Young Brokers for a Young Product
A broker’s youth can often work against them, as many clients typically prefer the most seasoned professional to lead the broker team, or to work with them on a regular basis.
But the case can be different when dealing with cyber insurance, as the product itself is fairly young, experts said.
Cyber insurance has only been around for about 15 years, and is now very different than it was many years ago, when it was a liability-only product, said Stephanie Snyder, national cyber sales leader in the financial services group at Aon Risk Solutions in Chicago.
The evolving cyber insurance field provides a lot of younger brokers “a ton of opportunity.” — Stephanie Snyder, national cyber sales leader, financial services group, Aon Risk Solutions
Given the small number of underwriters and brokers who have historical expertise with the product, the evolving cyber insurance field provides a lot of younger brokers “a ton of opportunity,” Snyder said.
“Since cyber insurance itself is such a young product, there’s really only a handful of people who were around when it came into being,” Snyder said.
“So as need for the product continues to grow, there’s a need for brokers with product expertise in cyber, whether they come from fields outside insurance such as technology or legal, or whether they are joining the insurance industry as their first job.
“So long as brokers demonstrate their technical expertise, clients tend to be more forgiving of youth in this situation.”
That is not to say that Aon doesn’t have both senior and junior brokers on its teams, she said.
“We don’t push any person who doesn’t have the appropriate experience — we want all people to be learning together with cyber,” Snyder said. “It is an evolving product as cyber exposure continues to evolve.”
Jeffrey Lattmann, executive managing director, national executive liability practice with Beecher Carlson in New York City, said that clients want the most knowledgeable cyber professionals placing their business in the marketplace.
The younger brokers are likely to be more in tune with various parts of the risk due to the advancement of technology.
“This encompasses a team made up of seasoned brokers with significant technical knowledge, understanding of the market appetite for a specific risk, experienced risk management personnel and younger brokers who bring a different level of understanding technology risk to the table,” Lattmann said.
“Additionally, helping to identify areas of risk aids in the understanding of the profile of the company looking for coverage.”
For all types of insurance, Beecher Carlson has a senior broker leading each client account, with younger brokers accompanying them to client meetings in order to learn, he said.
Senior brokers have typically been in the business for 15 or 30 years, and understand strategy, insurance companies’ appetites for risk, how to best structure specific programs, and placing sophisticated transactions with significant limits.
Younger brokers are likely to be more in tune with various parts of the risk due to the advancement of technology.
“We just took over a large client and they specifically wanted a senior person on our team to be the lead person,” Lattmann said.
“The other brokers they’ve used in the past had senior people in the presentations, but when it got down to the transaction, they never saw them again. We committed the senior person to be the point person all the time.”
Still, young brokers need to sit in on meetings with the client.
“In order for seasoned professionals to educate the young brokers to one day be leaders, younger brokers have to spend time with clients and experienced brokers,” he said.
“Working in the background is not the most effective learning tool — they have to be upfront and learning alongside the senior people.”
Regardless of age or experience, a young producer should nevertheless take “a mature risk management approach to cyber — measure the exposure and mitigate it,” said Martin J. Frappolli, senior director of knowledge resources for The Institutes’ risk and insurance knowledge group in Malvern, PA.
When there is a newly discovered risk, insurers typically scramble to exclude coverage and those at risk scramble to insure the risk, Frappolli said. The Institutes has been examining the ramifications of the maturity model pertaining to cyber insurance.
“As time goes by, market participants understand that insurance is just one tool in a risk manager’s toolbox.” — Martin J. Frappolli, senior director of knowledge resources, The Institutes
“As time goes by, market participants understand that insurance is just one tool in a risk manager’s toolbox,” he said.
“We like to compare cyber to fire. We build fire-safe structures, we hold fire drills, we install extinguishers and sprinklers. We do all we can to mitigate the fire risk. Then we buy insurance.
“At some point, we’ll have better cyber hygiene and follow the mature risk management model just as we handle the threat of fire.”
Cyber is “immature” in the sense that some insurers still scramble to exclude it — though many are figuring out, as always, there is a right price for every risk, Frappolli said. Those at risk often do nothing to mitigate the risk other than seek insurance.
“All this is to say that an experienced agent or broker already knows all this,” he said. “If the young producer is focused on sales instead of risk management, he or she could indeed be closed out by prospective customers.
“But when the agent or broker takes a mature risk management approach to cyber — measure the exposure and mitigate it — that approach should be persuasive to any client.”
Organic growth at brokerage firms slowed and profit margins declined last year.
The soft market for commercial property and casualty premiums, continued modest growth in the U.S. economy, and a sharp decline in crude oil prices are contributing to the problem, according to Reagan Consulting’s “Organic Growth and Profitability” survey.
Agent-broker organic revenue growth slowed to 4.6 percent for 2015, from 6.2 percent each year since 2012. That’s according to a survey of roughly 140 mid-size and large agencies and brokerage firms conducted by the Atlanta consulting firm.
Profit margins declined to 20.1 percent, a year after reaching record profitability of 21 percent in 2014.
The single greatest driver was likely commercial P&C pricing, which has now entered “soft-market” territory, said Kevin Stipe, Reagan Consulting president.
According to the Council of Insurance Agents and Brokers, Q4 2015 pricing decreased by 2.8 percent, compared with a 0.1 percent increase in 2014.
“Carriers are competing to get insurance premium dollars,” Stipe said.
“The macro dynamics of their marketplace indicate they’ve made enough money in recent times being more aggressive in pricing trying to get market share, and that’s driving premiums down as they compete for customers.
“This makes it harder for insurance brokers to grow, as the majority of a broker’s revenue is commissions from placing insurance.”
The U.S. economy’s growth also contributed, as the U.S. gross domestic product grew by only 2.4 percent in 2015, and decelerated to 0.7 percent during the fourth quarter.
“The pricing on accounts is driven by insurable exposures, such as the revenue or the payroll of the account,” Stipe said. “When the economy stalls out, exposures tend to decrease, resulting in reduced premiums, which results in reduced broker commissions.”
Despite the setbacks, more than two-thirds (68 percent) of surveyed brokerages expect a rebound of growth in 2016.
Another factor slowing organic growth was the sharp decline in oil prices, he said.
After trading above $100 dollars per barrel in 2013, oil closed out 2015 at roughly $37 per barrel. During the “oil boom,” brokerages in the major oil producing states grew by 9.4 percent, a full 3.3 percentage points faster than the other firms in the survey.
Two years later, during the 2015 “oil bust,” the oil-state firms grew at only 2.5 percent, which was 2.3 percentage points slower than the other firms.
“Many boom towns in places like West Texas and South Dakota are now becoming ghost towns as projects in those towns have been scuttled,” Stipe said.
“Accounts in those towns that are oil-and-gas related are now rapidly shrinking, resulting in declining insurance costs. Brokers that rode the wave up on those geographies are now experiencing a dramatic reversal of fortune.”
Rebound of Growth
Despite the setbacks, more than two-thirds (68 percent) of surveyed brokerages expect a rebound of growth in 2016, with a median projection of 6 percent. Slightly more than half also expect profit margins to improve, although the improvement is projected to be nominal.
Still the future is “really uncertain,” Stipe said.
“I think there are some alarming trends with a relatively weak economy and with softening P&C pricing,” he said. “But there are also plenty of things that could ultimately serve to create a rebound.
“If P&C pricing stabilizes or rebounds slightly, that would be a good thing, and certainly if the economy picks up that would also help. For individual firms, it’s all about things they can control, such as building a sales culture.”
Robert Rusbuldt, president and chief executive of the Independent Insurance Agents & Brokers of America in Alexandria, Va., said that organic growth for independent agencies obviously varies by agency, by line of business, geographic region, and other factors.
“While the wholesale industry has experienced similar rates of organic growth as the retail side … I think our profit margins have overall improved over the past several years … .” — Bobby Owens, president, programs division, Risk Placement Services
“However, the dominant factor is the state of the economy in the country, and in the region or state where the agency is located,” Rusbuldt said.
He noted that independent agencies can increase organic growth by enhancing technology capabilities, implementing workflow efficiencies and increasing digital marketing.
Wholesale brokers are feeling the pinch on the retail side, said Bobby Owens, president of the programs division at wholesale broker Risk Placement Services Inc. in Lexington, Ky., who serves as the treasurer of the American Association of Managing General Agents.
On the specialty side in particular, organic growth is slowing mainly because the property market has been softening over the last two or three years and pricing has been going down, Owens said.
“While the wholesale industry has experienced similar rates of organic growth as the retail side, interestingly enough I think our profit margins have overall improved over the past several years because our industry has become much more efficient, mainly through expense control due to automation,” he said.
Looking forward, if the economy begins to slow, it will definitely affect the wholesale side as well, Owens said.
“We will see less business, and the market overall will become a lot more competitive due to more capacity in the industry,” he said. “I’m also worried that a slowing economy will dry up new ventures, which typically are written by the wholesale market.”
M&As will eventually slow down because of a shrinking pool of available larger agencies offering scale that have not already been involved in M&A activity.
While organic growing has slowed, merger and acquisition activity among agents and brokers was at an all-time high in 2015, Stipe said, noting that North American deals topped 400 for the first time ever, and “valuations hit record levels for firms of all sizes.”
M&A activity is at a current “frenzy” because of low interest rates, a volatile stock market, technology advances, and retiring baby boomers creating a ready pipeline for acquisitions. However, it is unrealistic to expect the pace to continue, Rusbuldt said.
M&As will eventually slow down because of a shrinking pool of available larger agencies offering scale that have not already been involved in M&A activity.
In addition, inexpensive capital will eventually end; ROI will increase in other sectors and vehicles; and the math of high multiples for agencies in many cases outpaced the possibilities for efficiencies and/or organic growth.
“While no one can predict an exact date when agency M&A will slow down, it is inevitable,” Rusbuldt said. &
M&As Fuel Reps and Warranties Coverage
Demand for representations and warranties coverage is on the rise for a number of reasons: increased M&A activity, a continued seller-friendly market, and the increased acceptance of the insurance product by deal makers, including law firms and investment bankers.
When the product became available about 10 years ago, buyers primarily purchased R&W as supplemental indemnity coverage when they were unable to get sellers to provide what they considered to be adequate indemnification protection under the transaction agreement, said Kirk Sanderson, senior vice president, transactional risk at Equity Risk Partners in New York City.
Sanderson’s firm was recently acquired by HUB International Ltd.
But in today’s market, sellers are essentially mandating that buyers take a reps and warranties policy to remain competitive in an auction scenario while providing very limited indemnification and zero escrow to buyers, Sanderson said.
“Private equity firms and their outside counsel have really pushed the envelope over the past three to four years on developing the R&W insurance policy into a highly efficient and economically favorable capital solution,” he said.
Renee Szalkowski, senior vice president and transaction liability practice leader at Lockton in New York City, agreed. Sellers in prospective M&A deals now have more leverage to demand that buyers take out R&W policies to suit their own purposes, she said.
“They are dictating terms, including providing little or no indemnity in deals where they don’t have to set aside a large percentage in escrow for 12 or 18 months,” Szalkowski said.
Moreover, there is greater acceptance of the product because pricing — at 3 percent to 4 percent of limits purchased — is more reasonable, and the underwriting process more streamlined, she said.
The manuscripted polices are now underwritten by ex-M&A attorneys and are more insured-friendly, based on “actual knowledge” definitions, with limited subrogation against sellers and an increased appetite for certain types of damages, she said.
The “actual knowledge” exclusion in older vintage policies was much more expansive, said Matthew Heinz, managing director at Aon in New York City, and a 2016 Power Broker® in the Private Equity category.
He said the current exclusion is much narrower and makes it harder for the carrier to prove that the insured had actual knowledge of a breach at binding and to prove that the exclusion should apply.
In general, Heinz said, reps and warranties coverage terms have gotten a lot better, and are closer to the traditional indemnity provided by sellers in transactions.
Some exclusions, such as those limiting the breadth of recoverable loss for consequential damages or diminution in value, are frequently removed, providing the buyer with coverage terms that more closely approximate the types of loss the buyer would seek to recover from the seller if there is a breach.
An example would be the availability of consequential damages in connection with a seller’s breach of a regulatory compliance representation.
“If a target company was not compliant with some regulation and must pay a fine and shut down a portion of its operation as a result, the buyer would seek to recover not just the immediate financial impact of the breach (i.e., the fine), but also any consequential damages resulting from the shut-down, including lost profits,” Heinz said.
“Today’s policies allow for this coverage,” he said.
Using R&W Strategically
Reps and warranties policies are also more strategic now, as opposed to being driven by concern over heightened risk, Heinz said.
“Clients are strategically incorporating policies into the front end of deals, rather than when an issue comes up,” he said. “Sellers have been able to exit deals more cleanly by pushing buyers to obtain insurance coverage.”
Without insurance, sellers might have to indemnify the buyer up to 10 percent of the deal size, and potentially leave an escrow in place up to that amount, Heinz said. But now the seller may only need to put 1 percent or less in escrow, with the remainder of risk allocated to the insurance market in the form of a buy-side reps and warranties insurance policy.
Premiums have also come down from a range of 4 percent to 6 percent pre-2008, to the 3 percent to 4 percent range in the current market, he said.
Szalkowski and her team expect reps and warranty insurance will continue to be in high demand over the next year as the M&A landscape remains competitive.
“Sellers are retaining post-closing equity positions more frequently and selling management is staying involved,” she said.
“This will result in buyers continuing to use reps and warranties policies to protect these relationships post-closing.”
However, clients should not expect prices to fall further in the near future just because “quite a few” carriers have entered the R&W insurance market, Szalkowski said.
“Notwithstanding increased supply and given increased demand, the fact that insurers that have been around for a while are paying claims means that overall pricing is holding steady,” she said.