Academic journal article The McKinsey Quarterly

Brokers vs. Insurers

Academic journal article The McKinsey Quarterly

Brokers vs. Insurers

Article excerpt

Massive consolidation has taken place among the distributors of commercial insurance over the past ten years. Three global insurance brokers--Marsh McLennan, Aon, and Willis Corroon--now dominate most of the markets where brokers are active.

Insurance companies are taking the hit, for the clout of the global brokers has helped drive down insurance prices--a development that benefits corporate clients but squeezes insurers. Meanwhile, market deregulation in many markets, such as the European Union and Japan, has increased competition among insurers and thus exerted further downward pressure on prices.

Clearly, the balance of power between brokers and insurers is changing. But if they focus too closely on this competitive dynamic, both insurers and brokers may fail to address their fundamental weaknesses and therefore risk losing out to new entrants, such as investment bankers, Internet companies offering financial services, and specialist risk consultants. These competitors are in a position to exploit the inefficiencies of an insurance industry that is not sufficiently focused on the needs of its clients. Up to 35 percent of premiums are spent on transaction costs--equivalent, on a worldwide basis, to as much as $140 billion that is not invested in growth or returned to shareholders. By contrast, the most efficient companies, which deal directly with individual customers by telephone, spend only a third as much of their revenue on administration.

Brokers and insurers could pay a very high price if they fail to collaborate, to refine their organizations by segmenting their clients and improving their management of knowledge, to develop new products and service models, and to use technology to cut transaction costs. Among other things, this risks putting new entrants like investment bankers, Internet companies, and specialist risk consultants in the driver's seat.

A changing broker market

The traditional role of brokers has been finding insurance for corporate clients, negotiating the price and scope of coverage, and advising clients on the design of their risk programs. Most brokers make money by taking commissions from insurers on the premiums paid by clients.

In the United States, as well as the United Kingdom and some other European countries, brokers dominate the distribution of commercial insurance, for in these relatively deregulated and competitive environments they can influence the choice and terms of insurers. Brokers have also begun to gain market share in such deregulating markets as Italy, Spain, and Latin America. Japan's deregulation of insurance in the late 1990s legalized brokering and the entry of global brokers into the local market.

But industry forces are changing the role of brokers. Excess underwriting capacity and falling insurance prices have reduced the value they can add to transactions by matching insurers with customers and negotiating terms. Sophisticated corporations question the need for insurance, preferring instead to develop their own internal risk management operations, which has forced traditional brokers to develop new consulting skills to serve them. Technology is another source of pressure: brokers could find themselves bypassed altogether if they do not respond by devising technology-based service models. All of these developments are depressing brokers' revenue from traditional sources and turning transactional sales organizations, which receive commissions from insurers, into professional risk advisers receiving fees from clients.

Despite the structural pressure on the income of global brokers, they have performed well in recent years as compared with insurers by combining traditional economies of scale with increased buying power to gain a larger share of the value generated by insurance transactions. In the United States, brokers' shares have outperformed those of the insurance sector as a whole by more than 65 percent (exhibit). …

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