As we first noted in our 2014 publication, Broking 2020: Leading from the front in a new era of risk, trends reflecting larger macroeconomic forces have been fueling a contentious debate between brokers and underwriters on compensation, leading to a war of words in 2017 that saw leading players on both sides invest to reinforce their market positions. The same trends are also driving increased customization of products, increasing reliance on direct-to-consumer models and greater economies of scale for an increasingly large number of market participants. Collectively, we categorize these trends into the “three Cs” of consolidation, customization and collaboration.
Consolidation: We continue to see overall consolidation of the brokerage market; Conning tracked more than 450 transactions through October 2017. This activity compares favorably with 537 transactions in 2016 and an annual average of 414 transactions from 2011 to 2015. Looking forward, the factors that are driving consolidation and greater levels of operational efficiency include a low-interest-rate environment, the presence of alternative capital providers and continuing demand for expanded broker capabilities.
Customization: Over all, the desire for more localized market knowledge and custom products is a strong and recurring trend, with historically strong insurance hubs such as Lloyd’s recognizing the increasing need to meet local demands. For brokers, the need is clear: provide local knowledge coupled with global scale to rapidly place risks across geographies.
Collaboration: Technologies such as blockchain have the potential to transform insurance processes, providing efficiency savings and greater levels of information to both brokers and their customers. Depending on blockchain's ultimate implementation, it is possible that brokers could operate within a fully electronic process or be innovated out of it (i.e., be replaced by electronic platforms and algorithms for many categories of risks). Ultimately, the broker’s place in the insurance lifecycle likely will remain despite increasing automation, but for those risks from which an intermediary can be removed, disintermediation will occur. For example, we have seen innovative carriers such as Hiscox offer a direct-to-consumer model for small commercial risks.
Trends that had an impact on the personal lines market in prior years are beginning to affect commercial lines, with risk managers looking for more customized products and technology-driven innovations for even the most specific product classes.
Consolidation: The commercial brokerage market has experienced continued consolidation, with the top 10 brokers generating 2.5 times more revenue than the next 90 brokers in the market (Conning Insurance Segment Report: Property – Casualty Distribution, p. 2). We believe that three trends are driving this M&A wave:
1. Alternative capital – Alternative capital providers (e.g., hedge funds, private equity) have continued to play a role in accelerating consolidation, lured by consistent revenue streams (many brokers have renewal rates in the 80% to 90% range), as well as systemic diversification outside of the debt and equity markets. With continuing low investment yields, the presence of alternative capital is expected to keep influencing the market. The “hunt for yield” has raised broker multiples and created a feedback loop of higher valuations and deal volumes.
2. Stagnant revenue – Despite some short-term hardening as a response to catastrophic events in the second half of 2017, we believe generally favorable loss experience and historically high policyholder surplus will continue to pressure pricing for the foreseeable future. As a result, premium pricing could remain soft across most commercial classes, thereby restricting both premium and commission growth.
This ceiling on commission growth will challenge brokers of all sizes to improve their internal cost structures, particularly for back-office processing, which can represent well over half of their operating costs. They are increasingly able to cut costs through technology initiatives that automate standard or low-value processes, as well as introducing better analytics and sales tools to increase conversion and retention ratios.
3. Demand for local market presence – As risk managers struggle with increasingly complex risk exposures, they are looking for brokers to provide enhanced services across their enterprises. While this would seem to benefit the largest brokers, we believe there is a growing appetite for a seemingly contradictory skill set: a global footprint with enhanced local knowledge – which puts pressure on brokers to expand their footprint in new or existing locations.
See also: Why Commercial Insurers Can Rock
For brokers whose operating model is “hub and spoke” with branch offices remitting central placement to a global office, we believe smaller specialist firms that can provide immediate service on the spot will continue to compete strongly against brokers that are unable to provide comparable, enhanced local support. In fact, this expectation goes beyond the brokerage side of the value chain to insurers and even placement markets such as Lloyd’s, which are increasingly challenged to provide more efficient and localized service.
PwC’s 2014 “Risk Buyer Survey” noted that risk managers ranked price-driven change as the third most likely reason to switch brokerages, below service capabilities and geographic reach. This strongly implies that brokers must continue to expand their service offerings while simultaneously offering local market knowledge and global scale.
Three trends will continue to fuel the broker consolidation wave: alternative investors bringing new capital to the market, stagnating broker revenue driving efficiencies of scale and demand for greater local market presence.
Customization: Current operating models need reassessment as the insurance buyer demands change. Beyond price, buyers are looking for a variety of choices and flexibility when working with their insurance brokers. The demand for choice has begun to split the commercial market, with buyers falling into two behavioral groups:
- Insurance as a service: These buyers look for comprehensive risk management solutions and view insurance as a set of services (risk transfer, risk management and risk mitigation) that can lower their overall exposures to loss.
- Insurance as a product: These buyers view insurance as a product and transaction and therefore look for the best combination of price and ease of doing business.
- Direct-to-consumer carrier: Insurers such as Hiscox offer a consumer-facing website that allows SME markets to quote select liability exposures directly.
- E-brokerage: Internet brokers such as Coverhound allow purchasers to submit quote information on-line.
- Peer to peer: Startups like Lemonade and Bought by Many may displace the entire insurance model with peer-to-peer risk pooling.
- Risk Management – Blockchain could be combined with other Internet of Things products (such as RIFD) to track the transport of high-value goods.
- Policy Validation – Blockchain implementation could support policy validation in real time, minimizing coverage validation and improving subrogation/recovery capabilities. Steps to create insurer-to-insurer (I2I) communications have already begun, with the carrier-led “B3i” initiative between Aegon, Munich Re, Zurich, SwissRe and Allianz to link the numerous insurer-specific use cases for blockchain.
- Reinsurance – Complex, multi-layer reinsurance contracts could be managed on a common blockchain, allowing participants to automatically track and manage ceded/assumed premiums and losses.
- Faced with the “three C’s” of consolidation, customization and collaboration, we believe brokers have an opportunity to implement changes before these trends cause even more disruptive change(s). Changing buyer demands will require brokerages to reassess their operating models to confirm they provide the correct balance of enhanced local market knowledge and scale efficiencies.
- Industry consolidation will further concentrate market power. Smaller brokerages need to determine the appropriate business strategy for a market where the top 10 brokerages produce 2.5 times as much revenue as the next 90 firms.
- Brokers could position themselves to compete in price-sensitive “insurance as a product” markets or establish risk management/advisory offerings to serve “insurance as a service” buyers.
- Emerging technologies such as blockchain have the potential to disrupt insurance placement and policy management processes. Brokers should establish a plan to leverage these emerging technologies to manage or avoid disruption from new market entrants.
