The case for the important role of intermediaries in the ART market.
Disintermediation. It's a word you hear a lot in the insurance industry nowadays. Why, the argument goes, would you want to involve a broker and add another link to the chain, particularly when technology offers the potential to remove all unnecessary diversions from the pure business flow of supplier to consumer? This logic has been especially prevalent in the alternative risk transfer (ART) sector. In our view, that is mainly due to the fundamentally different nature of ART business compared with the trading of conventional insurance products. ART transactions will usually involve a sophisticated client and a sophisticated re/insurer, and feature an alignment of interest between client and carrier that avoids the win-lose scenario of traditional insurance. As a result, some insurers have come to view the presence of a ‘blunt instrument' like a broker as unnecessary and unhelpful.
Surprisingly you might think for a broking organisation, the drive to disintermediate is something we fully understand. In the London insurance market in particular, many intermediaries have continued to exist purely because convention has created a role for them, though the presence of such dead wood is undoubtedly detrimental to the health of the market. If the disintermediation trend results in a streamlined, more efficient market that provides clients with greater value and choice, then it must be supported. Our recently-announced participation in the dotRisk consortium, which is developing an open electronic trading place for corporate insurance, underlines this commitment.
However, we firmly believe that the continued existence of high quality brokers is essential to the market and, particularly, to the development of ART. Over the last seven years, JLT Risk Solutions has been involved in a number of successful ART transactions. We are confident that many would not have happened without our input, and that every deal we have participated in has been enhanced by our presence.
Indeed, we would assert that without intermediaries, the diverse and responsive ‘market' for alternative risks that we know today would not exist. So, where exactly does the intermediary add value to the ART market?
Structuring the requirement
First of all, JLT Risk Solutions takes a different approach to business compared to many of its peers. Our ART transactions tend to emanate from existing client relationships; alternatively, we will be engaged on a consultancy basis by new clients to provide input on a specific issue. We do not undertake extensive product development in order to offer ‘ready-made' solutions. Instead, we treat each client, each problem, separately, using our experience to define the precise requirement. This factor is key to the service we provide. Some brokers and insurers with ‘direct-dealing' aspirations market themselves in such a way that their response when approached directly by a client is to push a solution based upon their own acceptance criteria or product offerings. This can often leave the client feeling as if there is little room for negotiation and, ultimately, not wholly satisfied with the solution offered.
However, the intermediary's role can begin even before an ART requirement has been identified. It is often the case with ART solutions that the client hasn't even considered the insurance market as an answer to their particular problem. Many of the opportunities that we bring to the market come from clients of our conventional business, where a general conversation has uncovered an issue to which the insurance market could respond. This does not happen by chance – a fundamental skill of the intermediary is developing open and constructive relationships with their clients.
Turning an abstract problem into a proposition that can be underwritten is a key challenge in risk financing. For instance, credit-related risks often require a reassessment of the entire scenario before a solution can be found. The client may not be able to raise or service finance to fund a deal either because of its own credit profile or that of another party to the transaction. There may, however, be one party with a sufficient rating to be able to plug the hole. By restructuring the transaction so that the risk resides with this party, risk financing which appeared impossible suddenly becomes viable. It is the intermediary's third party perspective that is often the key to successfully reframing the problem.
Naturally, a professional intermediary will also add significant value to the structuring and presentation of the transaction. Most ART re/insurers tend to specialise in certain areas and have particular preferences. Over a period of time, this could lead to an inability to think laterally about the client's requirement. On the other hand, a successful intermediary will have wider, more diverse experience with a range of markets, and be able to adapt and combine techniques developed for other purposes. The broker's knowledge of these markets will be crucial in developing a viable structure and ensuring that the transaction is presented in a form that can be analysed and, ultimately, underwritten by insurers.
When these factors are taken into account, it is clear that the terms ‘broker' and ‘intermediary' do not reflect the true value they bring to clients. Although it has become fashionable in the insurance industry – in most cases it is also fanciful – to compare ourselves to investment banks, we believe there are great similarities between the role of the intermediary in risk financing and the facilitating role of bankers in general financing.
In fact, some believe that investment banks eventually will usurp the role of insurance intermediaries. This opinion undoubtedly has some reason. Investment banks are increasingly risk averse, preferring now to act as an intermediary between clients and capital markets. As the scope of the risk financing market expands, having access to capital in the form of insurance, as well as financial instruments, has a certain logic for banks.
But, although the presence of banks in the market may be the final straw for some of the weaker brokerage firms, there will remain a role in ART for more focused companies. Despite the consolidation of the last 15 years, both the insurance brokerage and investment banking sectors have continued to sustain many niche players, and there is no reason why this should not continue. Try as they might, big organisations are often at a disadvantage when it comes to delivering the key things clients expect from their intermediaries and service providers: quality of service and innovation.
Perhaps the most important role of the intermediary is creating new markets for risk. Because there is no ART market as such in the way that there is a marine market, for example, each transaction requires a considerable amount of development work and negotiation with potential markets. To illustrate this point, JLT Risk Solutions recently closed a financial guarantee with the involvement of a group of conventional credit and contingency insurers which had never previously underwritten this type of risk. We were able to do this by working closely with the insurers over a period of time, familiarising them with the business and addressing their respective concerns.
Risk financing deals, by their very nature, tend to involve substantial monetary exposures and risks that the insurance companies' senior management are often unfamiliar with. Consequently, the intermediary's knowledge of individual insurers' preferences and the practical workings of the insurance market is key to its effectiveness.
Another challenge we often face when placing risk financing transactions is the incompatibility of the insurance market with the terms and scale of corporate finance or capital market transactions. The gap can only be bridged if capacity is accessed from across the market spectrum and through creative structuring of the transaction. For example, JLT Risk Solutions recently worked with a very large Asian power project. The scale of the project would normally require the support of a state export credit agency, yet, for various reasons, this support was not available. Faced with the possible collapse of the project, our client asked us to investigate the possibility of an unprecedented private market placement. The tenor of the loan – 13 years – made this a considerable challenge. Our solution was to utilise the amortisation schedule under the loan agreement to create a structure that matched insurers' maximum contract tenor with the declining total exposure over time. In effect, as certain insurers come off risk, so others' percentage of the remaining, but reduced, risk increases.
The third area in which the intermediary provides a key service is acting effectively as the project manager of the transaction. Closing an ART transaction will usually be a long and convoluted process involving a number of parties during the length of the negotiations. The intermediary is ideally positioned to co-ordinate these parties and to drive progress. However, we don't believe in preventing direct contact between those various parties. Some brokers, in seeking to protect their position, attempt to prevent insurers from speaking directly to what they regard as ‘their client' without a broker present. In fact, protectionism is likely to be counter-productive both in terms of expediting the transaction and in securing the long-term future of the intermediary. For instance, a recent transaction that we structured involved no fewer than five legal and tax consultants acting on behalf of various effected entities, and the representatives of five major insurers including their in-house counsel and respective credit committees. Combine this with the client's people and a financial institution and spread the period of negotiation over ten months, and the problems that would arise if these parties could not talk directly to one another are obvious. The process has to be collaborative or it is likely to end in failure and recrimination.
The intermediary also provides important technical services, both to the client and the market. In most cases, the insurer will have its own analytical resources available to formulate the transaction. But a broker should also be able to provide input on actuarial, legal, tax and accounting issues to ensure the analysis that the final transaction is based upon is truly objective.
The ability of the intermediary to create an underwriting submission that includes detailed financial or actuarial analysis also assists the insurer. Without this service, underwriters would have to undertake the expensive process of analysing proposals, only to find that many of the prospective transactions did not meet their basic acceptance criteria. Not only would this expense ultimately be passed on to insurance buyers, but it could also serve to minimise the number of insurers participating in ART business. From the client's perspective, this aspect of the intermediary's work ensures that its proposal receives the widest possible market audience.
ART is at the leading edge of the market and is pushing the boundaries of what insurance can do. Intermediaries are part of the market's tradition and some people find this mix incongruous. But intermediaries, by being in tune with their clients' evolving needs and performing valuable services throughout the transaction process, have helped shape both the application of and market for ART. It is the intermediary's unique combination of market knowledge, technical capabilities and client relationships that drives innovation. And for this reason they will continue to add value.