On the Cost of Doing Business

Will the restructuring at Endurance prompt a wider examination of the industry’s cost base?

Already 2013 has the air of being a transformative year for the industry. Over the past 12 months the usage of non-traditional sources of capital has arguably reached a tipping point that shifts the reinsurance business model possibly forever and not just in response to the low interest rate world we presently live in. Equally the quota share sidecar deal struck in March between Aon and Berkshire Hathaway looks set to soon be repeated in a fashion by Willis, perhaps redefining how specialist insurance products are underwritten and distributed; certainly in the current soft market but potentially across the longer term trading cycle.

And now by reportedly axing 30% of his senior corporate roles and targeting savings of $20m per annum at Endurance, their newly appointed high profile CEO John Charman might just be signalling the onset of a wider appraisal of the entire market’s operating cost structure.  As reported by Insurance Insider, Charman views the infrastructure he has inherited at Endurance as unsustainable but not untypical of an industry characterised by, in his words, bloated expense ratios.

At the commoditised end of the insurance spectrum, where operating margins are thinner and every dollar counts, firms are used to tackling overheads; continually searching for more efficient and cheaper ways to service their business. In recent months Direct Line and Aviva have each introduced a programme of office closures and job cuts. If Charman is correct, however, then the time has arrived for the specialist wholesale and reinsurance players to also examine their organisational structures and weed out redundant management and administrative cost.

Those operating in the Lloyd’s market might need some persuasion. Generally syndicates do not carry large operating costs relative to their peers.  With expense ratios mostly measured in single digits there is little incentive for them to aggressively slash overhead. Instead positively managing even small fluctuations in the claims ratio is seen as a much greater priority. Satisfying as it might be for some hard-liners to take a Charman-esque axe to the central Lloyd’s bureaucracy and shared-services, it might not in reality deliver a truly significant bottom-line benefit.

A key part of the reason why Lloyd’s businesses are lean is that they do not support extensive marketing and servicing infrastructure. Yet relying more heavily than most other insurers on brokers to carry out these activities comes at a price. When syndicates add the higher commission they pay to their operating expenses, many are in fact likely to be at a competitive cost-disadvantage to their rivals taking into account all the costs of acquiring and running the business.

The problem for Lloyd’s underwriters is that squeezing the pips on internal costs is only part of the answer, and probably the easiest part, to improving the economics of their business model. Unfortunately for them, to also battle down the level of brokerage they pay out, at a time when distributors retain so much leverage, might prove to be a far harder task than wielding the hatchet around the office.

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