Magazine article Risk Management

Insurance Broker as Risk Consultant

Magazine article Risk Management

Insurance Broker as Risk Consultant

Article excerpt

Over the next ten years, the role of the insurance intermediary will expand into a function that will differ in many respects from the ways we have generally looked at this business in the past. The intermediary will be transformed in many ways similar to changes that have taken place in the securities industry--an occurrence that is not coincidental. As a consequence of this new role for insurance intermediaries, there will be several significant structural changes in the insurance brokerage industry.

There are certain underlying presumptions about the current functioning of the commercial property/casualty insurance industry from which I derive my views of the new role for the insurance intermediary. Let me enumerate these guiding principles at the outset. First, insurance is now thought of as only a subset of a broad range of risk management techniques for controlling loss exposures. In many situations, it is not the most efficacious method. Second, the commercial insurance industry has increasingly become a worldwide business in which pools of risk-bearing capital can be accessed in a highly efficient manner.

Third, the evaluation of credit risk, or the potential inability of an insurer to meet its policyholder obligations, has taken on a new dimension of importance in the current period due to the enormity and unpredictability of both underwriting and investment risk. Fourth, potential loss exposures have become increasingly large in size, complexity and unpredictability. These exposures parallel growth in the worldwide economy, continued advances in technology, geographic concentration of values, the increasing occurrence of weather-related catastrophic events and worldwide expansion of a judicial system based on contingent fees for plaintiff attorneys. And finally, further worldwide competitive pressures will continue to force buyers of commercial insurance to push down the distribution costs embedded in the price of the product and to foster more efficient distribution methods.

So what does all this mean for the insurance intermediary? Generally, it implies that the traditional insurance broker will give way to a new breed of risk management consultant who works for an entity that looks in many ways like an investment banking firm of today. Put another way, the added value associated with placing commodity commercial lines will become so small as to render this activity an extremely low-margin business. That isn't necessarily to argue that this activity should not be done by international brokerage firms, but that it will have to be performed in a more innovative manner than is done today.

These developments are very similar to the changes that occurred in the institutional equity secondary trading business following the end of fixed commissions. Commissions for this activity have been slashed dramatically to levels that are now only pennies per share. If investment banks had remained heavily dependent on the profits of their secondary equity market trading activities, their profit margins would have collapsed. Consequently, this industry was compelled to develop higher margin businesses, such as mutual funds and new forms of complex securities, to enter emerging securities markets and to undertake principal investments through merchant banking subsidiaries while re-engineering commodity-like operations to become more efficient.

Consequently, the large international insurance brokerage firms will increasingly be compelled to expand their business into higher-margin (i.e., higher value-added) activities. One noteworthy example of such diversification has been the move by major insurance intermediaries to create market capacity in lines of business that are experiencing acute shortages. In certain respects, this activity has become so institutionalized that brokerage clients are coming to expect that their intermediaries will play an active role in solving their coverage shortfall dilemmas rather than simply seeking out the available market capacity (often on terms and conditions that are highly punitive to the insured). …

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