With brokers still smarting from the effects of Eliot Spitzer's investigations, rampant diversification plans are underway throughout the industry. Some brokers are even looking to transform themselves into risk consultancies. Nick Thorpe reports.
Intermediate agents have enjoyed a vital place in business transactions for hundreds of years and the insurance and reinsurance industry is no different. The three biggest broking behemoths in the insurance industry, Marsh, Aon and Willis, had a combined brokerage revenue approaching $20bn in 2004 and, until Eliot Spitzer began his investigations, their grip on the industry seemed infallible. But recent announcements by Aon and Marsh, indicating they are repositioning themselves as risk consultancies, have led some to ask: "Is this the end of traditional insurance broking?"
An insurance broker, according to the British Insurance Brokers' Association, "is one who advises his clients in matters of their insurances. He/she is normally renumerated by a commission from the insurer."
As with most intermediaries, brokers arguably have little actual influence in the deal they are arranging. They are usually paid through flat fees and/or commissions and it is with a certain type of commission payment that ex-New York attorney general Eliot Spitzer took exception. Spitzer's issue with contingent commissions was that they are structured in such a way that the insurers compete for business from the broker based on the commission fee, rather than by offering the best price for the broker's client. This may therefore influence brokers to pass business on to those insurers who pay the highest commission fees, rather than those who are offering the most competitive coverage, and hence the client may lose out.
Spitzer focused on contingent commissions as part of his so-called "attack on white-collar crime" and maintained that his office was "establishing new ethical ground rules for (the insurance) industry". His investigations resulted in one of the largest ever compensation deals from one company, as Marsh & McLennan agreed in January 2005 to pay back $850m to policyholders over four years. Although the company did not admit or deny the charges brought by Spitzer, the case led to a massive fall in profits, which itself led to 3,000 job losses across the company and the departure of several senior executives. Aon, which also cropped up on Spitzer's radar, followed suit, settling for $190m and issuing an apology, while Willis got off fairly lightly with a $51m settlement and no lawsuit, a likely result of its speedy settlement and promises to improve transparency. Settlements aside, long-term damage had been done to reputations, and these firms faced the loss of contingent commissions along with expensive restructures in a bid to change deeply-entrenched business practices for the better.
The future's bright
Fast forward two years and the story has changed substantially. Marsh & McLennan, which two years earlier fell to its first quarterly loss in eight years, announced a doubling of annual profits to $990m for 2006 while Aon increased its total revenue for 2006 by 5% to $9bn. However, it was the announcement by Aon in late March that is was to form "the world's largest global risk consultancy" that really signalled a change in the wind. "The creation of Aon Global Risk Consulting (AGRC) is about being able to offer a fully integrated range of services from risk identification to assessment and management of risk, and risk financing," explains Stephen Cross, CEO of AGRC.
The announcement followed a story exclusively broken on www.globalreinsurance.com two weeks earlier that, according to sources within the company, Marsh waso looking to reposition itself as a risk consultancy. In contrast to the sweeping job losses post-Spitzer, Brian Storms, chairman and CEO of Marsh, announced the recruitment of 100 risk specialists and the expenditure of "hundreds of millions of dollars" to retrain senion staff, in an interview with The Times. "Our clients are now looking at risk in a much broader way than they did before," said Stroms. "When you gather around the table, you have your lawyer and you have your banker and now you also have your risk manager. And I want that manager to be Marsh."
Both Marsh and Aon had well-established risk consultancy practices spread throughout their businesses long before this recent move. So it is by no means a foray into the unknown. As Cross explains, in Aon's case, AGRC is simply an amalgamation of many existing facets of the company: "Until now AGRC was called a number of different things, including a whole load of brands for very similar businesses. Aon had a lot of these resources for some time but they didn't look, touch or feel like they came from the same company. We've simply brought them all together, aligned them and rebranded them."
The strategic move into risk consultancy may be seen by some people as surprising, given that in Marsh's case, broking accounts for 80%-90% of the company's current income. However the broking market has been shrinking for some time, and with Spitzer's legacy and resultant squeeze on revenue streams, brokers have been forced to consider diversification strategies. "Buyers have become much more sophisticated and perhaps we had a degree of complacency in the late 1990s early 2000s," said Cross. "There is now a huge focus, which is still increasing, on understanding risk. We're not talking just hazard risk; we are talking about governance and operational risk too. The corporate buyers of today are seeking more and more consulting-related strategic advice." However Cross is also at pains to refute claims that the moves are a direct result of the Spitzer investigations. "All these operations existed pre-Spitzer so I wouldn't correlate it back to that. Market forces triggered this move, particularly by clients who had a change in focus after 9/11 but also after Enron, which really brought the issue of governance to the table."
"I think there is a huge opportunity for Aon in the risk advisory market," agrees Cross. "Intellectually it could be at least as challenging as the broking side because risk is a constant, it will always be there. Broking, meanwhile, tends to be more cyclical - an event happens, the market dries up, a new entrant comes in and so on. Companies will always have a fluid risk profile to attend to and I can see a considerable market opportunity."
The risk consultancy business is already awash with established players such as Pricewaterhouse-Coopers, KPMG and Ernst & Young, but Cross remains unfazed: "There may be organisations out there that are bigger than some sections of our practice but that is usually the sole extent of their offering. Nobody else in this market has the depth and breadth of services that we have. Nobody has the pieces that we have, integrated the way we have them." Certainly Aon's global reach has meant that AGRC has been given a significant platform from which to launch. "We've launched with 1,500 people across 90 locations in 45 countries. It's real, it's alive and it's kicking," insists Cross.
Interestingly, Benfield recently identified enterprise risk management (ERM) as an area of growing importance in the reinsurance industry. Although the broker has not made any big announcements regarding additional strategic growth into this specific area, it acknowledged the huge potential for this business. In its "Pick 'n' mix" industry report, Benfield stated that "it has become widely accepted that rigorous risk management is essential to corporate stability and long-term performance. Managing risk is the raison d'etre of the insurance industry." And, of course, the impending implementation of Solvency II, which links regulatory capital requirements to risk, means insurers and reinsurers will be under increased pressure to implement ERM to comply with the regime.
Risk reporting has also become a top priority as rating agencies increase the importance attached to ERM in their rating process. In fact, Aspen became one of the first companies to have its rating adjusted (to a stable outlook in this case) as a direct result of its ERM competencies. And it is this increased focus on operational risk that has led Cross to spend the last two years setting up AGRC. "There is now a much greater understanding that the market capital of a company can be more severely damaged by an operational risk loss, rather than a hazard risk. If there is a fire or terrorist attack, a company can probably take a hit. But as soon as that company comes out and says they have insurance with an "A" rated company, you will generally see their stock price recover very quickly. If you have a severe operational loss, maybe something reputationally damaging, you see a much higher correlation to the downward spiral in the value of the company."
Tough at the top
Marsh and Aon's move away from broking and towards risk consultancy does throw up some more basic issues. The process of reducing a client's risk profile inevitably means that its insurance premiums will come down; ultimately reducing the amount of revenue the broking arm is likely to make from said client. Cross maintains that the company will not abandon the broking side of its business though. "We are very much aligned with the broking practice," he said. "The broking side of the business is still very important, a large portion of the risks, particularly hazard risk, still has to be placed in the market." Brian Storms, on the other hand, is more forthcoming in his take on the situation. "We are not going to remove the broking middleman by being a thoughtful adviser," he maintains. "At the end of the day, I care a lot more about what my clients think than what my brokers think."