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Opinion: The Reinsurance Market Needs More Distribution, Not Less

August 14, 2013 by Mike Schnur

t is a well-known axiom that for free markets to exist, access must be unencumbered. The more players there are, the more efficient a market will be. Unfortunately for those of us in the reinsurance space, we have entered into a Executive Summary period of reduced competition. In fact, many would argue that reinsurance Commenting on the state of the reinsurance distribution is significantly less efficient than it was only a few years ago. brokerage industry, TigerRisks Mike Schnur Why? explains why he believes a lack of competition is There are many reasons, but one reason eclipses all others. Today, 80 percent of hurting the industry and advocates that primary reinsurance premium goes through just three big brokers. Economists call this carriers demand innovative reinsurance unnatural state of affairs an oligopoly. Oligopolies disrupt the marketplace by solutions from intermediaries, which recognize limiting competition. When choices are limited, prices go upand service goes each carriers uniqueness and individual needs. down. Here are some examples: The mobile telephone industry in the United States is dominated by just four companies. Visitors from overseas marvel at how primitive (and expensive) the U.S. mobile system is; this occurs even though the United States invented the cellular telephone. Three airlines now dominate domestic air travel in the United States. Anyone who has been on a flight lately will tell you it was hardly a pleasant experience. The once fiercely competitive U.S. car rental business is now dominated by just three companies. Remember that one company whose slogan was We Try Harder? Its part of an oligopoly now. Like other oligopolies, the Big Three reinsurance brokers that dominate the market today did not fight and claw their way to the top. They were financially engineered through mergers and acquisitions, fueled with capital from Wall Street. As publicly traded companies, their loyalty (indeed their fiduciary responsibility) is to their shareholders. Clients come second. Because of this ceaseless imperative to maximize shareholder value, the big brokers can only grow by increasing fees or reducing levels of service. Because of their size, their actions can negatively affect the rest of the marketplace. A good example is contingent commissions. Only a few years ago, the mere mention of the phrase was enough to trigger an investigation by Eliot Spitzer. Remember how the big brokers made an elaborate show of backing away from contingent commissions? Remember their hand-wringing CEOs swearing Never again! Contingent commissions are backand in a big way. The only difference is transparency. Now its okay because brokers are

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Opinion: The Reinsurance Market Needs More Distribution, Not Less - Carrier Management

Contingent commissions are backand in a big way. The only difference is transparency. Now its okay because brokers are telling their clients theyre taking contingent commissions. Lately the big brokers have started charging for services which were previously Why would carriers pay for included in the commission. For example, they have developed internal information and access they used to information systems that supposedly give carriers an inside track on new business. get for free? But to get access to this information, carriers must pay an additional fee. It all seems counterintuitive for several reasons. Brokers are supposed to have a strong understanding of the cost of risk, the nature of a risk and which carriers are best suited for that risk. Its called broking. Carriers, meanwhile, are supposed to know how much risk theyre willing to take on and how much to charge for it. Its called underwriting. So why would carriers pay for information and access they used to get for free? Is it because they fear theyll be shut out unless they cooperate? It follows then that carriers paying for this information will be getting preferable consideration. But where does that leave the insurance-buying client? By limiting the number of carriers to those who are willing to pay a fee to a broker, isnt that limiting a clients access to the most efficient capital? Does that sound like a free market to you? In recent months, some big brokers have announced sidecar deals with certain carriers in which a percentage of all the business a broker writes will be assumed by the carrier. That sounds good for the broker; nice for the carrier, too. But what about the insurance-buying client? Was the business placed with the best carrier at the best price? Or was it placed with the carrier willing to pay more to the broker? To reduce expenses, the large brokers have started offering standardized products like property-catastrophe reinsurance. The buyer purchases multiple layers at a set price, and if they have a loss they are required to pay again for an additional limit. Again, its good for the big brokers but questionable for clients. Economies of scale are good for making flat-panel TV sets, not complex reinsurance structures. Its like giving a patient an aspirin, regardless of whats wrong. How do off-the-shelf products improve capital efficiency? These are just a few examples of how the behavior of these big box players can inhibit competition. Avoiding The Pitfalls What can primary insurers do to foster competition and improve reinsurance distribution? The obvious answer is to not acquiesce to these mega-brokers. But there is something even more fundamental than that. Start with the realization that your company is a unique organization, with its own problems and highly specialized needs. Then demand your reinsurance intermediary provide innovative solutions that give your company a competitive advantage. Upping everybodys game is good for the entire market. Fortunately, there are insurance carriers and clients that demand excellence and are sophisticated enough to realize that bigger is not necessarily better. Primary insurers that are serious about competing often seek out specialist or high-value-added brokers. These specialty brokers actually excel in areas that big brokers claim as their strong points: placement and analytics. Lets take a closer look. Placement. Large brokers like to boast that because of their size they have clout with the markets. Thats a myth. Risk is risk. Specialist brokers, which go the extra mile to understand and package a risk, typically secure equal or better rates. Indeed, many reinsurance markets actually seek out business from the value-added brokers because they know that plenty of hard work has gone into understanding the risks they are ready to trade. So bigger is not better when it comes to placement. Analytics. Big brokers, because of their size, are said to have better analytics. But is that really true? Many would argue that reinsurance analytics has been rather moribund over the last several years. Why? Lack of competition. Creating new technology is expensive. Moreover, the big brokers prefer clients whose programs they can easily renew. They dont want demanding clients; they want clients that conform. When it comes to analytics and technology, the real advances are coming from the Economies of scale are good for specialist companies, not the big brokers. For example, value-added brokers have making flat-panel TV sets, not found that there is too much reliance on model output, particularly the PML
complex reinsurance structures.

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Opinion: The Reinsurance Market Needs More Distribution, Not Less - Carrier Management

found that there is too much reliance on model output, particularly the PML complex reinsurance structures. (probable maximum loss). For that reason, specialist brokers have been working on developing more diverse risk indicators tailored specially for individual companies and simulation software that is much faster and cheaper to run. What little thinking or technology the big brokers have developed lately tends to benefit them, not necessarily the reinsurance client. Again, bigger is not better when it comes to analytics. In fact, specialty brokers are where the action is today. Forces For Better Distribution While reinsurance distribution remains constrained for the time being, I believe two forces will ultimately restore competition and improve reinsurance distribution. The first force will be smart, demanding clients that want to compete and will insist on a high level of performance by their reinsurance intermediaries. The other force will be economic. Low interest rates will be around for some time to come. The only way insurers can make money in this environment is by underwriting. Gaining an edge by working with an insurers broker to find customized solutions to make better decisions will be the key. Mass-produced, off-the-shelf products wont cut it. Insurance underwriting requires lots of hard work and creativity. Many insurers will seek out the high-value specialist brokers. In the meantime, I urge primary insurance carriers to demand the most of their reinsurance intermediaries as well as themselves. By striving for excellence, we foster real competitioncompetition which will be good for everyone.

CONTRIBUTOR
Mike Schnur, TigerRIsk Mike Schnur is a Partner at TigerRisk with more than 30 years of experience in the industry. Before joining TigerRisk he held EVP positions at Benfield and Guy Carpenter. He began his career as a reinsurance underwriter, first with General Re and then with F&G Re.

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