1. Executive summary

Insurance companies distribute their products through intermediaries or directly. Insurance agents (who can be tied, multi-tied or independent) are, in general, licensed to conduct business on behalf of insurance companies. At the other hand insurance brokers work for the policyholder in the insurance process and act on behalf of the client. Bancassurance generally refers to the provision for insurance services sold by banks. In Direct insurance, insurance covers are sold without the intervention of an intermediary.

Insurance distribution mix, as well as brokers' market share, varies significantly in different business sectors and geographic regions. This paper focuses on brokers in Europe, particularly on the commercial non-life brokerage and on the six largest European markets.

Insurance mediation has very long history and is highly regulated and multidimensional activity. The European Union passed a directive on insurance intermediation in 2002 that led to new legislation in all EU states. Insurance intermediaries reduce search and transaction costs. They also reduce information asymmetry between insurers and buyers.

Brokers are compensated for their services through commissions and fees. Commissions can be premium-based (expressed as a percentage of the premium paid for each policy) and contingent commissions (usually based on the profitability and/or volume of the business placed with the insurer). Contingent commissions have been seen as controversial which provoked the famous Spitzer investigation in 2004 against the worlds' largest brokerages. Brokers receive fees for particular services such as risk management, claims settlement, captive management, risk modeling... Successful brokers also receive non-cash compensation from insurance companies such as travel and vacation awards in recognition of superior performance. Brokers' profitability depends on underwriting cycle, although it is less volatile than insurers' profitability.

The insurance brokerage industry is highly concentrated with a small number of large brokers accounting for most of the market share. While the concentration is high, the absolute number of brokers and independent agents is very large. Competition between intermediaries is strongly negatively correlated with the size of the risk. In the last three decades brokerage industry witnessed several big consolidation processes. Global brokers have used M&A opportunities for growth what has resulted that 3 largest brokers (Marsh, Aon and Willis) are dominating the commercial brokerage market.

Brokers play much more significant role in commercial insurance business than in retail business. They are the most important distribution channel for commercial non-life insurance in every region. In Europe, annual commercial non-life broker revenue is about �10,4 billion, with UK as the largest market.

Key qualitative factors that can determine future of the broker channel will include changes in consumer demands and behaviours, information technology improvements, economic recession, further broker consolidation, the growth of insurance need in emerging markets, shifts in product mix and niche specialisations..


2. Overview on distribution channels in insurance

Insurance companies offer insurance covers either directly or through various distribution channels - agents, brokers and bancassurance. The insurance marketplace is undergoing a transformation that may eventually lead to significant changes in how consumers purchase insurance products.

2.1 Insurance intermediaries

Insurance mediation, although appears as a simple concept, is in fact a multidimensional activity that requires a great variety of skills and qualities if it is to be a successful business in a very competitive market. According to BIPAR, the European Federation of Insurance Intermediaries, the main characteristic of the insurance market is imperfect information by each party to the transaction, significant search costs to find the "best" deal, and asymmetric bargaining power. In the transaction process of searching a contracting partner and writing an insurance contract, usually insurance companies are better informed than the clients seeking insurance with respect to the relevant characteristics of the products offered and the contractual terms. Insurance intermediaries, traditionally called agents or brokers, serve as the critical link between insurance companies seeking to place insurance policies and consumers seeking to procure insurance coverage. Through their various activities, intermediaries help clients and insurance companies overcome a number of market failures which otherwise would hamper competition. These activities are important for all types of insurance buyers, large companies, SMEs and private consumers.

According to the Insurance Mediation Directive[1], the activities undertaken by an insurance intermediary include the "introducing, proposing or carrying out other work preparatory to the conclusion of contracts of insurance, or of concluding such contracts, or of assisting in the administration and performance of such contracts, in particular in the event of a claim".

There are a number of factors determining the recommendation that intermediaries make to their clients when advising them on the choice of a particular insurance (these factors should also be considered by the client himself). These factors include:

  • price of insurance coverage,

  • breadth of coverage available,

  • insurer's flexibility in agreeing coverage,

  • insurer's financial security, the quality and clarity of documentation provided,

  • insurer's image and reputation, especially in respect of claims service (speed, fairness of settlements, additional benefits to claimants),

  • technical competence of the insurer's staff, the quality and availability of advice provided to policyholders,

  • insurer's speed in issuing documentation or in quoting terms, timeliness in inviting renewal,

  • locational proximity of the insurer,

  • quality of the other services provided by the insurer.

2.2 Insurance agents

Insurance agents represent the insurance companies in the insurance process and usually operate under the terms of an agency agreement with the insurer. As insurance agents are tied to a certain insurance company (or few companies), they are specialised in its products. They are to be expected to have profound knowledge about the characteristics of the product range this particular company offers as well as about the company itself (its past performance, its behaviour with respect to claim settlement etc.). Information on the products of other insurance companies is to be disseminated only as far as that information can be used as a sales argument in favour of the own products.

The relationship between insurer and agent can take a number of different forms. In some markets, agents are "independent" and work with more than one insurance company (usually a small number of companies); in others, agents operate exclusively, either representing a single insurance company in one geographic area or selling a single line of business for each of several companies. Agents can operate in many different forms: independent, exclusive, insurer-employed and self-employed.

2.3 Insurance brokers

Insurance brokers work for the policyholder in the insurance process and act on behalf of the client. Brokers assist clients in the choice of their insurance by presenting them with alternatives in terms of insurers and products. Acting as "agent" for the buyer, brokers usually work with multiple companies to place coverage for their clients. Brokers obtain quotes from various insurers and guide clients in determining the adequate policy from a range of products. They are to be expected to have a better overview of the insurance market and not only of the products of a certain company. While most, if not all, brokers are active in commercial lines, some are also insurance intermediaries for personal lines policies. There are also distinctions between "retail brokers", who negotiate insurance contracts directly with consumers, and "wholesale brokers", who negotiate insurance contracts with retail brokers and agents, but not directly with consumers. Reinsurance brokers solicit, negotiate and place reinsurance cessions and retrocessions on behalf of ceding insurers seeking coverage with reinsurers.

Legal status of insurance intermediaries varies throughout the international insurance market and sometimes it is not easy to determine whether an intermediary is legally an agent or broker. An intermediary might be called a "broker", but actually represent the insurance company in a particular transaction. In such situations, the broker is actually (and legally) considered the company's agent. At the other hand, some brokers might be classified as agents if they are paid only through commissions (e.g. current legislation in Slovakia).

Sometimes it is not easy to differentiate insurance brokers from independent financial advisers (IFAs). IFAs offer unbiased financial advice to their clients and recommend the most suitable products, if any, after researching the whole market. The key differentiator is that they offer broad range of financial products (not only insurance products) and (theoretically) have to offer to the client the option of paying by a fee, as well as the option of paying by commission. IFAs are well-spread in the UK, mainly engaged in life and health business lines.

2.4 Bancassurance

Bancassurance in its simplest form is the distribution of insurance products through a bank's established distribution channels. Banking institutions and insurance companies have found bancassurance to be an attractive and profitable complement to their existing activities. Bancassurance is often considered to be more cost effective than traditional agency and broker channels. The primary advantage relative to other distribution channels is the customer relationship. Also, the ability to leverage fixed costs and brand awareness within the geographical region, frequent interaction with clients and the extensive use of technology, suggest a significant competitive advantage over other distribution channels.

Although the real pioneers of bancassurance were British, the term bancassurance is a French word. In France, bancassurance has long been popular, mainly because some tax-advantaged insurance products are only available through banks. Banks' insurance sales are high in countries where the products tend to be relatively simple and have a natural affinity with core banking products. Bancassurers have been most successful in selling deposit-substitutes, such as simple unit-linked products, and other products that are easy to bundle, or cross-sell with loans, mortgages or deposits (e.g. household insurance, mortgage related term assurance and credit insurance). These products are well suited to marketing by a generalist bank sales force. On the other hand, bancassurers have had limited success where expert advice is required to sell complex products, such as pensions in the UK. In the last decade there were numerous examples of both successful and unsuccessful strategic partnerships, joint ventures and mergers and acquisitions between banks and insurance companies.

2.5 Direct insurance

Direct insurance, as its name says, is the type of insurance sold directly by the insurer/underwriter, without the intervention of an intermediary. An example would be an insurance company that has traditionally owned its points-of-sale or an underwriter that distributes its own products through its website or call centre. There can be four types of direct networks: a branch network (or any type of physical offices), mobile salaried sales forces, Internet and call centres.

First dedicated direct insurance operation started in the UK in 1985. The market share taken by direct players has increased steadily ever since especially in the field of personal-lines general insurance and small commercial risks, partly at the expense of companies' own sales staff and agents, and partly at the expense of intermediaries. Success of direct insurance companies prompted traditional insurance players to set up their own distinct direct insurance brands. New entrants have also been attracted to the direct insurance market, as a result of the lower operating costs made possible by call-centre and Internet-based operations. The development of web technologies and of broadband Internet access made more customers go online to buy insurance policies directly, rivalling other remote channels, such as the telephone. The direct insurance industry is aggressively innovative in using technology to gain speed in obtaining competitive quotations. It invests heavily in IT, making great use of customer relationship management (CRM) techniques to supplement their call-centre and Internet sales opportunities.

The development of direct insurance sales and their perception differ significantly based on region, which is highly correlated with customer behaviours in different markets (e.g. differences in direct distribution market share between Northern and Southern Europe). In Europe, three main companies dominated Internet insurance in 2005: the UK insurer Prudential, Skandia of Sweden and AXA[2]. Other big European insurers, Allianz, Generali and Aviva have also launched their direct companies seeing direct channel as one of the key growth drivers in future.

2.6 Distribution channel mix in Europe

European insurance market is heterogeneous, and distribution channels vary considerably from one country to another. There is also wide variation across countries in the number of intermediary companies present. For example, in Finland, there are just 70 brokers, whereas in the UK, there are about 10 000 authorised intermediaries. The number of intermediary firms does not appear to be systematically related to the size and income level of the various countries. The reason is that in some countries, there has been a longer tradition for intermediaries to provide services to customers than in other countries.

In this chapter, the analysis of distribution channels in Europe will be shown, separately for life and non-life insurance lines of business. Source for this analysis is the CEA's report "European insurance in figures"[3] published in October 2009. This report includes data from 33 European countries, but 78% of all premiums in Europe in 2008 come from the largest 6 European markets: UK (23,5%), France (17,3%), Germany (15,5%), Italy (8,7%), Netherlands (7,2%) and Spain (5,5%). Therefore, special attention will be given to these 6 markets.

2.6.1 Life insurance distribution channel mix

In the UK, brokers are dominating life insurance distribution. They also lead the life insurance market in Ireland and are also quite common in Belgium. Agents are major distribution channel for life insurance products in the Netherlands[4] and Germany and in the most of Central Eastern Europe Countries (such as Slovakia, Bulgaria, Slovenia, Poland and Croatia). Bancassurance is the largest life insurance channel in Italy, Spain and France, but also in many other western countries and in Turkey. Direct writing prevails in Ireland and is also popular in Sweden, the Netherlands, Poland, Austria and Belgium.

2.6.2 Non-life insurance distribution channel mix

The distribution of non-life insurance products significantly differs from life insurance distribution. Brokers are the major channel in the UK, Ireland and Belgium. Germany is traditionally very strong tied agent market, with increasing market share for brokers. "In-house brokers" of large multinational firms, such as Daimler Chrysler, Aventis and Bayer, take on considerable share of this business. Instead of using independent insurance brokers, such as in the US or the UK, German corporations prefer to keep the broker function in-house so as to retain income within their group. France is the fourth biggest source of brokered business in the world (after the UK, the US and Germany), although the broker share is just 18%. The small broker share in the Italian market is apparently understated: 7,4% of business goes directly from brokers to insurance companies. AIBA, the Italian insurance and reinsurance brokers association, estimates that considerably larger share (about 24%) of total non-life business is channelled from brokers through tied agents to insurance companies and hence is recognised by insurers as agents' revenue. The tied agent system in Italy is often based on bilateral exclusivity rules, according to which all business within defined geographical areas must go through the agent.

As in the life sector, agents play an important role in the distribution of non-life policies. As already mentioned, they are very well established in Italy and Germany, also leading the non-life insurance market in Spain, France, Slovenia and Portugal. Unlike life insurance, sales of non-life insurance products through bancassurance are not really widespread in Europe, having one digit market share. Direct writing appears to be more common in non-life insurance than in life insurance, where products are more complex. It is the main distribution channel in the Netherlands, Austria, Croatia and Lithuania. We can also notice that "other" non-life distribution channels have larger market share in comparison to life business sector. This is the fact mostly because of the influence of retailers, for whom insurance is not the core business, on distribution of insurance products (e.g. auto retailers or supermarkets).


3. Introduction to Broker business model

3.1 Brief history of insurance

In encyclopaedias like Britannica or Wikipedia there are various stories about the origins in insurance in different areas of the world. One of them says that in ancient times farmers in China sent their crops to market on boats. But on occasion a boat sank along the way. The farmers began spreading their crops among numerous boats, so that if one boat sank, one family would only lose a small portion of their crops, hence avoiding financial devastation. The loss was spread among many families, and was therefore manageable for each one. Later, about 600 BC, the Greeks and Romans introduced the origins of health and life insurance when they organized guilds called "benevolent societies" which cared for the families and paid funeral expenses of members upon death.

The earliest authenticated insurance contract is a marine insurance contract on a ship "The Santa Clara" dated 1347 in Genoa. The policy is in the Italian language and appears in the form a maritime loan to avoid the church prohibition against usury.

Insurance as we know it today can be traced to the Great Fire of London, which in 1666 devoured 13200 houses. After this disaster, Nicholas Barbon opened an office to insure buildings. In 1680, he established England's first fire insurance company, "The Fire Office," to insure brick and frame homes.

It is believed that the broker originated in marine insurance. Ship owners tended to use their own agents to purchase insurance, and their agents owed their primary loyalty to the ship owner rather than to the insurance company. This development of the broker as an agent of the client was also encouraged by the organisation of the Lloyd's market, where competing underwriters could not appoint a network of agents and had to rely on brokers bringing them business.

3.2 Lloyd's of London

Toward the end of the seventeenth century, London's growing importance as a centre for trade increased demand for marine insurance. The market began in Edward Lloyd's coffeehouse around 1688 in Tower Street in London. His establishment was a popular place for merchants, sailors and ship owners. Lloyd's main business with his customers was to provide reliable shipping news, which he gleaned from all his different customers and then fed back to them. The shipping industry community frequented the place to discuss insurance deals among themselves. Soon after Christmas in 1691, the coffee shop moved to Lombard Street, where today a blue plaque commemorates its location. Long after Lloyd's death in 1713 the arrangement continued until 1774 when the participating members of the insurance arrangement formed a committee and moved to the Royal Exchange, and called itself The Society of Lloyd's.

Today, Lloyd's of London is the world's leading and uniquely organised insurance market (not an insurance company), providing specialist insurance services to businesses in over 120 countries. It is the world's second largest commercial insurer and sixth largest reinsurance group. Business can be placed only by approved insurance brokers, known as Lloyd's brokers. There are 176 accredited firms of Lloyd's brokers that bring in business from across the globe. Each Lloyd's broker is required to demonstrate an understanding of the Lloyd's market as part of Lloyd's assessment of its suitability to be registered as a Lloyd's broker. There are nearly 29.000 individual underwriting members, called Names, grouped in some 400 underwriting syndicates[6]. One person, the active underwriter, is empowered to accept insurances on behalf of the syndicate members. A syndicate is not a partnership: each member is liable only for a personal fraction of any insurance. Each syndicate has a managing agency which appoints the active underwriter. The membership of a syndicate varies from year to year. Each member's affairs at Lloyd's are managed by a member's agent. It also has the enviable position of never failing to pay a claim in its long history. It is backed by a vast pool of money called the "central fund". Each syndicate pays a levy to the central fund each year. In the event of a syndicate going bankrupt and not being able to meet its claims, then the names and the central fund ensure that the claims are paid. What began simply as a meeting place for people interested in marine insurance has evolved into a

3.3 Role of brokers - economic explanation

In previous chapter, the basic role of insurance intermediation was described. In this section, economic explanation of this role will be briefly explained. According to Swiss Re Sigma report, insurance intermediaries reduce search costs, uncertainty and asymmetric bargaining power.[7]

Because of the high search costs to acquire and process reliable information about insurance products and companies necessary to take a rational decision, insurance intermediaries have cost advantages compared to individual customers. They can realize economies of scale and scope by fixed cost investments in human capital and technology to assess the information about product prices, performance and terms. Repeated interaction with market participants provides brokers with information on the risk appetite of the various insurers. This information together with long term broker relationship is useful when placing business, especially when capacities are tight.

Insurance brokers help to reduce uncertainty with respect to quality and prices of insurance products and companies. In insurance, buyers and sellers have asymmetric information on the product service being sold, making it difficult for them to agree on the price and terms and conditions of a service transacted. The insurance buyer has more information about the underlying risk and, in interest of reducing cost of insurance, has an incentive to represent it as being as low probability risk. In addition, once insurance has been purchased, the insured may be less careful about the insured risk and the insurer may be confronted by moral hazard issue. On the other hand, the insurance buyer is obviously less informed about prevailing market conditions and generally assumes a credit risk in relation to the prospective insurance carrier. Insurers understand more about the details and complexities of coverage and non-coverage in the context of endless factual uncertainties that may arise. Insurers have unilaterally and carefully drafted the insurance policy, and are unwilling to negotiate the language of the document. An insurance carrier may not have sufficient funds to pay for a valid claim, which is an important consideration, especially for long term liability risks. Brokers solicit and provide information on buyers and sellers and make this information more easily understood for both sides. As brokers rely on long term relationship, they have a strong incentive to ensure that market transactions are completed and that no party acts opportunistically after an agreement has been signed.

Small and medium sized buyers might have significantly less bargaining power in dealings with large sellers. By leveraging their business volume with individual insurers, brokers are able to obtain better terms and conditions for their client, hence dealing with the problem of asymmetric bargaining power between buyers and sellers. Additional transaction costs are reduced on the side of the customers they have to deal only with intermediaries, instead of dealing with a multitude of insurance companies.

Over the last two decades, many insurance brokers have developed services that go beyond the services related to the transferring of risk from policy holders to insurers. Brokers and agents now offer services such as the evaluation and implementation of alternative means of funding for potential losses, risk management strategies and claims management.

3.4 Regulatory environment in EU

The term "Insurance Broker" was defined in Article 2(1)(a) of the EEC Directive on insurance agents and brokers in December 1976.

"Persons who, acting with complete freedom as to their choice of undertaking, bring together, with a view to the insurance or reinsurance of risks, persons seeking insurance or reinsurance and insurance and reinsurance undertakings, carry out work preparatory to the conclusion of contracts of insurance, or reinsurance, and, where appropriate, assist in the administration and performance of such contracts, in particular in the event of a claim".

The European Union passed a directive on insurance intermediation in 2002 (Directive 2002/92/EC) that led to new legislation in all EU states, Norway and Switzerland.

The primary results of this legislation were two-fold:

  • the regulation of insurance and insurance intermediaries was centralized under a single body in many countries;

  • a register of insurance intermediaries was created, which can often be inspected online by potential customers to check the status of an intermediary. The register sets new standards for intermediaries in terms of professional qualifications and liability cover, to make it possible for an intermediary to offer its services across borders once registered in its home country.

The EU distinguished between three types of intermediary:

  • those giving advice on the basis of a "fair analysis" of the clients' needs and of a wide range of products;

  • those tied to a single insurer;

  • those not tied to a single insurer but whose advice is not based on a "fair analysis".

    In most countries in Europe, this division equates to the categories of broker, single-tied agent and multi-tied agent, although this is not necessarily always the case:[8]

  • in Ireland, all non-life intermediaries are categorised as "intermediaries", and tied agents only exist for life business;

  • in Spain, two additional categories exist, namely bancassurance single-tied agents and bancassurance multi-tied agents;

  • in Slovakia, the terms for broker and agent are distinguished by means of remuneration - a broker must be paid by fees only, while an intermediary paid by commission is an agent, hence many intermediaries giving a 'fair analysis' and who are termed brokers elsewhere, such as GrECo and Marsh, are termed agents.
  • In some countries, while the distinction between single-tied agents, multi-tied agents and brokers is clear, it is possible for an intermediary to act in a number of ways depending on the client or the product. Intermediaries in the Czech Republic can be multi-tied agents or brokers, while those in the Netherlands can be single-tied agents, multi-tied agents, brokers or even direct sales forces if they are part of an insurer or own an underwriter themselves.

    For countries such as the Netherlands, the insurance agency estimates the activity of intermediaries acting only as agents rather than as brokers. This does not usually create a difficulty since commercial insurance tends to be handled as a broker and the agent approach is reserved for personal lines.

    The second main area of interest for the EU has been the competitiveness of commercial non-life insurance, and specifically whether the payment of commission creates a conflict of interest whereby brokers may choose the insurer that pays them the most money rather than the one that best suits the client. An inquiry into business insurance was set up in 2005 which issued a final report in 2007. This found that there were indeed conflicts of interest through the commission system, and through the lack of transparency in remuneration for intermediaries. The Nordic countries have led the way in addressing these issues through "net quoting" (i.e. quoting prices to customers net of commission, so that the remuneration paid to an intermediary whether as a percentage of premiums paid or as a fee is transparent). Norway and Denmark have taken this further by banning the use of commission. In Denmark, there is a transition period running to 2011 to phase out commission, although fees had already replaced commission for two thirds of revenue by 2005. In Norway, commission was banned from 1 July 2008 except for marine, aviation and transport (MAT) business and for insurers based abroad, since these markets are by their nature highly internationalized. Swedish insurers have opted to use net quoting, as a result of which commission is spontaneously disclosed to customers in nearly all cases. It seems unlikely that the EU will ban commission, but may well push markets towards net quoting in order to achieve transparency. It found that the spontaneous disclosure of commission was not common outside the Nordic countries, and legislation will probably be required to make this standard practice.

    Brokers have generally objected to the disclosure of commission, claiming that it may place them at a disadvantage to direct company sales forces, who are notably strong in the Nordic region. However, brokers believed their share of the market was rising in these countries, and whether or not net quoting has reduced profit margins, it has not reduced brokers' share of the market.

    3.4.1 The case of Italy - Bersani decrees

    Italian insurance law was reformed in 2006 and 2007 by Economic Development Minister Pierluigi Bersani. The two decrees known as Bersani I and Bersani II have had a major impact on the Italian insurance market in the sense that these decrees opened up a number of professions to greater competition, of which insurance was just one. The decree of 2006 banned insurers from having exclusive tied agents in motor liability insurance, which was extended to all non-life lines of business in 2007. This decree was most important for personal lines insurance, where single-tied agents had a market share of 70%[9], but much less for the commercial non-life insurance market as this was mostly in the hands of brokers already.

    The second Bersani decree, of 2007, ruled against multi-year contracts; this had also been a concern to the EU, since non-life contracts lasted an average of six years in Italy for SMEs, in contrast to 12 months in most EU countries. ANIA, the insurers' association, is opposed to both of these decrees, while the brokers' association has welcomed them, especially the ban on single-tied agents.

    3.5 Brokers' remuneration

    Brokers receive both financial (cash) and non-financial remunerations for their services. Most often they gain compensation from insurers, which is equal to the percentage of the premiums on each insurance policy sold. This type of compensation is called premium-based commission. Commission is earned over the term of the policy. If the policy is cancelled before the end of its term, the policy-holder receives a refund, and the brokerage only receives remuneration for the earned portion. Level of commissions varies significantly on a line of business. Typically, lines that are more difficult to underwrite and therefore are more information-intensive and more complex in terms of coverages and services required, tend to have higher commission percentages. According to A.M. Best survey[10] in United States in 2004, the average commission paid to brokers represent 10,3% of total premiums (9,4% of premiums for personal lines and 11,2% of premiums for commercial lines). Premium-based commissions were ranging from 22,1% for fidelity and surety insurance to 4,5% for medical malpractice.

    Insurance brokers may also receive another type of commission from insurance companies, called contingent commissions. They can be based on various performance criteria such as the profitability of the business placed with an insurer, the volume of business placed and/or the retention rate (i.e. the percentage of policies written by the agent that renew with the same insurer). Profitability-based contingent commissions are rewards paid at the end of the year for placing business with an insurer that results in higher than expected profits for the insurer. This type of commission is usually tied to the loss ratio of particular policies (the lower is the loss ratio, the higher is the commission paid). Volume-based contingent commissions are additional financial payments made for placing more business with the insurer. The economic rationale for volume-based commissions is that they enable insurers to achieve economies of scale and a desirable spread of risk in their underwriting portfolios. There tend to be fixed costs of dealing with any broker, and having a larger volume enables the insurer to reduce its costs per unit. Having larger volume the insurer usually can obtain more diversification of risk. Volume-based commissions also can be used as a competitive tool to provide incentives for brokers to place business with a particular insurer.

    Criticism of broker contingent commissions is based on the fact that they are structured so that insurance companies compete among brokers on the fee paid to the broker rather than the price to the buyer. This creates a conflict of interest for the broker influencing him to recommend his customer to place his business with an insurer who offers a higher level of contingent commission to the broker. Another criticism is that the full brokerage commission is not necessarily disclosed to the buyer, who therefore has less knowledge of the broker's incentives. Brokers' argument is that payments are made based upon the whole book of business that a broker places with an insurer and not for individual cases. Therefore this practice is intended to compensate brokers for activities carried out on behalf of the insurer, rather on behalf of their customers (for which they receive brokerage or fees). In 2004 New York Attorney General Eliot Spitzer led an investigation on the contingent commission practices in the U.S. insurance industry, though the fallout from his investigations have led to worldwide changes. Hence, one sub-chapter in this paper is dedicated to this topic.

    In addition to premium-based and contingent commissions, many brokers also receive fee income from their clients. Fee income is most common in instances where a significant part of the risk management and risk transfer arranged by the broker is through alternative risk transfer techniques such as self-insurance and captive insurance companies. Brokers also provide various services such as risk management consulting, risk modeling, loss mitigation, and claims management, which are not subject to commission-based compensation. In these cases, the broker and client will negotiate a fee to remunerate the broker for services provided. If the transaction does contain a significant insurance component, the fees are sometimes partially offset by commissions. The use of fees as a significant source of revenues tends to be most common among large brokers. Most medium to small brokers receive their compensation primarily through premium-based commissions.

    Brokers also receive non-cash remuneration from insurance companies. Usually, this takes the form of travel and vacation awards given to brokers in recognition of superior performance. This reflects the fact that for many insurers a notably high proportion of their premium volume is generated by a relatively small percentage of the intermediaries with whom the insurance company has sales agreements. In addition, the vacation trips often involve informal meetings with insurer executives, further strengthening the connection between the brokers and the insurer. The non-cash awards are an important tool to maintain good relationship and loyalty of high volume brokers.

    3.6 Underwriting cycle

    Brokers derive most of their revenues from commissions and fees for brokerage and consulting services and brokers do not determine the insurance premiums on which their commissions are generally based. Fluctuations in these premiums charged by the insurance carriers have a direct and potentially material impact on their results of operations. Commission levels generally trend with such premium levels as they are derived from a percentage of the premiums paid by the insureds. Due to the cyclical nature and impact of other market conditions on insurance premiums, they may vary widely between accounting periods.

    A "hard" market is a phase of the property and casualty underwriting cycle (also known as "insurance cycle") that is characterized by high demand and low supply. When the growth in demand for insurance increases more rapidly than the available supply of insurance, the outcome is a hard insurance market. In this type of market, insurance is generally more difficult for buyers to obtain. Buyers are also more likely to experience high insurance premiums and steady rate increases. Given the market dynamics, a hard market is usually considered a seller's market period. They can command higher insurance premiums from potential buyers because insurance coverage is in demand. Insurance companies are also able to underwrite more restrictive terms and conditions into their insurance policies. During a hard market, buyers lose some of their negotiating power. Based on these factors, insurance companies generally experience few underwriting losses during a hard insurance market phase.

    A "soft" market is the opposite of a hard market and is often referred to as a buyer's market. In a soft market, insurance is usually easier for buyers to obtain. Rates are typically lower because competition among insurance companies increases. In addition, insurance companies tend to adopt more lenient underwriting standards in order to secure prospective buyers and to retain existing clients. As a result, soft markets can mean significant underwriting losses for insurance companies.

    From 2000 through 2003 brokers benefited from a hard market with premium rates stable or increasing. During 2004, brokers saw a rapid transition from a hard market to a soft market, with premium rates falling in most markets. The soft market continued through 2005 and 2006 with rates declining in most sectors, with the exception of catastrophe exposed markets. In 2007, the market softened further and this has continued through 2008 with year on year premium rate decreases averaging approximately 10 percent across their market sectors during 2008.

    It is possible that the market may harden in 2009 as insurers seek higher premiums to cover a combination of weak investment returns, significant losses in 2008 and three years of soft market underwriting[11].

    3.7 E&O insurance for brokers

    In the beginning of the last decade, brokers' responsibilities and obligations have increased because of the changing market environment, which has resulted in a higher exposure to E&O claims. E&O (Errors and Omissions insurance) is a professional liability insurance that protects companies and individuals against claims made by clients for inadequate work or negligent actions. Errors and Omissions insurance policies often cover both court costs and any settlements up to the amount specified on the insurance contract[12]. The traditional claims for failing to find coverage have been supplemented by claims to the failure to find adequate coverage, misrepresentation of risks, delays in processing and for placing transactions with insurance companies who subsequently became insolvent. Inadequate coverage and misrepresentation account for more than half of all claims made on brokers. Other mayor types of claims on brokers regard delays in processing coverage, description and identification errors, improper cancellation and policy change errors.

    In order to protect themselves from such claims, brokers buy E&O insurance. As a result of the increasing claims on brokers, premium rates for Errors and Omissions insurance increased so much that some brokers filed to liquidation because they couldn't afford to renew their E&O policies, which are mandatory in some countries. Lloyd's broker, Bradstock Group went into provisional liquidation in September 2003 because of "inability to secure the renewal of its professional indemnity policy at an affordable premium".[13]


    4. Commercial insurance brokers' segmentation

    In the commercial insurance broker industry there are three general business models: global brokers, niche or regional brokers and wholesale brokers (Swiss Re Economic Research and Consulting). Some brokers have adopted more than one model, while others have adopted only one model.

    4.1 Typical functions of commercial insurance broker

    Typical functions of an insurance broker that represents commercial insurance clients are:

  • Brokers assess and analyse the insurance risk that corporate clients are facing. This is a global task for many large corporations.

  • Brokers provide market research and analysis. Commercial clients often request independent advice on what is being provided by insurance carriers. Modelling services are important for those clients lacking the resources to do these themselves.

  • Brokers structure, market and negotiate an insurance program. This includes, for example, aggregate policy limits, deductible and retention levels and coverage terms.

  • Brokers match a client's needs with one or several suitable insurance carriers. Therefore, they are increasing the options available to the insurance buyer and helping the client to select appropriate products and providers. Clients also rely on brokers' advice on the financial strength of their carriers.

  • Brokers handle the premium and loss payment cash flows between corporations and insurance carriers and (in the case of reinsurance brokerage) between insurers and reinsurers.

  • Brokers provide actuarial, loss control and claims management services. This ties in with risk management services for corporations that optimise the balance between reducing exposure, purchasing insurance cover and retaining the remainder of risk. These services provide important feedback for the risk assessment process, as described at the beginning of the broker's value chain (see Figure 3).
  • 4.2 Global brokers' business model

    Global insurance brokers are typically large companies that can provide their clients with global expertise their network of strategically located offices in different continents and countries leveraging on global experiences and local services. They deliver service and spectrum of products to companies of all sizes as well as to individual clients. Sophisticated global programs for international clients often go through one of these players, although sometimes a smaller broker can get a piece of the business.

    Within the global broker company differentiation strategy is clearly defined. Some of them have organized their operations into three specialised units: retail, placement and service. The retail unit works with corporate clients directly and passes on insurance program to the in-house insurance placement unit. By concentrating their insurance placement services, global brokers gain leverage and bargaining power with insurers and are able to negotiate better terms and conditions for their clients. More details about global brokers can be found in the following chapters.

    4.3 Niche and regional brokers

    Niche brokers are typically focused on selling specific products. They are small to medium-size companies specialised in particular industry or in a particular type of risk transfer. These brokers usually have high or very high market shares in one or in several narrowly defined niches, based on their own expertise in that area. Niche brokers are identified and recognised as experts for their niche and they often have loyal long-term customers. They play an important role in the market and effectively increase competition. Since these small and medium sized brokers may not have their own in-house risk consulting group, they sometimes work with an independent risk management company to enable them to provide services with similar quality as those provided by large brokers.

    4.4 Wholesale brokers

    Wholesale insurance brokers work with the insured's retail insurance agent or broker to provide comprehensive, cost-effective commercial coverages and specialty programs for a wide variety of risks. They often arrange coverage for special and hard-to-place risks, such as earthquake or windstorm damage. Wholesale brokers don't have contact with the insured. They often provide global brokers with advice and help in drawing up their risk analyses and insurance design programs. Also, regional brokers often use services of wholesale brokers to access specialty markets and to place risk globally through markets such as London or Bermuda.

    According to Business Insurance magazine, the world's largest wholesale brokers in 2006 were Crump Group, CRC Insurance Services and AmWINS Group with annual revenues exceeding $3 billion. Aon Corp. sold fourth biggest wholesale broker Swett & Crawford in February 2005, in order to eliminate potential conflicts of interests. Previously, Willis Group also sold its wholesale unit.

    4.3 Global brokers market

    Business Insurance magazine reports annual top ten global insurance brokers ranking by revenues. First ranking includes only "pure placement" revenues. Companies are ranked only by fees and commissions for placing commercial retail, wholesale, reinsurance and personal lines. This ranking excludes consulting operations and benefits revenue. This type of ranking was proposed by insurance companies few years ago. "Pure placement" ranking for 2008 is shown in Table 1

    Aon Corp.

    5.957

    Marsh & McLennan

    5.327

    Willis Group Holdings

    2.856

    Wells Fargo Insurance Services

    1.427

    BB&T Insurance Services

    858

    Arthur J. Galagher

    852

    Brown & Brown

    784

    Jardine Lloyd Thompson Group

    748

    Hub International

    650

    Lockton Cos.

    615

             Table 1: Ranking by pure placement revenues for 2008[15]

    Editors of the Business Insurance magazine believe that pure placement does not reflect the full role of a broker, which is to provide advice before, during and after the placement transaction. "That advisory role is intrinsic to what good brokers do." Hence, this magazine has also ranked top ten global insurance brokers based on their total brokerage revenues including consulting and employee benefit programs. Total brokerage revenue ranking for 2007 is shown in Table 2.

    Marsh & McLennan

    11.516

    Aon Corp. 

    7.310

    Willis Group Holdings

    3.362

    Wells Fargo Insurance Services

    1.743

    Arthur J. Gallagher

    1.611

    Jardine Lloyd Thompson Group 

    993

    Brown & Brown

    965

    BB&T Insurance Services

    962

    Gras Savoye[16]

    786

    Lockton

    778

             Table 2: Ranking by total brokerage revenue for 200813

    Business Insurance magazine also compiled its annual list of the 20 most productive agents and brokers. They ranked agents and brokers based on their 2008 revenue per employee figures. Mid American Group Inc., (employee benefits broker) is ranked as the most productive broker. Their 2008 brokerage revenue per employee figure was $367.892. None of 10 biggest global brokers was represented in the top 20 ranking. The best one among the world's top 10 biggest was Wells Fargo Insurance Services with $220.501 in revenue per employee, while Arthur J. Gallagher bottoms out the list with $163.368 in revenue per employee.

    4.4 The BIG 3

    Commercial insurance brokers market is highly concentrated and dominated by few broker companies based in the United States and in the United Kingdom. Eight out of ten biggest global insurance brokers are based in the US, including the biggest to (Marsh & McLennan and Aon) whilst other two are London based (Willis and Jardine Lloyd Thompson). The concentration of the great part of commercial lines business in a small number of large firms describes an "oligopoly" market structure. While for the medium-sized risks there is strong competition between the global brokers and their smaller rivals, the largest risks tend to be placed with the top three or four global brokers. According to the Directory of Agents and Strategic Investments Brokers published by Business Insurance in July 2008, the 140 largest commercial insurance brokers globally reported brokerage revenues totaling $37 billion in 2007, of which Marsh & McLennan Companies had approximately 31 percent, Aon Corporation had approximately 19 percent and Willis Group had approximately 7 percent (see Figure).

    Three largest brokers are all listed at New York Stock Exchange (NYSE). Competitive analyses between the three brokers by total revenue, pure placement revenue and market capitalisation is shown in the next figure:[18]

    From the previous figure we can see that Marsh & McLennan is the largest of the 3 companies, but also that Aon is the world's leading insurance brokerage. In the following sub-chapters you can find more details about the 3 giants.

    4.4.1 Marsh & McLennan

    Marsh & McLennan Companies, Inc. (MMC) is a New York City based global professional services and insurance brokerage firm. Through core insurance subsidiary Marsh, the company provides a broad array of insurance and risk management services; its reinsurance business is handled by subsidiary Guy Carpenter. Kroll is Marsh & McLennan's risk consulting and technology services arm. The company also owns Mercer, which provides human resources and financial consulting services to customers worldwide, and Oliver Wyman, which provides management consulting services.

    MMC at the beginning of 2009 employed 54.400 people, generating annual revenue of $11,59 billion. The company was ranked as #220 largest corporation in the United States by revenues by the 2008 Fortune 500 list. Share of revenue by operating segments and geographical regions for 2008 are is shown in the following

    4.4.2 Aon Corp.

    Aon (the name means "oneness" in Gaelic) was incorporated in 1979, and is the parent corporation of both long-established and more recently acquired companies. Aon has approximately 37.700 employees and operates in 500 offices in more than 120 countries. Total revenue for 2008 was $7,63 billion which placed Aon Corp. as #263 largest corporation in the United States by revenues by the 2008 Fortune 500 list.

    The company operates in two major segments: commercial brokerage and consulting services. The company's Aon Risk Services brokerage unit provides retail property & casualty, liability, workers' compensation, and other insurance products for groups and businesses, as well as risk management services. Aon Benfield handles reinsurance brokerage and analysis services to protect insurers from losses on traditional and specialty property/casualty policies. Aon's consulting unit, Aon Consulting Worldwide, specializes in employee benefits administration.

    The vast majority of Aon's revenues come from commercial non-life insurance, employee benefits and reinsurance brokerage. Revenue split by operating segments and geographic area for 2008 are is shown in the following figures:

    Aon also suffered from the 9/11 terrorist attacks in which 175 employees of Aon Corp. were killed. This year Aon signed sponsorship deal with English football giant Manchester United. The most lucrative shirt deal in history is said to be worth �80 million over four years and will be valid from 2010.

    4.4.3 Willis Group

    Willis Group Holdings is the world's third largest insurance broker, specializing in reducing risk for entities in such fields as aerospace, construction, energy, health care, marine, mergers and acquisitions, and such niche areas as fine art, jewelry, armored cars, racehorse breeding, and sabotage. Willis provides retail insurance policy placement (on behalf of insurance companies), as well as risk consulting and risk transfer services to its clients. It also has reinsurance brokerage operations. The company's clients include middle-market corporations, multinational firms, government and other institutions, and private individuals.

    Company was founded in 1828 in London, where its headquarters are still located in the new building next to Lloyd's of London. Willis, before an acquisition of Hilb, Rogal & Hobbs Co. in October 2008, employed 17.000 people in 400 offices in 100 countries. Total revenue for 2008 was $2,83 billion. Willis Group does not report revenue split by regions. In the following figure, revenue split by operating segments is shown:

    4.4.4 The Spitzer Investigation

    The Spitzer Investigation began quietly on February 10, 2004, when the Washington Legal Foundation (WLF), a free market oriented advocacy organisation, sent a letter to the state insurance commissioners and attorneys general of New York and California. Spitzer's interest in potential abuses in the insurance industry was further whetted by an anonymous letter received to his office on March 30, 2004.[22] The investigation became public on April 22, 2004, when Aon reported it had received a subpoena from Spitzer's office inquiring about its acceptance of contingent commissions from insurers. Marsh and Willis reported receiving similar subpoenas few weeks after. Within a month, Spitzer's office had broadened its probe to include large property and casualty insurance companies. On September 9, 2004, Spitzer's office received an e-mail indicating that Marsh had conspired with insurance carriers to rig bids on insurance renewals by obtaining false, inflated quotes from complicit markets to enable Marsh to direct business to a chosen market with an eye toward maximising contingent payments.

    In Marsh sales literature it was written:"Our guiding principle is to consider our client's best interest in all placements. We are our clients' advocates and we represent them in negotiations. We don't represent the insurance companies." At the other hand in the internal Marsh memo different message was presented:"The size of contingent commissions determines who we are steering business to and who we are steering business from."[23] Spitzer's office suspected that only from contingent commissions in 2003, Marsh collected $800 million out of $1,5 billion annual net income.

    On October 14, 2004, New York State Attorney General Eliot Spitzer's finally filed suit against the world's largest insurance broker Marsh & McLennan. It was the biggest scandal in the history of insurance broking. Marsh was accused of defrauding customers by "rigging bids" to maximise its own profits. The suit alleged that insurers paid Marsh more than $1 billion in contingent commission to steer them business and shield them from competition. At the same day, the Attorney General announced that two AIG executives pleaded guilty to criminal charges in connection with this illegal course of conduct and stated.

    Soon after the suit, stock prices of 3 major brokers were severely hit. During one week in October 2004, MMC's stock lost almost 50% of its value; Aon lost about 32%, while Willis suffered "only" 20% loss. Former MMC's CEO, Jeffrey W. Greenberg on October 25, 2004, and four of the company's employees have been dismissed. On November 9, 2004, MMC announced plans to reduce its staff by 5 percent, or approximately 3.000 positions, a move that was expected to result in annual cost savings of $400 million. The company's third-quarter earnings fell by 94 percent, compared to the same quarter previous year, as the company established a $232 million reserve to cover any settlement. On November 18, 2004, MMC also announced that five members of its board of directors have stepped down.

    Spitzer's filing of the Marsh Complaint sett off a nationwide wave of investigations and regulatory and legislative initiatives to reform insurance brokerage practices. On January 30, 2005, investigations reached an $850 million civil settlement with Marsh, a $190 million policy restitution agreement with Aon (March 2005), a $50 million one with Willis North America (April 2005) and $27 million with Arthur J. Gallagher (April 2005) over a series of allegations concerning contingent commissions and other issues. Money was supposed to be transferred over four years into a fund from which clients will be compensated. Marsh, Aon, Willis and Arthur J. Gallagher each agreed to essentially same set of "business reforms" as part of their settlements. The most important among these reforms were a ban on their acceptance of contingent commissions and other forms of incentive compensation among insurers and mandatory disclosure to clients of all insurance quotes procured and related compensation.[24] AIG and ACE have said they will stop making contingent commission payments to brokers. Marsh's next CEO Michael Cherkasky was also forced out when he couldn't make up $800 million a year in revenue the broker lost when it gave up contingent commissions.

    According to Business Insurance article in August 2009, contingent commissions appear poised to make a comeback among major brokers. Arthur J. Gallagher's July deal with Illinois authorities to allow it to again accept millions of dollars in contingent commissions beginning from October 2009 likely will open the door for similarly banned brokers to do the same. It now looks as if Spitzer's mandate will be reversed. Marsh and Aon are likely to get increased revenue from contingent commissions if things go back the way they were. However, Willis Group CEO Joseph Plumeri says his company will take the high road and not accept contingent commissions[25]. He expects Willis to be paid similarly to brokers that accept contingents, just in the form of upfront commissions.

    4.4.5 M&A within global brokers

    In the last 30 years, main opportunities for global brokers' growth have been mergers and acquisitions, rather than organic growth. Consolidation has played and continues to play a key role in the insurance brokerage marketplace, which has seen a number of big-name companies disappear over the years and new firms emerge. 1980s marked acceleration of consolidation deals but major wave of M&A processes between big brokers started in 1996.

    Marsh and Aon were responsible for the disappearance of eight of the world's 20 largest brokers from 1995 rankings. From 1996 through 1998, Aon acquired such top-tier brokers as A&A (ranked 4, Bain Hogg Group P.L.C., Group le Blanc de Nicolay, Jauch & Huebener KGaA and the Minet Group. Thanks to these acquisitions Aon doubled its revenues in only two years. During the same period, Marsh acquired Cie. Europeenee de Courtage d'Assurances et de Reassurances, J&H and Sedgwick. In 1997, Willis acquired 33% minority share package of Gras Savoye. Mr. O'Halleran, who at the time was president and chief operating officer of Aon Corp and president of its brokerage operations, explained that consolidation produced synergies: "What started the momentum was a growing recognition that clients were in need of global capabilities. We were in a very soft market back then and were all looking to grow. The inefficiencies were everywhere and the idea was by bringing one plus one together, you'd get at least two-and-a-half if not three in terms of a return."[26] Some big brokers merged during this period to form larger organisations and reduce costs. In February 2007, two big UK brokers, JIB (Jardine Insurance Brokers) and Lloyd Thompson merged to form Jardine Lloyd Thompson Group plc. Also in 2007, Benfield and Greig Fester merged to become Benfield group. Two years later, HLF Group was formed by merging 3 UK brokers: Heath, Lowndes Lambert and Fenchurch.

    v In the beginning of 2000s banks have started to be more involved in insurance distribution, also by broker acquisitions. In 2001, Wells Fargo purchased Acordia, the 5th largest insurance broker in the US. In 2003, another bank, BB&T acquired McGriff Seibels, the 13th largest broker in the US. According to Business Insurance magazine (July 2003), the ten largest bank-owned US brokers accounted for 10% of P&C brokers market share ($1,6 billion of revenues).

    Consolidation between big brokers was stopped for a while, because of the Spitzer investigation. Andrew Cuomo, who was Elliot Spitzer's successor on the position of the New York attorney general, made a settlement with top 3 brokers in June 2008. The settlement allowed Aon, MMC and Willis to acquire smaller firms that still collect contingent commissions with a condition that contingent commissions must be phased-out in the following three years. This deal has initiated a new wave of consolidation among insurance brokerage firms. The first big acquisition was made just one week after the settlement. Willis Group acquired Hilb Rogal & Hobbs for about $2,1 billion. Hilb Rogal & Hobbs was ranked as 7th biggest global broker for 2007 by Business Insurance. Willis estimated that its percentage of revenues drawn from North America will rise for 50% after this acquisition (from 30% of market share to 45%). In August 2008, Aon Corp acquired Benfield Group (based in London) for $1,75 billion.

    Despite the effects of greater global reach and economies of scale, mergers and acquisitions have not always led to improved performance. The absence of integration of newly acquired brokers has resulted in inappropriate coordination across different units, overstaffing, duplication of effort and other friction. These inefficiencies can significantly affect brokers' profitability.

    4.5 The evolving role of brokers as service providers

    During last two decades, commercial insurance and reinsurance brokerage business has evolved from its core function of matching pre-defined insurance coverage needs with insurance supply. This required primarily detailed market knowledge on the part of the broker. Brokers have begun to offer additionally new services and have changed the market's perception of their role. Some of the reasons for this change are the following:

  • Consolidation among brokers has increased their size and resources, enabling them to leverage these resources and offer sophisticated services to clients. By offering more services, they have been able to gain an edge over their rivals.

  • Soft market conditions put pressure on the added value provided by brokers, making it easier for clients to negotiate rates and terms and conditions with insurers. Adding new services, such as risk management advice, was one way for brokers to increase the value of the services they offered.

  • Revenues from fee-based products are not as sensitive to insurance premiums as are commissions on traditional brokerage services. This provides brokers with an incentive to offer new fee-based products, particularly when they find their traditional commissions coming under pressure.

  • The improvement in information systems and technologies have encouraged large insurers to make more use of sophisticated risk management technologies and offered them to their clients in the form of services.
  • Insurance brokers now employ sophisticated risk-modelling skills in combination with market knowledge to structure risk solutions for their solutions for their clients before placing the risk with the appropriate carriers. Such an improvement in risk analysis methodology has meant that brokers have evolved from being providers of basic brokerage services into risk advisors offering a wide variety of fee-based risk management and consultation services. Next figure illustrates how brokers are involved in the insurers' value chain (Source: Swiss Re Economic & Research).


    According to a Business Insurance (17 February 2003) survey of risk management consulting firms, some brokerage houses are leaders in risk management, as measured by number of risk management staff and unbundled revenues generated by risk management consulting. Marsh's risk consulting service was the largest overall risk management firm by number of staff and by revenues. It is interesting that Marsh's consulting revenues are more than double those of the next largest risk management consulting company mentioned in the survey, Deloitte & Touche. Aon Capital Markets and MMC Enterprise Risk (a part of MMC Group as well as Marsh) are listed as 2 of the top 10 specialists in risk securitisation[27].

    Risk managers are increasingly looking for enterprise risk-management tools that allow them to understand their risk profile, identify cost drivers and analyse enterprise-wide risk. Large brokers, along with insurance companies and independent software vendors, are active in the provision of such tools, referred to as risk management information systems.

    Commercial brokers have been very active also in captive management. Captive insurance companies are insurance companies established with the specific objective of financing risks emanating from their parent group or groups, but they sometimes also insure risks of the group's customers as well. Using a captive insurer is a risk management technique by which a business forms its own insurance company subsidiary to finance its retained losses in a formal structure. The world's largest captive management group is Aon Global Risk Consulting managing 1.269 of the world's 5.211 captives finishing well ahead of Marsh and Willis, with 1.120 and 298 captives, respectively[28].

    Commercial brokers also play an important role in the claims administration of self-insurance programs. According to Business Insurance (February 2007) three out of six largest claims management companies are brokers' affiliates: Sedgwick Claims Management Service Inc (rank 1, parent Marsh) , Gallagher Bassett Services (rank 3, parent Arthur J. Gallagher), and Cambridge Integrated Services Group (rank 6, parent Aon).

    These new services reflected a general change in perception of the role of the commercial broker. According to a Reactions[29] survey, 30% of the risk managers, reinsurance buyers, risk consultants and underwriters view brokers as being risk consultants and not just as placers and facilitators of transactions. However, the majority still considers placement of business to be the brokers' core business.

    4.6 Credit rating of insurance brokers

    Many of the criteria used to evaluate insurance brokers are similar to those used to evaluate other corporate entities. However, given insurance brokers' unique credit fundamentals and their operating environment, key differences are also identified.

    The financial leverage metrics demonstrated by the fastest-growing insurance brokerages are more aggressive than other types of companies in their rating categories. When an industry is run on personal relationships and grown by acquisition, the resulting balance-sheet quality is often poor. Specifically, goodwill and other intangible assets often constitute substantially all of a company's equity. Accordingly, many insurance brokers have negative tangible net worth. Liquid assets are not generally available to service debt. Instead, debt servicing is sourced from the sector's cash flow generation capabilities. Cash-flow analysis is the single most critical aspect of credit rating decisions for insurance brokers. It takes on added importance for speculative-grade issuers that constitute the majority of the insurance brokerage rated space. Although companies with investment-grade ratings generally have ready access to external financing to cover temporary cash shortfalls, speculative-grade issuers lack this degree of flexibility and have fewer alternatives to internally generated cash for servicing debt. Insurance brokerage provides cash generated service. Cash-flow ratios show the relationship of cash flow to debt and debt service, and also to the company's needs. The ratios themselves are affected by stand-alone financial strength as well as outside forces, most particularly Property and Casualty (P&C) cyclicality factors, regulatory risks, and mergers and acquisitions.

    Because insurance brokers' commission streams are variable and their costs are relatively fixed, the point in time in the P&C rate cycle plays a prominent role in determining the sector's level of organic cash flow capabilities, profitability and growth potential. Generally, during a hard market, P&C premium rates are increasing, and in a soft market commercial lines P&C premium rates are decreasing. Though some of the anticipated ups and downs of the P&C rate cycles are factored into the credit rating all along, ratings are not a mere snapshot of the present situation. Accordingly, one can expect to see more volatility in the speculative-grade category. This reflects the interest uncertainty and potential heightened financial risk that such a company may exhibit in contrast to its investment-grade counterparts. One may expect a speculative-grade rating to vary over time during the cycle. Although, credit ratings are meant to be forward-looking, the time horizon for a speculative-grade issuer is shorter than for a higher rated company that may be more insulated from cyclical influences. Accordingly, one can expect to see more frequent ratings and outlook changes for speculative companies.

    Insurance brokers are subject to regulatory scrutiny. Regulatory changes affect the sector's competitive landscape, business models, and client relationships. A regulatory charge against a firm may impair its reputation among customers. Conversely, competitors often capitalize on market disruption by hiring established producers from questionable firms, though it takes a few years to realize an increase in revenue productivity. Accordingly, an insurance broker's cash-flow ratios may fluctuate following times of regulatory uncertainty. These aspects were amply demonstrated during regulatory investigations that took place in the middle of this decade.

    The Standard & Poor's historical ratings for 3 biggest global brokers are shown in the following Table.

     

    2006

    2005

    2004

    Marsh & McLennan

    BBB

    BBB

    BBB

    Aon Corp. 

    BBB+

    BBB+

    BBB+

    Willis Group 

    BBB

    BBB-

    BBB

                Table 3: The S&P historical rating[30]

    S&P rates corporations on a scale from AAA to D. BBB+, BBB and BBB- grades are all classified as medium safe investment grades (lowest investment grades). They are considered satisfactory but should be monitored for longer-term investments.


    5. Commercial insurance broker markets

    Commercial non-life insurance in this report includes property, motor, liability, marine, aviation, transport, legal expenses, credit and other, smaller lines of business. However, it excludes accident and health insurance, which generally falls into the category of employee benefits for commercial customers, along with pensions and term life assurance. Nevertheless, commercial customers include small and medium-sized enterprises, self-employed professionals and tradesmen as well as larger organisations.

    Brokers are the most important distribution channel for commercial non-life insurance. They play much more significant role in commercial insurance business than in personal lines. However, the brokers' market share in commercial lines varies widely by region and country.

    5.1 Europe

    Estimated brokers' revenues from commercial non-life insurance in Europe are worth about �10,4 billion a year[31]. In this section focus will be on the biggest 6 European markets which are responsible for 80% of commercial non-life revenue: UK, France, Germany, Italy, Netherlands and Spain, respectively.

    In the more developed commercial non-life insurance markets, premiums are the equivalent of at least 0,7% of GDP. Most developed economies have more than 40% of non-life premiums coming from commercial customers. This second comparison is a guide to the importance of commercial lines in that country rather than a sure indicator of market maturity, because it also depends on the scale of personal lines insurance. Share of commercial non-life insurance in total non-life premiums and GDP for the six largest European markets is shown in the following table:

     

    Commercial non-life premiums as % all non-life

    Commercial non-life premiums as % of GDP

    United Kingdom

    37%

    1,17%

    France

    45%

    1,03%

    Germany

    47%

    1,02%

    Italy

    39%

    0,82%

    Netherlands

    51%

    1,17%

    Spain

    39%

    0,92%

    Table 4: Commercial non-life insurance compared to total non-life premiums and GDP, 2007

    Property, motor and liability insurance classes of business dominate commercial non-life insurance markets in Europe with total share of 78%. Interesting observation would be that motor insurance market share is higher in less mature European markets (e.g. Poland, Portugal, Slovakia...).

    Broker distribution channel for commercial non-life insurance in Europe handles more than half of all premiums in most countries. In every country, larger and more complex companies use brokers to a very high degree, with other channels gaining in importance down to the level of very small companies and self-employed individuals, whose distribution channels are generally close to those of personal customers. Within top six countries only in Spain share of commercial non-life premiums distributed by brokers is lower than 50%. In the UK, brokers' share of the commercial non-life insurance market has been stable for several years, fluctuating between 80% and 90%.

    As already mentioned, total annual broker revenue in Europe is about �10,4 billion. Top six countries are responsible for �8,9 billion. As expected, the largest European broker commercial market is the UK, given that it has both the largest commercial non-life market, and that brokers are dominant in this country, and it alone makes up 34% of European commercial non-life insurance broking income.

    Although there are thousands of brokers in Europe, the commercial non-life broking market is fairly concentrated because of the strength of the three global brokers, and because smaller brokers tend to concentrate on personal customers. In most of European countries Aon, Marsh and Willis are top three brokers. On average, the largest three brokers in each country control an estimated 41% of all commercial non-life insurance premiums, while the top ten control 65% between them. In most of European countries Aon, Marsh and Willis are top three brokers with 15%, 14% and 9% of market share on average, respectively. Aon has the highest market share in Norway (28%), Marsh in Italy (28%), while Willis has the highest share in Denmark (26%).

    The broker channel as a whole is likely to emerge stronger from the recession, although this process will cause a lot of pain on the way. Two trends are likely: for brokers to gain market share, and for the broker industry to become more concentrated. Finnacord estimation on total growth in five years for six major European markets is shown in the next figure:

    5.2 US and Bermuda

    In the US, broker's share of commercial insurance business varies between 67% in 2001 and 75% during the last two decades of the previous century[32]. Significance of the broker's share in the US also varies by business line. In 2002, brokered business accounted for a 75% market share of general liability, commercial auto, workers compensation and commercial multi peril business, but only 39% of medical malpractice net premiums.

    Although there was a decline in market share of broker business in the US, demand for large broker business has risen over the last decade and is expected to continue rising. One of the reasons is that the share of offshore insurers in the global market has increased. Offshore insurance is almost exclusively brokered business and the premier marketplace is Bermuda. An attractive feature of Bermuda as an insurance domicile is that Bermuda has no corporate income tax, (i.e. there is no tax on capital gains, profits, or shareholder dividends). The no tax guarantee extends until 2016. Aside from regulation and taxation, Bermuda is politically stable, with a low government debt burden, a high sovereign financial rating, and a stable monetary system. Both insurance and reinsurance market have been growing rapidly in Bermuda.

    The largest part of insurance gross written premiums in Bermudian market (62%) come from North American companies, while 29% of business come from Bermuda (mostly captive insurance). Only 7% total premiums in Bermuda are originated in Europe and only 2% from others[33]. The most represented lines of business on the island are captive insurance, property catastrophe reinsurance, professional liability, directors' and officers' liability and employment practices liability. Major brokers are present in Bermuda, offering mostly captive insurance. Big brokers helped creation of many (re)insurers on the island (ACE, XL, Global Capital Re, Montpelier...) by providing them venture capital.


    6. Future challenges and opportunities for broker channel

    It is hard to predict how broker channel will look like in future. However, key trends, challenges and opportunities can be recognised. They include changes in consumer demands and behaviours, information technology improvements, economic recession, further broker consolidation, the growth of insurance need in emerging markets, shifts in product mix and niche specialisations. Some of these factors are correlated and they will affect brokers of different sizes to various degrees of significance.

    Insurance distribution is evolving and becoming more complex as more customers go online and switch channels to research and buy insurance. In last decade the development of the Internet, has emerged as a competitor for traditional networks. The Internet provides access to a wide range of information, increasing price transparency and often forcing prices down. In more and more cases, customers even purchase and manage their policies online. In 2008, the majority of the US online adults who researched a financial product (including insurance) did so online, and the majority of those online researchers applied in a channel other than the Web. These cross-channel shoppers illustrate the importance of online-influenced sales in insurance. Forrester research from November 2009 shows that 56% of US citizens who buys motor insurance search for online quotes. However, only 42% of them buy motor insurance online that means 58% research online and apply offline. This fact also emphasises the importance of multi-distribution approach.

    The rise of online direct insurers tries to cut out the personal non-life insurance agents and brokers. This attempt has its limits, as the proliferation of direct writers makes it increasingly difficult for insurance buyers to make proper comparisons between them. In corporate lines of business situation is different. For them the most important is best-value approach because a low-cost coverage which causes delay at the claim stage can destroy a business. Corporate clients appreciate the advice that broker gives in comparing the total insurance proposition - cost and creditworthiness.

    The Internet can be advantageous for the broker in terms of providing them with a faster more cost efficient method of transferring information globally and therefore enabling them to pass on the savings to their customers and hence attract more business. The Internet is also changing the role of the broker from an intermediary to an "infomediary"[34] who conveys information to the customer. Brokers use their websites as a platform designed to inform customers (or potential customers) and to present their products and services. Brokers' websites offer possibilities for dialogue with experts by e-mail or telephone. It assures customers that it will connect them with the right expert, someone with answers and the ability to develop solutions. However, using real online brokerage is still rare. Those websites which do offer a brokerage service do it by drastically simplifying the problem: they standardise the products which insurers are permitted to offer through their sites.

    Brokers hold the advantage over direct sales forces and tied agents in their ability to look across the market, which is a distinct benefit in an economic recession if companies want to reduce the costs of insurance by changing provider. In addition, larger brokers hold an advantage over smaller intermediaries through their greater expertise and economies of scale; most agents are small companies, apart from a few large multi-tied agents. Recessions accelerate economic change as well, and brokers are best placed to benefit from this because they tend to be better at developing new specialisations.

    In case of severe economic recession non-life premium volumes and with them brokers' revenues would fall further, and more under-capitalized brokerages would go out of business. This would often mean very small brokerages, but often small or medium-sized family firms may be better placed to survive than those under pressure from shareholders. Mergers are the most likely response of small and medium-sized brokers to falling revenues, to preserve businesses from closure.

    There are many important emerging markets that are still in the process of privatisation and deregulation. It offers attractive growth opportunities given their exposure to the unfamiliar challenge of global competition. Both clients and insurers in these markets need advice and know-how. These can be supplied by insurance brokers who can instruct them in the use of commercial insurance. At the same time global brokers offer local expertise to foreign entrants into these markets enabling them to operate successfully.


    7. Bibliography

    Agreement Between the Attorney General of the State of New York and the Superintendent of Insurance of the State of New York, and Marsh & McLennan Companies, Inc. , Marsh Inc. and their subsidiaries and affiliates (collectively "Marsh"), New York, January 30, 2005.

    Anshu Arora, 2003, E-Insurance: Analysis of the Impact and Implications of E-commerce on the Insurance Industry, London, May 2003.

    Ahmed Beloucif, Michaela Waddell, Broker-client relationship: a conceptual framework.

    Aon Corporation, 2009, 2008 Annual Financial Report, Chicago, February 2009.

    BIPAR, the European Federation of Insurance Intermediaries, www.bipar.eu

    Business Insurance Magazine, May 2003, July 2003, October 2007, July 2008, August 2008, March 2009, July 2009, August 2009, www.businessinsurance.com

    CEA, 2009, European Insurance in Figures, October 2009, CEA Statistics N�37.

    CMS Adonnino Ascoli & Cavasola Scamoni, 2007, Italian Insurance Law Reform.

    Creadon S., 2000, e-insurance - problem or opportunity for brokers?, The Actuary, June 24, 2000.

    D.F. Spulber,1999, Market Microstructure: Intermediaries and the Theory of the Firm, Cambridge University Press.

    Encyclopaedia Britannica, www.britannica.com

    Encyclopaedia Investopedia, www.investopedia.com

    Encyclopaedia Wikipedia, www.wikipedia.com

    Finnacord, 2009, Commercial Non-Life Insurance Brokers in Northern and Central Europe, April 2009.

    Finnacord, 2009, Commercial Non-Life Insurance Brokers in Southern and Western Europe, April 2009.

    Forrester Research, www.forrester.com

    Gergana Rakovska, 2001, E-Commerce Business Models for Insurance: Application to U.S. and European Markets,

    Gilles Benoist, 2002, Bancassurance: the new challenges, The Geneva papers on risk and insurance Vol.27 No. 3 (July 2002), Geneva.

    Hazel Beh, Amanda M. Willis, 2009, Ii, Connecticut Insurance Law Journal Vol. 15:2.

    J. David Cummins, 2008, The Bermuda Insurance Market: An Economic Analysis.

    J. David Cummins, 2005, Should Contingent Commissions Be Illegal?, World Risk and Insurance Economic Conference, August 10, 2005, Geneva.

    J. David Cummins & Neil A. Doherty, 2006, The Economics of Insurance Intermediaries, 73 J. Risk & Ins. 359, 360 (2006).

    J. Robert Hunter, 2005, Contingent insurance commissions: implications for consumers, Report by the Consumer Federation of America, January 26, 2005.

    Marsh & McLennan Companies, 2009, Annual Report 2008, New York, February 2009.

    Martina Eckardt, 2002, Agent and Broker Intermediaries in Insurance Markets - An Empirical Analysis of Market Outcomes, International Society for New Institutional Economics - 6th Annual Meeting: "Institutions and Economic Performance" Cambridge, September 27-29, 2002.

    Online insurance glossary IRMI, www.irmi.com/online/insurance-glossary

    Online portal Reactions, www.reactionsnet.com

    Randy E. Dumm, Robert E. Hoyt, 2002, Insurance Distribution Channels: Markets in Transition, August 9, 2002.

    Rasik H Patel, 1998, The Role of a Broker in an Open Insurance Market Place, Afro-Asian Insurance Services Ltd UK.

    Sean M. Fitzpatrick, 2006, The Small Laws: Eliot Spitzer and the Way to Insurance Market Reform, 74 Fordham L. Rev. 3041 (2006).

    Spitzer, Eliot, 2004, "Complaint: The People of the State of New York against Marsh & McLennan Companies, Inc. and Marsh Inc.," Office of the Attorney General of the State of New York, New York.

    Standard & Poor's, 2008, U.S. Insurance Broker Criteria, April 2008, www.standardandpoors.com/ratingsdirect

    Swiss Re, 2000, The impact of e-business on insurance industry: Pressure to adapt - chance to reinvent, No. 5 of 2000, Zurich.

    Swiss Re, 2003, The picture of ART, No. 1 of 2003, Zurich.

    Swiss Re, 2004, Commercial Insurance and Reinsurance Brokerage: Love Thy Middleman, Sigma, No. 2 of 2004, Zurich.

    Swiss Re, 2007, Bancassurance: emerging trends, opportunities and challenges, Sigma, No. 5 of 2007, Zurich.

    Willis Group, 2009, Annual Report for Shareholders 2008, London, February 2009.


    [1] Adopted by the Council of Ministers of the EU on September 30, 2002, EC Official Journal L9, Volume 46, January 15 2003

    [2] Source: Forrester survey on direct insurance, 2005

    [3] This report can be downloaded from the CEA's website: www.cea.eu. The CEA (Comit� Europ�en des Assurances) is the European insurance and reinsurance federation based in Brussels.

    [4] In the Netherlands agents and brokers are classified in one group by Dutch Association of Insurers because of national legislation. Of course, the same remark stands for non-life analysis as well.

    [5] Source: CEA's report "European insurance in figures", www.cea.eu

    [6] Figures as at 1st of January 2008, source: Lloyds of London, www.lloyds.com

    [7] For further reading on this topic refer to: D.F. Spulber, 1999, Market Microstructure: Intermediaries and the Theory of the Firm, Cambridge University Press.

    [8] Sources are two Finnacord reports: Commercial Non-Life Insurance Brokers in Northern and Central Europe and Commercial Non-Life Insurance Brokers in Southern and Western Europe, April 2009.

    [9] Source: Finaccord report: Commercial Non-life Insurance Brokers in Southern and Western Europe, April 2009

    [10] Source: A.M. Best Company, Best's Aggregates and Averages: Property/Casualty, 2004

    [11] Source: Willis Group Annual Report 2008.

    [12] Source: Investopedia, www.investopedia.com

    [13] Source: Daily Telegraph, September 30, 2003.

    [14] Source: Swiss Re Economic Research & Consulting

    [15] Figures are in $ million. Source: Business Insurance, July 2009.

    [16] Willis has 42% shareholding in Gras Savoye (April 2009), source: Finnacord.

    [17] Source: Business Insurance, July 2008.

    [18] Source: Annual Reports for 2008.

    [19] Source for both figures is: Marsh & McLennan Companies Annual Report 2008

    [20] Source: Aon Corp. Annual Report 2008

    [21] Source: Willis Group Holdings Annual Report 2008

    [22] For further readings refer to Steve Fishman, Inside Eliot's Army, N.Y. Mag., January 2005, http://nymag.com/nymetro/news/politics/newyork/features/10815

    [23] Source: Should contingent commissions be illegal?, J. David Cummins, World Risk and Insurance Economic Conference, August 2005

    [24] Source: Agreement Between the Attorney General of the State of New York and the Superintendent of Insurance of the State of New York, and Marsh & McLennan Companies, Inc. , Marsh Inc. and their subsidiaries and affiliates (collectively "Marsh") dated January 30, 2005, available on the Attorney General's website: http://www.oag.state.ny.us/media_center/2005/feb/marsh_settlement.pdf

    [25] Source: Business Insurance magazine, Contingents returning for biggest brokers?, August 2009

    [26] Source: Business Insurance, October 2007

    [27] Source: Business Insurance magazine, May 2003

    [28] Source: Business Insurance magazine, March 2009

    [29] Reactions is online portal whose focus is "predominantly on the chain between businesses seeking to lay off risk to insurers, and insurers in turn looking to pass on parts of their risk to reinsurers". www.reactionsnet.com

    [30] Source: Standard & Poor's report: U.S. Insurance Broker Criteria, April 2008.

    [31] Sources for all data in this section are two Finnacord reports: Commercial Non-Life Insurance Brokers in Northern and Central Europe and Commercial Non-Life Insurance Brokers in Southern and Western Europe, April 2009.

    [32] Sources: A.M. Best, Swiss Re Economic Research & Consulting

    [33] Source: J. David Cummins, The Bermuda Insurance Market: An Economic Analysis, 2008

    [34] Infomediary gathers and organizes large amounts of data and acts as an intermediary between those who want the information and those who supply the information. The concept of the infomediary was first suggested by McKinsey consultants and professors John Hagel III, and Marc Singer in their book NetWorth.

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