Best Expresses Concerns over London Market Placement Deals

September 5, 2013

A.M. Best has been studying the recent innovation in the London insurance market, exemplified by the arrangement between Aon and Berkshire Hathaway announced in March, which automatically shares a percentage of premiums between brokers and insurers. In Best’s opinion this could “result in the loosening of underwriting risk management practices, and eventually lead to deterioration in technical performance driven by weakened controls around pricing and risk selection.”

Best’s report notes that “while similar types of arrangements have existed in the marketplace for a number of years in many forms, the new developments represent a key departure from current approaches, not least in terms of scale.

“Co-insurance quota share agreements, whereby brokers pre-arrange capacity with a single or small panel of insurers, have attracted attention in the past few months following actions by Aon plc and Willis Group Holdings Ltd., the world’s second and third largest brokers (see Exhibit). These brokers place billions of dollars of premium into the market.”

Aon Risk Solutions coinsurance agreement with Berkshire Hathaway International Insurance Ltd. covers all of its Lloyd’s market business. “Under the agreement, Aon’s managing general agent business will have delegated authority to grant cover on behalf of Berkshire Hathaway globally across all industry segments,” Best said. “Aon will automatically cede 7.5 percent of its Lloyd’s business placed in a sidecar facility to Berkshire Hathaway, although Aon clients will have the opportunity to opt out of the arrangement.”

Following the Aon/Berkshire deal Willis announced its “Willis 360” concept, which also plans to work in partnership with insurers “to develop commercial insurance cover and risk management solutions for medium sized UK businesses.”

Best explained that Willis has stated its relationships with insurers will provide “enhanced cover, increased limits and integrated risk management services” into its policies as standard. It is thought that the facility will provide capacity for approximately 20 percent of any single placement on its London market specialty book.”

The report described the actions taken by Aon and Willis as suggesting that “mega brokers are looking to make placement more cost effective and to maximize whole account commissions. Meanwhile, other intermediaries, such as Jardine Lloyd Thompson Group plc, the seventh largest global broker, have publically stated that they will not be adopting the same arrangement facilities.”

In Best’s opinion these arrangements present both positive and negative aspects. The rating agency is concerned that by entering into them insurers could “lose underwriting control. Should history repeat itself – as was the case in the late 1990s and early 2000s when many specialty companies in the United States and several Lloyd’s syndicates gave their pens to U.S. Managing General Agents, which were volume-driven and not focused on underwriting profits – the consequences could be disastrous.

“Additionally, the risk of non-disclosure may be heightened under the new arrangements, compared with per risk placements. Significant discussion among insurers can currently arise when brokers are dealing with a single risk. However, if risks are pooled into a portfolio, some disclosures may not be made, and the debate is likely to grow over what is deemed to be “material” disclosure.”

Best also indicated that it would be a “negative development if insurers become over reliant on whole account broker deals as a source of business flow and if they become even more dependent on large brokers. Insurer margins may also be squeezed if brokers take some form of block commission on deals. While brokers’ management information has generally improved in many aspects over the past decade, there are potential questions over their ability to accurately capture, for example, reserves.”

In addition Best points out that the development of “mega-broker” deals is occurring “at a time when excess capacity is chasing static volumes of business. Such arrangements could provide further opportunity for non-traditional capital to enter the market (including the primary market) and put further pressure on rates.”

According to a recent report prepared by Best, “$45 billion of additional capacity has entered the reinsurance market in recent years, with hedge funds, pension funds, endowments and trusts attracted by the relatively favorable returns.”

Another concern for Best is the possibility that insurers who don’t participate in these mega deals may be seen as “offering limited added value at the bottom end of slips may be removed from contracts. Consequently, smaller following market players, including some small Lloyd’s syndicates and international subsidiaries in the London market, could lose business flow as they are cut out of placements.

“It also remains unclear what impact these new deals will have on Lloyd’s intra market
– regarding the business flow from small syndicates to larger ones – and if there will be a loss of business for insurers that are unable or refuse to participate.”

Best also noted the concerns expressed by Lloyd’s senior management that Berkshire Hathaway will be receiving the returns that the Lloyd’s market generates “without having to make the same investment around underwriting expertise. Lloyd’s executives have been cited as stating these arrangements will face the same controls as other binding authorities as they involve delegation of underwriting authority to the broker.”

Some aspects of the new arrangements, however, do have a positive side. Best said it believes that for “rated entities participating in such programs, and other insurers more generally, the change in broker placements could have some positive implications.

“For example, insurers that are part of the facilities may benefit from a reduction in acquisition costs. Such partnerships with brokers can result in good business flow and provide risk diversification. Furthermore, insurers may welcome the assistance of broker management information, such as historical data on portfolios – provided the information can be verified.”

There is also the potential problem that UK regulatory authorities will be watching these deals very closely, and that they could run afoul of the Financial Conduct Authority’s “conflicts of interest thematic project.”

In conclusion Best said: “In reality, the Aon and Berkshire Hathaway deal and potential Willis arrangement represents a small portion of the brokers’ overall portfolios. However, concerns of anti-competitive practices could arise on future deals depending on the level of placement and the length of such contracts.

“Questions may also be posed regarding broker conflict of interest and whether the new arrangements could have a negative impact on smaller reinsurance clients whose inwards business plans have been curtailed.”

Source: A.M. Best

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