Disintermediation and denial

Disintermediation is heard increasingly often in the market’s lexicon these days. It is also also an awkward taboo for the sector. But accepting a situation is the first step of responding to most looming problems. It just won’t be easy to stomach for some well-heeled underwriters or intermediaries accustomed to pocketing comfortable salaries and fat fees.

Disintermediation was an elephant in the room when I was sourcing market opinion on several chosen topics ahead of this year’s Rendez-Vous de Septembre event in Monte Carlo. People are talking about it; luckily, a few chose to comment; but when it is discussed it is usually in hushed tones.

Simply put, disintermediation is the idea that there are too many links in the risk transfer chain (i.e. insured, insurance broker, managing agent, insurer, reinsurance broker, reinsurer, retrocessionaire), and because of operational costs throughout this chain, the industry is inefficient – leading to a suggestion that some links could be cut.

When the expense ratio is 40% and a significant chunk of premium is taken up by commissions, fees, administration and operational costs, the client has a right to wonder whether they are getting value for money from the risk transfer industry. How many re/insurance firms claim to be “customer focused” or “client orientated” (or some such vacuous marketing spiel), while the numbers reveal a long chain of self interest in action?

Inefficiency and expense are starting to bite the insurance industry. Lloyd’s recently announced a 10% cut to its corporation headcount. In this month’s CEO Risk Forum supplement, Beach’s CEO Grahame Millwater argues that the insurance value chain has become too long and too expensive.

The inefficiency problem has only grown with the continuance of the soft market. Traditional reinsurance firms are under increasing pressure: declining rates mean progressively weaker risk-adjusted prices; brokers likewise see their fees squeezed within shrinking premium; and expense ratios remain high.

I have never written about reinsurance during a hard market. The soft market has been a constant reference point during my years of writing at Reactions. In 2010 when I joined the magazine, the market had several characteristics: rates were stubbornly soft; competition was strong; and the supply of capacity was too plentiful to shift the weak prices.

Little has changed, you might think. Back then, insurance linked securities (ILS) seemed less of a threat. Of course back then – or so I thought at the time – it referred to a straight-forward concept: catastrophe bonds and industry loss warranties. Nowadays, of course, third party capital has boomed – boosted by pension fund money into collateralised reinsurance – into a major influencer of the soft pricing.

The ILS arm within a reinsurance business has at times been a pariah within the organisation. One reinsurance buyer I spoke to recently suggested that the relative cost of fees for ILS versus traditional reinsurance went some way to highlighting the fat – among brokers, in this example – that could still be cleaved from the sector. The question is this: when a cedant opts for a private collateralised reinsurance placement, do they go via their traditional reinsurance broker or an ILS specialist? The fees charged for the same end result may differ wildly, the source suggested.

The disintermediation theme is visible, to varying degrees, in some other re/insurance market trends. Reinsurers setting up primary insurance businesses is one potential example. Big reinsurance firms with the data and analytics as well as scale to do so think they can do insurance better than their insurance clients. It might also contribute to cutting out some of the other links within the chain.

Insurtech promises to be a disruptive force of disintermediation, promising to streamline insurance buying, broking and claims processes, as well as to replace more costly human roles within the chain. The industry is spending $1bn on insurtech as of the second quarter this year, according to a Willis Towers Watson estimate.

Insurers opening up managing agent businesses is, on the one hand, a sign that getting paid fees rather than running underwriting risks is increasingly attractive. However, much of the capacity comes from third party capital, particularly those pension funds, which is increasingly being drawn into insurance as well as reinsurance. This alternative capacity might be one of the disruptive forces that drives disintermediation.

The lesson in being disciplined – about headcounts, fees and other costs – would be better heeded sooner rather than later. Delaying or denying the inevitable could only make the medicine tougher to swallow, or in the case of companies with their heads still stuck in the sand, lead to them being disintermediated.

On a personal note, this will be my final comment as the editor of Reactions. It’s been lots of fun over the years, and I hope you enjoy this September’s magazine.