If two issues of Burke Ink in the last two years can be devoted to the future of Personal Lines, then we owe some ink to what a lot of people consider the most important part of an independent agency's business: Commercial Lines. One of the reasons we don't often see 'The Future of ' articles about Commercial Lines is because of the widespread acceptance that independent agencies own this segment of the Property/Casualty business, at least the part of it known as the middle market. The independent agency's market share in mid-market Commercial accounts is likely to remain strong, but there are still some important things for agencies to face if they want to stay and prosper in this part of the business.
SOFT MARKET
Like the weather, an often-discussed subject among insurance people is the so-called soft market in Commercial Lines-particularly when and how it might end. We should all stop referring to 'the soft market,' even to ourselves, and start thinking about 'the market.' The Commercial insurance market, like the stock market, is a place where the basic forces of supply and demand hold sway and human behavior is at work. All else being equal, the premium on a Commercial risk isn't going to go up until the person putting up the underwriting capital would rather lose it at the current price than keep it at a lower price. And despite the seemingly crazy pricing of some risks, what you're observing is rational behavior. It's rational for many reasons, but here are the three most important:
- First, the relative cost of risk in the economy is declining. This means that as a percentage of national income, the real costs in the Commercial P/C insurance business (the paid, reserved, and expected losses) are declining. Not in all classes, not on all exposures, and not necessarily by a lot-but they're going down, and as long as they do in a competitive market, so will the prices.
- Second, there's plenty of capacity. Put in the simplest terms, lots of people with lots of capital, both at home and abroad, enjoy investing in the P/C insurance segment of the American economy.
- Finally, because of the large build-up in loss reserves over the last decade or so, investment returns are much bigger as a percent of premium than they used to be. This permits higher combined ratios, contributing further to lower premiums.
Some people are waiting for the stock market to tumble, an event they're sure will be just the catalyst needed to jump-start an increase in Commercial premiums. That's a questionable outcome from an unpredictable event-which adds up to a worse bet than the state Lotto. Can you say when the stock market is going to decline? Even if your guess is right, ponder the fact that the bulk of insurer investments is in bonds, which have already taken some hits without the slightest noticeable impact on pricing.
ALTERNATIVE RISK FINANCING
In the arrangements known generally as 'alternative risk financing,' a creative broker usually teams up with a third-party administrator, a captive company, and a reinsurer to participate in the underwriting profit from a class or grouping of business in which they have some expertise. By doing their homework and providing the right incentives, the participants believe that they can field-underwrite and structure the insurance program more effectively than is done in the traditional market. If things go as planned, the participants gain from superior underwriting and expense results, and they're able to cut the insured into the deal by way of better pricing.
Sounds pretty sexy. And a lot of it is very creative and demonstrates the best in entrepreneurship. But from the standpoint of the Commercial Lines market's future, it's more of the same-that is, it's another example of the same forces at work causing the seemingly endless soft market. The underlying real costs in the system are improving, or are perceived to be improving (or improvable). The traditional system is still considered to be too inefficient. And down come the prices even further.
NICHES AND SPECIAL PROGRAMS
Although alternative risk financing is considered new and creative, producing niche business is anything but. The only thing new is that niches are now called ' crevices' by some-perhaps to connote deep knowledge in a narrow field. But old hat or not, program business is likely to remain an important part of the Commercial Lines landscape. Commercial Lines insurance sales is a competitive business, to say the least, and the most active producers, veterans, and rookies find the need to do more than 'write their community.' Specialization gives them more focus and the opportunity for better closing ratios. Thus, programs have been developed for virtually every conceivable trade group and class of business. And some prominent national carriers have made program business the centerpiece of their Commercial Lines marketing.
In some cases, even if there's no product innovation, the specialist producer becomes a genuine expert in the field and develops a strong referral base. In other cases, the program amounts to not much more than a coverage wrinkle here and a price wrinkle there, wrapped in a nice brochure. And a few programs actually do represent a genuine product improvement. This is usually the case when a producer discovers a changing segment in what was a traditional industry, clarifies the insurance exposure in the new segment, and develops an entirely new set of underwriting and pricing guidelines. This last activity is part of the same economic forces just described in the discussions of general pricing and alternative risk financing. It's the marketplace at work, recognizing lower costs-with the result that the entrepreneur (in this case the producer) is rewarded, and the insureds benefit from better pricing.
A RETURN OF THE MGA?
So far, we've looked at three seemingly sure bets to remain on the future Commercial Lines landscape. All of them are familiar. Two (general price declines and programs) are not new at all, and the other (alternative risk financing) is new only in parts.
But another development might be unfolding that's novel to the current generation of Commercial producers: the return of the managing general agency (MGA). There's no way of proving that this is going to happen, but it seems like the logical outcome of current forces at play, and there are a few small signs of its emergence.
When we look for examples of MGAs in the last decade or so, we usually come up with organizations in Excess & Surplus lines; or if standard lines are involved, they're usually for a specialized class. But this need not be. The P/C industry has a history of active and prominent MGAs in mainstream standard markets, many on the West Coast in the middle part of this century. Essentially, MGAs were a vehicle that solved the problem of carriers wanting to participate in the growing population and income in that region without the cost and time delays associated with putting up brick and mortar.
Although today is a different era, we have a similar set of economic circumstances-the need to market and a cost constraint. Some of the MGA stories did not have happy endings, especially for the carriers involved. In those instances, the problems were often attributable to general agents being compensated for top-line revenue and transaction counts while having no real stake in the game for underwriting results. The MGAs emerging in the next few years will be those that have the expertise and appetite to exploit modern technology for expense-management reasons but that also have the risk-taking mentality to field underwrite for cost-improvement reasons. They'll know their region, they'll know the producers in their region, and they'll get profitable results.
SUMMARY
In sum, for at least the next several years, Commercial Lines producers will operate in an environment with these characteristics:
- In general, prices will continue to decline. The macro-forces in the industry and the micro-forces of producer creativity are pushing costs and prices in the same direction-down. This will continue for a while yet. Commercial producers are in an endurance race.
- Alternative risk financing (such as captives), which was supposed to flourish only in hard markets, will continue to grow despite pricing declines, and will involve more agents and brokers seeking compensation for underwriting results.
- Programs and other specializations will continue to capture market share. Some will involve real innovation. But even those that aren't much more than a brochure will continue to serve as a track for producers to run on.
- And finally, we may see the emergence of the MGA as a new force in standard-market distribution. Commercial producers could wake up representing one-or, in a few cases, forming one.
The people who take a long-term view of things-in relationships, technology, and finance-should make good money.