Brokers pressured, but alternative capital (& insurtech) are opportunities

by Artemis on March 24, 2016

Brokers face increasing pressures, with revenue and profitability likely to continue to be impacted due to the softening reinsurance market environment, but one bright spot could be the growing alternative markets according to rating agency Fitch, while another could be technology.

Insurance and reinsurance brokers have continued to display strong balance sheets and operating performance, according to Fitch, with margins across a group of 5 U.S. brokers averaging 16.5% in 2014 and 2015. Fitch anticipates stable to modestly improved broker profit margins in 2016, but largely due to reductions in expenses as well as earnings growth.

But while balance sheets are strong, and performance adequate, organic growth potential is being affected by the softening of reinsurance and also pressures in commercial insurance markets.

“Revenue and organic growth rates will remain pressured from continued flat or declining premium rate changes in most commercial insurance segments and a soft reinsurance market,” Fitch Ratings explains.

So brokers are facing headwinds, in the same areas where reinsurance companies and commercial insurers are feeling the pressure. Despite this Fitch ratings maintains a stable outlook for brokers and expects their balance sheets will support that for 12 to 18 months.

Additionally Fitch sees opportunities for brokers, with one of those being alternative capital and ILS.

Organic growth is expected to continue, helped by primary insurance premium growth, with emerging markets, classes of business such as healthcare and “alternative reinsurance markets” seen as potential “sources of expansion and opportunities” for the broking community.

Brokers can establish themselves as experts in helping investors to access risk, as they hold the keys to significant amounts of the marketplace. But brokers need to establish themselves here rapidly, as already trends may be over-taking some smaller players.

With margins having flattened in recent years, as pricing pressure has resulted in brokers having to trim some of their fee income, there are other areas where disruption could be coming from next for the broking community and many are driven, in part, by ILS and alternative capital trends.

The trend towards narrowing the gap between risk and capital, as evidenced by the program business and fronting activities of some ILS investors and managers, as well as large global reinsurers willingness to go direct and disrupt the risk to reinsurance value-chain, will erode broker profits further.

While the large primary insurer trends towards greater centralisation, retention, or establishing their own internal, or total return, or sidecar type reinsurance structures, all in an ongoing effort to extract more premiums from the risks they underwrite, will again impact on brokers revenue opportunities.

Some of the fronting activities seen in the U.S. commercial property markets must already be eroding some broker income, as they often take a step out of the chain to bring risk more directly to ILS or capital markets investors, thus skipping the syndicated reinsurance market entirely.

As these initiatives gain more scale and become more widely practiced the effect could be that an increasing pool of risks is removed from the typical syndicated reinsurance renewal cycle, thus affecting brokers to a degree as they are taken out of the loop.

Add in the efforts of insurance technology (insurtech) start-ups, many of whom are looking not just at improving customer interaction or back-end efficiency but more holistically at making the chain of risk to capital shorter and more efficient, and it’s easy to see that brokers face a number of challenges going forwards.

The large global brokers will respond, with an expectation in the market that broker-led facilities will grow in prevalence, despite a number having failed to gain significant traction in recent years. Brokers should also be leading the insurtech wave, as these key holders to risk could themselves help the market to embrace efficiency.

Brokers should also position themselves as owners of new insurance technology platforms that can perhaps replace lost revenues, a case of disrupting themselves in order to keep their spot in the value chain intact. We could see a spate of broker and technology startup M&A.

How long until a broker launches a largely automated, algorithmically driven, capital markets investor backed re/insurance facility, perhaps tacked onto the side of Lloyd’s or simply taking a share of their diversified property catastrophe reinsurance brokered business? Surely only a matter of time.

Also read:

– Swiss Re ready to disrupt the risk to reinsurance capital value-chain.

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