The Intelligent Quarterly from the publishers of The Insurance Insider

Autumn 2017

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Pincer movement

Adam McNestrie

Broker remuneration is perhaps the London market's central preoccupation at present.

The Lloyd's expense ratio has swollen by 5 percentage points over the last three years, driven entirely by increased acquisition costs.

At a time when rates have fallen dramatically, underwriters in London are caught in an inescapable pincer movement.

When the results are fully loaded for cats the market is certainly in a loss position on underwriting. And on an accident-year basis the results look even worse.

The cyclical challenge is intense. But as combined ratios edge up from the mid-90s and begin to stray above 100 percent, London market (re)insurers must not allow that cyclical challenge to obscure the structural issues around distribution.

Bringing acquisition costs back from the low-to-mid 30s down to the mid-to-high 20s is not good enough. And an all-in expense ratio of 35 percent still points to massive and unsustainable inefficiencies, even if it looks much healthier than something in the low 40s.

The brokers are arguably taking too much out of the system, leveraging their greater scale and analytic sophistication, as well as their more intimate client relationships.

But their argument that distribution must be overhauled and modernised is surely beyond dispute.

London has unrivalled expertise and major capacity that needs to be brought to bear for specialty insurance risk, but accessing those things is currently prohibitively expensive.

Innovation needs to come from both brokers and carriers in order to find structures that allow for risks to be placed at a dramatically reduced cost.

The market needs to find a way to modernise and streamline its processes, while harnessing the potential of technology.

However, it must also balance the need for a lower cost approach with the maintenance of effective underwriting controls.

Risk selection - based on closely defined parameters or intelligent portfolio underwriting - must continue to take place.

London's success rests upon this strength and the modernisation agenda must focus on delivering this in a smarter way with fewer touches, not its elimination.

Another challenge is to find ways to divide the dividend that comes from cost reduction throughout the value chain.

If technology and new placement structures can eliminate cost, the margin benefit cannot sit solely with the brokers.

It must be equitably distributed if the long-term health of the market is to be sustained, which may mean that the brokers have to forego some of the short-term wins they have been making from market-derived income.

If all of the above is true then it is possible that broker facilities are in the somewhat paradoxical position of being both a major part of the carriers' problem and a major part of the solution.

Which is to say that in the short term they are driving acquisition costs higher at a time when loss ratios are also rising. But longer-term they present the prospect of a more efficient market that can run with fewer staff and greater economies of scale.

It is questionable, however, whether the incumbent facility structures create sufficient efficiencies to dramatically address the London cost question. It may be that if facilities are a major part of the answer to London's long-term distribution challenge, that we will need to see a second generation of structures that take efficiency gains to new levels.

Adam McNestrie
Editor-in-Chief
The Insurance Insider

This article was published as part of issue Summer 2017

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