Broker facilities an opportunity for third-party capital to expand reach?

Rating agency A.M. Best raises an interesting question in a report published today which looks at the impact of broker arranged facilities in the London insurance and reinsurance market. The report looks broker arranged facilities and suggests that they could be an area of opportunity for alternative reinsurance capital.

These broker facilities, often cited as ‘full-follow’ facilities as the participants typically contribute a defined amount of capacity on every placement through a broker in a market, have received a lot of publicity in recent months.

The Aon and Berkshire Hathaway sidecar type arrangement at Lloyd’s, which sees Warren Buffett’s reinsurer take a 7.5% share of all of Aon’s subscription business running through Lloyd’s, said to involve Aon brokered business with a retail premium in excess of $2.5 billion, is one example.

Broker Willis is also planning a facility, dubbed ‘Willis 360’, which is still in development but plans to develop commercial insurance cover and risk management solutions for medium sized UK businesses. It’s thought that the Willis 360 facility will provide capacity for
approximately 20% of any single placement on the brokers London market specialty book.

A.M. Best’s report suggests that these broker arrangement could result in a lossening of underwriting standards, eventually contributing to a reduction in underwriting performance. A.M. Best said that its concern is that participating insurers may lose control of where their capital and capacity is deployed.

Stefan Holzberger, managing director, analytics, commented; “A.M. Best would regard it as a negative development if insurers became over reliant on whole account broker deals as a source of business flow and if they become even more dependent on large brokers. Insurer margins may also be squeezed if brokers take some form of block commission on deals. While brokers’ management information has generally improved in many aspects over the past decade, there are potential questions over their ability to capture accurately, for example, reserves.”

Interestingly, A.M. Best notes that these facilities could offer an opportunity to alternative and third-party capital, as a new way for them to enter the reinsurance, and perhaps even the insurance, marketplace. Involvement of non-traditional capital in a broker facility could result in additional pressure on rates at a time when the market is over-capitalised and excess capacity is chasing business.

That is a very interesting suggestion. For alternative capital, participating in a full-follow, broker led facility like this would give excellent access to business and a diversified portfolio of risk. A facility which involved a fixed percentage of every line underwritten at Lloyd’s, similar to the Aon – Berkshire Hathaway sidecar type deal, could be extremely attractive to a consortium of pension funds, for example.

If a broker arranged such a facility, involving a number of large pension funds, it could have significant capacity to deploy each year, perhaps in the billions of dollars. By gaining a small piece of the riss underwritten in every bit of business a major broker placed at Lloyd’s, the pension funds would as a result be gaining access to an extremely diversified book of insurance and reinsurance. Far more diversified perhaps than most other reinsurance-linked investment opportunity in the ILS and alternative reinsurance market.

In a similar vein, perhaps a major reinsurer could establish a facility backed by pension funds as a way to boost its own underwriting capacity. If, for example, one of the big four reinsurers tied up with a number of large pension funds it could give the full-follow facility a small quota-share of every reinsurance contract it underwrote. The result of which would again be a highly diversified portfolio, across much broader lines of business than your typical ILS or reinsurance-linked investment opportunity.

This could give the alternative and third-party capital providers a way to broaden their reach much more rapidly outside of property catastrophe reinsurance. Facilities could be set up to focus on certain areas of the market, allowing capital providers to allocate capacity to many, or they could take a slice across the entire market, bringing alternative capital into areas of insurance and reinsurance it was once thought hard for it to reach.

Perhaps this is the kind of structure we will see evolving out of the current reinsurance market, as it evolves, adapts to and embraces alternative capital. Third-party or institutional investors such as pension funds becoming capacity providers, brokers taking charge of the placements, reinsurers acting as risk portfolio and underwriting managers. When you think about it, it’s not that different to the way some parts of the market are operating today.

You can access the press release and report on broker facilities from A.M. Best via this press release.

More reading:

There are so many reports and commentaries coming out on alternative reinsurance capital and ILS in the run up to the Monte Carlo Rendezvous event that we felt it worth highlighting some other reading on the topic, all from the last week or so, which you can find below (most recent first):

– Demand for alternative reinsurance instruments and ILS to continue: Fitch

– Alternative capital the biggest challenge for traditional reinsurers: Moody’s

– Lloyd’s Nelson warns on ‘systemic’ risk of alternative reinsurance capital

– Broker facilities an opportunity for third-party capital to expand reach?

– Opportunity for reinsurers to learn from ILS: Aon Benfield CEO

– Capital markets investors boost global reinsurer capital to $510 billion (including a useful list of links to many alternative reinsurance capital initiatives that we have covered previously)

– Strong capital inflows bring ILS & cat bond market to new high: Aon Benfield

– Alternative capital a disruptive force in reinsurance: Goldman Sachs