Are We Finally Ready for Electronic Trading?
April 2007
In the first of two articles, I examine the
current state of electronic trading in the insurance industry: where we are
and what's driving adoption. In the second article I will analyze the current
players in this area and the different components of electronic trading.1
by Andrew
Berry
Newport Risk
Services
There have been numerous efforts over the years to improve the efficiency
of the commercial insurance industry through electronic trading. Advocates point
to a cost structure where as much as 40 percent of premium dollars is absorbed
in expense costs, and a supply chain that requires re-keying of data throughout.
Despite the potential benefits and seeming necessity of electronic trading in
today's increasingly digital age, the insurance industry has managed to be largely
unaffected by each successive wave of electronic trading initiatives. Or has
it?
Certainly the Internet bubble of the late 1990s did not yield the revolutionary
changes in the industry that were once promised. Virtually all exchanges and
electronic trading initiatives failed. The most recent and perhaps most heavily
financed initiative to close was Kinnect, the trading platform backed by Lloyd's
of London to the tune of $120 million but which ceased trading in January 2006.
With all these failed attempts, surely electronic trading is one idea that
simply will not have its day—an idea that will forever be bogged down in the
industry's entrenched business processes and the relationship nature of its
business. Think again. Electronic trading is more prevalent now than at any
time in the insurance industry's history, and we may be standing on the verge
of major advances in the use of electronic trading throughout the industry.
What's Happening in Electronic Trading
Since the bursting of the Internet bubble and the hardening of insurance
premiums post-September 11, there has been less hype about progress in electronic
trading, but there has been steady progress nonetheless in both trading systems
and electronic exchange of data between counterparties. Progress varies by sector
of the market with the most significant developments being seen in small commercial
lines insurance and facultative and treaty reinsurance. Developments include:
-
Increasing connectivity of agency management systems to carrier systems.
AMS, a leading agency management system, reported that more than 2 million
transactions were processed by its TransactNow data connectivity platform
in the year from April 2005-2006.
- The embracing of electronic trading by the London market.
- In April 2006, a group of six London underwriters—Amlin, Beazley,
Catlin, Hiscox, Kiln, and Wellington (collectively known as the G6)—successfully
exchanged risk data electronically on a peer-to-peer basis with brokers.
Subsequently, Aon, Willis, Marsh, and Benfield have formed a group of
brokers (the G4) to facilitate electronic communication between the
brokers and the G6.
- In June 2006, Aon announced that it will transact all insurance
and reinsurance business in the United Kingdom electronically by the
end of the year, via a combination of direct integration with its broking
systems and the use of the RI3K trading service.
- In January 2007, the London Market Reform Group set a target to
automate all risk and claims submissions in the Lloyd's and London markets
within 3 years. This followed the market's progress to meeting requirements
for contract certainty at the end 2006.
-
The use of electronic trading systems to process the high volume of transactions
seen in facultative reinsurance. In March 2007, eReinsure announced it had
processed over 120,000 reinsurance submissions over its electronic trading
platform.
-
The proposed launch of a new insurance exchange backed by the Council
of Insurance Agents and Brokers. Plans for the exchange were unveiled in
December 2006, with the exchange due to be operational by the end of this
year.
Factors Driving the Growth of Electronic Trading
The latest trend toward electronic trading is being fueled by different forces
in the various markets affected, although interesting similarities are emerging.
Regulatory Compliance
The strongest regulatory pressures are being seen in London with the Lloyd's
and London market becoming subject to oversight by the Financial Services Authority
(FSA). The first initiative was the imposition of contract certainty by the
end of 2006. Electronic trading is now being embraced as the next step, with
support from the Market Reform Group. Elsewhere, the regulatory pressures are
less strong, but have been aided by the Eliot Spitzer investigation. The increased
focus on transparency and auditing of placement negotiations post-Spitzer has
created an industry more receptive to electronic trading.
Market Competition
The strongest driver behind London's reforms is competition from Bermuda,
a market not encumbered by centuries-old business practices. With most transactions
in Bermuda occurring via e-mail, London realizes it needs electronic trading
to exchange data and supplement its traditional in-person trading floor structure.
If it can achieve that, London believes it may actually gain a competitive advantage
over other markets in being able to feed data directly into back-office systems
rather than re-keying data from e-mails.
The need for reform in the face of competition will not be lost on the recently
appointed chief executive of Lloyd's, Richard Ward, who oversaw the development
of an electronic trading system for the International Petroleum Exchange in
London under competition from Nymex and other exchanges.
Insurer Automation
Insurers are increasingly automating the underwriting process for smaller
commercial lines, encouraging or even requiring that submissions be made via
their Web sites. For some insurers, 80-90 percent of their submissions are received
this way. This is creating a serious problem for brokers. No longer can they
prepare one submission and send it by e-mail or hard copy to multiple insurers.
Instead, the broker is faced with re-entering data into each insurer's Web site.
For low premium and commission business, this is threatening to make these lines
of coverage unprofitable.
This problem will get worse for the brokers as more sophisticated rules engines
lead to greater insurer automation. While automation has started with the smaller
commercial programs and standardized products, it is creeping into the middle
market. Already we are seeing business package programs with premiums in excess
of $500,000 being handled electronically.
The problems created by insurer automation are forcing the industry to finally
create some form of single entry multiple company interface (SEMCI). The threat
of losing business is proving a strong enough motivator for brokers to overcome
any fears of change.
Softening Market
The bursting of the Internet bubble was shortly followed by 9/11 and a hardening
of insurance premiums. Insurers' and brokers' margins increased, and the industry
became less receptive to new ways of doing business. As premium rates and margins
begin to come down, there is a renewed focus on attacking the high expense structure
in the industry. This is helping to fuel the pace of insurer automation which
is having a knock-on effect on the brokers' submission process.
Efficiency
This is the most often cited benefit of electronic trading. Competition and
the threat of losing business are driving brokers to adopt tools to electronically
interface with insurer Web sites. Efficiency is the main argument, as electronic
trading allows the broker service representatives to cover more insurers and
be more productive. One of the problems with the efficiency argument, though,
is that the real benefits will only be realized with integration allowing straight
processing of information. In the short term, the costs of integration, training
personnel on a new system, and potential duplication of activities pending integration
are likely to increase costs, not reduce them.
Management Information
Automating the placing process has the potential benefit of providing better
management information over both the process and the placements themselves.
This could prove to be a significant advantage for brokers and cedants managing
decentralized placement processes and for underwriters in managing their producers
and own performance. To provide effective management reports, the system needs
full adoption by that company. For most users of electronic trading systems,
this is an added benefit but not the primary driver.
Advances in Technology
Service-oriented architectures, Web services, and XML technologies are all
helping to make electronic trading more seamless and less costly. These technologies
are creating more flexible structures and easing integration between systems,
both internal and external. As a result, insurers and brokers are able to leverage
existing systems to connect directly to business partners or into trading networks,
realizing more of the efficiency benefits from the use of these systems. More
flexible architectures are allowing the trading systems themselves to better
mimic each user's existing workflows and reduce the amount of change involved.
Prior Attempts
Strangely, the number of largely failed prior attempts may be helping the
current efforts. Electronic trading is a complex undertaking, not least because
of the potential changes it involves in existing business processes. There will
inevitably be false starts. However, those false starts have served to raise
awareness, address concerns, promote industry initiatives, such as the creation
of data standards, and test different business models. There have also been
survivors and profitable, sustainable businesses which have developed. Their
ability to stay the course adds credibility and stability to the electronic
trading initiative
Predictions for the Future
The question is not if, but how quickly and where? Electronic trading is
happening in the insurance industry and it will continue to grow. How quickly
it grows, particularly into the middle and large account insurance market will
depend on the market forces driving change. There are significant change management
obstacles to overcome. Without a compelling market force driving the change,
adoption will be slow. London is driven by both market competition and regulatory
compliance; the small commercial insurance sector, by insurer automation. These
sectors may be reaching a tipping point where the growth of electronic trading
will accelerate. The next 2-5 years should see significant expansion.
Adoption in these sectors will drive adoption in the middle and large account
market as insurer automation and market competition expands, but the pace of
adoption will be slower. It could be another 10 years before we see much activity
in trading large insurance placements electronically. With low volumes of transactions,
the first activity in that area is likely to be the electronic exchange of information
around the policy (accounting, policy documentation, claims and exposure data)
rather than the negotiation of the placement. A change in market forces, such
as contract certainty, increased disclosure requirements, or even deregulation
could speed adoption. Other forces such as a prolonged hardening of the market
may have the opposite effect.
Either way, the train has left the station. Just how quickly we reach our
destination and which route we take is yet to be determined.
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