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If brokers want to succeed in commercial lines insurance in the future, they need to target specific segments, provide value-added services and retain the best talent, a consultant says.
Despite such market obstacles as intense competition, rapid consolidation and soft insurance prices, there are many opportunities today for brokers to succeed, contends Frederick H. Eppinger, a principal and insurance practice leader in the Boston office of management consultant McKinsey & Co.
"It's a tough market, but there is an enormous amount of opportunity, because there is an enormous amount of need," Mr. Eppinger said. "There is a need for risk management services and a need for advice. The world is not getting less complicated; it's getting more complicated. So if you add value-added services and you have distinctive positions in the marketplace, you will grow."
"I don't know if bigger is better," he said, referring to increased consolidation among brokers. "But I do know the people who win the war on talent will be the winners."
During a session of the National Assn. of Insurance Brokers meeting, held in Colorado Springs, Colo., last month, Mr. Eppinger described the current state of affairs in the commercial lines market and outlined what he thinks brokers must do to succeed in the future.
Mr. Eppinger said commercial lines pricing in all lines has decreased an estimated 35% since 1988. And, he said, based on numerous case studies from 1994 through 1997, there have been tremendous decreases in prices on a same-exposure basis with no apparent reduction in loss costs.
He blames the soft pricing environment in part on buyers who continue to self-insure and find alternative ways to transfer risk
from the traditional market. "People who don't want to extract capital from the industry have created a tremendous overcapacity, and that overcapacity has caused a lot of irrational pricing," he said.
Furthermore, buyers have become more sophisticated and are demanding more services from brokers, he said.
"Where are we as an industry?" Mr. Eppinger asked. "We are in a pressure cooker," he answered. Brokers face pressure not only from the difficult market and from more sophisticated and demanding customers; they also have the added tension of insurers trying to go direct with reinsurers and customers, he said. "Insurance brokers are caught in the middle of the sophisticated customer and underwriters, who are consciously squeezing every nickel out of the market."
Consolidation is one result of the current market.
"This has not been a normal time," Mr. Eppinger said of brokerage consolidation. While brokers say the reasons behind the connections have to do with economies of scale, he pointed out that consolidation also "clearly increases the leverage brokers have with markets." Mr. Eppinger questioned the efficacy of this strategy, however, if cost and leverage alone are the reasons behind the associations.
"It's a great short-term strategy," he said. In the long run, however, "it's not going to work." Insurance "is an industry of scale of skill and executing distinctive value added," he explained. "If scale is used to create distinctive positions in segments with distinctive value added, then you've got something. But if it's about infrastructure, cost reductions and leverage, that is going to go away, because insurers are not going to stand back and let it happen"; they are concentrating on targeting specific segments.
Despite what Mr. Eppinger calls "all the upheaval" in the industry, there are opportunities, he told brokers.
"I think what you're going to have is more sophisticated clients that pick and choose value-added services," he said. The traditional way of doing business does not
work any more. In fact, "if you look at just the traditional services brokers provide and they did nothing more and didn't change, the brokers not only would see flat growth, but they would see between 10% and 20% decreases in revenues," Mr. Eppinger said.
"When I look at all the upheaval in the industry, I see money to be made," Mr. Eppinger said. "This is a day of opportunity, because the traditional way of doing things doesn't work."
Mr. Eppinger pointed out some of those opportunities he sees:
* New and uninsurable risks.
In a number of risk management case studies from a variety of different industries, 80% of the risks talked about are uninsurable today, Mr. Eppinger said. He admitted he is unaware if those risks would be considered good. "What I do know is that people are going to be pushing the edge here," he said. "For people that either push the edge of what's insurable or push the edge of what's uninsurable today, there is a real opportunity to make money."
* Capital markets.
"We all know it's going to grow about two to three times the traditional growth of self-insurance and other alternative risk products, but the question everyone asks is, how much and when?" Mr. Eppinger said. "There's a lot more talk than action right now," he observed.
However, what Mr. Eppinger described as intriguing is the "feel of it now." "We are closer to something real, particularly with securitization," he said. At least where mortgage banking is concerned, Mr. Eppinger sees the growth of securitization as initially driven by some need for capital; securitization continues to grow because of the cheaper cost of capital.
"What's interesting with (risk) securitization, if some event does occur, we could see a real growth in this market," he said. Mr. Eppinger added that United Services Automobiles Assn.'s $477 million cat bond issue in June 1997 was an indication that, despite the opportunity to have sealed a cheaper deal in the traditional market, USAA was "trying to make a market to prepare for that day."
* Globalization of the world economy.
Mr. Eppinger estimates that 23% of the world's industries are globalized, 15% are accelerating in that direction and that the rest are in the early design days or have no globalization plans. "More and more, the skill of handling global risks is going to become more important," he said.
"As manufacturing goes to emerging countries and the cost of risk follows," participating in that movement will mean "great growth," Mr. Eppinger said. While every emerging country is different, "the tremendous growth opportunity is significant," he said.
Given the opportunities in the market, Mr. Eppinger said that, overall, winners in the commercial brokerage market will be those that retain the best talent. "The battleground for winning is about attracting the best and brightest talent," he said. "My fear is that the industry trades
people that are good in the old game for people that aren't really good at the new game."
To change this, Mr. Eppinger suggests brokers instill a pervasive mind-set within the organization that fosters development of talent. Brokers also need to inspire the right behavior and hold people accountable for hiring the most talented people for key leadership spots, he said.
Five years from now, there will be a lot of winning brokers, Mr. Eppinger predicted. Those winners will have some common characteristics, he said. For instance, they will be focused on winning in targeted segments, they will have excellent knowledge and share information around the country and the world, and they will position themselves with appropriate cost structures for the markets they serve.
Additionally, he said, they will act more like consulting firms, and they will have a portfolio of relationships to draw on to add value for the customer.
"There will be some very, very successful companies," Mr. Eppinger predicted. "The industry will never go away from the notion that it is a game of inches. It will always be a game of execution." He said the important question is, "Can you combine some strategic and bold move that positions yourself to have a better shot at excellent execution?'