The high cost of distribution was top of mind for chief executive officers speaking at the Standard & Poor’s 2016 Insurance Conference on Wednesday.

“If somebody asks you to donate a dollar to a nonprofit, and 65 or 62 cents on the dollar went to the cause and the other 38 cents went to administration or frictional costs, you have a problem with it,” said David Long, chairman and chief executive officer of Liberty Mutual Insurance Group.

Long was responding to a question from Kevin Ahern, managing director of S&P Global Ratings, about the expense ratio component of insurer combined ratios and whether the traditional distribution model is starting to break down.

Long and other executives participating on the panel said that at a time when costs are transparent to buyers of insurance, customers are going to demand more value for their money.

Ahern led off the session, which also featured W. Robert Berkley Jr., president and CEO of W.R. Berkley Corp., and Scott Carmilani, president, CEO and chair of Allied World Assurance Co. Holdings, by describing the array of challenges facing P/C insurers: slow growth, low yields, excess capital and increasing regulation.

Predicting an “incrementally more difficult” environment going forward, Long was the first to tee up the expense issue as a way to navigate the landscape.

“I think there has to be a lot more attention turned to expenses in the system and distribution costs and bringing a little bit more value to the customer,” he said.

Berkley agreed. “Clearly, if you look at the cost of distribution, it is unusually high compared to other industries,” he said. “The number of pennies on every dollar that is effectively frictional cost between where the product is manufactured…and where it actually is consumed by the insured—there is a lot of cost associated with that and ultimately, from our perspective, that is going to change over time.

“We don’t know exactly how that will change, but the consumer will demand that, and we think that’s opportunity for the industry as well,” Berkley said.

Long suggested that “intermediaries have to take a hard look at compensation and commission structure, with less of an emphasis on policy sourcing,” as options for policy sourcing “become more free” for customers who can buy some products directly. Describing a potential change in compensation structure, he said an independent agent should “get paid less for policy sourcing and more for data and analytics and partnering and packaging and placing.”

He concluded: “Somewhere along the line, we have to figure out a better model to deliver more value than 65 cents on the dollar for the customer. It’s going to come, because they’re going to recognize it.”

Allied World’s Carmilani described bifurcation between small high-volume accounts, where technology makes policy access easier, and those involving tough underwriting—”the structured deal where there’s hundreds of millions of capacity [for] a gigantic construction project or a major company,” for example. For those more technical risks, “there’s still a lot of room for creative innovation and marketing. And there’s a value proposition.”

Adding his voice to those of the other executives, however, Carmilani agreed that distribution is getting too expensive. “Look at the margins of the insurance brokers and the margins of the insurance carriers. It’s way imbalanced at the farthest end…It’s not sustainable for sure.”

Agreeing with Berkley, Carmilani said, “The consumer in the end is going to ask, ‘How does this affect me and why am I paying for it? How does it really affect my price?'”

“With full transparency in the world today,” he said, “buyers care. Money matters in this slow-growth economy.”

Brokers Respond

“What a shock that insurance companies think acquisition expenses are too high,” Peter Zaffino, president and CEO of Marsh LLC, said at a later conference session.

“We are not put into business to make it easier for insurance companies to assume risk. We are there to service clients locally…

“Most of the insurance companies, [excluding] a handful, cannot connect globally or even in some of the major geographies,” Zaffino said, adding that “there is an inherent cost to that.”

Breaking down distribution between retail brokerage and wholesale, Zaffino said a lot more insurance companies that don’t have broad geographic footprints are starting in London. “London is an inefficient business model from an acquisition expense standpoint because it’s more of a wholesale model,” which means costs are higher to acquire the business.

Turning to direct retail, he said that while commissions may be going up, those costs are fully disclosed to clients. “Clients pay the commissions. So if they don’t think the value is there for the brokers in terms of their remuneration, they have a point of view. You’re not going to accept remuneration that a client doesn’t see as appropriate for the value.

“There has to be a balance for sure, but I think there’s a lot of rhetoric because there’s a lot of pressure on the accident years,” he said, referring to accident-year combined ratios. “It’s the distribution, their [the carriers’] own infrastructure plus the loss ratio,” he said.

Mike Sicard, chairman, president and CEO of USI Insurance Services, observed: “There isn’t an aligned incentive, necessarily, between carriers and clients.

“On the one hand, it would be in the carrier’s best interest to increase the premiums…The client wants the premium to be decreased.

“It’s in the carrier’s best interest to narrow and restrict the coverage rather than expand coverage because then they’re on the hook for less. It’s in the client’s best interest to expand that coverage as broadly as possible,” he said.

“And when it comes to an actual claim, the client wants it paid at full value instantly, and the carrier wants to make sure there isn’t fraud” and to determine the actual proper value, Sicard added.

Given that there is a misalignment of interest, the brokers have to play a role in figuring out “through analytics and through facts, what is the appropriate premium for the broadest coverage, and then get those claims appropriately paid.”

Sicard added that most buyers like the idea of choice—they would rather have access to a multitude of carrier markets available through a “broad and entrenched brokerage universe” than a single market on a go-direct basis. “Right now, this market might be interesting and attractive, but three years from now, it might change its appetite. [They] want the flexibility and the freedom to be able to migrate.”

The USI leader agreed, however, that in situations where brokers aren’t doing anything more than presenting premiums, then it’s fair to criticize them for not earning their commissions.

“Carriers want to be seen as more than just a balance sheet,” he said, noting that the insurers are proud of their differences in coverages, forms, services and claims-paying abilities. “They are looking for broker partners who understand that and know how to sell and present that appropriately,” Sicard said.

Zaffino said the amount of modeling and advisory services between brokers and client is not always visible to the carriers.

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