The Clock Strikes Midnight on Commercial Lines
By: Banham
From California to New York, agents and brokers are bemoaning sharply reduced revenues from their commercial lines books. The credit crunch and housing crisis have spilled over to drown contractor wrap-up policies and related insurance products for real estate developers, homebuilders and builders of commercial structures such as office buildings and shopping malls. With “House for Sale” signs rotting from age and foreclosures figures spiking, insurance companies are writing smaller volumes of business. Translation—fewer commission dollars for agents.
Trickle Down Economics
And that’s just the beginning. When a contractor builds fewer homes, business for subcontractors shrinks, and there are fewer visits to support businesses at the fringe of the industry, such as lumberyards and landscape designers. In the Reagan era, this was called the “trickledown theory.” With business prospects softening in the interconnected world of commerce, companies have scant recourse other than to cut back, slashing headcount to save a few bucks. When heads fall, this creates less workers’ compensation premium for insurers, squeezing commission revenue for agents.
Now add in the soft commercial lines insurance market and the situation becomes even bleaker. On average, rates are more than 10% higher than they were last year, depending on the class and line of business. Indeed, many agents have dubbed the current difficulties a “double whammy,” describing the soft commercial lines market on top of reduced demand caused by the economy. However, if you’re Sam Rogers, Jr., CEO of Rogers Gunter Vaughn Insurance in Tallahassee, Fla., the dire situation is a “triple whammy.”
“Not only are we experiencing a 40% drop in our construction (insurance) business and a soft commercial lines market,” he says.“We’re also dealing with a property insurance market in which rates are down 20 to 25%. This is worse than in the late 80s and early 90s when rates dropped during the mini-recession.”To underscore how bad things have become, Rogers relays this story: “I had a producer come in my office yesterday who said the premium for one of our workers’ comp accounts, post-audit, was down 70%. They had cut headcount, their payroll dropped, the premium fell, our commission fell and then the rates fell, too.”
Outlook: Negative
Earlier this year Standard & Poor’s revised its outlook on the U.S. commercial lines property-casualty insurance sector from stable to negative. The sector had been stable since June 2005, and after first quarter results poured in, S&P stated that it might pencil in a negative outlook at the end of the year. Instead, the rating agency jumped the boat.
“We looked at the second quarter earnings results and saw the same pricing trends continuing with really no let up, and on top of that saw worse than expected investment income and larger realized and unrealized losses than anticipated,” says S&P Director John Iten. “Rather than wait to change the outlook at year-end, we did it in summer.”
Insurer pricing in the second quarter declined in the mid-single digits range in most lines, and in the low-double digits for new business. “Absent an extraordinary event, we do not see anything reversing the general downward direction of rates over the next six to 12 months,” Iten says.
How Bad Is It?
The consensus from economists is a gloomy economic forecast. According to experts, the economy is on track to post four straight quarters of annualized economic growth below 2%, the longest stretch of sub-par growth since the 2001recession. The odds of a recession were tabulated at 60%, with 19,000 people expected to lose their jobs each month, rising to a 6.4% unemployment rate by mid-year 2009. Growth in the first quarter of next year is gauged to be 1.3% on an annualized basis.
The culprits: home prices, tighter credit, falling stock values, rising unemployment and the psychological effects of reduced consumer confidence reverberating into fewer dollars spent on food, clothing and other items (economists project a 0.1% contraction in consumer spending during third quarter 2008).
Iten says the p-c industry needs to feel more pain before it will alter its pricing behavior. Certainly, the economy is on track to inflict this pain. As for actual downgrades of insurer ratings—a negative outlook means “expect more negative rating actions than positive,” which he explains are right around the corner. The A.M. Best Co. rating agency has a similar view of the situation. “When the economy slows down, payroll falls; and that translates into less audit premium for workers’ comp,” says Dan Ryan, a vice president at A.M. Best. “We’ve seen weaker auto sales also affect the commercial lines market. People hang onto their older vehicles or buy older cars instead of new ones, which cost less to be insured, thereby reducing overall premium. Whether an agent is providing general liability, workers’ comp or surety bonds, they’re looking at less demand on top of soft market conditions.”
The surety market, which sells a variety of bonds to developers and builders, is suffering, Robert Hartwig, president of the New York-based Insurance Information Institute, concurs. “Housing starts are 54%off where they were last year, and this is expected to be the case again next year,” he explains. “As for the construction sector, if an agent has a fairly good sized book in a state like California or Nevada, they are going to be hit harder than national numbers would suggest.”
Housing Crunch Ripple Effects
No need to tell that to Tom Burns, vice president of Cragin & Pike Insurance Agency in Las Vegas. “The city stopped flat outbuilding houses about nine months ago and there is little going on and not much on the horizon,” Burns says. “We’ve experienced a perfect storm here. After a tremendous uptick in the residential market from 2004 to2006, things have cratered. When the clock struck midnight, all those homes bought by people who could no longer make their mortgage payments came home to roost. Foreclosures were the result and now we have a glut in housing.”
The economic downturn is forcing vacation-minded people to rethink Las Vegas and consider a “staycation” instead, causing companies, particularly in the gaming industry, to trim their workforces. This, in turn, has taken a knife to Burns’s workers’ comp book.“My largest client had 2,500 people on the payroll last year; this year they have 600,”he says. Burns also writes a fairly good-sized book of construction business, particularly subcontractors that do infrastructure work like sewers and water. “They’re the people who go in first on a project, and with fewer projects they’ve taken a bit hit,” he notes. “Hate to say it but getting paid (from them) has become more challenging.”
The construction insurance market isn’t all that much better in New York State, where Neal Sullivan, president of Sullivan Financial Group, Inc., in Mahopac, N.Y., recently met with a group of agents around the state. “I wanted to get a feel from them about things,” Sullivan explains. His upshot: “Things here are no different than everywhere else in the country. Construction business is way down. The insurance market is soft at the same time, which seems to be driving buyers to become more price conscious. Everybody is taking a harder look at things, insofar as what they’re spending their money on.”
This includes insurance. “Policyholders are requiring their agents to do more shopping to make sure they have the most competitive price,” he says. “My peers are all doing a lot more work just to retain what they have.” Sullivan estimates prices have come down across the board in the commercial lines market nearly 30% in the last two and a half years.
On the other side of the country, in California, Scott Kerns, says the Bay Area hasn’t been hit as hard by the country’s economic woes. Nearby is another story.“We’re two hours from Stockton, the foreclosure capital of the world, and one of my producers is in Lodi, right next to it,” says Kerns, president of Bay Risk Insurance in Alameda. “I’m told things have crashed to a halt there, but where we are located business is off but not terrible. Payroll, of course, is down, which takes a whack at workers’ compensation, with premiums being returned to buyers translating into reduced commissions for us.”
It could be worse, he says. “An agency not far from here that insured a lot of auto dealers was hit hard when one of them closed its doors at the end of June,” Kerns notes. “After the (workers’ comp) audit, a million dollars in premium was returned (to the carrier), which took a huge slice out of the agency’s commission.” Helping Kerns tread water is the fact that his agency doesn’t write a lot of construction business. The downside is workers’ comp. “I estimate we’re 70% off in premiums from last year,” he says.
In the Rocky Mountains there are similar tales of woe. Steven Goble, president of The Mahoney Group, a Mesa, Ariz.-based agency with nine locations in the state, says “We’ve seen a lot of developers, contractors and subcontractors go bankrupt or stop doing new housing, causing demand for construction-related insurance products to basically tank. Our exposures in the construction segment are down 30 to 50%in the past year, and the situation is common across all agencies.”
The Mahoney Group customarily handles a decent size book of construction business, which has taken a toll on the agency. “Since construction is such a big deal in the state, we also write a lot of the supporting businesses like wholesalers and retailers whose sales have dropped off, as well,” Goble says. “With all the gloom and doom being projected, we’re seeing companies pull in their horns, shoring up cash and being more careful about their finances. Credit is tight, so clients that previously relied on financing also have been hurt. Meanwhile, we’re coping with a soft market that produced 12to 15% rate decreases last year and around12% so far this year.”
Hit, But Not Hard
In Portland, like much of the Pacific Northwest, the situation is not nearly acute as it is elsewhere in the country. Jim Ginger, president of KPD Insurance in Springfield, Ore. (the agency also has an office in Portland), says from a production standpoint his commercial lines book, excluding workers’ comp, is flat. “Our payroll and sales from a comp stand point is not really growing either, but we don’t see any major decreases, thanks in part to the dollar looking pretty good and export activity to the Pacific Rim being decent,” Ginger explains. “Certainly, our real estate writings have backed down, but it isn’t a huge part of our business. I was just reading the paper and a house that took 60days to sell last year now takes 120 days, which isn’t too bad. We’re also not seeing the home price decreases that other parts of the country are seeing.”
This could change, he acknowledges. “In Oregon, we often say ‘We may not be the first to fall but we may be the last to recover.’”
Virginia also seems to be faring a bit better than the remainder of the nation. But, Bill Ball, president of Ball-Martin Insurance Agency in Richmond, Va. says he is beginning to notice an increase in foreclosures coupled with a decrease in the number of housing starts. “We’re coming off of a solid five to eight years of growth, seeing new developments and schools spring up,” he says. “That has virtually halted. Since we’re an agency primarily commercial in focus, with an awful lot of work done for homebuilders and trade contractors, when they suffer we suffer with them.”
Workers’ comp revenue has also fallen at the agency. “Our largest account went from $300,000 to $200,000 in one year—$100,000 right out the window, strictly due to payroll forecasts for the coming year. As a small to mid-sized agency, with 11 employees, a $300,000account is a good-sized one for us… I’ve been in business since 1972 and have never seen a down economy and a soft market at the same time.”
When the Going Gets Tough
Agents are doing what they can to weather the difficult climate. Many are going after new business. Others have learned the prudence of diversification.“We probably put too many eggs in one basket with trade contractors,” Ball says, “and need to diversify our book with some recession-proof industries so we can temper things next time around. For example, we’ve just started marketing auto services businesses, which seem to be doing fairly well in the current economy. With people keeping their cars longer, they need more service.”
Many agency principals site diversification as balancing the downturn. Rogers cites his employee benefits business as offsetting the 40% plunge in construction premiums the agency incurred, on top of a 15% drop in commercial lines rates. Van Gilder similarly notes his agency’s significant oil and gas book of business. “Obviously, that is one industry that isn’t hurting,” he says. “We’ve got 35 people here, that’s all they do. Still, it feels a bit like ‘robbing Peter to pay Paul.’”
How long will it take for the down turn to ease? Nobody is willing to bet on the market’s revival any time soon. Rogers, however, is sanguine. “We’re actually seeing some signs on the horizon of a turn around,” he says. “I had a conversation with a couple real estate agents last week and they told me for the first time in many months they had more listings and more sales. It appears things may be shifting, albeit very slowly.”
Banham (Russ@RussBanham.com) is an IA senior contributing writer.
Residential Construction on Hold
The construction slowdown is hitting both the commercial and residential building sectors. In Denver, Michael Van Gilder, CEO of Van Gilder Insurance Corp., says many commercial building projects “have been put on hold or the companies have stopped building. Since we have a lot of sizable homebuilders here, this is a problem. What has really been hard hit is wrap-up insurance—the insurance for contractors that stops at the front door, picking up risks associated with their subcontractors. They’re dramatically down for us in the residential sector, although less so in commercial building. I guess overall our construction business is down 10%. We expect to grow this year by 2%, which is a far cry from what we’ve been doing in past years, but all things considered we’ll take it.”
—R.B
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