Getting Cozy with Capital
Reinvention of the global risk distribution chain is under way—and the transformation is accelerating.
It’s all about matching customers with the right capital to back their risks. Costs and coverage are critical—and information is key. The word “disintermediation” is on everyone’s lips, but it represents a lot more than cutting a broker out of the value chain. The overhaul of the way risk ultimately reaches capital is much more fundamental than that.
An obvious and immediate front-line change has already battered personal lines retailers. Agents and brokers are losing their grip on customers to virtual Internet salesmen (often dressed as cute animals like a smiling lizard or a meerkat). In 2012, more than three million U.S. auto insurance policies were sold online, and the number is surely much higher now. Agent networks are shrinking across the country, a long process initiated by Hank Greenburg’s shake-up of AIG’s distribution in 1962 and seen most recently in MetLife’s sale of its 4,000-strong employed sales team.
Developments are even more radical further up the distribution chain, and more are coming soon. As risk moves toward the ultimate insurance capital provider, especially in commercial lines, links in the value chain are being twisted, replaced and sometimes simply removed. Retail brokers can’t do much to change this, but if they react carefully they may get better deals for their customers and secure a prosperous position in the recrafted chain.
“Capital picks distribution,” says Steve DeCarlo, longtime CEO of wholesaler AmWINS. Whether that capital is a traditional insurer or a capital-markets insurance investment fund, the money calls the tune, and it has plenty of alternatives. Geico goes direct. Cincinnati uses a panel of agents. RSI uses wholesalers. Lloyd’s uses cover holders, managing general agents and wholesalers.
“Some people say we will be disintermediated because we add cost to the chain, but capital will decide how they want their products distributed,” DeCarlo says. “Some want a wholesale broker, an aggregator, to manage their distribution strategy.”
And another thing he points out: everyone in the chain—from retailers to capital—has to want to act in the client’s best interest. “If you don’t, you won’t survive for long,” he says. “Our role as an aggregator is to present an opportunity that gets sold by the retailer to the client. If we don’t do that, we don’t get paid.”
Wholesalers must offer retailers the best deal for their customers. That may be judged on price, coverage, attachment points, service, claims, the carriers’ ratings or probably a combination of all of these. If they can’t offer a better insurance product, they go unremunerated.
“Because of that, as a wholesaler, by definition I don’t take money out of the chain,” DeCarlo insists. With about 26,000 retail brokers and more than 1,000 underwriting companies on AmWINS’ books, rumbling talk of the death of the wholesaler seems overblown.
Will you be among those disintermediated?
Steve Hearn, chief executive of the London-based international wholesaler Ed (until September known as Cooper Gay Swett & Crawford), says risk capital will “find the path of least resistance to get to the source of the dollar flow.” That is, to customers.
Meanwhile, buyers want to work with insurers who operate locally, speak their language and understand their risks from a local perspective, both on an engineering and cultural basis. “There is the potential for disintermediation,” Hearn says, “but not necessarily of the intermediary.”
From his offices in the heart of the world’s wholesale insurance sector in London, Hearn sees the risk distribution continuum from a global perspective—with customers at one end and the ultimate capital providers at the other.
At the buyers’ end, a seismic shift is occurring from west to east as China and other Asian nations become more dominant in global industry and commerce. At the capital end, massive asset pools such as pension funds are muscling into the territory of shareholder-owned insurers, and Asian capital is pushing aggressively into traditional insurance markets through acquisitions. Everyone wants to move toward the center of the continuum. Both trends are just beginning, Hearn says.
The phenomenon has many moving parts. For example, Florida property catastrophe risk has ultimately been dominated by the traditional reinsurance community. But new investment capital raised and deployed by insurance investment fund managers has displaced some of that capacity, prompting even the largest reinsurers to target some of their capital at opportunities they perceive to be potentially more profitable. In an effort to reinvent themselves, some traditional reinsurers have moved into new territories and product classes. To get closer to premium sources and the ultimate customer, some have built or acquired direct insurance functions.
The big international brokers are also changing their tack, sometimes by doing more of the insurers’ job. As Hearn says, “They are wandering up the chain.” Many now own MGAs, which underwrite risk without holding underwriting capital. One of the largest brokers, Willis, now owns a Lloyd’s syndicate, Acappella, which shortens the continuum even more. “Capital is coming further down, while brokers are going up,” Hearn explains. “We are in uncharted, unprecedented territory. The winners will be the businesses that can take advantage of these new dynamics.”
He believes that as capital gets closer to the customers to better understand their changing requirements, it will “disintermediate” incumbents that fail to perform adequately. Similarly, brokers will disintermediate insurers by going straight to capital. One group that does not face redundancy is commercial retailers, Hearn says, since “they own the customer.” Without them, no one else on the continuum can do much. Those who do not respond to the new dynamics of the customer, however, could lose their place. “Retailers need to be agile and adaptable and take advantage of the dynamics,” Hearn says. “Customer and capital will drive the outcome. Holding back the tide won’t work.”
To survive, wholesalers like Ed have to be better, too. “The pure London wholesaler who is distant from the risk and doesn’t understand the emerging customer’s local culture, language, tax regime and so forth is going to become a scarce entity,” Hearn believes. “Equally, the underwriter domiciled in just one jurisdiction, who operates with a niche capability only, is going to struggle.” Hearn doesn’t contend that big is always beautiful, however, declaring “plenty of room for specialization,” but to survive and prosper, brokers of all sizes need to “access capital and customer on terms that are satisfactory to both.”
Customers and Costs
The world is changing dramatically for the people who provide insurance capital and pick the distribution method. Their trading environment is characterized by unprecedented competition. Traditional underwriters are facing down a massive challenge from new capital with different agendas, sometimes including lower expectations for long-term investment returns. In the background, customer loyalty is largely a thing of the past.
Two themes dominate their distribution concerns, says Andrew Bustillo, president and CEO of New York-based BMS Re U.S., part of London wholesaler BMS Group. First is satisfying all of each customer’s insurance needs, including their need to cover exposures that either don’t match the insurer’s risk appetite or fall short of its threshold return targets.
“Challenge number one—how to handle all of a client’s needs—is about defending and servicing those clients with risks and exposures that the carriers want to write,” Bustillo says. “If they can’t achieve this, they are at a competitive disadvantage compared to other forms of risk capital or to brokers who say they can take care of everything.”
The second theme is the cost of distribution and, in the process, obtaining the risk data they desire.
Easing costs inherent in the distribution chain while collecting all the data needed for analytics and regulatory reporting is “an extremely hot topic,” Bustillo notes. “A local retail broker may go to a wholesaler who may go to an MGA or another distribution source before the risk even gets to the risk taker,” he says. Everyone’s slice of the premium pares it down before it reaches capital providers, who want to reach the ultimate customer more cheaply and more efficiently and capture more data along the way. Thus, Bustillo says, “the traditional linear model is under cost pressure.”
Adapt and claim your place.
“Distribution is changing massively,” says Andrew Newman, co-president and CEO of alternative strategies and head of casualty at Willis Re, the global reinsurance broking arm of Willis Towers Watson. “We are entering chapter one of a book with several more chapters to unveil.”
Driven by technology as well as market forces, disintermediation, he believes, will be seen in two distinct forms—of capital and of the distribution chain. The rate of change will vary depending on the line of business and the part of the world, but it is coming everywhere. “The changes are presently less significant for more complex risks, which require greater evaluation skills, but that’s temporary,” Newman says. “Where they are more homogeneous, the change is already more visible and immediate.”
The examples are clear. In U.S., U.K. and other mature personal lines markets, insurers have already “pretty much abandoned the agency distribution model, with companies going direct via the telephone and Internet and originating insurance on mobiles and user-based apps.”
In doing so, “technology has compressed the traditional value chain,” he says. “There are some geocentric anomalies where agents continue to play an essential role, but it’s hard to see how that model will endure.”
The extent to which commercial risks lend themselves to these dynamics is less well established, but Newman believes the direction of travel “will be similar and move at a pace concomitant with the complexity of each market segment’s needs.”
He cites the small and midsize enterprise space, which represents large pools of homogeneous risk where individual risks are “generally fulfilled with standard and often packaged products.” As a consequence, various so-called “direct” business-to-business strategies are already being adopted by conventional insurers seeking to shorten the distribution chain and claim the implied economics of doing so. “Examples of peer-to-peer ventures can also be seen in their early stages of formation,” he says.
As the boundaries between capital provider, insurer, reinsurer and broker become more opaque, “the winners will be those that can get closest to the customer and are able to best weaponize all the information, technology and data while retaining access to the lowest average cost of capital across the cycle,” Newman predicts.
He notes access to low-cost capital as a particularly compelling advantage in a market where industry surplus has grown “four times faster than premium, directly impacting insurers’ ROEs [returns on equity] and leading to pressure to manage both the R and the E of that equation.”
Just as loan securitization transformed the banking industry, risk securitization could change the face of insurance, he says. “Capital disintermediation offers new operating models that can connect structurers, underwriters and claims managers with an investor base that is increasingly comfortable with insurance as a lucrative and diversifying asset class. I don’t see this fundamentally changing purely if or when interest rates rise, as others do.”
Newman highlights the proliferation of new sources of information and data—such as through telematics and the Internet of Things—as greasing the evolution of risk securitization by increasing confidence in the ability to price risk more precisely. And new ways to invest are emerging all the time, creating “increasing excitement about who plays what role in matching risk and capital.”
“Brokers and underwriters alike have to decide whether these developments are theoretical and the impact immaterial to their business-as-usual strategies or consider this a world of opportunity and adapt and claim their role,” he declares.
Rise of the MGAs
Bustillo expects underwriting companies to address these challenges by creating alternative structures to sell insurance through wholly managed but separate underwriting facilities. “They will own the managing general agents,” he declares, citing the example of Nephila, an alternative capital provider that raises underwriting investment through pension and hedge funds. With almost $10 billion of capital, it is the largest alternative capital player in the market. Originally the brainchild of Willis, Nephila comes up in almost every conversation about changes in the distribution chain.
It has set up an MGA called Velocity Risk Underwriters to get direct access to insurers’ U.S. wind catastrophe exposures. Fronting specialist State National provides the paper, and the deal is intermediated through an arrangement with DeCarlo’s AmWINS.
In 2016, Velocity assumed the risk under tens of thousands of wind-only policies underwritten by Florida’s Citizens Property Insurance Corporation under a “takeout” deal.
Steve Evans, publisher of industry blog Artemis, says by leveraging a fronting-style insurer and its own MGA to effect the takeout, Nephila reduces frictional costs and enables its capital “to get closer to the source of risk” and to save on broking costs.
“For Florida residents, the takeouts not only pass the risk on to private insurance and risk markets but also reduce the load on Citizens and lower the chance of the state-established insurer suffering a particularly bad hit when the next hurricane hits,” Evans explains. “The changes to the distribution chain that we’re currently seeing, as evidenced by Nephila and other ILS managers’ work, ultimately benefit the insurance consumer, as they are removing some layers of intermediation costs out of the equation.”
Traditional insurers are also establishing MGAs for the same reasons: to reduce costs but also to get closer to customers while retaining the risks they want (maybe auto and GL) and handing off the rest to specialists (perhaps earthquake or cyber). They may have some of their own capital backing their MGAs, but typically much of the risk is placed with others. Insurers adopting this strategy can become a one-stop shop, leveraging their policy processing and claims facilities.
“The winners will be those risk-taking balance sheets that move closer to the customer by providing mechanisms to be able to control all of a client’s risk,” Bustillo says.
Rarely a week passes without some new MGA appearing on the scene. AmWINS’ DeCarlo says MGAs that keep their focus on underwriting and protecting their capital-providers’ balance sheets will be successful.
While the rise of MGAs does threaten to remove links in the distribution chain, plenty of space remains for wholesale brokers, provided they don’t just “act as a post box,” says Bustillo. Wholesale brokers are one of the main ways retailers can gain access to MGA capacity. As Bustillo says, they must “create value along the way, on the client’s behalf, working on coverages and risks that are important to the client. Those that don’t will face challenges.”
The automobile model may create insights you can use.
Auto insurance accounts for nearly half of the world’s insurance premium. Conventional insurers have dominated the field because they have amassed large pools of data about the average inherent risk presented by different types of individuals and their vehicles. But today many cars have been fitted with devices that transmit vastly more detailed, real-time streams of data to those who install them. They will soon be a standard accessory. In effect, cars have been connected to the “Internet of Things.”
The accuracy of the data they deliver is unprecedented in its ability to support the assessment of auto risk, so the telematics box destroys the big-data barrier to entry for those tempted by the world’s $800 billion of auto premium. Other than for extreme loss scenarios, such as major liabilities, or perhaps dramatic natural catastrophes like hailstorms, a conventional insurance company is no longer necessary to get auto risk priced correctly and competitively. And as recent history shows, customers are happy to buy auto cover over the Internet instead of conventional channels.
The scenario is not entirely theoretical. Most motor manufacturers already have an insurance company, and they are best placed to collect information from the dongles they install in their cars. Now they are getting into the telematics business. In 2014, the huge Japanese car components manufacturer Denso Corp. bought Ease Simulation, a telematics business in Pennsylvania. Later in the year, Japanese owned insurer Aioi Nissay Dowa Insurance Europe (ANDIE) bought the British telematics insurance company Insure the Box. ANDIE has strong ties to Toyota. Expect action soon. The auto insurance value chain may look completely different in just a few years.
Broker Platforms—The Digital Squeeze
One such MGA is Ascent Underwriting, a niche operation that specializes in cyber insurance and other specialty lines like healthcare regulation. Most of the business it underwrites reaches its London operation through conventional wholesale relationships. But Optio, Ascent’s online quote-and-bind “broker platform,” allows producing brokers with a U.S. E&S license to go straight to the MGA and its Lloyd’s capacity. Wholesale Lloyd’s brokers’ involvement in the transaction is limited to the introductions, for which they receive retrospectively a small commission for bound risks.
Ascent chief executive David Umbers describes the system as “a service for brokers, providing instantaneous document issue and requiring no manual processing. It’s a user-friendly no-brainer.” For the Lloyd’s-based insurer MS Amlin, Ascent’s lead capacity provider, and for the MGA’s other insurer backers, the system creates a new stream of premium income from small U.S. businesses that probably wouldn’t reach Lloyd’s through the conventional distribution chain due to the friction created by its inherent costs. “Our platform provides a distribution extension for business that a Lloyd’s syndicate would not otherwise benefit from,” Umbers says.
A similar broker platform was launched directly by Tokio Marine Kiln in late July. The Lloyd’s insurer describes its system, dubbed “One TMK,” as a “digital exchange for brokers to quote and bind policies online in real time.” At launch, it supported only cargo insurance for registered U.K. brokers, but the intention is to rapidly expand the online product and geographical offering. “Our first objective is to continue adding products to the platform,” says TMK’s head of innovation Tom Hoad, noting that demand exists for more electronic transacting, “so we’re hoping to add other features to this broker-driven platform.”
TMK chief executive Charles Franks, explaining some of the reasoning behind the initiative, says high costs and inefficiencies have caused troubles throughout the insurance market. “This will help brokers reduce the time and cost of getting quotes and policies to clients,” Franks says, “and it will help us to move closer to our customers.”
Wholesalers Revive Facilities
Another significant change in distribution is the reintroduction and widespread promotion of “facilities,” which readers with longer memories will recall as broker binders or lineslips. With this vehicle, wholesale brokers take greater control of the distribution process by enlisting multiple carriers to assume a specified share (no matter what) of any risk of a certain type that the broker chooses to insure through the facility. These usually have a lead underwriter. Additional insurers on the facility accept the terms and conditions set by the leader and the broker without further consideration of the risk.
One of the newest facilities was introduced recently by Marsh. FL ECHO is the latest in its ECHO suite of facilities and offers excess lines of up to $105 million to U.S. buyers of D&O and other professional casualty classes. It places primarily at Lloyd’s with other London market supporters.
The arrangement is only the latest of many. Much hoo-ha greeted the March 2013 launch of a deal between Aon and Berkshire Hathaway International Insurance Limited. Warren Buffett’s mega-insurer automatically took, as a follower, 7.5% of any retail subscription insurance contract that Aon Risk Solutions placed into Lloyd’s—if the client wanted it. About a year ago, the insurer pulled out of the arrangement (though it remains involved in several others), as it built its own specialty insurance division—Berkshire Hathaway Specialty Insurance.
No doubt Buffett’s insurance behemoth could have gleaned much detailed risk knowledge and pricing discovery for its new venture from its brief involvement as an automatic follower of Aon’s Lloyd’s placements. So the move to build its own specialty insurance provides a prime example of high-level capital moving down the chain to get closer to the customer.
To say the least, “facilitization” has been controversial. Steve Hearn, CEO of wholesaler Ed (which until September was known as Cooper Gay Swett & Crawford and which runs some facilities of its own), shows only limited enthusiasm for what he describes as the “current abundance of facilities and lineslips.”
Without doubt, he says, they have the potential to “capture huge swathes of homogeneous customer business and to realize economies as they do so.” But for atypical risks, they may not be appropriate, he says. “Getting the customer into the right home with the model’s inherent challenges and conflicts of interest is not without
its potential issues,” he admits, although he is optimistic that the market has sorted out the latter concern.
Facilities do, of course, provide capital with easy access to large, low-cost portfolios of risk. They must look attractive to non-insurer investors like Nephila, which want to get efficient access to insurance risk. They also generate reams of risk information, which in the hands of a dynamic broking organization could be used to disintermediate insurers that may have an interest in the class of risk but not the facility.
That’s already happening to a degree as some smaller underwriters in niche lines, those who have not elected to participate in relevant facilities, are beginning to find following lines less accessible than before. But so far, at least, no big move in this direction has occurred.
And Hubs Pull Business from London
A geographical shift means a lot of business is now being handled much closer to home. Regional underwriting hubs have been emerging for more than a decade but are now challenging the supremacy of London for some international risk classes (just as Bermuda did, first for U.S. casualty risk, then for catastrophe reinsurance).
One of the more established hubs is Singapore, the key center for large commercial risks and reinsurance from across the Far East. In contrast, but with the same function, is Dubai, which has only recently emerged as the underwriting hub for the Middle East. Lloyd’s has established underwriting rooms and a solid presence in both, as well as in Miami to service Latin American risks. With Britain set to leave the European Union, Zurich has an opportunity to develop its already-important insurance sector as a new hub for the European Union.
Alex Becker, a marine underwriter with MS Amlin, has worked in the insurer’s Singapore office and currently is the marine underwriter in its Dubai office. He says the reasons for establishing the local underwriting offices were three-fold. “We came to build new relationships and to underwrite business we were never able to see in London, business that was developed locally,” he explains.
Second was the defense of business that had previously been underwritten in London but which no longer wants to stray across the English Channel so far from home. “More business is being repatriated back to local markets, sometimes because the capacity that was in London is now local and sometimes because the expertise is now local too.”
Finally, underwriting in hubs keeps acquisition costs down because it allows Amlin to deal directly with local retail brokers and ceding insurers rather than operate through wholesalers.
Moving closer to the business in this way doesn’t work for everyone. Atrium Underwriting, a long-established Lloyd’s insurer now jointly owned by Enstar Group and Stone Point Capital, opened an underwriting office in Singapore in 2009. In July this year, it shut down the operation and put its marine, aviation and transport book there into runoff. The operation hadn’t grown sufficiently, Atrium chief executive Richard Harries says, so the business it wrote there will now be underwritten in London.
Hubs, of course, are the enemy of wholesale brokers who bring risks from far-off lands to sedentary underwriters across the world. Unless they change their strategies, it’s game-over for the wholesalers who survive on such fare and for the capital they feed, many in the industry believe. The brokers must find new roles and new ways to facilitate the introduction of the right customers to the most appropriate capital with the very best offer as efficiently as possible. That’s everyone’s challenge in the new distribution chain.