The reinvention of the reinsurance broker

21-09-2015

The reinvention of the reinsurance broker

The business model of reinsurance broking is evolving fast, with clients now demanding everything from the latest analytics software and risk modelling support to access to alternative risk transfer structures and alternative capital suppliers. Bermuda:Re+ILS examines this changing landscape and asks ‘where next?’ for brokers.

Aon Benfield is now a software provider,” Charles New, catastrophe analyst at Aon Benfield, told a London conference on cat modelling in June. In the same month, James Vickers, chairman of Willis Re International, told the 2015 IIS Global Insurance Forum at the United Nations that the reinsurance business is morphing to manage risk for capital suppliers.

Both statements are true—more or less. Aon Benfield is a lot more than a software provider, of course, but developing such solutions for its clients is certainly an increasingly important part of its business. Most of the bigger brokers are indeed managing risk for capital suppliers working both with, and in competition with, some of the big investment banks that approach this space from a very different perspective.

Are brokers becoming more like investment banks or investment banks more like brokers? Does it matter? The reality is that reinsurance brokers have been forced to diversify in recent years to keep pace with the increasingly dynamic way in which risk is priced and transferred. This has meant new revenue streams and also new skillsets and cultures some of which are a far cry from brokers’ traditional roles as intermediaries.

There was a time when most people had a fair idea of what being a broker involved—be it in stock, commodities or indeed re/insurance. In its simplest terms, they acted as an intermediary between buyer and seller. The arrangement was transactional and required high levels of expertise and analytics. But it was also personal, requiring skill, knowledge and judgement and a lot of face-to-face meetings before, finally, the structure and price of a deal would be agreed with which parties would participate.

Any regular attendee of the Monte Carlo Rendez-Vous will know, of course, that this dynamic is far from dead. Yet today’s reinsurance brokers must also offer so much more to their clients. Many have also developed expertise in risk modelling and management, claims, software and many other forms of alternative risk transfer. Today, many work directly with the capital markets. 

Both sides of the fence

While the old guard have moved gradually into these new fields or acquired the expertise along the way, some of the relative newcomers into the sector have also looked to move into these areas that offer a diversification of income and a foot in a rapidly growing market.

Broker TigerRisk, formed in 2008, hired Tony Ursano from Willis Capital Markets earlier this year to help it grow a capital markets division that will seek the most efficient forms of capital available for its clients and develop a mergers & acquisitions advisory business.

Ursano believes the brokers have a big opportunity in this space and all the qualities and attributes to do a better job than some of the incumbent players.

“For us, it’s not a question of whether convergence (between reinsurance and capital markets) is going to happen—it is already happening. It’s simply a case of capital that comes from different sources and we need to give clients the best advice and that means looking at it from the perspective of both sides,” he says.

“There will be a need for the traditional broker, but perhaps as a division within a bigger brokerage where the face-to-face approach is required." Peter Gorman

“It is the brokers who live, breathe and drink insurance in the market every day. They have the relationships with all the global insurance firms together with more sophisticated analytics than any investment bank, coupled with lots of market intelligence around what’s happening in pricing.

“If you can then bring investment banking to the table and add that to everything the brokers have, that would then create an investment banking practice that works a lot better than traditional banks.

“This is the way things are going to continue to move. The traditional broking industry has been brilliant in resisting change. It has been doing the same thing for 35 years.”

Peter Gorman, chief executive of Cooper Gay Re, agrees that the rate of change for brokers is accelerating. There has been more change in the past five years than in the preceding 50, he says.

“These changes have been brought about by the soft market, which seems to be permanent, and the influx of new capital including hedge fund capital has driven consolidation and that has changed the industry,” he says.

Not everyone is convinced that this rapid diversification is all good, however. Professor Paula Jarzabkowski, co-author of Making a Market for Acts of God, which discusses the implications of major changes in the reinsurance industry, has real concerns about the changing nature of broking and reinsurance generally.

“On the one hand, changes in the reinsurance market are creating a wider pool of insurance products and access to cover, and driving prices down. On the other hand, what is the quality of these products? Under what circumstances do they pay?” she asks.

“We don’t know if new insurance-linked securities (ILS) are the right way or not—but we do know they don’t operate on the same principles as the traditional reinsurance that has paid for major losses in the past.”

Keeping pace with change

There can be little doubt that, compared with the recent past, bigger is now perceived as better in many parts of the industry. That’s not surprising as clients are demanding greater access to analytics such as cat modelling and access to, and the ability to drill down into, big data and provide meaningful risk analysis.

Analysts at Morgan Stanley agree that the influx of alternative reinsurance capital signals a change in the reinsurance pricing cycle, as traditional reinsurers and primary players continue to navigate market challenges. And brokers must predict where any change will occur and try to remain relevant.

It’s a dynamic that Ben Love, head of business development at re/insurer Hiscox, recognises. He stresses that the old order of things has changed and brokers have had to adjust accordingly.

“Capital and risk are moving closer together which means that the old chain where the broker was key to an orderly progression to placement no longer exists. Now you have streams of capital looking for direct access to risk,” he says.

Ursano argues that this reinvention of the role of the reinsurance broker has been driven by client demand.

“Companies are in ever-greater need of advice—about how to grow; how to respond to third party capital; how to think about technology and how to optimise their operating structure and issues around consolidation—they are crying out for advice and I don’t think that the big three are well-positioned to offer this,” he says.

For Gilbert Korthals, chief actuary at GuideOne Insurance, an insurer of churches in the US, only a broker that can offer a truly holistic solution will get a chance to bid for his business and that has been the case for the past couple of years.

“The advent of alternative capital into the marketplace has firmly taken hold and fundamentally changed the dynamics. Given all the new reinsurance options that came with this, it is all the more reason I need an informed broker (and his/her team) to navigate the best choices for me given my objectives,” he says.

For Korthals, this has been driven by two motivating factors. One is the trend in the industry to become more data-driven and analytical.

“Many small to mid-sized carriers don’t have the means and scale (from the perspective of the expense of the technology and the cost of the talent) to carry out certain key analytical capabilities, but through their broker they can leverage a pool of talented analysts who are experts at running things such as catastrophe models and economic capital models.”

Korthals also notes that regulators and external analysts including rating agencies have also increased their expectations of insurers’ ability to analyse their business and manage risk. He cites the advent of Own Risk and Solvency Assessment (ORSA) requirements and AM Best’s move to a stochastic Best’s Capital Adequacy Ratio (BCAR) calculation as two examples.

Using a broker to help deal with these requirements is one way of coping with this. Meanwhile, the emergence of collateralised reinsurance products such as ILS has also had a bearing on brokers through meeting the demands of clients already armed with product knowledge and seeking alternatives.

As Paul Markey, the chairman of Aon Benfield Bermuda, says: “Large buyers are very sophisticated, they have access to an awful lot of data, plus advisory work from the accounting profession, all sorts of areas.”

Hiring to fit the need

This all means that brokers need to upskill and be on top of all the market developments. Increasingly that means drilling down into the operations of ILS fund managers and working closely with alternative capital providers.

With sophisticated buyers of collateralised reinsurance looking more closely at the operational models of fund managers and in particular at their investment mandates and at risk allocation it’s only natural that the nature of the service to clients would adapt to their needs.

It also means hiring the right type of people. “We offer a broader perspective today than we could even three years ago and that’s because we have gone out and hired investment bankers—that’s what we needed to do,” says Ursano.

It’s a scenario that outgoing Willis deputy CEO Steve Hearn is well aware of and he has helped to remodel the broking giant’s business offering accordingly.

He told PwC’s Broking 2020: “To lead, there needs to be a shift in mindset from ‘we have a policy’ to ‘we understand the dynamics of your business and market and can help you to develop the solutions’.

“We’re engaging with our clients in a different way than if we were just transacting. The new breed of ‘analytical brokers’ are more information-driven than their traditional counterparts and have a deeper knowledge of the client’s particular industry.”

Gorman agrees: “Brokers must have all the tools in their toolbox to operate in the new marketplace and this includes expertise in cat modelling and other analytical software.

“Most clients will want these tools and they are expensive. Some are simply sales tools and window dressing, but I think as they become more widely available in the market they will become more cost-effective.”

Will there remain a place in the market for the traditional transaction-only reinsurance broker?

Undoubtedly technology has had an effect on how firms do business with brokers. At the same time ceding firms have become much more data-savvy and have a better idea of their own risk profiles, resulting in a greater retention of routine risks and increased use of captives and other risk transference procedures. What operational space does that leave the traditional broker?

Korthals believes that for companies around the size of his organisation, which has net written premiums of between $500 million and $1 billion, not much.

“I am speculating that there could be a niche for such brokers with either large firms who have their own analytical staff to crunch the best options or really small firms who fly under the radar and don’t have complicated reinsurance or risk management needs,” he says.

“Speaking from my perspective and again for a company our size, the value a broker brings in cat bonds is if the firm can source and private place the bonds itself. The reason is to make them cost-efficient. I am not buying large enough placements to make the public sale cost-effective.

“A broker can bring real value to me by finding ways to cut down the overhead costs associated with placing a cat bond, but then it still needs to make sense for me in the overall context of the cost of traditional cat covers and my risk appetite. A good broker helps me figure that out.”

A new landscape

The changes occurring in the market are very fundamental in many ways. Daniel Glaser, president and chief executive officer of Marsh & McLennan Companies, told PwC’s Broking 2020 that we are living in an ‘age of ages’, in which the age of information (data and connectivity), age of uncertainty (cyber and heightened climatic risk) and age of accelerating change are coming together to create a set of coalescing risks that few corporations have yet been able to build into the economics of the businesses.

This new landscape is testing brokers to the limit and could be a factor in driving mergers in the market. This is reinforced by the squeeze the evolution of new risks is placing on brokers.

PwC concludes that the market is polarising between standard and non-standard risks where the development of fast, efficient and cost-effective electronic platforms are crucial in being able to serve the standard end of the spectrum. In turn, a combination of analytics, expertise and bespoke solutions are key elements of the consultative approach needed to manage non-standard risks.

Both these scenarios leave the traditional transaction-only broker with a huge headache.

“In the property-cat world there is a requirement to have a level of expertise/analytics and that in itself creates a barrier to entry,” Love explains.

“Similarly, where the traditional placement process would have been towards the end of the year when the face-to-face meets with the buyer and reinsurers took place, is almost redundant. Today both buyers and reinsurers are much more proactive and active throughout the year.”

Bill Marcoux, an international lawyer specialising in re/insurance with DLA Piper, says:

“There is no doubt that the role of reinsurance intermediaries is changing and will need to change. There may be some that will continue to operate in a very traditional way, but competition and pressure on commissions are making this model increasingly hard to sustain.

“The firms that will thrive, not just survive, in the future are ones where the broker is really a balance sheet adviser. This will include advice on many aspects of risk and capital management.

“Traditional broking skills and insurance market knowledge will continue to be a key ingredient to success, but for most it will not be sufficient.”

Love adds. “The conversation has moved away from simply renewal terms to one concerning what new solutions you can bring to the table. The role of the reinsurance broker is a lot less defined that it once was.”

While some smaller brokers may lack the scale to develop advanced capabilities in-house, that is not to say that they can’t access those capabilities by perhaps pooling resources or utilising a third party.

Gorman suggests the partnership approach. “There will be a need for the traditional broker, but perhaps as a division within a bigger brokerage where the face-to-face approach is required. But the industry is swiftly moving towards more complex and solutions-based transactions,” he says.

At a crossroads

Reinsurance broking is at a once-in-a-generation crossroads. Brokers face the parallel challenges of developing the capabilities needed to enable their clients to manage a new and escalating set of emerging risks, while remaining relevant and cost-competitive within a standard risk management market. So which way to jump?

For many, the response is likely to be a twin-track approach based around the varying scale, complexity and expectations of their clients’ businesses. But there are also important interdependencies as effective management of low margin business frees up expert resources for higher margin client support for non-standard risks.

At the same time it also presents an opportunity for nimble operators to differentiate by offering some sort of bespoke service and product innovation development that can drive business in their direction.

What seems certain is that a re/insurance brokerage cannot afford to stand still and rely on old ways of operating. It must evolve or die, whether that means merging with others to scale up; offering a boutique service with a suite of tailored products and services; investing in new geographical locations or selling out to one of the big boys. Standing still will only result in becoming roadkill, crushed under the wheels of a runaway reinsurance broking bandwagon. 

Aon Benfield, Charles New, James Vickers. Willis Re, TigerRisk. Bermuda

Bermuda Re