Last week, we attended the Wholesale & Specialty Insurance Association’s (WSIA) Annual Marketplace in San Diego, featuring nearly 8,000 attendees. We met market participants along the length and breadth of this food chain.
There was optimism and exuberance that the current favorable rate climate would continue and lift E&S insurers’ top lines. The role of MGAs and program partners was hotly debated, with the view that a repeat of the past was unlikely. Even social inflation and litigation financing were in part seen positively as creating pressure on pricing and the admitted markets to step back.
The size of the $86bn E&S market (excluding Lloyd’s) and its growth trajectory were viewed as a way to gauge the role of the safety valve in the marketplace. However, how much of that comes from new entrants is not fully discussed. We revisited our prior analysis to examine what E&S carriers did not exist a few years ago.
Additionally, not all E&S business is created equal. Our analysis looked at the band of results and noted the industry optimism in margins due to lower loss picks shown by lower combined ratios in recent years.
Beyond the size of the E&S market is the role of MGAs. MGAs used to be a four-letter word in the early 2000s, but they have since made a splashing re-entry into the P&C space. At WSIA, we discussed the role of MGAs in sourcing new classes of business, complex risks, ease of distribution, and expertise.
Meaningful new capital has entered this space as well. Our analysis shows the level of new business these entrants have written. Yes, many of these are sourced by well-known management teams. However, should we be giving them the benefit of the doubt that all systems, claims and underwriting teams were fully and adequately staffed, and that this is all good quality business?
With litigation financing being the term of the year (again), we revisit the assets backing this class and the role of “Big Law”. Big Law is usually at the front of technical changes, including the role of generative AI and the changing landscapes, and we examine the percentage of funding going to this sector.
We discuss these points in greater detail below.
New entrants in the E&S space wrote close to $9bn of an $86bn market in 2023
When discussing the surplus lines market, much of the focus has been on its size relative to the broader P&C marketplace. It is well accepted that as the admitted market remains selective in casualty and property, as well as personal lines classes, the surplus lines market has grown meteorically.
This market in the US is at $86bn of premium (excluding $11bn of Lloyd’s), 14.4% growth vs 2022. Less discussed is the role of new entrants and the level of premiums they are putting on their books.
The chart below shows that close to $9bn, or 10% of the market, is now being written by carriers that didn’t exist at the end of 2019. In terms of companies, this totals 82 new or re-entering carriers out of 462 individual insurers.
Recall that 2018 going into 2019 is the inflection point in the E&S supercycle, where the market started growing in the double digits following several years of single-digit growth.
The table below shows the distribution of E&S carriers and their combined ratios.
The optimists will say that many of these writers are stacked with well-known management, and it is tough to disagree with that. However, the pessimist in us thinks one should be careful when expecting every new entrant to have similar results. To illustrate this point, the table shows the bands of loss ratios and the percentage market share.
Only 9% of the business written in 2023 recorded combined ratios in the 91%-100% range, nearly half of the pre-2020 number. A lower loss ratio is analogous to a lower loss pick.
With the low loss picks, if loss trends worsen, these years might not have the right level of conservatism.
In other words, this double-digit growth combined with lower loss picks could result in inadequate reserves and have the potential for future adverse development.
MGAs that didn’t exist in 2021 now write 14%, or $11bn, of the market
A similar trend was observed in the MGA space, where 14% of the growth came from new entrants. With the evolving loss inflation and social inflation climate, the books haven’t seasoned to battle test against initial expectations.
This $11bn premium came from 198 new companies that started writing business in 2022 or later, out of 711 total MGAs in the data set.
In the second-quarter earnings season, Selective Insurance was one of the carriers that revisited its recent year loss picks. As we have suggested, we would not be surprised to see other carriers revisit their loss picks as well.
This brings us back to the question of the quality of growth from new MGAs and what sort of systems they could develop and back-test to ensure that their risks were written at an appropriate rate level.
The food chain will take a few years to digest this growth, and a clearer picture will emerge of the loss cost trends and how ultimately profitable this business is for MGAs’ carrier partners.
Litigation financing and social inflation are poorly understood
In almost every discussion at WSIA, the topic of social inflation and litigation financing came up. Unsurprisingly, every carrier suggested being on top of the latest trends.
Litigation financing refers to third-party investors financing a court case's legal fees in exchange for a share of the proceeds. While the practice has been around for decades in the form of small, targeted investments mainly made from asset managers' “friends and family” capital, it has taken on wider popularity among investment firms in recent years.
The chart below shows the assets under management by third-party litigation financiers since 2019.
In the past five years, the amount of assets under management by third-party litigation funders has grown by more than $5bn.
The space has transformed from investments into individual cases into a small yet lucrative financial subsector with entire funds dedicated to the asset class. This growth has been driven by the sheer profitability of the business, with average returns estimated at more than 30%.
Aside from investing in the outcome of court cases, certain private equity firms have made strategic investments in law firms to entrench themselves further into the legal system. Some, like Buford Capital (the largest fund in the field), have directly acquired minority stakes in law firms.
In contrast, others, such as Permira Private Equity, have invested in secondary legal assets like LegalZoom (a legal services provider) and Axiom (a legal talent management service). This has been facilitated by the loosening of specific laws about non-lawyer ownership of law firms, which has gone from being legal in a small handful of states to 32 by the end of 2023.
Access to litigation financing is an attractive prospect for litigants, largely because it offsets the expense of hiring lawyers to pursue more significant payouts from insurers, especially because everyday folks cannot afford to hire quality lawyers for the duration of a court case.
Private equity capital allows plaintiffs to pursue cases that would otherwise be unaffordable, opens more cases for law firms and brings considerable returns to PE firms that can afford to wait months or years for a settlement. In short, every party benefits from this situation – save for insurers of defendants.
The following chart shows the percentage of total litigation capital commitments allocated to Big Law firms.
Since Westfleet Advisors began reporting this information in 2020 as a part of its annual Litigation Finance Market Report, lawyer-directed financing experienced a brief decline in 2021 but has had consistent growth since.
Lawyer-directed deals are somewhat different from client-directed ones in that law firms will provide their services under the expectation of receiving a portion of the proceeds from the settlement instead of charging by the hour.
With their compensation and that of the funds determined by the settlement size, lawyers have a greater incentive to drag cases out and pursue larger payouts. This will likely increase defense costs and the fear of insurers potentially facing a larger-than-anticipated payout.
In summary, although we understand and appreciate the enthusiasm surrounding the E&S market, we would wait for the books to season to ascertain the actual quality of underwriting.
Additionally, we anticipate litigation financing, attorney involvement and more significant jury awards to continue pressuring the frequency and severity of loss costs.