) and fronting companies, which monitor the programs, are more often than not required to take on some of that risk along with the reinsurance companies. As a result of this shift, fronting companies have become a rare, if not endangered species, and program administrators are following suit.

Legion Insurance Group’s Legion Insurance Company and Villanova Insurance Company subsidiaries, both once highly active in programs, provide extraordinary examples: Both units were put into rehabilitation in Pennsylvania earlier this year after reinsurance capacity contracted, leaving them exposed to deal with losses accrued following years of soft-market growth. As it turns out, Legion’s collapse indicates a trend for the program markets rather than an isolated incident.

Hard markets harder for programs?
While program business has some advantages over standard commercial lines in soft markets, they can conversely face greater difficulties in hard markets. Larry Spoolstra, chief underwriting officer at GE Reinsurance, explained, “I would say that if you look at the degree at which the market pendulum works, the programs side is going to swing more than a traditional business is. It’s going to be a little softer and a little more vibrant during a softer marketplace.

“In a hard market, it’s gonna be tougher, because a lot of the parties that prop that area up change their underwriting stance, their position,” he continued. “If you look at, as an example, the companies who put their paper out for the programs, the number of companies that will do that today is clearly less than what it was a couple of years ago. Those companies are now being required pretty much across the board by all reinsurers that reinsure these programs to keep a material piece of the program—quite often something in the range of 20 percent. So those companies are now risk bearers. They’re really no longer fronts—they are really a company that needs to monitor and control that program. The day and age of somebody being a pure front, you know, is largely gone.

“I will say there are a couple of exceptions. If you look at some of the financial companies that write some of the captive programs, some of them still have retained a status where, once you get through the machinations of the reinsurance programs, they’re really keeping almost nothing back.”

Market Darwinism
Spoolstra noted that the lack of fronting companies willing to share losses has scared off many reinsurers from accepting all but the sturdiest of programs.

“So the number of companies putting their paper out are fewer,” he said. “They need to keep more of the program, which means they’re gonna be a lot more selective on the ones that they’re willing to do. One, because of their surplus constrictions. Two, because they’re really at risk. The number of reinsurers that were in the program market—that number is reducing all the time. If you look at some of the reinsurers that have gone out of business this year, all of them have done a fair amount of program business. If you look at folks such as Gerling, Hannover—[they] reduced their operations through the ICH operation here in the United States. Opus wrote a fair amount of program business. So those are companies that are out—they obviously provided some capacity to that market.

“Other reinsurers have reduced down the amount that they’re willing to write, such as the operation that I work for, GE Re. Our program business is dramatically less than what it was a couple of years ago. Some of that is driven by classes of business—we used to write a fair amount of auto on the program side, nonstandard auto. Now we won’t do that at all. We used to write some commercial auto, and we’re far more restrictive there than we were in the past. There’s a lot less capacity, and there are a lot more eyes, when people are doing deals, that are looking at them. So the best programs survive and those that are average to mediocre are either gone or struggling,” added Spoolstra.

Seeing is believing
Well-established, stable programs maintained by the same administrator for a significant time period fare much better when reinsurance capacity shrinks. At the same time, getting a new program off the ground can prove a Herculean feat. Spoolstra explained, “The program manager really has to have a track record—those that have moved their program from year to year and you can’t get at the data, or those that say, ‘We’ve got this wonderful idea and we want to go out and do this, but we don’t have any data on it,’ I think they’re going to have a very, very difficult time getting the program off the ground.”

He continued, “Whereas two or three years ago, somebody could put a filing out and say, ‘We’re just gonna copy what this other company does, and they expect to write this stuff at a 60 percent loss ratio, and we should be able to do the same thing.’ A lot of that took place, and today you’re wasting your breath to even try that. The better the data a producer has, the more likely they will find a marketplace today. The ability to get paper today, to write business for just average business is much more difficult.”

Reinsurance brokers also scarce
Spoolstra mentioned another issue constricting the programs market, the decreasing numbers of reinsurance brokers needed to connect program administrators and reinsurers.

“One of the other major players in this arena are reinsurance brokers,” he said. “Quite often they’re the marriage makers in a lot of programs. They find an appropriate manager for the paper or the front paper for the reinsurer and kind of pull it all together for everybody. A lot of the brokers these days have been indicating that their appetite for program business is a lot less than it used to be. It’s a pretty time consuming thing—they need to make two negotiations each year, not one like the standard [lines]. They need to negotiate between the paper and the producer. They also need to negotiate between the those two parties and the reinsurers.

“So they’ve got two major negotiations each year,” added Spoolstra. “They quite often have programs that don’t last for more than a couple of years. So there are high start-up costs, high maintenance costs, and then the program doesn’t stick around for a long period of time. A number of brokers have indicated not necessarily that they’re getting out of programs, but that they’re going to de-accentuate, put a lot less of their resources towards it. If you take the brokers and pull them out of this equation, I think that’s also going to be a bit of a chilling effect on the placement of programs.”

Will the market swing back?
While one could assume that once insurance markets in general begin to soften, standard lines capacity will likely increase, whether or not the program market bounces back is much less certain.

“I think a lot of the programs are having to be superior today to price their business at a superior hard market level,” Spoolstra said. “When the market as a whole starts to come down and soften, really to a large extent the program market is going to soften to the extent that the reinsurers allow it. Is that going to be at the same rate as the rest of the market, as the standard market, to get back to whatever the middle level is? I’m not sure that I can say. It’s really kind of predicting a few years out. I don’t know whether the reinsurers of that day are gonna say, ‘Yeah, we really want to grow, so let’s grow with MGAs,’ or if they’ll say, ‘No, we’ve got all the growth we want in standard-type operations, we don’t need to get it from the MGA side.'”

Longevity helps
Spoolstra’s assessment of the programs market was echoed, by and large, by Bryan Brownyard, president of the Brownyard Group Inc. Founded in 1950, the company administers programs for the security, pest control, and beauty and cosmetics industries.

“The capacity on programs has drastically reduced—we’re seeing consolidations of programs all across the board,” Brownyard said. “We run three programs ourselves, and we’ve noticed the constriction in the reinsurance market, obviously, on it. We’ve been doing it for 40 years, so we’ve got a leg up on most of them.”

Brownyard continued, “I think in a market like this, you need some very credible long term loss experience to be able to go to the reinsurers and make your case. Basically, it’s a very tight market right now—it’s all reinsurance-driven, actually. [The market] was hardening prior to Sept. 11—that was really the catalyst that tightened down the screws all the way.”

Fewer competitors, fewer fronts
Brownyard pointed out that as more competitors withdraw from the program market, companies like the Brownyard Group are able to increase their volume in these lines only because of their experience in the business, as well as their willingness to assume some of the risk along with the reinsurers.

“We had a number of our competitors go down—Legion went down, Frontier went down, Reliance went down, Frontier prior to 9/11, Legion after 9/11,” Brownyard explained. “Besides a capacity crunch, you have all this increased volume. We’ve doubled our volume in the last 12 months.”

“We were using fronting companies up until about six months ago,” he continued. “We decided to go a little bit more conventionally.
“A lot of the fronting companies don’t want to take a piece of the risk. They don’t want to take a piece of the action, and the reinsurers don’t want to get behind any fronting company that’s not taking it … [The reinsurers] want to be able to monitor MGAs. If [the fronting companies] don’t have some skin in the game, they don’t feel as though they’re properly monitoring them. As a result, I think a lot of people are getting away from the fronting companies right now.”

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