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
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.
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:
- 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 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 email, 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 emails.
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 websites. 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 email or hard copy to multiple insurers. Instead, the broker is faced with re-entering data into each insurer's website. 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 websites. 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
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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