The scramble for business

The fiercest battles in the insurance industry are set to be waged in the SME market. In the past months insurers have been piling into the already crowded market eager to win a share of its riches. Most recently Sterling Hamilton Wright has unveiled its new SME insurer, Minerva, and the Royal Bank of Scotland has waded in using its new purchase NIG.The established insurers also looking to make significant gains. Allianz Cornhill is beefing up its presence in the sector, and Groupama has withdrawn from its co-insurance deal with Saga to double its SME capacity. And AXA, Norwich Union and Royal & SunAlliance (R&SA) are fighting hard.But there are fears that the market is overheating, plunging into a downward rating spiral. Brokers are also concerned that it is becoming increasingly commoditised and that insurers are cherry picking the best risks at the expense of the less standard risks. And the spectre of direct distribution is hovering in the background.The SME market is attractive because it is perceived to be a low risk, low cost sector. Norwich Union commercial product manager Mervyn Harris says: "It is low exposure. It has a good spread of risk and doesn't produce volatile returns. It is also easy to market to and there is a lot of data on it."Insurers' definitions of SME business vary. R&SA, for instance, defines an SME as a business with a turnover of less than £1m. But NU takes a wider view, making the cut off point £50m turnover. Some insurers go even higher.Like other lines of business, the SME sector has been experiencing rising premiums as insurers attempt to return to underwriting profit. Independent analyst Datamonitor found that 77% of SMEs had experienced rating hikes of up to 40% in 2002. But there is fear among both insurers and brokers that the current scramble for business will begin to drive rates down, sending the market into a damaging deflationary cycle.

Premium discountRumours are already circulating of falling rates, with talk of "silly and unsustainable" pricing by some insurers. One broker has even been mailing potential clients claiming to be able to get over 30% off current premiums.But at the moment, these stories appear to be exceptional and do not represent the overall trend: in fact some brokers are still seeing increases of up to 20% on renewals, and others are witnessing only small decreases - in the region of 5% - on low risk occupations.The feeling among insurers is that the market is beginning to level off.Harris says: "We are not getting the increases that we were. It is on a plateau at the moment."Yet there is still downward pressure as some insurers are engaging in aggressive price competition. R&SA small business and e-business director Simon Cooter says: "Rates are softening in certain areas. There is some silly and unsustainable pricing at the moment. This could be in an effort to increase market share."But the major composite insurers are adamant that they will not be drawn into deflationary price competition - in fact they are looking for further increases. R&SA corporate business director Brendan McManus says: "Rates need to track claims inflation, which in casualty is running at about 12% and in property at about 9%. If the market stays flat next year it will need to rise in 2005. The industry can stand only one year of flat rates."

Leaving marketThe concern is that if rates begin to fall, what is perceived to be a profitable market will no longer be so. If that happens then insurers will be leaving the market just as quickly as they entered.Zurich UK Commercial head of market management David Smith says: "It will be a big test for insurers not to be dragged down by the pricing actions of others in the market."At the end of the day, if we can't sell profitably we will move out and shift our resources to others areas. We will not be dragged into a price war and will not drop below our technical price. If a significant price difference exists (between us and our competitors) it will be difficult for us to compete."A further concern is that as insurers fight ever harder for market share the sector will become increasingly commoditised, with competition being based on price, and products, tending towards homogeneity. This has happened in personal lines. The fear is that, as has happened in the motor market, insurers will take an inflexible one-size-fits-all approach that cannot cope with non-standard risks.The march toward homogeneity is already beginning. Marrs Insurance managing director Mark Coffer says: "The products are becoming more similar. Insurers are looking over each others' shoulders to see what they are doing."There is some agreement among insurers for this. Smith says: "I agree, products are all the same. It just is not possible to differentiate on products and cover."

Specialist adviceThe major insurers are attempting to differentiate their products on the basis of service, risk management tools and specialist advice on matters such as health and safety and employment law. But underpinning the products is a desire to use increased automation in the underwriting process, such as internet-based portals or auto-rating systems. These are used to improve efficiency, by increasing volumes and reducing cost. But brokers argue that this is driving the market ever close toward commoditisation.Coffer says: "Insurers are marketing the products as commodities. Take R&SA's Enterprise, it has removed the need for proposal forms and uses the telephone instead."Insurers are at pains to point out that their efforts to increase their use of auto rating will be limited to the bottom end of the SME market.For instance, Cooter says that R&SA will push auto-rating "as far as possible", but will be looking to include manual underwriting where necessary to cope with the more complicated risks.The problem that many brokers have with commoditisation is that it leads to an inflexible approach to underwriting, with insurers "cherry picking" the risks.David Perry is managing director of Warren Hill, the broker for the Federation of Small Businesses. Perry says: "The insurers are approaching it as they would motor insurance; they are picking and choosing the risks that they want to underwrite and disregarding the rest."The problem is that there is an increasing number of businesses that don't fit into the category of risks that the insurers want. It is OK if you are a florist, but if you are a non-standard risk it is looking very bleak."

Cutting costsThe Broker Network chief executive Grant Ellis says: "At the moment, everyone wants low-risk property-based business. I have so many markets for the standard risks and not enough for the less standard."Coffer also points to declining service standards as a by-product of the drive towards commoditisation. "Insurers are cutting costs by employing cheaper inexperienced staff to man call centres. It is going the way of the banks. Insurers are shooting themselves in the foot. The independent entrepreneurial side is being squeezed for the sale of mass market products."But other brokers are less concerned about the effects of commoditisation.They argue that it will help them streamline their businesses.Gale and Phillipson corporate manager David Raw says: "The clients assume that the policies are the same. Even when we explain the policies they are not interested. Commoditisation will make it easier to process the business."The trends suggest that the SME market is beginning to divide between the smaller and the larger risks. The smaller are becoming increasingly commoditised, with insurers utilising auto-rating and e-commerce distribution, whereas the larger risks are remaining less commoditised. The challenge for brokers will be to evolve and get in a position to take advantage of this polarisation.Raw argues that brokers will need to focus on the larger end of the SME market and offer additional services, such as claims, risk management and health and safety advice. "At the moment the average premium spend of our clients is £1,000. In five years' time it will be £5,000."On the other hand, for brokers wishing to target the smaller end of the SME market the challenge will be to adapt to meet the demands of increasing commoditisation.Alec Finch Group director Alec Finch says that in order to compete, brokers will have to become involved in schemes and facilities. "Technology will be key," he adds. "And joining an alliance or a network will also be useful."Some brokers are starting to look at transposing the personal lines systems developed for the retail telesales environment to commercial lines. Hill House Hammond (HHH) has installed a system developed by IT provider CDL to deal with tradesmen's liability.HHH divisional director Paul Williams says: "Not only has the impact on efficiency and performance been dramatic, but it has meant higher levels of service to SMEs, because we are able to deal with quotes and issue policies more quickly."Many fear that the move towards the commoditisation of the smaller end of the market is simply a precursor to direct sales, leaving brokers potentially redundant. The composite insurers deny that this is the case.AXA broker development manager Andy Heap is typical, saying: "There will always be SMEs that want to go direct, but the vast majority trust brokers and want to deal with a broker - they want them to decode the jargon."There is nothing in the (Datamonitor's) research to suggest that SMEs would go direct."But brokers are sceptical of insurers' reassurances. Many draw comparisons with the motor market, where the direct route proved very successful for the likes of Direct Line. "The route to market is comparable to motor," says Perry.

Direct channelDatamonitor's research also supports the view that the direct market is growing. Based on ABI statistics, it found that between 1999 and 2001 the direct channel increased its share of the commercial market by 6% to 11%. This growth was at the expense of the broker channel, which fell by 7% to 81% over the same period.The research also suggests that the brokers' decline is set to gather pace in the coming years. Projections for the broker channel are sobering reading, with only 60% of SME business being placed through intermediaries in 2006.The direct channel is expected to pick up a significant portion of the lost share. Significantly, 50% of SMEs said that they would consider purchasing cover direct from insurers.The extent to which the direct market will be able to grow will depend on the pace of technological advancements. "Insurers will sell direct if they can keep their expenses at the same level, but they need to have better systems," says Raw."As technology improves, more direct writers will dip their toes in the SME pond."Another potential force in the market is the bancassurer. Datamonitor's report comments: "Banks have experienced a high degree of success in cross-selling personal insurance products to their personal banking customers.They are keen to tie-in these customers by offering them as broad a product range as possible."It is a model that could be rolled out across the competitive business banking market as well. Indeed HBOS has already announced its intention to do so."

Bank competitionDatamonitor predicts that the banks' share of the market will grow over the coming years, particularly at the smaller end of the market.And the banks' presence is already beginning to show up on policyholders' radars. A survey by Norwich Union found that 20% of SMEs have noted the bancassurers' offerings.More generally, the question on many lips is whether the SME market can sustain this level of competition."If everyone who said they wanted to write SME business did so, there wouldn't be enough business to go around. Some people will get their fingers burned," says Cooter. But he is confident that the market will settle down in the coming months."The market won't become overheated as insurers are trying to write for profit. Silly pricing will disappear as quickly as it has arrived. Insurers will need to be focused on cost base if they want to grow, as it is a competitive market."Smith anticipates that the market will see changes in 2005. "The SME market is overcrowded and competitive. There are just too many people in the market and some are charging unsustainable rates. 2004 will continue to be competitive, but in 2005 insurers may begin to drop out, especially if premiums do not keep pace with claims inflation.Ellis argues that the insurers who are cherry picking the best risks could find themselves losing out in the long run to insurers who consider writing non-standard business."The non-standard insurers may accept these risks only if the broker places the standard risks too. This will take business away from the standard-only insurers."If insurers wish to grow they will have to widen their acceptance criteria.That's good for brokers."

What are standard and non-standard risksBrokers are concerned that many insurers are focusing their capacity on standard risks and ignoring the more complex risks.Royal & SunAlliance is one of the insurers that provides cover for standard and non-standard risks through its Enterprise platformA typical example of a standard risk is a shop, such as a florist. Royal & SunAlliance small business & e-business director Simon Cooter says such risks are catered for by simple package policies. "With this contract, we just need to know the sums insured and a range of covers are provided automatically. Our underwriters will ask a small number of extra questions, such as claims experience and level of security."A typical non-standard risk is a trade printer. R&SA does not provide a packaged set of covers, but tailors the insurance to suit each client.This requires more detailed information from the broker, on areas such as nature of the printing processes undertaken.

What Datamonitor says about targeting SMEs86% of SMEs purchase their commercial cover direct from a broker, while only a small minority approach insurers directly to take out policies25% of SMEs have changed their commercial insurance provider in the past two years. Switching habits are most prevalent among liability policyholders20% of SMEs believe they will change their insurance provider in the next 12 months, and only 8% of liability policyholders are likely to consider looking elsewhere.Price is the chief rationale for choosing an insurer, and also as the factor most likely to tempt SMEs to change insurance provider. SMEs believe the best way insurers can improve their image is by lowering premiums66% of SMEs consider advice to be a valuable provision when taking out a commercial insurance policy, especially advice relating to risk management77% of SMEs reported premium hikes of up to 40% during 2002. 83% of SMEs said property insurance premiums had gone up and 62% revealed liability premiums had risen. These premium increases have generally had no effect on the attitude of SMEs towards their insurance provider64% of SMEs viewed insurance cover bundled with other insurance products as quite attractive or very attractive, primarily because such schemes may be able to deliver cost savings.- Targeting SMEs in UK commercial insurance 2003 - Datamonitor. Tel: 020 7675 7487.