Is Excess & Surplus Right For Your Business

Air date: 1/23/23
Record date: 12/13/23

Excess and Surplus (E&S) Lines insurance is an important and growing segment of U.S. insurance industry. While standard lines carriers or retails agents can cover many business needs, E&S can provide cover for new products, new business innovation or higher risk policies. Christopher Lewis, Head of Excess and Surplus Lines at Zurich North America, discusses some examples and touches on upcoming risks all businesses should be paying attention to.

Guest:

Chris Lewis
Head of Excess & Surplus lines
Zurich North America

Christopher M. Lewis is Head of Excess & Surplus (E&S) for Zurich North America. He is responsible for developing and executing E&S strategy and actions to best respond to the needs of customers and brokers, while helping Zurich better serve the E&S market and achieve growth in it. Prior to joining Zurich, Lewis served as President and CEO of International Financial Services Group, a private excess and surplus lines insurance company. He began his career as a Senior Economist in Washington D.C. at the Office of Management and Budget and the Office of Federal Housing Enterprise Oversight. He left Washington to join Ernst & Young, LLP, where he helped develop and implement an enterprise risk management consulting practice for financial services clients. From there, Lewis moved to NetRisk, LLC, where he was Managing Director and Head of Consulting Services. At The Hartford Financial Services Group, Lewis served in a number of positions of increasing seniority in both finance and risk management, ultimately serving as the P&C Chief Risk Officer and the Enterprise Chief Insurance Risk Officer.

Host:

Stephani Gordon
Executive Employee Communications Business Partner
Zurich North America

As part of the Zurich North America Communications team, Stephani Gordon finds and shares stories by asking questions that connect people with ideas to pique curiosity, broaden awareness and create communities. Fondly considered a compassionate interrogator, she has coached executive communications for the CEOs of Zurich North America and Zurich Canada, lead C-suite video productions and connected employees with corporate strategy through storytelling and engagement. In addition to hosting this podcast, she unabashedly admits to spending too much time on TikTok in the guise of “anthropological study.”

Episode transcript:

STEPHANI GORDON: Hi, my name's Stephani Gordon. I'm here hosting Zurich's Future of Risk podcast and today I am so excited to welcome Christopher Lewis to the program. Chris is the Head of Zurich Excess and Surplus lines. Chris, welcome. I'm so excited to have this chat and get started.

CHRISTOPHER LEWIS: Well, thank you. It's a real pleasure joining you today.

GORDON: So, let's start out, for someone who's not super-deep into the insurance industry, could you give us a quick overview of the definition of Excess and Surplus insurance lines?

LEWIS: Absolutely. Yeah, that's an interesting question. Excess and Surplus lines insurance is actually an important and growing segment of overall U.S. insurance. For a business or an individual, normally what they'll do is they'll go either directly to a standard lines carrier or they'll go to a retail agent to try to get the coverage they need, either for homeowners, or auto or for their business. And that works pretty well. They get policy terms and rates that are regulated by the states, but occasionally a business or an individual may have a unique risk that doesn't fit into that model and the standard line insurance carriers can't provide the coverage at the rates and forms that fit the unique aspect of that business. Maybe it's a new product or it's a new business innovation, or it's a higher risk policy. In that case, the retail agent will turn it over to a wholesale broker and go to an E&S insurance carrier who has more flexibility to tailor the coverage to the needs of the individual insured. That's a growing market because as our economy changes —more innovation, more new products — you're seeing more and more business going into the E&S market, which today on the commercial side represents about 20% of the total premium written for businesses in the U.S.

GORDON: And that makes sense. You talk about risks that are unique to businesses, but I think we're going to also talk a lot today about emerging risks and how that landscape is changing. So, when we look at the customers in the U.S. that are looking for Excess and Surplus, or E&S insurance, what are some of the key future risks that you see them worried about?

LEWIS: Yeah, it's a great question. There's a lot of risk out there. Those of us in the risk and remediation business are always focused on so many different things and they're constantly changing. So, as we talk with our business customers today, they're focused on a myriad of different risks, and risks that are constantly changing. The three main risks, I think, that repeat themselves are the breakdown of social and political cohesion and its impact on their corporate legal risk, the risk of a prolonged period of slow economic growth, and the risks associated with climate change. Each of these risks is important and each of them keeps showing up in risk surveys that are being conducted around the globe, and they also showed up on the risk survey that was done by the World Economic Forum earlier this year.

GORDON: So, you've picked up on three fairly meaty topics there. We could probably spend a whole conversation on each of those, but why don't we start by having you talk a little bit about the concept of the breakdown of social and political cohesion and then the impact that that has on corporations’ legal risk.

LEWIS: We've all witnessed around the globe over the last several decades, a process by which you're seeing more and more polarization within society. Researchers have identified many potential causes for this, whether it's the deregulation of the airwaves, whether it's the widespread use of social media, entrenched special interest groups, or even gerrymandering of voting districts. For our purposes, the cause matters a lot less than the impact on corporate legal risk. What happens is that legislatures in a polarized environment just are less effective in passing consensual-based laws. And when that happens, you have more and more policy that's implemented through regulations and rulemaking processes at the administrative level. We've seen that globally, we've seen that at the federal level, and we've seen that at the state level. The challenge for businesses is that instead of dealing with a regular case of new laws, they're now dealing with a high volume of new regulations that actually change with each election cycle, and they change by state and within various jurisdictions. And it creates a real challenge for them in terms of monitoring costs, compliance costs and potential litigation.

GORDON: I think that's really interesting perspective. Chris, can you maybe give us an example of how you're seeing that happening from cycle to cycle?

LEWIS: Yeah, a good example in the United States is the rules that were published by the Department of Labor governing how a fiduciary should implement any factors associated with environmental, sustainability or governance considerations for investment decisions or for corporate actions. If you go back to 2018, the Obama administration issued a rule that basically told fiduciaries that they should consider ESG factors in making investment or corporate action decisions under the Employment Retirement Income Security Act of 1974. In 2020, the Trump administration sought to reverse that guidance and actually issued two rules that limited the consideration of these ESG factors, solely in terms of pecuniary factors as defined under ERISA, really trying to negate the guidance that was being provided under the Obama administration.

GORDON: And ERISA is, Chris?

LEWIS: The Employment Retirement Income [Security] Act of 1974. It governs the process by which fiduciaries can make decisions on behalf of the beneficiaries of a retirement plan. And then just last month, the Biden administration reversed the Trump administration rules issuing a new rule that once again established that these ESG factors — environmental, sustainability and governance factors — should be considered in any investment decisions, provided that the fiduciary continues to focus on the relevant risk-return considerations for those investments. So, putting aside the merits of any one of these actions, you have a situation which companies are dealing with three different standards for interpreting the rules related to fiduciary actions just within the last five years. And it just speaks to the pace and the breadth of compliance issues that companies are facing, and then also their legal risk, because if they're deemed not to be in full compliance or if others are concerned about it, it really increases their risk exposure, relative to implementing these new regulations.

GORDON: That has to be incredibly frustrating for companies to go back and forth like that, because when you're constantly having to change, redirect, and you might just get yourself adjusted to one way of doing business to become compliant, and then something changes. That has to be a lot of expense and hassle, et cetera. And you still don't know if you're up to date, right? Is that driving an increase in litigation?

LEWIS: It is driving an increase in litigation. If you think about the underlying drivers of social cohesion and deterioration, the impact is also being felt by individual citizens. So, citizens looking back at the political process are losing faith in the regular government processes for managing the development of laws. And so, when they lose faith in the government process, then, what it also does is it starts to break down social mores against rent seeking by compensation from other means. And so, you see citizens more likely to, instead of pursuing changes in laws, pursuing their kind of compensation for alleged harms through the court system.

GORDON: Because they don't really think the government is going to give them the recourse that they might historically have expected.

LEWIS: That's right. They've lost faith in the political process, and so they'd rather pursue the courts and take their chances there. The problem is that increases the overall volume of litigation that companies face. When you combine that with the breadth of different regulations that are coming out, which can come out at multiple levels within different states in the federal government, you have a real backlog of litigation that you need to contend with. We've just seen it in the last year, between suits on whether or not there's excessive fees on defined contribution plans, to a variety of actions in terms of corporate risk disclosure where individuals are suing to, basically, seek compensation for alleged harms that normally would be processed through a federal legislative process.

The other key piece of this is that we're also witnessing an increase in the damages that are being sought by individuals when they are trying to take their grievances through the court system. And so, the alleged harm is many multiples of the actual economic harm and that pursuit fueled in part by private-financed litigation, as well as speculative lawsuits, leading to large punitive jury awards that is increasing the cost for businesses and ultimately for consumers. That ultimately feeds into social inflation overall and businesses are feeling that, and we're trying to help our business customers manage that process.

GORDON: You mentioned tight labor markets, and earlier you noted the risk of a lower period of macroeconomic growth. That was the second of the three bullets that we started with. Can you describe the overall economic risk and how that relates to the labor market’s trends that you're seeing in evolving risk?

LEWIS: Yeah, we just spoke about polarization and that polarization, from an economic perspective, also has developed a kind of nationalistic view in terms of our trade position. So, we've gone through 30 or 40 years of trade liberalization where we've had freer and fairer trade, which is driving economic growth, and now we're pulling back and you have a global realignment that is more consistent with trade blocks or moving production closer to home. And we talk about that in terms of supply chains. We think about that in terms of how we disseminate information about technology. But the same applies to labor and companies that are wrestling with having to move labor — their employees — back closer to home, potentially in smaller labor pools and trying to compete for a shrinking labor pool with lower opportunities to hire high-quality employees. So, they're looking at fewer opportunities to hire and higher costs of bringing that labor on board, which is constraining their opportunities to grow.

GORDON: So, what are some of the things — if we look historically before we look forward — what are some of the drivers that traditionally drive growth?

LEWIS: If you look at long-term economic growth, in simplest terms, the main drivers are labor — your employees, capital — the machines that are actually being used to drive the production, and the technology. For most economic history, labor is really the largest driver. So, population demographics and how the population is moving is driving your long-term growth potential. The challenge we have right now is that we have a shrinking labor force because we have an aging population in most societies, and the population replacement rate is also low. And our labor force mobility is lower because the same polarization's driving kind of less immigration, so we have less mobility to move labor around. And then some of the drivers that we saw historically in terms of women entering into the workforce and higher educational attainment have kind of run their course. So, the drivers around labor have actually waned somewhat globally, but also in the U.S. The second piece is capital, and for capital we're seeing — if you look at the overall returns on capital over the last 40 years — low interest rates. And so, the returns on capital have been much lower as well, so you're not getting the boost in capital. And then the last piece is that productivity piece. And productivity has really gone through a couple different cycles. We had a period of very strong productivity growth immediately after World War II, where it was averaging about 2.5% that, with labor dynamics after World War II, drove a lot of the increase in economic production. And then you had, post-1974, a real drop-off in productivity other than a little recovery in the mid-nineties that now is averaging around 1.4%. So, companies are facing a situation where labor force is not growing rapidly and productivity is actually constrained, and that's what their risk is. That's their concern, that looking forward, where's that source of growth and how do I operate in that environment?

GORDON: It's fascinating to hear how all of these strings come together behind the scenes. A lot of these we see in the headlines and the news, and really looking behind at some of the causes is really interesting, so I appreciate you pulling all this together. Are there thoughts about what's causing that decline in these areas that you're talking about?

LEWIS: There's a lot of thoughts. There's no clear answer that actually can identify all of the drop-off in productivity. So, one theory is that we have too much savings that have been accumulated by an aging population. And so, you have too much savings that's driving down the returns on capital. Basically, too much savings chasing too few dollars. Another theory is that we have a cyclical drop-off in investment to drive productivity enhancement after the Great Recession in the mid-2000s. When you have a real financial contraction driven by credit conditions, there tends to be a lag in an economy's ability to reinvest, and so one theory is that we're just experiencing a prolonged lag of new investment that is therefore not driving that productivity improvement. Another theory is that there's just been an ongoing shift from manufacturing into service, which tends to have a lower productivity, although the data doesn't really support that as much. And then the last one is that the economy simply has fewer transformational investment opportunities than it did previously, a form of secular stagnation. And that's the more risky one, because that would suggest we don't have any transformation to really drive that future growth through productivity enhancements.

GORDON: So, what are some of the things that can be done to increase potential growth opportunities in the economy?

LEWIS: From a public policy perspective, there's a number of things. The most immediate would really be to substitute for the lack of private investment and capital by investing in productivity-enhancing public investments. This has been done in the past with investments in railroads and transportation networks and internet networks. Today, an example would be investing in our infrastructure to try to position it to be resilient to a warming climate and help to spur some additional growth that we're not seeing in the private sector.

GORDON: I think that's a really good transition, then, because the third area that you wanted to talk about is climate. And speaking of warming climate, the risk of climate change appears on the top of almost every Future of Risk survey that we've seen come out from WEF, as you mentioned, over the past few years. So, I'd be interested in hearing your views about that and how that risk is interrelated for our customers.

LEWIS: Yeah. It is a material risk for all of our customers, and one thing that we hear when we talk to them is not a lot of disagreement that the risk is real. If you think about going back to the science, scientific research going all the way back to 1895 has shown a causal link between greenhouse gas emissions and a warming climate. And some of the more recent research has been pretty clear that current estimates are that the climate has already warmed about 1.09 degrees Celsius from the pre-Industrial Age average, which is driving more frequent severity in our weather. And if that continues, they expect to have a lot more conditions that we have not experienced in the last a hundred years or so, and that if we don't, in fact, abate some of the increase in the temperature rise, we're going to see worse impacts because of the non-linear impacts. So, the risk is there, even those that will question whether or not it's being driven by anthropogenic change don't really question that it's a material risk, and the scale of the risk is what really puts it at the top of a lot of surveys of conditions of risk.

GORDON: Right. And some of the examples of that, again, we go back to the headlines that we've seen. But share some of the examples when you talk about extremity.

LEWIS: So, we'll see more extreme periods of drought and high risk of wildfires, as witnessed in California and Australia in the last couple of years

GORDON: And Canada.

LEWIS: And in Canada. More extreme periods of flooding, most recently evident in Europe last year, but every continent has experienced it. More extreme heat waves, especially with a combination of heat and humidity, are extremely dangerous to human health. We saw that most recently in the United Kingdom, but also in evidence in France, and then increases in sea level due to ice cap melting and decreases in ocean salinity and the reductions in fisheries. Which, again, on a global scale, we're seeing this on a regular basis.

GORDON: I think also, we've seen examples, you mentioned the flooding in Europe, Germany, obviously and in Pakistan as well. We saw the historic freeze that happened just last year in Texas, historic hail in Nebraska we experienced this June. So yeah, a lot of examples of that.

LEWIS: You make a great point. It's volatility in the weather. It's not just warming of the weather, and that's what climate change is really about. It's about climate change, not global warming per se.

GORDON: Right. Is it possible to stave off some of these dire projections, especially in our business in insurance, that we're seeing?

LEWIS: So, I think the concern around our position right now is that governments have not kept up with their pledges under the Paris Agreement in 2015 to reduce greenhouse gas emissions, to keep the post-Industrial Age temperature rise to be less than two degrees Celsius. And if you look at current projections of greenhouse gas emissions, if you adjust for population growth by country — adjust by consumption patterns, realizing that as certain economies become wealthier, they're more likely to buy more cars and use air conditioning more frequently — and then you look at existing commitments; it's hard to reconcile a two degree increase in Celsius with the commitments that they're verbally saying. And to give some examples, if we wanted to limit the increase in average global temperatures to only 1.5 degrees Celsius, we would have to ensure that our future emissions were no more than 500 gigatons of carbon dioxide. We're currently averaging about 40 to 50 gigatons of carbon dioxide per year. So that budget would be exhausted in 10 or 12 years.

GORDON: Wow.

LEWIS: And if you take that and say, okay, well if we go to the two-degree Celsius mark, then that would say your future carbon budget would be about 1350 gigatons for carbon dioxide, but that level would likely be eclipsed by 2052. So, the concern, and why it keeps getting elevated from a company perspective, is that the actions that are in place today, which are themselves not easy, are still insufficient to get us to a point where we're limiting the temperature increase to two degrees Celsius. And so, our business partners are planning for how we get that coordinated public policy so that we can push climate change, but at the same time contingency planning for a warmer climate.

GORDON: So, Chris, one of the things that makes me think about is what about electric vehicles?

LEWIS: That's a great question. A lot of the public conversation has been around the adoption of electric vehicles. And I think that's a good direction to head, but it's important to keep in mind that [transportation] only represent about 16% of the total annual greenhouse gas emissions. And if you look at cars and SUVs, it's really only half of that.

GORDON: Really, huh?

LEWIS: Yeah. The largest drivers of greenhouse gas emissions are the fuels used to power the grid, the production of goods, including steel and concrete. And those two are about 30% of the total production, so 60% in total. Emissions from agriculture, animals and land use … it's about 19%. And then heating, cooling, and refrigeration’s about 7%. So, it's good that we’re focusing on electric vehicles, although even implementing the commitments that we've lined up there require a lot of concerns around how do we actually source the rare materials? How do we improve batteries? How do we continue to improve the functioning of the engines and the materials to actually get to those commitments? But the real focus needs to be on the grid and how we power the grid in order to reduce our overall consumption of greenhouse gas emissions.

GORDON: So that’s actually surprising, because you hear, obviously, a lot about electric vehicles. But from a business resilience perspective, then, you say the priority really needs to be transitioning around power grid and the production of goods.

LEWIS: It does. And there is work going on there, but as we saw with the Russian invasion of Ukraine and the impact it's had on the European power systems and the grid, we can see that trying to create a resilient power infrastructure is not easy. And if we're trying to do this transition from our current infrastructure to a more sustainable infrastructure while doing it while temperatures rise — that's a pretty significant challenge. That's what businesses are very concerned about; [it] is both climate change and then how do we effectively transition our energy sources in a way that keeps the lights on while we're in the middle of this transition?

GORDON: Let's go back for just a second to the question of how all of these how all of these issues are interrelated.

LEWIS: As we just talked about from climate change and the grid…that's one of the biggest inhibitors to growth, the potential impact it has in terms of the future, if climate change actually inhibits our ability to power our industry. At the same time, if we make investments to build a more sustainable grid, then that actually can be the type of capital investments that we talked about earlier in terms of trying to foster more long-term economic growth.

GORDON: And infrastructure projects.

LEWIS: And infrastructure projects. The problem is, if you go back to our conversation around social cohesion and political discord, is that climate change has become one of the key things where there's been a lot of polarization. And so instead of focusing on infrastructure projects and larger scale climate policy, instead we have more of a focus on the regulatory type of activities where we're talking about corporate disclosure around what your carbon footprint is or pledges to become carbon neutral over a certain period, or regulations that may either support or restrict investments in certain industries.

GORDON: And to your point, that keeps oscillating back and forth based on the political party in power, right?

LEWIS: Right. And any one of those may be good in isolation, but they're really second- or third-best options, and they have positive and negative side effects that won't solve the long-term problem and really distract from kind of core public policy that's needed to make a material change.

GORDON: So, one final question. I think we could keep talking about this, but if you could connect the dots a little bit … I find these topics and insights are absolutely fascinating, but I'm curious; we started the conversation talking about Excess and Surplus Insurance. Why is an insurance company spending its energy thinking about these kinds of things? These represent material risks?

LEWIS: So, there's two reasons why we spend a lot of time thinking about it. One is because, like any other company, we have to contend with the risk ourselves for our own operations. The second thing is that we're helping our business partners also contend with these risks, whether it is insuring their property that is exposed to a variety of climate perils — that could be, as you mentioned, hail or tornado risk in the Midwest, or flooding; it could be suits that go after directors or officers for litigation related to various compliance or regulatory matters, to other new products that they're developing or new innovations that are intended to address climate change, whether it's a new technology that's trying to help take carbon out of the air. So, we're trying to help protect them. We're also trying to help provide the insurance coverage that they need to develop new products. One thing about the Excess and Surplus lines industry, which is true for the overall insurance industry, is we're here to facilitate commerce. So, if they want to develop new innovation, if we need to move our economy forward, we need to have a robust insurance industry that can support that. And we're trying to be there for our customers so that we can actually provide them the coverage that they need so they can continue to grow and to innovate. And the more the economy innovates, the more the insurance industry innovates. And that's where the E&S market tends to thrive.

GORDON: That's really interesting. So, we really have to stay almost a step ahead of where those risks are developing in order to help protect customers against things that didn't exist or we weren't having conversations about even five or ten years ago.

LEWIS: Right. Which is why this Future of Risk program is so important because it's something that we live with every day. It may sound downbeat to some, but actually by identifying the future of risk now, we know where we can direct the energy, we can direct the attention, so that we can take the actions to protect ourselves and protect our customers and innovate and come up with solutions that help move the economy forward.

GORDON: Chris, thank you again for joining us today. This has been an absolutely fascinating conversation. Like I said, I love the way you've tied so many timely and topical subjects together and really shown us the thread that connects all of those. So, thank you for the conversation.

LEWIS: Well, thank you very much.

GORDON: And thanks to all our listeners for joining Zurich's Future of Risk podcast. We look forward to talking to all of you again soon.