Howard Green outlines the problems in the facultative book.

Imagine a great river with communities on either bank keen to build a bridge. But rather than band together or collectively hire a bridge builder, they separately begin their own bridge projects, each located at different points along the bank, all of different design and none lined up with the bridge structures emerging opposite.

But surely this could never be - throughout the ages even the strangest communities have seen the logic of collaborative bridge building. All, it seems, except the global reinsurance industry.

Believe it or not, the reinsurance industry is busy building shaky bridges for facultative business. It started innocently enough; industry leaders could see that facultative was one arena where large productivity and efficiency gains were possible because these are high frequency transactions where some degree of standardisation can be applied. The internet was seen as a nucleus that the counterparties could use to structure and negotiate these transactions. But this is where logic departed and ego took over.

Instead of collaborating, the key players all decided to build their own proprietary solutions. There were more than ten at the last count, all expensive, non-compatible initiatives attempting to achieve essentially the same thing. Six ceding companies have either launched or are busy building their bridges. Two massive reinsurer bridges tower on the opposite bank and a couple of broker bridges are vying for space.

We now have the spectacle of well-intentioned bridge building turning into an unseemly conflict. Some cedants have become quite aggressive in pressing reinsurers to use `their system' but the reinsurers are justifiably horrified at the prospect of toggling between proliferating cedant systems and, in any event, would much prefer that cedants used `their system'. Some long-standing relationships reportedly have been fractured. Watch out for more. Shaky bridge building is an ugly business.

This is a classic case of confusing infrastructure with competitive differentiation. This happens a lot and always has painful consequences - mainly for shareholders and customers. In the 1860s, the railway barons built parallel tracks. More recently, the telecommunications industry built the equivalent of parallel tracks, but many times over, and, as a consequence, vapourised biblical amounts of shareholder capital. In spite of these lessons, many in the reinsurance industry continue to believe that infrastructure is only relevant if it is built by them and tattooed with their branding.

Optimists believe some good always arises from even the darkest events. Thus the trillions that have been lost by shareholders from the bursting of the market bubble carries with it a silver lining of salutary lessons for the future. One of these lessons is surely that infrastructure has little value as a differentiation tool. It is what you do with infrastructure that counts. Worldcom or Global Crossing might have fibre optics that circle the globe 50 times over and a control room that rivals the bridge of the Starship Enterprise, but this is irrelevant if the customer gets lousy service or, worse still, if a local provider without all the paraphernalia can fulfil that customer's needs at a much lower cost. The point is that value derives from innovative and customer-focused uses of infrastructure and not from the infrastructure itself.

Room for improvement
There is clearly immense room for improvement in the services that customers receive in the facultative arena. The fact that so many cedants have taken it upon themselves to build systems, at great expense, in the hope of achieving some efficiency, would be taken as a wake-up call in most industries. This is somewhat akin to Starbucks customers bringing along their own percolators. The needed modernisations in the facultative arena fall into four categories:

  • time compression - the ability to structure quote requests, obtain pricing and close deals in a much shorter timeframe. This is particularly important in facultative, because the success of the original transaction often depends upon a timely response;
  • information - in today's market, reinsurers require vastly increased underwriting information. This places greater burdens on the cedant, which must develop, collate and track this data and documentation, and for the reinsurer which must unpack and analyse it;
  • certainty - facultative is plagued by rework. In some markets this has been measured at 20% or more. Rework is enormously expensive and risky because where there is rework there is always a high risk of errors and omissions. Rework and errors have been greatly increased by the addiction to e-mail as a means to structure, offer and close facultative transactions. The problem is that e-mail systems were never designed to keep track of interactions in a highly iterative and document-intensive business such as reinsurance. The industry's records are becoming increasingly fragmented into hundreds of e-mail inboxes and outboxes and millions of document versions stored on computer hard drives and servers. It is virtually impossible to reconstitute many of these transactions. One broker, who told us about a $10m E&O claim, said the biggest cost had been a team of lawyers camping out in their office, trying for weeks to re-assemble the audit trail on the transaction. Lack of certainty causes vast inefficiencies and adds greatly to the cost of transactions; and
  • interoperability - the builders of shaky bridges often use the rationale that by using their proprietary device, a stream of data will pop out at the end of a transaction that will upload their back office system and that of the counterparty. Buzzwords like XML are frequently bandied around. It is my belief that modern web-based standards like XML can indeed have a big impact by making it possible for counterparties to exchange information without re-keying, but the problem here isn't about technology, it is about ego. There will be no exchanging of data when the pervading attitude is: `I won't use yours if you don't use mine.'

    The ability of the facultative industry to improve customer service, reduce expenses and innovate is linked to achieving these modernizations. The question is: is the industry is on a path that can do that or will shaky bridge building make things worse? I think the latter.

    So what are the alternatives to the follies of building shaky bridges?

    Alien hubs
    Promoters of hubs sometimes describe them as the thing an alien would do if it arrived from Mars and was confronted with global reinsurance. It does seem logical that all facultative transactions could be routed through a hub that would match buyers and sellers, standardise the workflow and strip off valuable information that could be pushed back to the counterparties. After all, hubs work famously well in arenas like check clearing and stock exchanges. But hubs have several problems when applied to insurance.

    Firstly, there is no central authority, like the Bank of England or the Stock Exchange, so the hub must be owned and operated by the parties themselves. If you want to witness true anxiety, get a group of brokers, reinsurers and cedants into a room and talk about who is going to own the industry hub.

    Secondly, hubs work best when the transactions are identical. Reinsurance is not like that and neither should it be. Reinsurance makes a living by solving complex problems for customers and this is what they value most about it. Complexity is good for reinsurance.

    Finally, in order to work, hubs require a critical mass of players to all agree at once to adopt the hub method of operating. As we know, it can sometimes be difficult to get a cedant, a broker and a reinsurer to agree where to have lunch. This all proves that Martians may not do well in reinsurance. This is depressing - shaky bridges, hubs - but fortunately, there is a new approach that provides enormous efficiencies and enables each participant to differentiate and innovate, while avoiding shaky bridge building. It enables everyone to move at their own pace and to have the customisation and distinctiveness they seek. It is called collaborative commerce and is based on Microsoft's new direction .net web services technology.

    Collaborative commerce
    Collaborative commerce is software that can be customised to the specific needs of each firm. It can carry the firm's branding and conform to its unique best practices. The clever bit is that one firm's version of the software can interact and exchange information with another firm's version, thereby capturing all of the interoperability benefits without the need for a physical hub.

    The strategic benefit of collaborative commerce is that it enables firms to differentiate without building their own infrastructure. The software can be tailored to support innovative services while remaining interoperable with other instances elsewhere in the market. Firms can run the best railroads without owning the tracks.

    Special versions of collaborative commerce software have already been developed for use in the risk management, insurance and reinsurance industry. They pull together all of the functions that insurance firms must have if they are to operate efficiently and with certainty. These include the management of documents, interactions, communities (teams), data and transactions. This software wraps around and integrates with Microsoft Office, Outlook and other desktop systems in which insurance firms have invested, to make them capable of producing a detailed audit trail of every transaction, interaction and document version.

    How would this work? Let's say cedant A and reinsurer B adopted the software. Each would have the software customised to meet their specific needs - thus if cedant A wanted to capture an item of data that reinsurer B didn't care about, that would be OK. Each would have an `inbox' similar to the familiar e-mail inbox, but dealing with events as opposed to messages, examples of events being quote requests or claim notifications. Assume that cedant A initiates a transaction by opening the workflow dialogue that enables it to efficiently create a quote request: cedant A enters the data and attaches the documents necessary for the reinsurers to provide a quote. Once cedant A clicks `done', a message appears in the inbox of reinsurer B advising that a quote request has arrived. Reinsurer B can see quote requests arriving from numerous cedants in its inbox, and can process and respond to them all from a single interface. This works because the software uses the one universal factor in insurance as its nervous system - it is called the e-mail address. Every person in reinsurance has a unique e-mail address and collaborative commerce software uses this to pull counterparties into transactions. Microsoft's .net technology is used to form a web between instances of the software so that a user can interact with multiple instances through a single interface.

    Collaborative commerce software is built on web services standards, like XML, that make it easier to synchronise and integrate with other systems such as back offices.

    Of course, this approach does require some standardisation. For example, the parties need to agree on a core set of data that will be provided in each quote request. However, a lot of this work has already been done by Acord. The developers of collaborative commerce software have worked closely with Acord so that industry standards are embedded throughout.

    We can see eight key benefits of collaborative commerce software as a solution in the facultative arena:

  • flexibility - it can be customised to the specific needs and identities of each firm and is incredibly flexible;
  • not hostage to the slowest - the forward-thinking can adopt and unobtrusively pull their counterparties in. They are not held back while the slowest decide;
  • interoperability - each version of the software is fully interoperable with other versions;
  • cost and risk - because this software has already been built specifically for the risk management and insurance industry, there is none of the high cost and risk of development. Firms pay only for the value they receive;
  • secure - the collaborative commerce model means that information and documents remain under the control of the firm and can only be accessed by users who have been granted explicit permission and are authenticated;
  • audit trail - the software provides each party with a detailed and non-refutable audit trail of the transaction;
  • standards - the software embeds Acord standards; and
  • straight-through processes - collaborative software can be used equally to support the original transaction, thereby enabling a straight-through process from original to facultative placement.

    Insurance and technology are two streams running at different speeds. This helps to explain the many examples of gargantuan insurance technology projects that end up looking obsolete well before they are finished.

    This is what is happening here; building shaky bridges was never a good idea but it is now looking disastrous in the face of web services technology that can solve the problem in a vastly more elegant way, at a fraction of the cost and without the massive development and inter operability risks now being taken by cedants and reinsurers.

    Problem solving
    The web services approach is not a passing fad. Microsoft and other technology industry giants see it as core to their future developments. The details will no doubt mature but the basic `flexibility with inter operability' message will endure because it is the answer to many intractable business dysfunctions in our industry.

    The parties in the facultative arena owe it to themselves, their shareholders and their customers to reassess the large investments being sunk into proprietary initiatives and to investigate the possibilities of collaborative commerce, to make the facultative process more efficient and certain. Collaborative commerce is the best bridge builder ever devised for our industry.

  • Howard Green is president of Riskclick, a company that develops collaborative commerce software for the risk management and reinsurance industry.