Ronald Gift Mullins conducts a thorough examination of the current state of health of the broking community
Of the major components of the insurance and reinsurance industry - primary insurers, reinsurers, agents/brokers - none has been hauled out and pilloried by federal and state agencies, the legal profession, risk managers, investors and the media to the extent that the insurance brokers have.
Yet, even with all the hullabaloo starting in 2004 with investigations by the attorney general of New York involving conflicts of interest tied to contingent commission arrangements and bid-rigging at some big brokers and insurers, followed by further examinations by federal and state legal and regulatory authorities, which led to sizeable settlements by a number of brokers, the discontinuation of contingent commissions by many brokers and insurers, and the sell-off of some affiliates, the broking industry has emerged bloodied, but unbowed.
With such a tumultuous recent past, what does the future hold for this critical linkage that offers advice and arranges protection for personal and commercial risks with insurance and reinsurance companies? In a special report, "Insurance Broker Industry Outlook", Fitch Ratings predicted stability and growth for the broker industry in 2006, while admitting that earnings would be down in 2005 because of litigation connected to federal and state investigations.
"One key consideration in determining a better outlook for 2006 is that brokers have largely put the issues from recent investigations behind them," said James Auden, a Fitch Rating's analyst. "We foresee organic growth, meaning that there will be a resurgence of new customer-based growth as brokers continue to put in place processes to eliminate any conflict of interest in their businesses."
Intermediaries elude spotlight
Although the investigations and trials brought unwelcome high visibility to the brokering sector as a whole, reinsurance intermediaries were only marginally seen in that unflattering spotlight. Geoffrey Bromley, chairman of Guy Carpenter's European and Asian operations, said the settlement of the suit with the New York attorney general "does affect us as a member of Marsh & McLennan, but we have not had to change our practices to any significant extent. We are required to handle more red tape and paper work, but this adds nothing to the process of doing business."
The Spitzer issue is a principal issue, a major one, said Noel "Skip" Dunn, president of Aon Risk Services Americas. "We came through that from a reputation point of view all right. Contingency fees for us were small, represented just 2% of revenues, and Aon does not participate in those fees any longer. Not a real problem. Our services remain intact. We have had to retool, but we were very pro-disclosure anyway before all of this came out."
The investigations and lawsuits have had no affect on Willis Re US, said Peter Hearn, CEO, Willis Re US Inc, since the intermediary affiliate of Willis NA did not support contingency fees. "From the disclosures made by brokers and insurance companies, a heightened awareness of ethical behaviour has come about in the insurance brokerage industry," he said. "There is a code of conduct that each broker has to abide by now."
Appraising the business environment of the broking industry, Bromley observed that the industry is in a very interesting state of development. "The efficacy of the reinsurance product itself is under the spotlight," he said. "Because if we can't provide the protections our clients are concerned about, if we are de-risking the risk itself, then some clients will question if there is a sustainable solution at all."
He said there is talk among the big companies about the cost and coverage of reinsurance. "Does it make sense? Should I look at alternatives to supplement reinsurance?" Bromley asked rhetorically.
"I think that if all brokers did was broke," Dunn said, "that would be a problem. We are, of course, still broking, but we are into services as well." He noted that when a hard market comes, "it takes greater knowledge to get things done, to find capacity and get the terms you need. Then there are employee-related issues, healthcare, pensions that create real opportunities for brokers."
Dunn observed that segmenting various risks by industry and then by product is critical. "There is no question that different industries do have different needs, and a broker has to be able to understand what business they are in. Once you achieve a critical mass in a specific business within an industry, you can create forums and help look at the problems of that industry. Aon very much does segment industries, such as energy, heavy retail, railroad, pollution as well as products - brand protection, business interruption, enterprise risk."
Consolidation a concern
There has been a consolidation trend within the broking market for at least a decade. Today, the top ten brokers in the world control close to 84% of the $30bn of total global commissions in 2004. Astoundingly, the two top brokers, Marsh & McLennan and Aon, account for almost 60% of that total. The other brokers in the top ten include Willis Group Holdings, Arthur J Gallagher & Co, Wells Fargo Co, Jardine Lloyd Thompson Group, BB&T Insurance Services, Brown & Brown, Alexander Forbes, and Hilb, Rogal & Hobbs. (This list was compiled by Fitch Ratings and is based on brokerage revenues for 2004).
Keeping pace with the consolidation within the insurance and reinsurance broker market, the stable of reinsurers has become populated with fewer and fewer players. The announcement that Swiss Re would buy GE Insurance Solutions removes a large reinsurer from those available for placing risk and may influence future reinsurance costs.
Stewart McCulloch, managing director of Alexander Forbes International Risk Services division, said the Swiss Re/GE Insurance Solutions merger is "of concern to us. It concentrates risk and there is a real reduction in choice for our clients."
For Guy Carpenter clients it means stronger, more financially sound carriers, observed Bromley, "provided that always we have sufficient options available to make choices to meet our clients' needs. Obviously a potential problem of consolidation is concentration of risk and lack of choice. We've seen a number of new entrants come into the market to provide choices, but also we have to be concerned with the financial security of these new entrants."
"Consolidation doesn't necessarily always add up so that one and one equals two, it often equals three," Dunn said. "Capacity tends to lag, and one party may not be as healthy as the other and you can end up with restrictions on capacity. We have to hope that doesn't happen, because last year several reinsurers had substantial losses and had to repair their damaged balance sheets by raising more capital."
Rise of risk manager
Risk managers have become more than just buyers of insurance and often reinsurance for their companies. As reinsurance becomes a significant expense item, however, more CEOs and CFOs are stepping in and making the final decision on how much risk should be laid off to reinsurers.
Hearn said there is greater attention being paid to the purchasing of reinsurance than ever there has been in the past. "Request for Proposals have become more formalised because of the inherent expense of reinsurance." He continued, "In many cases, decisions on the purchase of reinsurance are now being made at the highest levels in insurance companies."
Forbes embraces the increasing professionalism and welcome procurement on value and merit rather than price and relationships, said McCulloch.
"Risk managers are more and more becoming chief risk officers because Sarbanes Oxley requires measuring the total cost of risk," Dunn of Aon said. "We actually have taken broking out of our vernacular. We have become deliverers of intelligence capital to enlightened risk managers to make their jobs easier. We look at return on risk investment, how we can increase their earnings per share through any number of risk management techniques. We are in a kind of partnership with these risk managers to provide consultative advice."
Within the past decade there has been a big shift in risk management, Bromley acknowledged. "The big shift we have seen is that risk management has moved from underwriting to the financial sphere," he said. "CEOs and CFOs are making decisions on reinsurance. Often a pretty large segment of a company's P&L statement is reinsurance recoverables. The heightened interest in reinsurance comes as part of new sophisticated techniques that cover capital efficiency. It has come about in the last decade."
Backing the future
The Fitch report emphasised that the risk of losses from shareholder, class action and other lawsuits still clouds the future for brokers with some uncertainty, but the report said brokers will continue to struggle to restore profit margins to prior peak levels and to restore trust in the broker-customer relationship. While profit margins and growth pressures are likely to continue going forward, the report noted that earnings are likely to improve in 2006 as the impact of settlements and other one-time items diminishes.
Fitch noted confidently that the larger insurance brokers possess several key factors, including enduring operating franchises, reasonable balance sheet financial leverage, and adequate cash flow and interest coverage to support debt servicing requirements. With the removal of contingency fees as a substantial percentage of the biggest brokers' net profits, they have returned to charges based on commissions for placement of insurance and reinsurance and fees for other services.
McCulloch of Forbes sees one of the biggest threats or opportunities (depending on whether you are a hiring broker or an employee) to the future of brokers is the "war that goes on for the most talented people within the broking sector."
Hearn thinks that the skillsets brokers have been able to embed within companies to help them in underwriting and financing will lead to an increased value for a broker's services. "If the only value that you bring is in the transaction, then your value and your relationship with the client is limited," he explains. "However, if you embed your services within the organisation, on various levels, be it underwriting or operations, you are seen as a problem solver, not just as a transactor and so your value grows considerably."
A major factor that will enable brokers to excel is to do a better job at assisting clients, explained Bromley. "We have to address the complicated risk management issues they face, such as capital management, financial issues, the plethora of different constituents - shareholders, regulators, rating agencies stock market analysts. We need to assist them to achieve their corporate objectives. And being able to draw on the experience gained from working with a large client base gives a robustness to the process."
Movement of corporations toward more risk managers purchasing services is going to be a big area of growth, Dunn observed, and he believes brokers are well positioned to do this. "Not only in terms of advisory groups," he said, "but also in technology. Enterprise risk management requires sophisticated information technology and we have a great group of products. Also, globalisation of corporations holds high promise for the future, not just with the largest companies but with medium-sized ones also that are going overseas. This benefits the larger global brokers. Companies will need help managing risk no matter where they are located."
The reinsurance industry, by its very nature, is a volatile business, Hearn of Willis Re concluded. "There are numerous variables out of our control that influence the buying of reinsurance. We have to accept the volatility in the reinsurance brokerage business and manage our business accordingly," he said. "We have to be diligent to deliver value and the cost should be representative of that."
After enduring a period of uncertainty and uncommon revelations that have compelled some of the major players in the broking industry to make substantial changes to their methods of producing revenue, the broking industry looks forward to a future of challenges and rewards.
- Ronald Gift Mullins is an insurance journalist based in New York City.
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