2006 - mirabilis or horribilis?

Richard Adams: How long and deep will the current softening cycle be?

Peter Staddon: I don't think we will be able to tell how deep it is; each sector has its own particular problem. Normally when the rates start to drop, it is motor - predominantly commercial, sometimes big-vehicle, motor. We just need to look at that. The thing that worries me is whether or not we are going to get into this ridiculous cycle of rates tumbling down and then suddenly getting a huge rate increase in a couple of years' time, as we saw in the liability market.

Oliver Laughton-Scott: The impact of the equity markets is an important factor. The slump in the Stock Exchange took far more capital out of the industry than losses. The reason we have a cyclical industry, ultimately, is because we have a cyclical equity market and no one knows what the equity markets are going to do in future. Thus anyone whose states with confidence what the underwriting cycle is going to be is either a lot cleverer than the rest of the world, or is in fact very silly.

Steve White: There is also an element of readjustment following substantial increases that were applied across liability sectors following 9/11.

Richard Adams: Insurer chief executives talk of underwriting discipline and underwriting for profit, but their firms are competing for business aggressively at present, which is totally at odds with the rhetoric. Why is that?

Oliver Laughton-Scott: The problem is that people have budgets and they say they are going to write so much premium income. When they lose a bit of business, they go out and fight for a new bit. And if they have a target of £1m premium income, they go and find £1m premium income. As business is run sort of by budget, and with X amount of premium income, I am afraid they push themselves from the cycle. As it gets softer, that is when they tend to accelerate - and the losses which stop that take six months to two years to come through. So hence we have the cycle.

Peter Staddon: We are being told that when insurers go out and get new business, they actually write that business for less than their existing business. Their existing business could have a rate increase of 7%, yet when an almost identical piece of new business comes in, they will actually put that rate down by 10% to get it. They want continuity, but it's no wonder that brokers are moving (from insurer to insurer), if the insurers are doing this.

Oliver Laughton-Scott: What is important is technology. Historically, it might have taken you three months to change your rates, and a year or two to discover what the loss is. With better IT systems, insurers ought to get much quicker feedback as to what their loss ratios are likely to be and that would tend to lessen the severity of the cycle. But if we expect technology or regulation to remove the cycle, I think we will be disappointed.

Richard Adams: How can brokers improve their prospects in a soft market?

Peter Staddon: Many actually have untapped income streams that really they should exploit at this stage through cross-selling.

Oliver Laughton-Scott: The single most important factor in the quality of a broker is whether they systematically sack clients. You can't choose which clients you take on, but you can choose which you keep. Many brokers only make 10% or 15% margins, but 3% or 4% of their clients take up a disproportionate amount of their time and effort. If you can systematically sack those clients you will improve the quality of your business. Never chase brokerage income at the expense of profitability.

Steve White: It is important in a soft market that brokers are clear about what it costs to operate. What does it cost to put that piece of business on the books? What does it cost to maintain my relationship with my customer? If you haven't done that, a nasty situation could creep up on you.

Richard Adams: What of the suggestion to move from commission to fees?

Peter Staddon: Accountants and lawyers set out from day one what it is going to cost. If we want to make this industry into a profession, we have to embrace that.

Steve White: There is an interim step that brokers can take: they should be prepared to operate on a fee basis for those customers who express an interest in doing so. BIBA's view is that if we were to go overnight to fees rather than commissions, that would almost certainly guarantee an increase in charges to customers. Remember that, if you are running a commercial operation, the commissions you receive on the business that you write cover the cost of running a department. On the new business side, for example, you may only write one in four cases that you get, so the commission you get on the one covers the three that you don't get. If you are working on a fee basis, you have to either increase your fees or start charging for quotes.

Richard Adams: Regarding consolidation, is there a perception among buyers that there is a window of opportunity at the moment?

Oliver Laughton-Scott: There is clearly a lot of interest among buyers. A couple of things have happened: first, as markets soften, insurers worry about distribution. Shortly after 9/11, they didn't give a toss about distribution - they could make so much money. As rates go down, distribution becomes more important and therefore insurers will put money into distribution and help brokers actually make acquisitions.

Richard Adams: A question has been come in while we have been on air from Peter Wilby, who asks: "Is the proposed future treatment of goodwill by the FSA going to be a block to future acquisitions and MBOs for the average-sized broker?"

Oliver Laughton-Scott: There was a recent report that said it was. I have to say I think there is a straightforward misunderstanding. My understanding - and I haven't looked at it in great depth - is that you will be in the trading position of a holding company which makes the acquisitions. The goodwill is realised in those accounts and therefore has no impact whatsoever. I may be wrong. People are always say that X, Y and Z accounting is going to impact how things are done. My experience is that how accountants treat things for their books is pretty irrelevant.

Steve White: I disagree - and we have raised this issue with the FSA. The larger firms can speak to their supervisors about the ways in which acquisitions can be put through the books. Just simply creating a holding company in which to move the bad debt doesn't solve the problem because the FSA will be interested in the holding company, despite it not being an authorised firm.

Oliver Laughton-Scott: I hear what Steve says, but the fact of the matter is that the FSA has a job to regulate certain companies. The big boys aren't going to be put out for that: if the FSA is not regulating the holding company, then they will do what they want with it. And if the big boys can do it, the small boys can do it as well. It is none of the FSA's business. I remain unconvinced that it will have a huge impact.

Richard Adams: Another question has come in, from David Wagstaff. "There is a lot of discussion about the cost of maintaining client relationship, but what about the costs of maintaining a relationship with insurers? Particularly those who suffer from patchy service levels?"

Oliver Laughton-Scott: As a general rule, I would suggest that brokers look at their clients, and then look at their relationships with their insurers and put some pressure on them. You own your clients, you look after your clients, you place that business where you want to extract value from the manufacturers. These are commodity products and you should be getting a large share of the rewards.

Richard Adams: How does a broker know when is the right time to sell?

Oliver Laughton-Scott: Never sell at the top (of the cycle). You always miss it. If I could tell you when the right time to sell your business was, I would know all about the equity markets and I wouldn't be doing this job: I would be on a beach with two telephones and three dolly-birds buying and selling dollars. We aren't that clever. Even Warren Buffett doesn't know whether the stock market is overvalued or undervalued.

Richard Adams: Does the panel expect the FSA to take more active interest in the way businesses are acquired, and, if so, how is the approach likely to change?

Steve White: It is argued that the FSA does not like to involve itself in the commercial workings of markets, and that therefore their interest in acquisitions is likely to be restricted to compliance issues surrounding individual takeovers rather than takeovers in the round.

Oliver Laughton-Scott: Yes, I broadly agree with Steve. I think as soon as the FSA get involved in commercial decisions, they are going to come terribly unstuck.

Richard Adams: What about the possible increase in control by insurers over distribution as it was with the IFA market?

Peter Staddon: A lot of these insurers do like to try to control. I have got a bit of a bee in my bonnet in relation to the medical insurance companies and am unimpressed with the way that they deal with the broker's client. Let's be quite clear: the broker is the agent of the insured, not the insurer.

Oliver Laughton-Scott: At the small end, if it is a process-driven business like Tesco, it is absolutely fine to have a direct relationship. But a large corporate client needs independent advice from a broker. Whenever insurers try to buy that relationship and control it, it has been a complete disaster.

Richard Adams: Your concluding remarks?

Peter Staddon: The FSA is here to stay. There is nothing we can do; we have to embrace it.

Oliver Laughton-Scott: Work out how much your customers make for you. The ones that aren't making you money - sack them or charge them more; they will probably stay with you anyway. And brokers should look at the risk management field for a whole range of services they are providing more cost-effectively than lawyers and accountants.

Steve White: Brokers should ensure that they have appropriate systems and controls in place to achieve and to evidence compliance. It is argued that well-run firms are those most likely to succeed in future.

THE PANEL

Richard Adams, Editor, Professional Broking magazine

Steve White, Regulation and compliance manager, British Insurance Brokers' Association

Peter Staddon, Technical director, British Insurance Brokers' Association

Oliver Laughton-Scott, Managing principal, IMAS Corporate Advisers

Hear this debate in full, and previous debates, by accessing the archive on the website at www.brokermanagementforum.com

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