Vantage points

With nearly 40 years of experience working for Commercial Union, and having advised thousands of brokers as a consultant after that, Tony Cornell is something of an industry sage. And, as readers of Professional Broking's sister title, Insurance Age, will know, he does not pull his punches in print or in person.

True to form, his assessment of the current position of the market cycle is somewhat at odds with the views of a number of insurance chief executives. He dismisses the proclamations of some that 2006 will be a hard market as 'wishful thinking' and is sure that, despite the rhetoric, profits from previous years will be increasingly used to grab market share.

"I know two insurance companies that have plans to grow rapidly in the first half of this year. How will they do that when there is no new business? The only way is by taking business off a competitor and the only way to do that in the current market is by undercutting them substantially."

Such is the current willingness of underwriters to match competitive quotes (by up to 10%) to retain existing business, Cornell says, that insurers looking to obtain business from rivals will have to undercut them by up to 30%. "Some will even match 20% - and they can do this because they are over-reserved," he states, explaining: "Bear in mind commercial premiums are close to double what they were four years ago. That increase is all profit. There is no extra risk; in fact, risks have been cut back because terrorism has been excluded. Claims inflation has been there, but not hugely so. A lot of money is being made."

Cornell says that, in 2001/2002, insurers' profits were used to rebuild their balance sheets after the under-reserving in the 1990s. But, in 2003/2004, the money was put away for a rainy day - and it is about to pour. "In 2005, rates probably dropped by between 10% and 15% and profits were declared the best ever. So the scenario still looks good, even though they will fall by as much again this year," he says.

Growth means cuts

Contrary to what some insurer top brass would have the market believe, if competition determines what prices will be, and with everybody looking to grow in the UK, there will be rate reductions, argues Cornell. "The end of last year," he says, "was a bloodbath." The reason for this was that insurers overestimated their top-line figures and the only way this shortfall could be made up was to fight for new business.

So, what of the discrepancy between what is happening in reality and all the talk of underwriting for profit, discipline, technical pricing and avoiding the great peaks and troughs of the cycle? "I really don't understand why there is that gap there. I remember working for an insurer some years ago that was in the process of empowering people - to make it more of a risk-taking business - and the chief executive at the time told his staff to go out and write business that "frightens me to death". Everyone thought "right, we can do anything now", and the underwriting director was panicking because he knew, if we took 10% off our rates, all our profit would go. How can an insurer say "we want to grow by 10% this year" when they know rates are dropping by 10% and they normally lose 10% in addition to that?"

Obviously, those that manage insurance firms cannot present to the board a plan to stand still and, if the best form of defence is attack, then any proactive management team will draw up a scheme to that effect. However, even to Cornell, there are some things going on in insurance companies that just don't make sense.

With regard to the cycle, he concludes: "The market will harden in 2008, possibly the end of 2007. There has never been a market cycle lasting less than four years and this cycle is starting from the highest level of profitability there has ever been. So there is no reason why this soft market should be less than four years."

Having led hundreds of strategy days for Axa brokers, Cornell has his finger on the pace at which the broker market is evolving. "In a perverse way, consolidation offers a lot of opportunity to good-quality, second-tier brokers," he says, referring to the preoccupation with consolidators to integrate, cut costs and 'screw' insurers. He explains: "As such, consolidators don't have time to go after new business - and the predators line up. The SME businessman wants continuity, good service and to feel loved by someone who is local or an expert in what they do. For consolidators, it is increasingly difficult to achieve that. As soon as a major broker sells to a large consolidator, other brokers should be lining up to attack the business that is up for grabs."

Cornell cites the weakness of the firms being acquired as an opportunity for competitors: "The principal will probably go in two years - and chances are that service will suffer and you get this constant churning. We have already had it with the nationals - they took over lots of brokers - but they are no longer a force in the SME market. They regard any business under £10,000 commission as not worth bothering with."

Naturally, having decided to sell, a broker's attention will be shifting from the business to realising the value of their life's work. So, is this a good time to divest? "Definitely, what you have to remember is you can only make money according to the market cycle. You cannot buck that trend, all you can do is ride the cycle. If the market softens by 10%, the value of your brokerage goes down by 15% to 20%. So, every year you hang on - unless you have the drive to grow the business, which most do not - the value of the firm is dropping by so much per annum. So if you want to sell, you should do it this year."

Networks

For small brokers of £500,000 commission in-come or less that want to continue, Cornell recommends joining a network. "This at least provides some protection - access to markets with some commission leverage and muscle behind you. If your commission income is under £500,000 and you have a large chunk of commercial, the network solution is the only place to go."

He continues: "If you are a broker in your late 50s and 60s, and you have run a business for 20 or 30 years and you are still a small broker, you have probably had it. If you have not made a go of it during your good years, when you have enthusiasm and dynamism, you are not suddenly going to get a new lease of life at 55 and go out and change the world. The difficulty for brokers like that is their clients are old as well, so they will not have strong clients. If they have flagship accounts, they are under pressure because the smaller broker cannot access markets."

However, although Cornell spells out a harsh reality, he is by no means dismissive of such firms - quite the reverse. "These small businessmen are wonderful people because they totally believe in customer service and they do not deserve anything the Financial Services Authority throws at them. They probably over-service all their clients, with many making themselves available 24 hours a day."

Future mergers

About the flow of consolidation generally, Cornell observes: "Last year was quite busy but there was a gap towards the third and fourth quarters where not a lot happened." And, in 2006? "There is speculation about Towergate and Smart & Cook - that must be a possibility - and, while it is speculation, it will be interesting to see what happens. I imagine Paul Meehan would probably run Towergate North, which, with the existing Smart & Cook interests, would be a huge empire."

PB understands that, although Meehan was recently pressed hard on the issue by a fellow broker, this acquisition, as yet, remains the stuff of rumour. But, at the time of writing, Peter Cullum's behemoth continued to acquire firms and hoover up talent, with Andy Homer's ex-colleague (and Groupama customer service director) Amanda Blanc joining the fray.

As Towergate's stated targets draw ever nearer to being within reach, are there any upsets that the sale of a company that size might cause? "They could do a trade sale - but there is no logical reason why an insurer would want to buy them. An outside institution such as a bank or private equity firm could make sense. There is a lot of cash flow, a lot of profit, and it is a well-established business in a niche market."

Cornell also thinks the other route available is a float - but not before 2008. This is because he considers it would need a couple a years of excellent returns in a hard market to optimise the final consideration. "In these circumstances, it would be an attractive animal - provided the stock market can understand it, because it is not straightforward; it is not just an insurer or a low-cost operator."

Cornell also offers an interesting take on its recent acquisition of Fusion. "There is this slightly absurd situation where Aon and Marsh are disposing of their wholesale arms and underwriting vehicles because of conflicts of interest while, simultaneously, Towergate is doing exactly the opposite and acquiring Fusion. This will be core to Towergate's strategy, unless of course the FSA breaks it all up. Fusion is the last piece of the jigsaw. But I do find it quite amazing that nobody in the industry has questioned that deal from a conflict-of-interest point of view."

Commercial concerns

Cornell is not overly concerned for brokers about the commoditisation and direct selling of commercial lines due to a lack of innovation with the products themselves.

He explains: "The first packaged policy for shops with a simplified rating structure appeared in the mid 1970s and nothing has moved on since then. I am still amazed that, when looking at a small engineering risk, the process you undergo to rate it is no different to when I started over 45 years ago. The only industries in which products are packaged is where there is a certain amount of homogeny about it - like a shop or a hotel."

Cornell seems to suggest there is a natural ceiling on commoditisation due to a lack of a commonality between risks in certain classes. "The industry has not created the products to enable commoditisation to go ahead," he adds.

While he concedes that a new entrant attacking commercial business direct is possible, there are difficulties in ironing-out the weakness in such a model, which tends not to attract the best-managed risks. "Progressive, in the US, went from nowhere to being one of the largest. Some would say Quinn in the construction market has a new model that threatens the establishment." But, even if a plan for mass commoditisation could be conceived and executed, Cornell adds that "the industry doesn't like new models - it does its utmost to destroy them."

While brokers can take some comfort from the fact that their relationships are unlikely to be seriously threatened by the commercial direct threat on this basis, he bemoans the lack of innovation in the industry. "I find it amazing that true innovation in the industry is very limited - most of it is coming from brokers, not insurers. In the 1990s, where 10 or 12 insurers were competing for market share, there were product launches every week, but this has slowed down enormously."

In terms of the next big threats, Cornell mentions Royal Bank of Scotland - with its huge direct-marketing skills - Direct Line, Churchill and NIG. "They are in an ideal position to take any gap in the market that emerges," he says.

He continues: "At the moment, the majority of medium to large commercial brokers are not interested in growing their small commercial book because the FSA is taking most of the profit out of doing that business. So they are not marketing to businesses paying less than £5000, but going to the mid-market instead. A number of them will gradually come out, leaving a vacuum in that market that RBS could take over."

The invasion of the high-net-worth niche by a firm such as Direct Line is also a distinct possibility, Cornell says. However, he sees a degree of security in brokers' current high-net-worth arrangements, which are often wrapped up with commercial relationships.

Cornell concludes with the following advice for brokers looking to focus on the mid-commercial market as a growth area: "The skills required to service the mid-market will have to be continually be raised, as competition will be fierce. Many brokers say they have identified this as an area they want to attack, but have not thought through what they have to offer. This is one area in which having a unique proposition is essential. Decide what unique selling point you will take to that market, because things are hotting up there."

CV

1999: founder, Cornell Consulting

1986: broker manager, Commercial Union (later head of broker relations, general insurance, CGU)

1980: sales manager, Reading, CU

1969: city inspector, Birmingham, CU

1959: joins CU.