Well connected

In the early 1990s, the broker network was little more than an idea, and one hardly anybody had heard of at that. Today the concept has evolved, weathered controversy and is now - according to some - the only viable option available to small brokers apart from selling up.

In 1994, Grant Ellis was convinced some brokers needed the services a network could offer and set off in his car to drum up interest. Now Broker Network Ltd has over 150 members and premium income over £300m, has floated on the Alternative Investment Market and recently became the first network to receive Lloyd's accreditation.

Buy-ups

BNL has also begun acquiring companies and concern has been expressed by some that the network is in danger of swallowing its own tail through its acquisition programme. Ellis says that is partly why it plans to have a 50/50 split between network members and acquired firms. He explains: "Without the ability to buy retiring members' businesses, our business would stagnate. If we were going to continue to replace a retiring member with a new one, we would have reached a plateau and wouldn't grow any bigger."

This is part of Ellis's view that there is sustainability in diversity. He explains: "We are a support services business for network members and our own businesses. We are a retail broker in our own right; we are a wholesale broker, Lloyd's and London market; and we're also an underwriting agency." It is precisely this diversification that so far has allowed BNL to produce consistent results throughout the market cycle.

Ellis says BNL's plan will take it up to 2010, when it aims to have 250 brokers on a half-owned, half-independent basis. He continues: "Marketers tell us there are 250 significant firms in UK high streets and we want a presence throughout the UK. When we floated we stated this aim and we are on track with 155 members - and we had five applications in January."

Part of achieving this involves communicating exactly what the network offers, as Ellis says confusion about networks generally abounds. "We've found that brokers that wouldn't have considered a network a few years ago are now interested, and some of the recruits we've had this year have been slightly larger firms than we have had in the past."

But the confusion is a challenge for Ellis and other network operators. "All three of the major networks are markedly different and the biggest misconception brokers have is 'I will lose my independence'. But if being independent is about choice - i.e. 'I don't have to follow a particular route' - then I think being in a network gives greater independence."

Ellis mentions four or five new network propositions now in play, but says these are mostly small groupings of brokers banding together - "co-operative arrangements", as he calls them. He continues: "I'm a bit critical of co-op arrangements. There is some value in them, e.g. sharing best practice, but where's the resource? Insurers will want to know what they are going to do that justifies giving them extra. A proper network will manage its members in terms of credit control, quality of presentation, quality of loss ratio, and to an extent it will police behaviour. All these things have benefits to insurers and they accept that it is easier and more cost-effective to deal with members under an umbrella than it would be individually."

The proposition

For those interested in signing up for the benefits offered by BNL, Ellis says most people take between six and 12 months to decide. "We go into a lot of detail. Nobody joins without understanding what they are going to get out of it, what it will cost, and what the commitment is from them and vice versa. Better this way than for problems to come to light after an agreement has been made."

One of the other issues Ellis says needs to be addressed with potential recruits is the opportunist approach of some network propositions that sprung up prior to statutory regulation day and withered shortly after. Has the threat of new entrants now largely subsided? "We ran the business for five years before we made any money at all - you need deep pockets to start up a network."

The network's journey to full Lloyd's accreditation was not without trial, as it gained its provisional accreditation at the peak of the hard market. It therefore found that capacity had been largely already allocated and had to fight for scraps. So are BNL members gaining access to skills and capacity through Lloyd's yet?

"We're still the new kid in Lloyd's and you have to earn your spurs. In 2005, I think we started to do that, with a 26% increase in turnover in the first six months of this financial year, but we're still new, still very small. However, we are starting to form some good relationships - we're very competent at property and liability. We're gradually converting members over to give us a go. We moved into Lloyd's in September and our rent went from £12,000 to £76,000 a year. In fact, the rent here for six desks is only £4000 a year less than we pay for our 7500 sq ft office in Harrogate, housing 100 people. So it's a big commitment."

And the benefits of being in the building, rather than round the corner? "The guys don't have to get wet if they want to go to Lloyd's! And the wholesalers that are finding it tough at the moment have found that the provincial market is prepared to take business back again now brokers don't want to share commission. So if we're seeing our turnover going up in a market like that I'm pleased, because when the market goes hard this business will really come into its own."

The cycle

Concerning the discrepancy between insurers talking of underwriting discipline while increasingly undercutting one another to win business, Ellis says: "It's a really strange phenomenon. The results in 2004 of the major composites were good, but this was based on what they did in 2002. In 2005 they were good - not quite as good - but that was based on what they did in 2003. This year's results will be based on behaviour in 2004, and 2005 behaviour won't be apparent until 2007.

"So my theory is this. If you are one of the big six insurers, you have a considerable cost base. If you see your premiums cut dramatically then your combined operating ratio - because your expenses are a percentage of your premium - goes up because you can't fiddle around with your cost base quickly enough. So the only way to get combined ratio down is to grow top line again by acquiring more customers. And if everybody does this at the same time, then your ticket price starts to fall and you're going to churn customers - and this forces down the price.

"Andrew Torrence said in 2004 'we've broken the cycle'. I think that should come back and haunt him. The trouble is, insurers will say now 'we're still reporting good profits'. Well of course they are - but were they reporting good profits in 2002? No, because 2000 was soft. That's what they need reminding of - patting themselves on the back for great results in 2005 is nothing to do with what they did in 2005."

The other thing that prolongs the cycle, Ellis says, and which the analysts do not like about insurance, is that it is very easy for an insurer to turn their results round very quickly. He explains: "Insurers can turn things round, but they can find themselves doing a bit too well. So they re-examine their reserves, and they salt away a bit for a rainy day. When that rainy day comes, they eke a little bit of the previous profits out, but that just continues to bolster up the business for a little bit until the results go back down again - and then the hard cycle starts again."

Ellis is not alone in his annoyance with such practices: as he says, this way of doing things exacerbates the cycle because it stretches out the bad times artificially.

Mediating skills

The thing that makes most brokers tick - looking after clients and making profit from the proceeds - applies just as much to Ellis and BNL. "I've been a broker most of my life so we (he and brokers) think alike. I've learnt as much about broking doing this job as anything else. I go back 20 years and actually I don't think I was a very good broker - in fact I'm fairly sure I wasn't, because I hadn't had much exposure to a wider variety of ways of doing things. At BNL I've had the benefit of everybody's experience. But this is not a difficult business: we take best practice, disseminate it and ply it out for the benefit of network members."

Ellis has recently been lobbying to put forward the provincial view on the regulator's approach to conflicts of interest via the trade press. "It's a shame that we have come in for criticism for sticking our heads above the parapet," he says. "We weren't grandstanding or having a pop at the FSA, we were just stating an alternative view."

Conflict resolution

Whatever criticisms have been levelled at this effort, Ellis was due to be part of a group to visit the regulator at the end of February. And his hopes for the meeting? "We need to get an understanding of what their concerns are. And we will discuss these with a specific regional-broker perspective. The second point we need to stress is how little scope there is in the regional market for some conflicts of interest - e.g. binders, claims settlement authority and line slips. So few provincials have any of these. And once we've got to the bottom of those issues, we will probably be able to come up with other conflicts of interest that are applicable to us and how to address them."

As an example of this, Ellis cites the instance of two customers insured with same broker having an accident or dispute over liability. "That's a genuine conflict that needs a policy addressing it to ensure either customer is not disadvantaged," he says.

And he adds: "The FSA hasn't got a good handle on the level of risk being posed, but I have a lot of faith in them. Unless we adopt something voluntary, they may want to press for commission disclosure. If they do, they will have to go to consultation and we will put the arguments we gave 18 months ago. They were comfortable enough to say then that there was no need for it. It doesn't need regulation." Without naming names, Ellis also believes there has been some manipulation of the conflict-of-interest issue to draw the regulator's attention away from contract certainty.

He also mentions the danger of compulsory commission disclosure, which would lead to added cost for the insured. "A suggestion has been made that at renewal the broker has to remind the client of their right to ask what the broker is earning. The problem comes if we invest in big infrastructures to give a better service to customers and have to release our profit margin, and the little guy down the road doesn't, and he only earns 4% and we earn 10%. We do that because we save the insurer 8%, but we could be perceived as earning too much. As soon as you start looking at that, you quickly find you are comparing apples with pears. We charge the same net price as the broker that gets 4%, so the consumer could end up bearing the cost, because someone has to do the work."

Alliances

In 2006, Ellis believes broker Oval's tie-up with insurer Allianz could start a trend. He explains: "This has meant that the players in receipt of that business are going to lose it to Allianz so Allianz will see their business grow and others will see it fall. It will be interesting to see if more arrangements come to market seeking sole-supplier status. I think that might happen in 2006. And in order for insurers to retain some certainty over their earnings, they are going to have to exert increasing influence over distribution. If you look at the IFA sector, the big distributors have very close relationships, and I wonder if that will be what happens with broking."

His parting comment is one that has stood him in good stead. "'Never give up' is one piece of advice that has been invaluable. Also, somebody once said to me 'you'll never make that work' and I think entrepreneurs are often driven by the need to prove someone wrong. In the early days I was continually knocked back, but the guy who established Kentucky Fried Chicken was turned down 99 times before the hundredth person backed him.

"So if you believe in what you're doing, don't give up. Michael Winner said it's more important to be relentless than intelligent and I think that's right. If you think about some things, you wouldn't do them. So be single-minded."

CV

1994: Co-founder and chief executive, Broker Network Ltd

1980: Co-founder and partner, Ellis Bates & Co Insurance Brokers

1976: Partner, Ken Crowther & Co Insurance Brokers

1973: Management trainee, Halifax Building Society.