Traditional insurers will quickly lose business to capital market players if carriers don’t work together to drive costs and inefficiencies out of their transactions by adopting data standards and going electronic, one leading broker warned.

“Challenges don’t always come from within, but from without, with the capital markets and insurance markets rapidly converging,” said Dennis Mahoney, chairman and chief executive officer at Aon Global, based in Bermuda.

“We’ve got to become more efficient and remove frictional costs,” he added during a panel on the industry’s challenges and opportunities at the ACORD London Forum.

A big part of the problem is a lack of cooperation among insurance companies and their brokers in terms of standardizing data exchange so they can process more transactions electronically, he said.

“We need to put aside our competitive differences and realize there is a much greater threat out there–the potential for more efficient players to take over our business,” he said the day before the ACORD panel, during his keynote address.

“If we don’t act collectively, our product is going to be replaced,” he added.

Noting that capital market players trading catastrophe bonds and other insurance-like derivatives are totally electronic, compared to a traditional insurance market that still relies too heavily on paper-based transactions, Mr. Mahoney said that in a short period of time, e-traders could “force we, the inefficient players, out of our own markets.”

Traditional carriers and brokers don’t have a lot of time to dawdle, he warned during his keynote speech. “The convergence of the insurance and capital markets is happening far faster than anyone realizes,” he said–noting that in the United Kingdom, securitization is not limited to catastrophe exposures but is being expanded to trade in “high-frequency, low-severity risks like motor coverage.”

During the panel discussion, he said that insurers “can’t afford to operate under the delusion that we can change at whatever pace we choose. In fact, we must change to meet the demands of our customers and trading partners, as well as to meet the pace being set by our new competitors in the capital markets.”

Making the transition to electronic transactions, based on industrywide data standards negotiated via ACORD committees, is critical if traditional carriers are to compete in the long term with the capital markets, where virtual trading has long been the rule rather than the exception–as it is with insurance, he said.

“We must move quickly to an electronic marketplace to drive out current inefficiencies before those inefficiencies drive us out of the market entirely,” he added, lamenting that London in particular still has a long way to go to break its paper-dependency and go completely digital.

Indeed, on Oct. 17, the day of his keynote speech, the London Market Reform Group announced that 45 percent of the market’s total volume of claims is now being handled electronically via the Insurers’ Market Repository–up five percentage points from the start of 2007 but well below the target of 60 percent set for the end of the third quarter.

“If you think we’re making progress, go outside and stand on the corner here and watch all the brokers running around with their arms full of paper,” said Mr. Mahoney. “I’m always tempted to just stand by the door and stop anyone carrying piles of papers and demand to know where they think they are going and why they need all of that baggage to do business.”

Replacing bits of paper with bytes of data will not only cut expenses but will also allow the market to grow considerably, he predicted in his keynote speech.

“Whenever markets go electronic, volume always increases exponentially, but margins compress dramatically,” he said.

To accomplish this goal, however, setting and implementing data standards are both crucial tasks, he added.

“We need more standardization of products to have an efficient electronic market, and that should not be a problem since so much is identical in every transaction,” he observed. “We too often use customization as an excuse to avoid cooperation on standards, when what we should be asking ourselves is what makes us truly unique in this market.”