The Intelligent Quarterly from the publishers of The Insurance Insider

Winter 2017 / 2018

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That's the way to do it

Laura Board

It's 1992, Denmark has just beaten Germany in the Euros and a young broker nervously slides into a long queue of Lloyd's supplicants, his palms sweating.

After a long wait, he is summoned to the front by a barked order from the underwriter. But just seconds into his spiel the underwriter hurls the slip onto the floor and demands he move on.

Fast forward 25 years, and a young broker saunters up to the underwriter's box. No waiting in line for him. The underwriter eagerly takes the slip and scans it, while the broker uses the time to "like" a post on his girlfriend's Instagram account. And then with no more than a grunt of acknowledgment, he grabs the signed slip and moves on.

Caricatures aside, it is fair to say the balance of power between carriers and brokers in the UK has swung dramatically towards the brokers in recent years, and left underwriters feeling under the cosh.

The sustained soft market created by a flood of alternative capital and an absence of major catastrophes has given brokers options aplenty for placing their business.

The impact of broker M&A, which has included Willis' $18bn fusion with Towers Watson in 2016 and Aon's $1.4bn purchase of Benfield in 2008, has improved intermediaries' market reach.

Brokers have also been inventive in devising new sources of revenue, such as support services, software systems, and data and analytics products such as Aon Inpoint and Marsh Connect, which have further embedded them into the underwriting process.

And the development of rival insurance hubs to London has played a part. The London Market Group/Boston Consulting Group "London Matters" report, released in May this year, noted that the London commercial and specialty insurance market is shrinking, while those of Singapore, Switzerland and Bermuda are expanding.

The steady increase in funds flowing from carriers to brokers has long been a sore point, but earlier this year three industry titans abandoned carriers' time-honoured method of complaining in private.

In his company's annual report, Chubb CEO Evan Greenberg lambasted brokers for their "predatory" and abusive" behaviour around commissions, and accused them of "enrich[ing] themselves at the expense of both their customers and underwriters".

Sompo International CEO John Charman, in an April statement to sister publication The Insurance Insider, condemned the broker push to facilitise the market and inflate commission levels in London over the last three or four years. And Validus CEO Ed Noonan, in an interview with the same title, complained of the "excessive clout being wielded by brokers".

Mounting costs
Many other, less pugnacious observers have warned that high acquisition costs have become an almost existential threat to the London market.

Data from The Insurance Insider shows that the Lloyd's acquisition cost ratio mushroomed from 27.5 percent in 2013 to 32.4 percent in 2016.

As a result of the deterioration, the Lloyd's market has effectively forfeited almost 5 percentage points of underwriting margin - something that could have brought its combined ratio in at 93.0 percent for 2016, not the 97.9 percent reported. That cost hike is equivalent to more than £1.0bn ($1.3bn) of lost underwriting profits last year alone.

Add to this the other costs of doing business, and in the Lloyd's market the expense ratio stood at 40.6 percent in 2016.

That's almost 41 pence for every pound in premiums that is slipping through insurers' fingers even before they have paid claims.

The evolution of lengthy distribution chains potentially featuring an insurer, a Lloyd's broker, a managing general agency, a wholesale broker and a retail broker, is one factor considered to have pushed up costs.

The rise in commissions, such as syndicate market brokerage and line-slip commissions, has also played a part. But arguably the most controversial development has been the growth of broker facilities and the commissions that accompany them. Under these arrangements, participating carriers pay fees or enhanced commissions to defray the costs incurred by the broker of creating the structures. Panel leaders secure the opportunity to quote business and others take pre-agreed shares on business bound under the facility.

Commercial sensitivities around facilities make information hard to come by, which in turn fuels the whispering campaign.

The best-known facilities include Willis Towers Watson's WTW Global 360, which was launched in October 2013, with Hiscox, People's Insurance Company of China and Berkshire Hathaway as founding capacity providers.

About two years later it was followed by the Aon Client Treaty, a Lloyd's facility with a target to write $500mn-$600mn of business in its first year. Carriers that signed up included XL Catlin, as leader of the facility, and QBE.

The many others have included Marsh's London market terrorism and political violence facility, which went live in February 2015 with backing from Amlin, Beazley, Chaucer, Hiscox and Talbot; and Marsh's Airline Portfolio Placement facility

As well as taking issue with the charges associated with them, critics argue that facilities give rise to conflicts of interest, to the detriment of customers.

"Are they being given the choice of markets? Do they know what's going on in terms of broker pay? Are higher fees landing back with them?" asks one insurance executive.

Underwriters also say facilities amount to a "pay-to-play" system, and that carriers risk getting shut off from open market opportunities if they don't sign up to facilities.

Some say facilities are often badly managed, with the panel leader not always the best choice to inspire confidence among other participants; others argue that they negate the benefits of carriers' investment in underwriting expertise.

Underwriters also complain that the fees associated with facilities are not always commensurate with the services offered in return.

UK regulators have recently begun examining facilities in more detail amid concern the arrangements could even pose prudential risks, given the distance that they create between the risk being written and the risk carrier.

AM Best's Gregson Carter, who is the agency's EMEA analytics and rating services managing director, notes that no carrier has been downgraded because of a heavy use of facilities.

But he adds: "I would say that broker facilities shift more of the control into the hands of brokers, and from a credit perspective that can't be a positive thing for insurance carriers.

"It would be a negative factor in terms of the credit strength at any insurer that became increasingly dependent on facilities."

In defence of facilities
Advocates for facilities see them as a natural evolution from the line-slip that can make insurers and insureds lives' easier when structured correctly.

Brokers argue that they are a key part of a sorely needed London market efficiency drive, with improved data and analytics being harnessed to make placements more efficient and cheaper for clients.

At the Association of Lloyd's Members conference on 1 June, Wills Re CEO John Cavanagh said: "My view is Lloyd's and London are the best facility underwriters in the world. We have been doing it forever - binders, treaties etc. We're the best at it so why fight it? Most of the business that comes over is homogenous in nature, so it should be facilitised."

Click to enlarge One senior executive at a top global broker says his firm is "creating advanced products that have brought new business to London" when the risks could otherwise have gone elsewhere. And brokers will also say that carriers need to stop whingeing and look at their own costs.

Some carriers, it should be noted, are grateful for the business expansion opportunities that facilities provide, including for those seeking a foothold in a new line of business.

But attitudes to facilities can differ greatly within a single insurance company.

One senior underwriter says he is a big fan: "Facilities are effectively pushing out the irrelevance in the market. I aim to be on the preferred list and also gain in the open market."

Yet a top executive at that particular underwriter's firm describes its involvement in facilities as a "very tough balancing act", driven in part by the need to avoid being cold-shouldered by the big brokers.

There is, of course, a wide range of facilities available, with specialist products sitting alongside those that have become infamous for their vast scope. Ed Group CEO Steve Hearn, who was Willis Ltd CEO and deputy CEO of Willis Group at the time of the Global 360 launch, warns against generalisations.

"I don't think facilities per se are necessarily a bad thing provided they are meeting the needs of a truly homogenous group. I'm not sure all of the facilities we've seen turning up have achieved that.

"We just need to be careful that we don't fit square pegs into round holes."

He says the proliferation of facilities is a function of supply and demand.

"Some of those who were most critical of me when we introduced Global 360 now lead most of the facilities in the market," he notes.

But at Ed, he adds, "big generic solutions where you're addressing 20 percent of customers' needs through generic quota share or follow-form capacity [would be] incompatible with our business model".

Frank Murphy, who is CEO of AmWins-owned THB, says: "Brokers shouldn't have a facility just to take an extra bite of the cherry, but if it's a more effective way to get capacity to the end user that is great." Of the current round of broker bashing, Murphy says: "I hear what the carriers are saying and in some instances they are right, but my issue is that carriers shouldn't tar all brokers with the same brush."

He agrees that the Lloyd's expense ratio is too high but he notes that not all of the 40 pence-plus in the pound of costs is distribution.

"Brokers need to be comfortable that they are treating customers fairly, but Lloyd's will have to look at their own costs or continue to lose market share," he said.

Toughening up
At Lloyd's that effort has begun. The Corporation is perceived to have helped facilitate brokers' revenue expansion efforts, for example, by clearing the launch of Aon Client Treaty.

Recently installed director of performance management Jon Hancock has acknowledged that the expense base for Lloyd's, and the wider London market, needs to come down.

He told delegates at the Association of Lloyd's Members conference on 1 June that "acquisition costs are often unjustifiably high" and that he will work with CEOs and managing agents to "understand where levels of payment are not justified, just as well as when they do represent value for money".

On facilities, Hancock is diplomatic."Facilities can be very good sources of business if they are written right," he said at the conference. "They are efficient, they are simple, they provide strong security for difficult-to-place business. They give strong data on customers and exposures, and they allow underwriting intervention and underwriting management by syndicates. But if they are done badly, they are undefined, uncontrolled and they lead to unknown exposures, and they can also be very expensive to operate."

There are some indications that a pushback against facilities has already begun. The Insurance Insider reported earlier this year that the Aon Client Treaty wrote only about a third of the premium that it had targeted in its first year. Some observers suggest that the pendulum will swing away from facilities when the market eventually hardens.

But evidence that insureds are losing out from the current arrangement is scant. Four years' of falling insurance premiums speak against the notion of risk managers crying into their coffee cups, though executives at several carriers noted that the level of savvy among insurance buyers varies significantly between companies.

Mel Goddard, market liaison and underwriting director at the Lloyd's Market Association, advocates a simple reform that would ensure insureds are never in the dark.

"Brokers are agents of their clients. The days when they were London-owned companies largely operating as the marketing force of Lloyd's and London, and being remunerated accordingly, have moved on considerably. As such, as with any other contracted professional service, in my view brokers' remuneration should really be set, or at least agreed, by their clients."

She added: "Maybe we are moving to a place where underwriters should quote many more of their risks on a net basis. They already do this for many larger, sophisticated clients who otherwise quite understandably want to know how much of their gross premium is being paid in commission on their placements."

Going it alone
The nuclear defence in the fightback by carriers is so-called disintermediation - cutting the broker out of the distribution chain. In April, John Charman threatened that insurers will look at alternative distribution channels because broker behaviour is doing "irreparable damage... to the very substance of our businesses". And Validus's Ed Noonan has also warned that that the industry is inviting disintermediation of distribution and the creation of new underwriting models based on big data and machine learning.

However, tellingly, brokers are just as likely to argue that insurers could eventually be chopped from the chain.

And THB's Frank Murphy notes that both sides are vulnerable to technological developments.

"Distribution will change more in the next five years than in the last 40," he says. "There will be fewer underwriters and fewer brokers.

"The London market has been slow to embrace change but that change is coming."

Regulator to the rescue?
Ten years after the-then New York Attorney General Eliot Spitzer went to war against brokers' contingent commissions - payments by insurers dependent on how a given risk performed - intermediaries operating both sides of the Atlantic remain alive to the risk of regulatory intervention.

And watchdogs appear to be stirring. The UK's Prudential Regulation Authority is known to be examining facilities and has asked certain carriers and managing agents for copies of their agreements. It is concerned about swelling combined ratios at insurers and is looking at the extent to which these can be attributed to rising acquisition costs.

The Financial Conduct Authority (FCA), too, is conducting a review on value in the insurance distribution chain, and a study on the wholesale insurance market.

Insurers and their advisers are not, in the main, expecting that radical change will result.

But Moore Stephens' Teresa Mazur, a conduct risk expert and a former lead supervisor at the FCA, says that whatever the outcome, the current burst of regulatory activity can only help.

"For outsiders looking in, it should give people more confidence. With Brexit you really have to maintain the integrity of the market," she says.

At the Association of Lloyd's Members conference, meanwhile, Willis Re's Cavanagh struck a conciliatory note. "Facilitisation has turned into a contact sport rather than a partnership," he said. "We need to address that."

This article was published as part of issue Summer 2017

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