Sarah Goddard: Financial services industries in general are beginning to adopt the principles of e-commerce. How is the re/insurance sector adapting to the e-business revolution?
Kathryn Huelster: I would like to start by pointing to a couple of statistics relevant to this discussion.
The first is that if you compare the efficiency measurements of productivity improvement in re/insurance compared to other sectors of the financial services industry, over the past ten years, on average, efficiency has increased by some 20% in non-insurance financial services. In our sector there has been no change in efficiency and productivity.
Secondly, another interesting statistic comes from Booz Allen, which identified that for us to meet the efficiency challenge, we need to cut our cost base by some 40-60%. So the challenge is there. It could be that one of the ways of achieving that would be through the effective deployment of technology. Many people believe that e-business means easy business and they think that sticking a fancy front end on archaic business processes and systems that have been around for the past 20 years is going to leapfrog them into the e-age. That is simply not going to happen.
Benito Pagnanelli: I think that we are at the stage where there is confusion because everybody is talking of new technology, internet, intranet. There is too much “e” and too little commerce behind. Everybody is looking at the issue, but it is not being understood. It is a fashion now, however, I believe that the new technologies can help very much in reducing the costs.
Obviously we are under the pressure of return on equity, and this is the dominating factor.
I believe that we have to reflect a little bit more to understand where e-commerce can be introduced and where it will take more time. In my company we have a complex situation, being a large group. We have a different local situation in Germany, in France, in Italy, etc, with different legal requirements.
However, I have to say that I believe that the e-commerce introduction of the one system clearly is the final product. There are a lot of human considerations and indications, which we have to look at. How people can trust the technology? They are asking a lot of human consideration in communications which we have to look at.
Chris Aujard: When it is up-and-running, Lloyd's dot.com will try to replicate what Lloyd's is about. It doesn't try to occupy that space on the internet which is occupied already by a transactional engine; instead, it tries to set the marketplace, a portal through which visitors can promptly be channelled to our quote engines. In that sense the net is an opportunity for Lloyd's because we are leveraging onto the brand: “Think insurance, think Lloyd's, think Lloyd's dot.com, go in and have a look to see what is on offer.” The obvious reason for doing this is that insurance is expensive and has a high cost base and this is one way of taking the costs down in a pretty simple manner. The non-obvious reason - which is probably the back of everybody's mind anyway - is that if we don't do it then somebody else will. That is a very real pressure in the e-commerce world. If we don't get there first, then somebody else will and occupy the space that we should have occupied.
Sarah Goddard: But does that lead to people doing it for the sake of doing it and therefore having an unstructured view of what they are trying to achieve? Is it a case of going forward because everybody else is doing it and not being left behind, rather than having clear aims?
Chris Aujard: From my experience I would say no. Lloyd's has a rather committee-based approach to life and that means that only the very best ideas filter through to the top. I would say Lloyd's dot.com is one of the very best ideas that we have had to consider.
Steve Bell: Lloyd's is an interesting entity because of its structure, because the pressures aren't necessarily coming from shareholders. By contrast, shareholders and analysts are expecting most companies to have an e-commerce strategy and will then assess the quality of that strategy and whether it is fit for shareholder value. That in itself is forcing everybody to think about what they can develop as their strategy. Lloyd's is probably the one organisation that doesn't have that same pressure.
David McIntosh: But isn't the pressure coming from what is happening in the wider world? Bill Gates says business is facing 50 more times change in the next ten years than in the last 50 years, primarily in communication. Therefore we have to adapt to it and anybody who doesn't adapt isn't a player. So there is a reaction to what is happening in the front line and the insurance industry has not historically been in the front line. So we're actually, as an industry, responding. It is very helpful in our everyday life having a laptop where you can download wherever you are. But we need to use it as a tool and there has got to be a degree of contemplative time. The underwriter has got to think about it and must not make his decision immediately.
The lawyer who is advising sometimes must say to the client, yes I could respond today but please let me respond the day after tomorrow because this is so important I need some contemplation. I think that you need to respond to the tools we have and we should treat them as tools. They should be used by us, they shouldn't lead us.
Chris Aujard: I think there are two aspects to come in there on e-commerce. One is there is e-enablement of the traditional businesses, which is to help you do what you do faster, smarter. Then there is the e-commerce involving total re-engineering of the business structure. Instead of having a syndicate or an insurance company staffed by hundreds of people, it is staffed by six people and a computer programmer.
Andrew Pincott: But there is also pressure coming from the advisors who say that you have to be e-enabled now. To get in first means an advantage and if you leave it too late, then you will lose lots of cost benefits that you can secure by moving into a sensible e-commerce strategy.
Keith Rutter: Ironically, when we founded The Underwriter, it was built around a traditional model, taking advantage of options such as outsourcing rather than e-commerce. What we have sought to avoid is huge overheads, enabling us to manoeuvre in the insurance markets. So our advisors and our capital providers are at the forefront of technology and the use of technology, but there were no actual overt pressures for us to devise at day one an e-commerce strategy.
Now, you are inevitably drawn toward some form of e-commerce strategy and we have our own views on where it is going. Do you try and re-engineer it to make it faster and smarter? Do you take it to the next level where it is truly interactive? And that is the question that hangs over the insurance industry.
Benito Pagnanelli: The security aspect is enormous. I have read that out of 789 transactions in a bank, frauds were 15% of this figure. That made a deep impression on me. The fraudsters were employees and also people within the management.
David McIntosh: There is another security angle - confidentiality. At this moment in time there is a problem on the horizon we are trying to address. There is a bill that has been passed called the Regulation of Investigatory Powers Bill, and regulations are going to flow from it. This bill is aimed at getting at money launderers, so it has admirable intentions. However, it will allow government agencies to intercept e-mail without the need for high-level ministerial approval, as would be required for tapping into phone calls. Intercepting mail requires court orders. This bill is quite frightening to everybody, I think in particular lawyers because of the confidentiality of their communications and there is some liaison with the US where this is also recognised. It is quite wrong that e-commerce should be easier to be eavesdropped into than mail and phone.
Kathryn Huelster: We need to approach this issue as an industry - we want to get a precise aim and deal with it. There is no competitive advantage in dealing with it as any individual organisation. It also makes sense for us to look at security aspects in a collaborative sense as well.
One of the areas that WISe has been working on is the Interchange Agreement, a broad base legal framework which helps put some guidelines and structure around electronic communications specific to our industry.
Andrew Pincott: The WISe initiative is very interesting because apparently the insurance regulatory authorities in Germany regard the internet and e-commerce as a wholly lawless and unregulated territory. As a result, it will take many years before the legislative powers that be and the EU itself set up the necessary regulatory framework. It is left to private initiatives like WISe.
Chris Aujard: I think this is a big issue that is facing Lloyd's dot.com. It is accessible to all, all around the world, and you are immediately in danger of being seen to trade in every jurisdiction in the world. On the security side, one of the key issues is to make sure that only those that can lawfully enter the site, enter by password protect, getting advice in from 50 or 60 jurisdictions is a very, very expensive exercise.
Steve Bell: Another thing is in the UK, there is a huge amount of change in the FSA, and as an organisation it is still coming to grips with what e-commerce means. We have seen various different regulatory kinds of sign-offs with new entrants, and the FSA is focusing very much on security and availability.
Keith Rutter: It is a major factor when you are applying for approval from the
FSA to trade; if you have any e-commerce strand or ambition to sell by an e-commerce strand, there is an e-commerce questionnaire. The approvals that you need from the FSA are, to say the least, onerous.
Sarah Goddard: This leads us on to the issue of globalisation through e-commerce or physical local presence.
Keith Rutter: In the insurance industry, if you were to contrast The Underwriter with Generali - single site to a global organisation - even with the benefits of e-commerce, I couldn't envisage the situation where we could compete adequately at a local level with Generali worldwide, on domestic business. On major risks, it could be dealt on a surplus lines basis perhaps, rather than flowing through a local broker to a London broker.
You can engineer this cost out of the system. But the deployment of the intellectual capital at the front end is the significant advantage a global player has over people like us. We simply couldn't and shouldn't try and substitute e-commerce for the deployment of intellectual capital. We can't compete.
David McIntosh: Keith, as an underwriter, how important is it on a major risk to have eye-to-eye contact?
Keith Rutter: I don't think it is necessary to have eye-to-eye contact with the broker in London; it is necessary to know that somewhere in the food chain that went before there was eye-to-eye contact. That could have been either with the buyer, or from the surveyor that went and saw the physical risk or the local underwriter that actually understood the risk at the front end before it became a surplus lines product in the London market.
Kathryn Huelster: But the follow-up processes could all be straight through then. You enter the data once and it goes right through with no human intervention.
David McIntosh: I am very pro e-commerce, but to try and humanise it you have said, Keith, somewhere down the line there needs to be the human interface because that creates a more personal and detailed exchange. It also creates a comfort factor between the underwriter and the insured. Then you say, well, up the line it can be dealt with by e-commerce. But I would suggest that even up the line, the foundation of being able to deal with it by e-commerce is that at some stage you have had that personal face-to-face interface with the people who are insured and you are happy with them. Once you are happy with them, having checked it out in a human way, then you can use the tool of e-commerce without repetitively meeting the same person you already trust.
Andrew Pincott: But that doesn't explain the Swiss Re initiative, for example - put up X capacity on their electronic reinsurance placement website, ELRiX. There are a number of reinsurers which are actually quite prepared to e-trade, in terms of giving their reinsurance capacity to whoever will come and buy it from their website.
David McIntosh: If they know about those people because they are market players or because they have had them analysed or because they are comfortable with them or because they like the way they are run, that works. But if they are going to sign up with unknown entities which have just emerged from the e-commerce world, they are running a risk.
Andrew Pincott: The financial markets are really uninterested in looking at the counterparty in the eye. It is simply a financial derivative transaction.
Stephen Stonberg: As far as our counterparty is concerned, we actually do care a lot who we are facing on our transactions.
Andrew Pincott: But you do a credit analysis, you don't decide by staring them in the eyes.
Stephen Stonberg: No, exactly. If their credit quality is fine, then we are happy to trade with them.
Steve Bell: There has been quite a bit of talk around the importance of costs and I guess if I was to think about e-commerce in the reinsurance sector, does this mean you are going to try to strip the costs out of the reconciliation and transaction processes? If you can spend that same cost on the things that are important such as looking at the quality of the underlying underwriting of the companies you are reinsuring, if e-commerce is a way of shifting the costs into something that is much more value added, then it's a useful tool. But in itself it is not going to do that.
Andrew Pincott: But the reinsurance initiatives are to some degree a question of stripping out costs. I can't remember what the exact statistic is but I think somewhere somebody has said that the cost of issuing an insurance policy traditionally is $19. If you do it over the internet, it is less than $1. That's a very obvious cost saving, but what one is always looking for, if you are going to make your fortune in e-commerce, it is the sort of quantum leap into becoming an e-enterprise.
Steve Bell: I guess that the insurance industry is so broad that we have got a complete range of transactions. We have got the really high volume, low value transactions for which e-commerce is probably very, very suitable. Where you are talking about a much more complex transaction, then I suspect the costs of due diligence on the second pair of eyes or the person who is going to do the inspection makes the cost of processing the transaction higher.
Keith Rutter: Well the cost once they have used the original bad underwriter. You take two points off your costs it means nothing if you have not got the front end right on an insurance or reinsurance transaction. Being able to say to a shareholder I have saved 2% on the expenses but the loss ratio has gone way up gets you absolutely no sympathy.
Kathryn Huelster: That comes back to intellectual capital. Your core competence is your underwriting skill. Where I think there is a substantial opportunity is leveraging that, but in all the following processes - the back office - to try and make it as electronic and technology-enabled as possible; to get the claims processing cycle down to four to ten days than four to ten weeks. That has got to be rather, I think, where we have got to go. It is not the glamorous end of the business but it is really where we can look for substantial cost benefits.
Chris Aujard: There must other benefits that flow through the system - the empowerment of the intermediary that is closest to the client at the expense of those intermediaries which are downstream. There are two obvious advantages. One is that you are cutting people completely out of the food chain so there is more money for the underwriter concerned and the second is that the flow of information should in theory be that much cleaner and better. I think that is the bigger aspect with e-commerce, in the sense that it changes the whole balance of power and the whole structure of the industry.
Sarah Goddard: How much is e-commerce being influenced by the capacity situation in the international re/insurance marketplace?
Andrew Pincott: An exchange is being set up in Germany, the effect of which is a risk is put up for acceptance electronically. There is price disclosure in the sense that if anybody wants to write this, whether it be 100% or a lesser portion, their rate is disclosed, but not who has offered to write it at that rate. Anything to do with price disclosure is almost certainly a downward pressure on the price and I do think that those electronic exchanges will inevitably mean there is more pressure on the underwriter.
Keith Rutter: I think the natural effect is that rather than anything else, we would expose the inferior underwriters an awful lot more quickly than currently. The natural benefit to the market is hopefully those that are not as smart get driven out, and then hopefully we get more stable conditions for the longer term.
Sarah Goddard: So you could see a potential for smoothing out the cycle.
Keith Rutter: Yes.
Andrew Pincott: I think that is a little optimistic. Even very good underwriters make mistakes from time to time. The London market is full of people who were star underwriters in their day. Where are they now?
David McIntosh: It doesn't give you a better communication, a system in transparency. It makes it more difficult for people to be evasive. It probes more quickly and somebody would actually have to flatly refuse to provide you with information if it is requested in the proper way.
Benito Pagnanelli: I want to turn back to the globalisation. Generali already is global, so there will be zero change in Generali's geographic spread as a result of e-commerce. It is obvious that you can use the modern technology to improve other relations. This is particularly good for personal lines business we handle, but for large company clients, multinational clients, it is totally different. I think that there, the underwriter remains the determining factor. But for us globalisation meant we have set up some branch offices to service our large clients. As a matter of fact, in addition to our regional places in many countries we have some units which are totally dedicated to large clients, and there internet or e-commerce has little impact. Internet to collect information, but not on the decision to take this business, because there I would say human resources are absolutely necessary at the top level.
Andrew Pincott: Isn't it the case that every insurer, that whatever they may want internally, they are going to be put under tremendous pressure by the larger brokers controlling a lot of business. The brokers have an agenda about e-commerce and it isn't currently the same agenda as the insurers. They are very keen and have been able for some time to do all sorts of things electronically with clients. So there could come a point when their frustrations will explode and they will say either you write the business and comply with our e-commerce agenda or you don't get to see the business.
Benito Pagnanelli: We should have a combined union by the brokers because otherwise we are dealing with these brokers through different systems. I don't think it is this feasible now because there is also competition there, but the battle can be fought in a lot of different ways.
Andrew Pincott: But the two major brokers control so much business through to the London market that I think it is a real political problem for London market underwriters.
Keith Rutter: In that situation, the pressure is the pressure, you have to make that decision depending on the desirability of the business in terms of what is offered. Even if you are as small as we are, the first day you give in to that one, you might as well give in completely. Hank Greenberg doesn't understand the term “give in to a broker”. Having worked there in a previous life, I was always taught at AIG there is one thing that matters, that is underwriting profit; the investment income belongs to the shareholders. It is a purist view, but it is one we can strive for. You won't hit that year in and year out, it is impossible. But it is the purist view.
If you look just at casualty business in the London market - I am not talking about North America - if I wished to transact business with two of the larger brokers, currently I could use something like six or seven different e-commerce platforms that they have under development. Even within them, divisions have their own version of an e-commerce platform. There has to be a common platform.
David McIntosh: Picking up on AIG - a company to be massively admired - to what extent is their success hinged on the way they place their own reinsurance? What sort of retentions do they maintain? They are a magnificent company and they exercise control. They control what they underwrite but they also exercise control of what they retain.
Keith Rutter: When I was there, David, there was an article published by Forbes which showed that one of our operating companies could operate at 140% gross loss ratio and make money. That is just very, very smart and takes advantage of market conditions. With the brokers bringing the business, I think one of the things that the brokers, the very smart brokers, realise is they have to bring more to the table now than just the transaction. Certain divisions of both of the megabrokers probably have as much intellectual capital in terms of risk evaluation, investigation and modelling than any of the big insurers.
Andrew Pincott: We are seeing a shift away from commission-based remuneration towards fee-based payments to brokers. I think it is that and other developments in the insurance and capital markets which are encouraging the brokers in terms of intellectual capital. The number of big deals in the London market which turn upon the provision of financial modelling is increasing that at an enormous rate. You couldn't do that financial modelling previously. You need the information technology and these people are very skilled in doing that sort of process. Certainly the sorts of risks which are, whether they are actually true transfers into the capital markets or more frequently, exotic insurances, it is certainly the case that investment banks are very interested in using their expertise in this area and casting the products that they can sell in the form of insurance.
Stephen Stonberg: Banks are buying insurance companies and vice versa so it will be interesting to see what the financial services sector will look like in the future. For example, Travelers Group in the US. What is that? Is it an insurance company or a bank? Citibank is now selling insurance products and vice versa. I think we are going to see a lot more consolidation in Europe.
In terms of what is going on now between the two markets, you have a combination of factors. Some of the investment banks have set up insurance subsidiaries. Goldman has a company called Arrow Re, Lehman has Lehman Re trying to compete in the cat bond market. I look at it as very small activity, very focused. But again they trying to basically use their capital markets expertise to create products. But what is much more interesting right now and what has happened very quickly and on a much bigger scale, is the credit derivatives market. The first application of this is that the banks under the BIS regime have huge pressures right now with the regulatory capital. In the past they could use securitisation as their methodology, sell assets funded in the ABS market. What they are doing now is they are using a credit derivative, entering into a very large credit swap. So there is no funding going on, they are just buying protection which looks like insurance. The reinsurers are desperate for premium income and all of a sudden you have this whole new source of risks. So you have senior tranches of these large portfolio swaps coming out and they could be $2bn or $3bn notional and they are considered AAAA - they are super senior risk. We are seeing huge activity and entrants into the market, billions and billions of dollars. You see risk transfer going from somebody who is BIS-regulated to somebody who doesn't care about BIS rules and is happy to take AAA or 100% risk weighted assets without having to get funding.
They started out with super senior and now they are starting to get down the credit curve. I think you are seeing continued trends as well with the development of the credit derivatives market. Things that were done in the past through ABS are now moving into synthetics. You will see all different sorts of asset classes which turn into a credit derivative which again looks like an insurance contract. So these are just new sources of premium income which as your markets get more competitive, you have got access to assets and things that you just couldn't have any access to before. The only barriers we have seen really have been in the documentation that our market uses, and your market uses insurance. We have set up a documentation transformer, a company called GC Re, Global Credit Reinsurance, in Bermuda. It is just basically an asset-backed type of a shell company and its only purpose is it does back-to-back issues to Deutsche Bank and then it faces an insurance company on the other side. We can get insurance policies to look pretty much like Istar standard credit default language.
Where we have problems are in the political risk market - it's a bit trickier. There is a lot of language in your market like nuclear contamination and war which are not what we would consider credit events in our markets. It is interesting seeing how there are two different approaches to risk. It is rating agency driven in our market while there is the actuarial approach in your market. So I think the two things drive value and I expect that we have just really seen the tip of the iceberg. I expect this to be huge.
David McIntosh: We talked about globalisation. What has come with it is consolidation and if you look at the big brokers, they have said they want to get out of the commission business, to be in fee consultancy income and to add value; eventually they will do everything. Then you look at major banks, they are going into a very attractive market and whether it is risk transfer, unbundling, what it comes to in the end is sharing all. If the players are big enough, they will be able to assume all the risks and eventually there will be a limited number of giant entities looking after risk and they will cut out the various interfaces. They will provide you with - I won't call it a policy because it won't be called a policy - a composite solution, and you can see that coming as clear as blue skies.
Chris Aujard: There is a move in the direction of finding integrated solutions for big corporates. But there is also a heightened awareness of bespoke solutions, generally, in the financial services industry. You get very big investment banks and boutique investment banks. I don't see any reason why that trend shouldn't be discernible in the insurance industry of the future, where there will be very big players applying holistic solutions and rather smaller players who are very clever.
David McIntosh: But there is that already, Chris. You are seeing, particularly in the financial risk area, people coming out with individual solutions for individual transactions which require individually written insurance policies to cope with a particular risk for that particular transaction. It is all financial risk. It is all structured. Sometimes it goes into the capital markets, usually by way of derivative transactions behind an insurance policy or a reinsurance policy, but sometimes it is a straight derivatives transaction. They are usually confidential transactions, but there is an increasing amount of it going on.
Chris Aujard: Different markets have different appetites for different types of risks. The financial markets, capital markets, like average risks. They like to know on average what is the risk of something happening to this type of structure or what on average is the risk of an earthquake occurring. Whereas insurers are much more interested in specific risks, just by the nature of the business that is done. Fundamentally they are different approaches to assessing the risk of something and my contention is that in the brave new world of the future they will be a place for both types of risk bearers.
David McIntosh: I do accept what you are saying and if you look at any other service provider you will find big players and bespoke players. The danger is the big players might open bespoke departments.
On a different note, corporate governance is having as big an influence on individual underwriting as e-commerce. It is something that some people are having to get used to. At Lloyd's the corporate capital providers have become the boss instead of a whole group of individual names, some of whom knew a great deal and some knew nothing. The corporate providers tend to be specialised people and when then they are, they become a controlling influence. The banks will provide some support. The banks will expect, I believe quite rightly, discussions about underwriting philosophy. They would not wear the answer, “mind your own business, that is up to me”, the voice of the Lloyd's underwriter in years gone by, though they wouldn't necessarily deter the natural flair of the underwriter.
Chris Aujard: The essence of Lloyd's is changing at all the time. If you look at Lloyd's, it has certainly changed enormously in the ten years and beyond recognition in the last 30 years. That, I think, is the benefit of a marketplace. You have all the benefits of small business units that are nimble and fleet of foot with the combined global functioning power of a big organisation, and that is Lloyd's. Markets move quickly. They adapt and they evolve and they become different things.
Steve Bell: Picking up on corporate governance, it means something else, of course, which is an increased appetite and awareness among corporate customers for risk control mechanisms. This has increased the profile of the insurance purchaser - the risk manager - and it creates an appetite at a corporate level for buying protections in a way which they previously didn't. Those are the things that present great opportunities for the insurance industry. There are all sorts of a simple examples; the bringing of intangibles on to the balance sheet has opened up a world of opportunities for re/insurers that now insure intangible assets just as easily as 50 years ago they insured tangible assets. Similarly, we now focus on risk controls. There are very large companies out there that will want to buy insurance protection that gives them the peace of mind that so they can say in their report and accounts that they are doing everything the responsible company does to control risk. So I think that is a very, very positive thing from the re/insurers' perspective. It has opened a whole new market.
Sarah Goddard: But those intangible risks may be deemed uninsurable by the conventional re/insurance market and remain on the companies' balance sheet at a time when the companies themselves are managing risk better than ever before.
Chris Aujard: Yes that is quite right. I think the survey that Lloyd's conducted last year, out the top ten risks that face insurance managers in FTSE-250 companies, three were non-insurable, at least not currently.
Sarah Goddard: What are the new areas of risk we are seeing emerging at the moment and can the re/insurance industry address these problems?
Keith Rutter: The most frequent requests now for coverage in the casualty market is cyberliability - first party, third party, protection for cyber vandalism. There is a whole army of people out there wanting protection against things that we actually don't understand well enough to protect ourselves from. Because all the time it is possible for an 18-year-old somewhere to gain access to NASA's computers which surely must have the best firewalls and protections. It is impossible - I don't see how currently as an underwriter signing a piece of paper that I could offer people protection against that.