Bigger Not Necessarily Better With Re Brokers

The insurance and reinsurance brokerage sector has been consolidating for many years, to the point where the industry has evolved into a virtual oligopoly, where the top-three reinsurance brokers are owned by the top-three insurance brokers.

Indeed, Aon Benfield, Guy Carpenter and Willis Re expect to generate nearly $3 billion in revenue in 2009–in an industry that likely has less than $4 billion in total revenue.

Have the primary insurance customers really benefited from this consolidation?

It began in earnest in 1979, when Marsh and McLennan, the largest U.S. brokerage house, launched a bid for C.T. Bowring and Company of London.

Certainly consolidation has changed the nature of the business in many ways, but at what cost? The gap between the large and the medium-sized brokers has never been greater, as the big-three increasingly focus on selling the toolbox as an alternative to consultative advice.

Quantitative modeling is valuable and is here to stay, because the industry's “pseudo regulators”–the rating agencies–require modeled loss-return periods from their customers, the insurers.

However, expected losses generated by property-catastrophe models, for example, have proven to be a dangerous exercise for many insurance and reinsurance companies–as the models regularly fail to come close to estimating actual losses.

Yet brokers appear to be moving away from providing the consultative advice that can be described as qualitative analysis of their customers' needs, versus the products available to meet those needs in the reinsurance market.

While this may suit the largest insurers quite well, what about those small- to medium-size insurers serving the needs of millions of small business and individuals?

Many of these smaller insurers succeed because their focus on the customer's individual needs allows them to compete against much larger competitors. Shouldn't they receive the same kind of focus from their reinsurance broker?

After all, their dependence on reinsurance, particularly within the policy limit, is often much greater than the dependence on reinsurance by their much larger competitors.

No doubt, many insurers must feel alienated by the ongoing efforts of the largest reinsurance brokers to sell the toolbox instead of high-quality advice. This just waters down products and services vital to the health of their business.

The brokers, in turn, are doing themselves no favors in commoditizing their business. They are operating in a very mature business with little organic growth from year to year.

The rise of the Information Age has put pressure on their margins, as it has in many other service industries–and the margins are further eroded by the cost of many expensive services they give away for free.

In addition, they spend millions of dollars each year on request-for-proposal competitions that most likely result in a net loss, when compared to the business won. It is an arms race, where only the largest customers win as they force the brokers to compete on price.

This is not solely the brokers' fault. It is a natural result of the consolidation of a mature business into an oligopoly.

So what comes next? The large brokers need to get better at measuring the cost of the services they provide to each customer. They already have minimum revenue guidelines that have been set subjectively and are not for public consumption.

There must be opportunities for new boutique brokerages to spring up in the gaps left by the big three. This has been proven true a number of times in the investment banking business, where respected individuals have formed firms to focus on offering strategic advice in their particular expertise. These banks often sit beside the largest investment banks as strategic advisors to the buyer or seller.

Boutique reinsurance brokers should be able to follow a similar path and carve a niche for themselves, by selling strategic consultative advice to smaller insurers that still value the personal touch and highly personal service from their reinsurance broker.

There must be companies that seek not just quantitative tools but also advice on how to approach the market–yet perceive themselves to be too small to get top-flight talent from the major brokers.

To a certain extent, this already exists. Seven of the top-10 existing reinsurance brokers cannot compete in an RFP that involves the big three. They must win their business based on the quality of their service and their relationships, not on the quantity of tools they can give away for free.

While this may sound old-fashioned, there is a need for this type of broker that hasn't yet been fully recognized. These new boutiques will be unburdened by the legacy costs of servicing long-lost business and should be able to fly under the radar of the big-three while establishing a foothold in both specialty areas and the small- to midsize insurance community.

Customer-focused, high-quality service and advice will be the key to their success.

Jim Buysse is president and CEO of Buysse and Associates Inc., a reinsurance brokerage, in Paoli, Pa