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The London Market – technology to the rescue?

As usual, it falls upon me to be the controversial one. "We want someone to write an article about what's wrong with the London Insurance Market and how technology can help". The resulting flurry of heads disappearing below the parapet was a picture to behold – mine was up just a microsecond too long and the PR company grabbed it, span the spin, and here I am, victim to my own inertia.

I have a good underwriter friend in Lloyds who has a wager that within 5 years, you'll be able to get a Big Mac on the first floor of the Lloyds building and lingerie on the third. An extreme view, hopefully, but what is underlying the sentiment?

The London Market is unique: the oldest Insurance market on earth, the only subscription market of any consequence and the highest density of Brokers anywhere. The way it works today is, essentially, the same as it worked a hundred years ago, fully tried-and-tested with some of the most talented underwriters working anywhere you care to name. And it costs far too much to run and is very inefficient; but to say that new technology is the only way to help is missing the point, as I shall endeavour to explain.

A good reason for having a subscription market is to spread the risk and another is to get some economies of scale. London certainly spreads the risk and it realised many economies of scale years ago, up to a point, with the LPSO, LPC, IUA, LIRMA, ILU, et al, but basically it stopped there. Once a risk is placed, every subscribing company or syndicate management agency still has to duplicate all of its transaction processing systems, infrastructure, support personnel, and so on, to handle it, and the same for the claims. Bureaux-style technology could, of course, solve most of this at a stroke but only if there were massive and probably unacceptable changes to business practices.

Much work is being done by Lloyds, the IUA and the LIBC in concert to develop reforming practices (not necessarily technology related) to improve policy issuing, claims payment efficiency, service standards, adoption of international processing standards, furthering e-commerce, and so on. If widely adopted - they will not be mandatory - then they may help matters. But are they enough and, crucially, can they be implemented in time? Some people think not.

No business can be placed in Lloyds without a Lloyds Registered Broker and virtually none is placed in the companies market without one. It has been a simple logistical fact of life, since more than two capacity providers sat around a coffee table, that a subscription market needs someone to place the risks. That's a 20% cost and, if the business comes from outside the UK, which a lot of it does, a producing broker trail as long as your arm is needed to get it into London in the first place and that seldom comes for free. If the Brokers were making stacks of cash then they would be an easy target for criticism, but they are not. Broking to this market is a very expensive and currently unprofitable business.

Apart from the regulatory impossibility of taking business directly without setting up satellite service operations to handle it, as a few have done with varying degrees of success, how would a syndicate/company actually get business directly? At least one major insurer recently has all but run down their London Market operation from the dominant force it was up to the 1990s, replacing it with a Global operation run from London, marketed directly to the prospective clients. With a premium income of close to $1 billion, that 20% in brokerage fees goes a long way towards paying for the global marketing, infrastructure, policy and claims services that the Brokers used to provide them, so long as there's the technology to back it up. Will it be long before others follow suit? Only the major players; smaller organisations simply would not survive.

Then there's the government, the FSA and the other regulating bodies conspiring that make things costlier than they need necessarily be. No market should be allowed to go about its business unregulated but we are no respecters of the subtleties of measure, balance or degree in the UK. When we regulate, we do it with style - centuries of finely-honed, draconian interference resulting in a veritable maze of complex and anachronistic legislation designed, if that's the word, to make London uncompetitive in the international arena. Please don't ask for examples as we'll both need a law degree and a significant amount of spare time, which is what underwriters in Lloyds need by the truck-load. So, that's another couple of percent.

Then there are the Names who put up the capacity in Lloyds, for personal gain, as do the Companies likewise but for their shareholders. There is, however, a crucial difference: in Lloyds, each year of account gets closed after 3 years and the Names take out in cash what profits there are after administration costs and so on. That means the money disappears from the market, never to be seen again. Companies rarely do that sort of thing – they reinvest, they do R&D, put money aside for a rainy day and, after all that, they pay their shareholders as small a dividend as they can get away with without being lynched at the AGM. This means that the profits can stay in the company to be used for new product development, technology, infrastructure, communications, relationships, lunch, virtually anything in fact. The Names, in return for unlimited liability, have removed most of the profits from the market – historically, that money was not much use to the syndicates as, up to about the 1970s, not much really changed from quill pens and parchment. Since then, however, the business world has been changing at an alarming and exponential rate. To keep up with the technology alone costs plenty but syndicates are expected to rely on around 5% of gross premium revenue to cover all costs – everything, not just IT.

How about all this new IT then? Technology take-up here has always been somewhat slow and this is caused by two main factors. Firstly, you need to look at the history of the market: technology did not contribute to its success nor did it enable any of the more senior and exceptionally talented professionals to achieve their current positions within their organisations. It helped the back-offices enormously in their traditional areas of transaction processing and the like but remained completely absent from the sharp-end. The perception still remains, in many organisations, that IT does not have a critical role to play in the underwriting. Secondly, being a parochial market, there exists a collective inertia that slows or even prevents the implementation of major market working practice and systems changes. Quite where this leaves us here with the biggest development in communications since the telephone, the Internet, I do not know. Business-to-business e-commerce presents the greatest single efficiency opportunity that we've seen for decades yet, without the collective will to adopt new working practices to make it work properly, the ability and funds to develop it and a critical mass of exponents to adopt it, there is little hope of the Market realising any benefit within the short timeframe necessary.

But would it solve anything anyway? Is the technological drive to create systems that generally preserve the status quo, making the current market a bit more efficient a misguided quest? Will replacing the "front-end" to the market with e-commerce and streamlining the back-end for more economies of scale necessarily do the trick, especially if you look at what seems to be happening at a corporate level?

There's corporate capital moving into Lloyds, buying out the Names' capacity. This makes perfect sense but for one fly-in-the-ointment: namely some Names not wanting to go (some of them, by the way, make a substantial amount of money for, ostensibly, rather little in the way of input). But let's make the reasonable assumption that the corporate money mostly gets its way and takes over a significant proportion of the capacity in Lloyds and, in the companies market, most of the independents. What then? Well, the stock market has no time whatsoever for the "little fish" in this dimly-lit sector of the financial world and terribly undervalues it. However, the increasingly frequent mergers and acquisitions are creating a market consisting of fewer and fewer, larger and larger fish who are a bit more attractive and, soon enough, once they are big enough but still desperately undervalued, the "big" fish pounce.

In one bite, they have a major presence in the vast London market without any of the Names, small independents, systems conversions and so on to worry about, with all the infrastructure in place and a large and hugely talented underwriting team to play ball with. Within a few years, all the syndicates and independents will be gone in all but name, replaced by a small number of major global insurers using their acquisitions as London representative offices, channelling the business back to base where lies untold billions of capacity. How they choose to get their business from the global market will be a matter for them but they may well use fewer Brokers, as they do in their other territories. They will also use all the technology that they can muster and this will look absolutely nothing like the technology that the current subscription market needs to develop now to survive in the short-term. It also seems unlikely that they would want to share their e-commerce or physical facilities with any of their small number of major competitors, any more than they would want to share the risks themselves, which seems to indicate an end to the subscription market as we know it. As for the Lloyds building and their IUA equivalents – hamburgers and lingerie? I think it highly unlikely, but with the structure of the market undergoing such dramatic change, the City will look quite different to the underwriters of the near future.

Just one last thing: a frightening statistic regarding the strategic importance of e-commerce, courtesy of ClearCommerce and Internet World magazine. In the UK, 85% of e-commerce decisions are made at board level in Banking and Financial service companies compared to 11% in Insurance. Oh dear. Now I'm off to get my head down before it gets knocked off by a flying claim file.

-   National Underwiter