The changing face of the market

Has there ever been a period of greater flux for the UK insurance market than the past three years? The post-Spitzer, post-contract certainty, regulated environment is one in which mutability seems to be the only constant.

The explosion of broadband access (54% of the UK population is now online), has transformed the distribution of primary financial services products like travel, household and motor covers as confidence grows in online purchasing. This is having an accelerated impact on the insurance market, as the opportunities for micro-segmented web marketing and associated facility management and policy tailoring bring new efficiency to the customer experience. In 2008, we can expect continued technological advancements, with the internet market taking off further and insurers realising benefits from investments in straight-through processing.

Meanwhile, there has been major consolidation and significant insurer investment in intermediaries. This is leading to the polarisation of distribution via the rise of consolidator and network models.

Reform

The regulatory environment raised costs for both insurers and distributors, forcing them to address heritage processing inefficiencies and look for ways of segmenting their service propositions to deliver profitable returns. Industry-wide rework levels remain outrageously high, despite contract certainty, but the move towards e-messaging-based processing stands the best chance of improving this in the mid-term.

With Solvency II on the horizon, more stringent capital requirements are starting to constrain the decisions of some insurers, which are more demanding in terms of where they deploy capital and the expected returns. The new external investor class is creating a broader range of demands on insurance businesses, not least in respect of their control environments and adequacy, timeliness and accuracy of their management information.

The current soft commercial lines market, buoyed by a near absence of catastrophes in 2006-7, is not predicted to bottom out until mid-2008, although there are signs of rate hardening within the 2007 renewal season. The biggest surprise has been the amount of money still entering the market, mostly linked to demands for diversification from asset managers.

Softening market conditions have seen a slowdown in the growth of the commercial lines market, however the SME segment is forecast to grow and represents over 40% of the market with gross written premium in excess of £9bn. This means one thing; SME is the new battleground.

Bancassurers are well positioned to exploit the SME segment and many are gearing up to capitalise on opportunities in this sector in both primary and reinsurance capacities. Banks are slowly increasing their share in distribution, and as they begin to increase their investments, especially in direct distributors, this trend is expected to accelerate.

While distribution has remained relatively stable in recent years for large corporate business, the broker distribution channel for SME business has transformed.

The "big three" control over 80% of available GWP for reinsurance and large commercial business between them, but distribution of intermediated SME insurance has transformed in recent years. Over 20% of GWP is now in the hands of 10 large broker consolidators that have ambitious growth plans and threaten to transform the market. (See diagram.)

Action

Will the largest insurers sit on the sidelines, or will they look at strategic plays to lead the market? Far from allowing themselves to be disintermediated, it seems that the primary market is being extremely active in its response.

Some have started developing a multi-channel SME strategy with a direct offering, including a field force and a broker offering. Some have made use of technology links with brokers, while others have made broker acquisitions to capture SME direct capability and thereby increase their share of the market. Additionally, others have focused on SME customer segmentation.

Given this range of changing circumstances, what can we predict for the SME market over the next few years? In the age of "what you know", who will win and lose?

Overall, the national brokers share will stay stable or increase through initiatives such as the Willis Commercial Network and the dawn of the super-MGA. However, the figures will likely hide a lot of change in portfolio dynamics as the make-up of the client base shifts and the servicing models become more streamlined. Brokers will need to concentrate on where they add value, not aim to differentiate themselves in the transaction.

The big winners will be the tier-one intermediaries that will continue to gain ground through acquisition activity and insurer lock-ins. We can expect the trend of consolidator models to continue and it is also likely that further tier-1 brokers will be acquired by insurers, but that the market will not fully polarise.

Unless they can embrace the new business dynamics of technology, flexibility and agility, larger provincial intermediaries' share of GWP will decline, leading to a reduced market share by 2012.

Banks are also a likely major gainer as they leverage their distribution capability and existing web-purchasing technology to harness customer risks from their SME client base.

Opportunities

Given the potential market changes over the next five years, there will be opportunities for brokers to add value not from the transaction perspective, but from using their expertise and relationships to design programmes for primary insurers.

SME direct is an area characterised by increasing competition. A low cost operating model, and micro-segmented customer knowledge, underpinned by integrated modern technology could prove to be the key to success in this market.

Banks and building societies are looking to develop their commercial direct infrastructure to offer insurance to their large SME customer bases. The more sophisticated of them are considering this from both primary and reinsurance angles, yet they will need to partner with specialists able to bring expertise to both the assessment of risk in primary portfolios and the structuring of their risk transfers and retentions.

On the affinity side, numerous opportunities exist both for risk-bearing entities and MGAs to utilise infrastructure and economies of scale to offer "white labelling" services to organisations seeking to exploit their retail and SME potential.

There remains massive potential across the UK market, nowhere more so than in the SME space. The next five years will see dramatic landscape changes as organisations consolidate their investments in distribution and technology to leverage enhanced positions. The ultimate gainers should be the end-customers, but there remains more work to do for the value inherent in the broker model to come fully to the fore.

Simon Burtwell, Insurance director, Ernst & Young.