Grant Ellis says that commercial insurance market must change its inefficient operating model

It’s funny what ‘goes around, comes around’ isn’t it? Five years ago exactly, in December 2002 I was asked to write an opinion piece for an insurance publication due out the following January. Hot topic of the moment was Folgate, recently acquired sister corporation of Towergate, who were in the process of remodelling themselves as a broker.

Their strategy was simple – buy regionally based SME brokers, and work exclusively with a small number of insurers to improve the earnings on the business transacted by both parties. A pretty straightforward strategy when reviewed from a 2007 viewpoint, but in 2002? Rereading my missive now, it’s clear how shocked the rest of the market was by what was considered a very audacious move at the time.

Many pundits, yours truly included, speculated on how sustainable such a model was, and on the ‘ethics’ of leveraging one’s influence so pointedly.

Those insurers on the outside also rushed to side with their independent broker colleagues in condemning the model, expressing their horror at the levels of commission which were being mooted.

Despite the protestations of doom, Folgate (which formally merged with Towergate in 2005) continued to pursue its strategy and grow its business through acquisition. To the consternation of everyone else, the model did not fail, but continued to prosper. The supporting insurers continued to support it, and others clamoured to become involved.

Brokers, who were quick to condemn in 2002, started to wake up to the fact that, as long as they had scale, they too could negotiate improved earnings from the business they transacted. And so the consolidator was born.

Today much of what Folgate was pioneering in 2002 is ‘business as usual’. There are fewer brokers, and insurers know that they have to pay a fair price for access to the very lucrative SME market that the remaining large brokers provide.

But while size is clearly important, it’s not simply a matter of scale but also of efficiency and profitability too. For far too long the commercial insurance market has had a very inefficient operating model, awash with duplication, and parochial behaviour. In the new world where distribution is king, this is the next battleground.

Of course we’ve been here before. On personal lines it was the advent of direct insurers who forced intermediated business to address their inefficiencies. However, by the time EDI was commonplace, much of the business had already been lost to ‘direct’. When it comes to SME commercial we have already had a few false ‘efficiency’ dawns and promises of ‘imminent change’ but in truth little has changed.

And the reason for this apparent apathy? In a word, profit.

“Efficiency is no longer a luxury and brokers, quite rightly, are increasingly refusing to subsidise the current inefficient model

Insurers have been making money since 2002, so the emphasis has been on growth for more of the same, with efficiency drives pushed to the back of the queue.

However, with the spectre of underwriting losses on the horizon, that will have to change. Insurers will want to reduce their costs, and broker earnings have historically been the soft target, but not any more.

So what else is there? Well, that only leaves their own central costs.

With the growth of consolidators there is a decreasing need for insurers’ full blown regional structure.

Indeed, with the advent of more managing general agencies more and more of the tasks that insurers historically undertook are being shouldered by brokers – tasks such as underwriting, policy issue, claims handling and so on, further decreasing the need for the large and expensive infrastructure that insurers currently employ.

Efficiency is no longer a luxury, and brokers, quite rightly, are increasingly refusing to subsidise the current inefficient model.

But it will be a bit like turkeys voting for Christmas.

However, with Towergate once again blazing the trail and on this occasion at the forefront of a heavy hitting pack of other distributors, it would be a brave man who bet against them.

And after all, it is surely inevitable. Inefficiency is ultimately unsustainable and has to be removed.

Such removal will however involve quite a bit of pain.