Big Data vs Big Service

BIG DATA VERSUS BIG SERVICE

JAN 2016 MADE IN SINGAPORE

ONLY WHEN THE TIDE GOES OUT DO YOU DISCOVER WHO’S BEEN SWIMMING NAKED 2008

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Sub-prime crisis; near collapse of US & European Banking Industry.

2009

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Global Recession; growth of US Shale Gas production at record levels; development of new global banking regulations in response to Subprime.

2010

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Eurozone crisis emerges.

2011

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ECB bailouts for Spain & Greece; S&P downgrades US Sovereign Debt; Chinese post-recession boom commences; Arab Spring.

2012

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Number of unemployed Europeans reaches its highest ever level.

2013

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World begins to emerge from recession albeit slowly.

2014

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Russian invasion of Ukraine; deflation in Japan, recession in Russia; collapse in oil prices.

2015

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Slowdown in emerging market economies particularly China; Baltic Dry Index hits record low; Brent Crude oil spot price crashes to below 35USD/ bbl; tangible signs of economic recovery in US.

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Eight years after Sub-prime and we are still waiting for the global economy to emerge from the depths of the most severe downturn since the Great Depression of the 1930s. The December 2015 increase in US interest rates is seen by many as the first tangible sign of a sustainable recovery but with Southern Europe, China, Japan and Russia all facing unprecedented economic challenges in 2016 it remains to be seen whether this will prove to be yet another false dawn. Some would argue that normal service has been resumed with the US regaining its position from China as the dominant ecomonic force in the world, industrialised nations generally prospering and volatility being experienced in emerging markets.

The insurance industry meanwhile continues to flatter and deceive in equal measure.

Predatory investors desperately seeking better returns in an era of near zero interest rates have found some comfort in an insurance industry that has enjoyed a period of remarkably low natural catastrophe activity.

Reinsurers are widely reporting 2015 as the lowest in terms of insured natural catastrophe losses for several years (USD 27bn insured losses part of USD 90bn total losses), and down on 2014 (USD 31bn insured losses out of USD 110bn total losses) – Source: Munich Re.

At their current level natural catastrophe losses are significantly below 1% of total global insurance capacity.

That influx of capital has saturated a market already struggling with excess capacity and the marine hull market in particular, with the added appeal of nonaggregated risks, has been profoundly affected. Premium rate reductions of 2030% for well performing operations are not uncommon. That is great news for our clients but not such good news for the long-term sustainability of an industry in which insurers have consistently struggled to deliver single digit underwriting returns.

Many believe that the release of financial reserves to boost short term profits blighted by poor underwriting results has become a steroid that the industry may find difficult to live without.

To counter this contractionary pressure on revenues insurers and brokers are seeking to achieve growth and realise economies of scale through mergers and acquisitions, resulting in a dramatic period of consolidation within the industry.

2015 was by far the most active year in terms of M&A deal values since 2010 with well in excess of USD 100bn of deals.

MAJOR MERGERS & ACQUISITIONS AFFECTING THE MARINE HULL MARKET (CONFIRMED AND/OR PENDING) INSURERS

EU Solvency II regulations came into effect on 1st January 2016, 13 years after their origins. The regulations reward well diversified insurers with lower capital requirements. This is expected to contribute to more M&A activity as larger insurers look to diversify further and smaller niche insurers seek to better cope with the new analysis and reporting requirements that Solvency II brings.

BROKERS Lockton

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LCH

Lockton

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PL Ferrari

Willis

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Miller

Willis

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Towers Watson

Sande

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Houlder UK

Barbican

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Seacurus

Marsh

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SIS Korea

Odyssey

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Integro

Integro

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KWW

Mitsui

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Amlin

Hyperion

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RK Harrison

Ace

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Chubb

Calera Capital

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RFIB

XL

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Catlin

Partner Re

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Axis

TokioMarine

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HCC

Fairfax

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Brit

Endurance

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Montpelier

Fosun

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Ironshore

Swiss Re

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RSA HK

Allied World

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RSA Singapore

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The wave of M&A is set to continue in 2016 as a number of intermediaries look for sales, pushed by competitive pressures and pulled by elevated valuation multiples.

AM Best are negative about insurer prospects in 2016 due to low investment income and low underwriting margins. They see consolidation, diversification and balance sheet scale as the answer.

SOURCE: DELOITTE

As insurers and brokers continue to grow so too does the temptation to depart from traditional risk based underwriting and broking and move towards ‘big data’ portfolio trading.

This is nothing new. For years now the larger brokers have sought to subsidise falling income levels from their clients by actively seeking out market agreements with selected insurers, trading portfolios of risk rather than broking individual accounts on their own merits.

These agreements generate additional revenues for the broker and enable insurers to capture a share of evasive premiums without incurring the costs usually associated with underwriting individual risks.

The unprecedented level of M&A activity in the market will only accelerate the process.

This commoditisation of risk is creating a divide within the marine insurance industry. There are those that believe it is the future. That we are in the age of ‘big data’ and only organisations of a sufficient size and scale will survive this purge. Others view this trend as the single largest threat to the industry and opine that if left unchecked could spell the end of marine insurance as a specialty business.

The reality, as is so often the case, exists somewhere in between those two extremes. There is no doubt that the mega brokers and insurers have changed the specialty insurance landscape. Their scale combined with the globalisation of our business enables faster and more cost efficient risk transfer, generating savings that should be passed on to our clients in the form of lower premiums.

There is however a very real danger that in the pursuit of operational efficiency the industry is neglecting to invest in its primary assets, its people.

There is however a very real danger that in the pursuit of operational efficiency the industry is neglecting to invest in its primary assets, its people.

A broker today has more clients to service, less time to understand his/her client’s business, less time to consider the exposures that business faces, less time to develop an appropriate wording, less information to effectively and accurately broker the risk to the insurer and crucially, less of an incentive to address these shortcomings because of the level of brokerage he is likely to earn on each risk.

Stagnant top line growth is leading big companies to consider M&A as the ultimate solution to the grind of sales and marketing.

The Willis - Towers Watson deal worth USD 18bn was completed on 5th January 2016 creating an entity of 39,000 people in 120 countries. The deal is expected to generate USD 100-125m of annual “mergerrelated” savings.

The colossal Willis - Towers Watson deal was eventually completed after much ado about [under!] valuation on 5th January 2016 creating an entity as impressive as it is monstrous. The senior executives and rainmakers will doubtless be well taken care of but it remains to be seen what impact those higher costs and the expected USD 100125m of annual “merger-related” savings will have on client service.

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In such times it is all too easy for decision makers to lose sight of the real prize in what is after all a service industry.

Success in any M&A transaction is well deserved with the countless challenges that exist when trying to integrate organisations of such size and diversity.

Cross-selling is no easy win. Neither is cultivating a positive corporate culture against a backdrop of higher revenue targets and depleted resource. In such times it is all too easy for decision makers to lose sight of the real prize in what is after all a service industry.

An underwriter today has fewer revenue streams, is more dependent on his/her biggest producers, has less underwriting information, less underwriting authority and is more reliant on his/her underwriting model and peer review process than ever before.

Risks that do not fit an organisation’s underwriting appetite are either discarded or a solution is applied that is not fit for purpose because the time required to properly assess the exposure, come up with a solution and obtain approval from management to apply it, renders the risk uneconomical.

Portfolio Underwriting is the market’s attempt to overcome these afflictions but as with many would be remedies, it addresses the symptoms rather than the cause. In the long term, this ‘remedy’ is likely to compound the problem by accelerating the ‘brain drain’ effect that has been so prevalent in our industry for the last decade.

How do we incentivise investment in young talent if the brokers and underwriters of the future will exist to provide little more than a glorified post box service?

How do we incentivise investment in young talent if the brokers and underwriters of the future will exist to provide little more than a glorified post box service? Those that already have the knowledge and expertise are being denied the opportunity to use it and tragically, the platform on which to pass it onto the next generation.

The quest for new revenue is also blurring the lines between the role of the broker and that of the insurer.

Traditionally brokers acted as the distribution arm of the insurer who focused purely on underwriting but the market is evolving. Reinsurers continue to jump into the direct market, Swiss Re and Berkshire Hathaway being two of the most active in that respect. Japanese insurers have huge war chests available to them as they seek solutions to a shrinking domestic economy and business.

Lloyd’s continue to drive growth in their overseas platform with new operations in India and Malaysia expected to commence trading in 2016.

The threat to wholesale brokers has never been so evident but brokers are evolving too.

The transition from Portfolio Broker to Managing General Agent is a short one and is becoming so common in this market that it can be almost impossible to differentiate between broker and underwriter.

Both portfolio underwriting and the emergence of MGAs is contributing to a weakening of the traditional client – broker – underwriter relationship, the impact of which can become acutely evident when trying to collect a complex claim.

Insurance is not a perfect science and imperfection always has the potential to cause differences in interpretation and application.

Where strong, clear relationships exist between the client, the broker and the underwriter, parties will invariably work together to find a solution in the best interests of maintaining those relationships, with insurers more often than not willing to give the client the benefit of any doubt.

Where no such relationship exists then the dynamic can be very different.

Increasingly insurers and MGAs seem quite prepared to sit behind spurious technicalities and caveats in an attempt to mitigate their losses Increasingly insurers and MGAs seem quite prepared to sit behind spurious technicalities and caveats in an attempt to mitigate their losses – a worrying trend evident even amongst some of the most recognised claims leaders in the industry. This is a natural result of the separation between client, broker and underwriter and will continue to deteriorate if the market remains on its current path.

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The cure is simple but difficult to swallow; fewer clients, bigger service.

Global Economic Slump

Fewer clients, bigger service.

Lower returns from traditional investments

With CEOs already struggling to satisfy shareholder expectation you will not find many organisations willing to embrace that mantra but then when has the correct decision ever been an easy one?

One of the negative consequences of Solvency II is that it encourages the misguided belief that “bigger is better”.

The same sort of arrogance that led to a "too big to fail" attitude in the banking sector. Ironically the bigger the financial organisation (no matter how well diversified and balanced) the harder it is for the often under resourced regulator to unpick their activity leaving the organisation to police themselves.

“If a blind man leads a blind man, both will fall into a pit.”

There is certainly a place in our market for big data and it would be naive to think otherwise but we must guard against over-commoditisation and the pursuit of growth without due regard for quality or long term sustainability. If Sub-prime has taught us anything it is that taking short-cuts and flouting the fundamental principles of your business will result in spectacular failure with far reaching consequences for your industry and for those that depend on it. We must endeavour to preserve and impart the knowledge we have accumulated over centuries to ensure we continue to provide our clients with products and a service that they can truly rely on. After all, “If a blind man leads a blind man, both will fall into a pit.”

Insurance relatively more attractive

Increased capital in insurance particularly marine due to nonaggregation of risk

Excess Capacity

Downwards pressure on premiums

Erosion of Underwriting and Broking margins

Pressure to reduce costs

Reduced investment in underwriting, broking and claims expertise

Increased M&A activity, portfolio underwriting and MGAs

Commodotisation of risks, generic products not fit for purpose

Weakening of client – broker – underwriter relationship

More claims disputes

Tigermar Global Pte Limited 24 Raffles Place, #11-02 Clifford Centre, Singapore 048621 (Company registration number 201331624C) TEL: +65 6715 8760 FAX: +65 6532 0194 www.tigermar.com