18 February 2014News

Broker facilities impact profitability and underwriting judgement

The impact of broker sidecar facilities is already being felt in property insurance, and, while they represent a low cost and diversified strategy for re/insurance participants, there is a danger that certain such facilities may erode confidence in underwriting.

That is the view of Paula Jarzabkowski, professor of strategic management at Cass Business School, who says that sidecar facilities are attractive to some re/insurers, since, in many instances, they drive down costs, while providing considerable diversification benefit through quota share arrangements administered by large global brokers.

“As long as the rates are adequate, participants are essentially acting as a following market that does no work. The costs associated with such an approach are very small. The only issue is that, while they are getting a diversified spread of risk, they are not personally overseeing it. Essentially brokers are taking on risk with your pen” says Jarzabkowski.

The impact of this “automatic” capacity was felt in 2013 and at the recent January renewals, with rates and traditional capacity coming under some pressure as a result, says Lou Adanio, executive vice president and chief underwriting officer for property insurance at Markel Global Insurance.

“Terms tend to be in line with the wider market, which provides insurers with a level of confidence, while insurers know that a slice of their capacity will be automatically placed by the broker”, says Adanio.

"However, the long-term commitment to these facilities remains to be seen, as highlighted by the recent cancellation of two such agreements due to poor results. One issue is that the development of broker sidecar facilities is placing some incremental downward pressure on rates, contributing to a general softening in property insurance pricing,” he adds.

“Property insurance rates in the US declined 5 to10 percent during 2013”, says Adanio, “and there is an expectation that this will continue in 2014, barring a significant loss event”.

Perhaps of more concern, however, are the long-term implications of broker sidecar facilities. Jarzabkowski says that, for now, the concept works, particularly for brokers who are looking to deliver capacity to the market, but she cautions that there is the potential for such capacity to undermine the need for underwriting talent.

“The danger is that traditional underwriters will be forced out of business because they simply can’t produce high enough returns to compete with broker sidecar facilities,” says Jarzabkowski, adding “By essentially making the broker the underwriter, these facilities may lead to an erosion of knowledge and professionalism in the industry, with companies potentially exposing their capital where there is insufficient expertise”.

Jarzabkowski expects that such facilities will tend to remain the preserve of the larger brokers, as “smaller brokers are about niches and relationships. These broker facilities are really just a capital play”.