Pollution Solution

By William Pritchard Jr., ERM
Printed in the February 2011 issue of American Agent & Broker

2010 saw a rapid expansion of the environmental/pollution insurance marketplace in the face of daunting conditions. Why this growth has occurred, and what it means to an agency, are important to understand. The performance of this niche clearly illustrates the efforts being made to find success in our evolving market, and agents that can correctly tap into it will see significant return on their investment.

In 1990, four companies offered dedicated environmental insurance products. In 2000 there were closer to 10. At the end of 2010, there were at least 40 companies with environmental practices. One thousand percent growth over 20 years is significant, but even more significant is the growth in the last 3 years, from 20 to 40. Companies including XL (formerly ECS), Chartis (formerly AIG), Zurich, Markel, Liberty, Chubb and others have been involved almost from the beginning. In the face of the most difficult market most can remember, why has environmental been such a draw for carriers? And what does this explosive growth mean for the insurance agent?

At the root of the growth in environmental carriers is the underlying shift in how insurance works. Carriers have long underwritten to very small profit goals, recognizing investment income as the true driver of their profitability for their investors. Equity market returns of 10 percent or greater were the norm for many years. Carriers generated premium, reserved conservatively, putting that money into IBNR, and saw the investment income profits role in. This model served our industry very well for many years and through many market cycles.

Unfortunately, this underlying dynamic has changed. The investment market is no longer able to return such generous results to its investors, and this is in turn is forcing companies to find their profits elsewhere. The only viable solution is to try to underwrite accounts more profitably than before.

While this seems like a simple task, it is anything but. Due to the difficult economic environment over the last 3 years, the insurance industry is struggling to write as much premium as in the past, not to mention at a greater profit. As whole sections of the economy lose value, the insurers that cover them generate less in premium. With current unemployment figures hovering at just under 10 percent, the industry that rates based on payroll has taken a real hit. Adding to this the anemic overall growth of the economy, and you end up with carriers fighting for more slices of a shrunken pie.

Add to this the reduction of loss reserves at many companies. Carriers traditionally bring reserves down as prior year results have allowed, dropping those dollars right to their bottom lines. Unfortunately, given the lack of investment returns, they are no longer filling that reserve pool back up as aggressively as they once did. The money that eventually came out and bolstered the bottom line is rapidly going away. If a company can maintain strong underwriting profitability, this is not a huge problem. If, however, carriers have to fight for business and write risks for less than they want to, this can quickly become a significant long term issue.

The final piece of the puzzle is the dramatic influx of capital into the industry as a whole. While the insurance industry has been struggling, the promise of a decent enough return excites investors into the marketplace, especially compared with the return the equity markets have yielded. Over the last 5 years there has been a steady influx of money into the insurance industry, all of it seeking a home and a respectable ROI.

So how does this all lead to an increase in environmental programs over the last several years? The answer is simple. When environmental business was first written in the late ‘70s and early ‘80s, carriers had no idea how to price it. Coming off of horrific asbestos-related claims, carriers were very cautious in how they priced these products. Over the intervening 30 years, it has been shown that environmental exposures are not significantly more challenging than many other casualty lines. While there are of course exceptions in certain areas, the general consensus is that environmental risks are more profitable than many other mature market segments.

This is where things get interesting. While this may be true, it is by no means universally true. Over the last 10 years carriers have blended coverages to sell under the heading “environmental.” Many of these combine CGL and products with site or contractors pollution. While the environmental component of the package may in fact be profitable, there is ample evidence that casualty business is, and will always be, casualty business. If you write tough products, you are going to have some real claims. If you write a combined CGL and contractors pollution policy for a tank installation contractor, you are more likely to see claims from people falling into holes than you are from pollution. So while “environmental” insurance has proven itself to be very profitable over the last 30 years, it is mutating into something different where the genes of its more standard components may well be dominating the results.

Another challenge is the people. Environmental insurance has had a very short and squat pyramid; broad base but not much room at the top. Over the last 10 years many talented men and women have risen in the ranks of environmental insurers. Many of them have been looking for the next step into senior management. Heading an environmental unit is often the crown jewel of someone’s career. Many of these people are looking hard for the opportunity to jump their careers to the next level, and are aggressively reaching out to carriers without an environmental unit to try to create the job they seek. All of the above pieces have lined up over the last several years. We have an influx of capital, we have carriers looking for ways to write more business more profitably, we have a market segment with a history of profitability and we have people willing to lead these new divisions. Given all of the above, it’s a wonder we don’t have even more markets focusing on environmental accounts.

What does this mean for an agent? Many may think choice is a good thing, and in many respects it is. Environmental insurance is a class of business where individual underwriter appetite often dictates what a carrier will write, or at least will try to write aggressively. Having only one or two relationships leaves an agent at the mercy of one or two individuals. If, on the other hand, an agent can go to 40 different markets, he or she should never have to worry about any single underwriter blocking the path to success.

While on the surface this makes some sense, it is a very dangerous path for an agent to follow for a few reasons. The characteristics of a good carrier relationship differ for many agencies, but in general they include carrier stability and commitment to the line, underwriter knowledge and responsiveness, solid claims handling system and track record and proven service capabilities. All of these components add up to not only success writing an account, but long-term success in servicing and maintaining the business. Compounding growth only comes through happy insureds renewing year after year. If claims are not being paid and endorsements not delivered, it makes every renewal a fight instead of an affirmation.

Determine your Partners

The environmental marketplace has grown quickly, and the development of many programs has been somewhat mixed. There are surface indications that agents can review to determine if a market will be a good partner for them.

The first is the commitment carriers have made to environmental insurance. Are they in this for the long haul or are they simply trying to write some quick business? A gauge of this commitment is their staffing situations. How many employees have they hired? How many offices or locations do they have? Are they making enough of a commitment for an agent to know that they can adequately service the business they are writing, and that they are in it for the long run? We have seen markets enter this arena recently with two or three employees, and we have seen others enter with 15. Clearly one is making a bigger commitment than the other.

A similar issue is the claims handing staff. Has it hired at least a few key claims people to handle environmental claims? Environmental claims are not the same as regular casualty claims, and people with experience in this area are critical for long term success of a program.

The final key component is management and underwriting staffing. Is the person the insurer hired to put the program together an experienced environmental and insurance professional? A senior underwriter making the move to management can be fraught with problems, as the management role is so complex. Does the person coming on board have the background to be successful? Also, who has been hired as underwriters? Do they have experience and credibility in the marketplace? Again, seasoned experienced underwriters and a structure to enable them to succeed are very important.

Agents need to partner with companies that are committed to the line of business. A company that hopes to be doing this in 10 years is far more likely to responsibly deal with the issues that will inevitably come up than one who is in it for short term premium volume. While the above do not guarantee commitment, they certainly indicate it.

Once an agent is satisfied with this, the next important component is reviewing and understanding the coverage being offered. No two environmental policies are the same, and there is huge diversity in the type of coverage being offered. Knowing what you’re offering the client is crucial, certainly as crucial as knowing the carrier you are offering it from.

Given the above, an agent may find that the best way to access environmental carriers is to go through a specialty broker. In the current marketplace these brokers typically pay the same commissions that direct carriers would, and give the added advantage of having done a lot of the above leg work for the agent. The same criteria need to be utilized to make this selection as was used for the carrier review. Longevity, commitment, expertise, reputation are all import and easily judged items. Spending a few moments researching the web and talking to other agents and carriers can bring you excellent choices for partners.

The environmental market is still growing fast. One of the positive offshoots of so much competition is a huge increase in marketing. All of these carriers, and the many brokers focusing on the line of business, are marketing the coverage. This is leading to an increased awareness at all levels. More job specs are requiring pollution coverage, as are landlords, lenders and attorneys. This increase in exposure is a definite plus for agents seeking new coverages to offer their clients.

Last year’s BP oil spill has been yet another driver of increased interest. Many of the business impacted by the spill, from coastal property owners to people making their livings along the Gulf Coast, could have been protected by the right environmental coverage. Many businesses have learned from this situation, and other lesser-known ones in their own back yards, and are reaching out to their agents to discuss what coverage is available to them. Most insureds can talk about a similar business or an associate they know that has had an environmental issue come up. This increases the population buying these products from hundreds in the early days to hundreds of thousands today.

The evolving insurance industry has challenged many but has also created opportunities unlike any seen before. Agents wield a great deal of power in this market, being the gate keepers to their clients. With so many agents and carriers scrambling to find business, and in some cases willing to do almost anything for it, the potential fallout is huge. Inadequate coverage, carriers gone after a year or two, and similar problems will force many agencies and carriers to the sidelines. Those that take time to consider the choices they are making, and the long term ramifications of them, will rise above their competition. This is already beginning to happen, as some are seeing significant growth in new business and strong renewal retention while others are falling fast. As the economy continues to improve, and with it the equity markets, the frenzy of the last few years will fade, and competence and professionalism will prevail. A solid environmental strategy is only one component, albeit an important one, of the thoughtful agencies’ strategy to continue to succeed in our new marketplace.