Can the broker market recover from the last twelve months in the eyes of the investors? asks Lindsey Rogerson

The disparity between the brokers and reinsurance companies on the relative firmness of the market is causing concern among investment professionals.

Add into the mix the impact of legislative change for UK-based brokers and the fallout from the Spitzer investigation, and analysts and investment managers are not exactly flocking to pick up the stock of brokers companies at present.

Specialist fund Hiscox Insurance Portfolio has just one broker among its holdings at the moment - two years ago brokers made up 20% of the fund. The sell off was triggered by the movement of the insurance cycle.

Brokers, the vast majority of whom remain commission driven, are an early play in an insurance cycle, but once the cycle moves on so does the attention of fund managers.

Brokers have been doing well out of the reinsurance market over the last few years, according to Robin Mitra and Maurizio Lualdi, authors of Credit Suisse First Boston's most recent analyst note on the global insurance market. Their dominance over direct challenges is especially noticeable in the London, US, Bermuda and, increasingly, the French markets, a fact the authors attribute to the brokers' focus on getting the best deal for their client and their ability to add value (see table 1).

The note said: "Spitzer notwithstanding, all but the largest of customers probably have perceived the benefits of using the services of brokers to improve the price and conditions on which they purchase their risk coverage, especially during the last hard market."

However, as it will be some time before the full ramifications of the investigation by New York State's Attorney General, Eliot Spitzer, become clear, CSFB feel that in the near term direct sellers of reinsurance may fair better than brokers.

In contrast, Willis, one of the broker firms embroiled in the investigation into contingent commissions, believes it has put the matter to bed. Joe Plumeri, chief executive, said that he was confident that the Willis that was emerging as a result of the changes agreed with both the New York and Minnesota Attorneys would be a stronger, more resilient brokerage, capable of producing long term success.

Willis' announcement of a $300m share buy-back at the time of its first quarter results in April, along with an announcement of cost-cutting layoffs, could usually have been expected to help to ease concern among investment professionals, as would the maintenance of the dividend.

However, Nick Martin, investment analyst on the Hiscox Insurance Portfolio Fund, is not convinced. He told Global Reinsurance: "We did hold Willis up until a few weeks ago. The reason we sold out of that stock was because Plumeri quite often talks about different buckets of revenue that they can use to recoup the revenues that they have lost as a result of the Spitzer enquiry. We are not convinced, and we also noticed that Plumeri sold a significant amount of Willis stock himself."

Martin does believe, though, that Spitzer has provided an opportunity for some broker firms. He singled out Benfield Group, who last month announced they were setting up a primary brokerage, as one of those for whom Spitzer could ultimately prove fortuitous.

"They are going out and going after Aon, Marsh and Willis, which has got to be a sensible move in the long term," he said, adding though that it would be 18 months to three years before any benefit began to filter through to Benfield's bottom line.

Brokers operating out of the UK and the Lloyd's of London market have suffered their own pressures on profits, arising out of having to update systems and staff because of the start of regulation by the UK Financial Service Authority. According to accounting group Mazars' annual survey of insurance brokers, which gathers the opinion of some 220 senior managers, found that almost two thirds expected profits to be adversely affected by more than 5% this year as a result of preparing for regulation, while almost 20% thought the dent in profits could be more than 10%. (see chart)

Indeed, Mazars found that brokers expected the cost of preparing for regulation to be a bigger drain on margins than the softening of the market this year. The soft market was having an effect on new product development, however, with 70% of brokers saying they were looking to grow business from existing lines, rather than exploring new ones. Mazars concluded, "This suggests that in the soft market, many brokers go back to their knowledge base and remain with their known markets and products."

Looking to the future, Hiscox and CSFB feel that brokers are integral to the ongoing success of reinsurance markets, because of their ability to serve both primary insurers and to help place business with new reinsurance players as and when they emerge.

CSFB said, "Brokers can be useful to the insured and helpful to new reinsurance companies. Also, brokers eliminate the need for primary insurance companies to have a dedicated reinsurance specialist department, and of course the attendant costs."

All of which has the welcome knock-on effect for reinsurance brokers, of making clients in the primary insurance market more dependent on their services.

- Lindsey Rogerson is a financial journalist.