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In
response to Eliot Spitzer's investigations, brokers may
stop sponsoring reinsurance start-ups to avoid potential
conflicts of interest. But this could do the industry
more harm than good.
Since the
mid-1980s, brokers have been active backers of new
Bermudian reinsurers.
Some of the best-known names in the industry have
benefited from brokers' capital. Marsh helped to create
Ace, XL Capital, Mid Ocean Re and Axis. Aon sponsored
LaSalle Re and Endurance. Benfield
backed Montpelier Re. And Arthur J Gallagher helped set
up Allied World Assurance Company.
But this rich source of capital for
new ventures may be about to dry up. Eliot Spitzer has
highlighted potential conflicts of interest arising from
brokers holding stakes in companies that they place
business with. The New York attorney general has already
forced brokers to overhaul how they are compensated for
their services. He may now cause the removal of another
lucrative source of brokers' income.
Brokers have been accused of favouring reinsurers that
they hold stakes in when placing business for clients.
This could be by either placing more or better-quality
business with companies because they have a vested
interest in them.
In a testimony to US Congress in
November, Spitzer said the insurance industry's use of
offshore domiciles such as Bermuda required further
investigation. He pointed out that brokers part-owned or
operated many offshore reinsurers.
This, he claimed, “sets the stage for conflicts of
interest, steering and self-dealing in insurance and
reinsurance markets that we are just beginning to
understand.”
In a January testimony to the New York
State Assembly Standing Committee on Insurance, Spitzer
again drew attention to brokers' investments in reinsurers. He said
large brokers have created numerous ways to receive
undisclosed compensation. Three of these are contingent
commissions with insurers, tying, and contingent
commissions with reinsurers.
He added: “Finally, some brokers manage a fourth bite at
the apple through maintaining investments in reinsurance
companies to which they steer the reinsurance business.”
Conflicting views
Opinion is divided about whether there is a conflict of
interest in brokers backing
reinsurers (see box). And it
remains to be seen if Spitzer or regulators will uncover
any evidence of brokers steering business to reinsurers they
hold stakes in.
But given Spitzer's lurid revelations
of Marsh executives steering business to insurers they
had contingent agreements with, brokers could be
forgiven for staying clear of anything that he believes
is questionable.
Yet on the face of it, Spitzer's
comments do not appear to have dampened brokers'
enthusiasm for investing in
reinsurers. In December, two
start-ups were unveiled with backing from brokers. Marsh
helped fund Bermudian life
reinsurer Wilton Re, which was set
up with $600m of capital. And
Benfield invested $30m in Swiss
start-up Glacier Re.
Benfield intends
to continue investing in new ventures. The broker
believes it is doing its clients a service by sponsoring
new capacity in the market.
Grahame Chilton,
chief executive of Benfield,
said in a statement when Glacier Re was launched: “As a
reinsurance intermediary, it is a key part of our role
to access and structure contingent capital for our
customers. Where it is appropriate we will work with the
capital markets to facilitate the creation of additional
reinsurance capacity to meet our customers' needs.
Benfield's
founding investment in Montpelier Re in December 2001
helped to bring significant new capacity to the market
at a time of considerable uncertainty.”
Some of
Benfield's competitors disagree
that it is part of the broker's role to sponsor new
capacity. Willis believes it is not appropriate for
brokers to invest in companies that they place business
with.
“Post September 11, we were approached
by several entities to invest in insurance companies,”
says Dan Prince, spokesman for Willis. “Joe Plumeri [chief
executive of Willis], seeing that as a potential
conflict and seeing the potential for clients to
question why we are putting certain risks with certain
markets, decided not to.”
It is possible that Spitzer's
attentions will force more brokers to come around to
Willis's way of thinking. Despite the signs of continued
investment in start-ups, many believe the amount of
capital brokers put into new ventures is set to fall.
The backing for Wilton Re and Glacier
Re was probably in place well before Spitzer drew
attention to potential conflicts of interest. For
example, Wilton Re was registered on Bermuda on
September 1 last year. A more accurate hint of the
future may have come shortly before Wilton Re and
Glacier Re were unveiled.
Take the money and run
At the beginning of December,
Aon sold almost all its 19.4%
stake in Endurance, receiving $321m. The timing suggests
that Aon was
selling the stake to remove what could have been seen as
a conflict of interests. Steve Dreyer, managing director
of rating agency Standard & Poor's (S&P), says other
brokers with stakes in reinsurers
may follow suit.
“Aon was always going to sell, but
this probably hurried it along,” he says. “There is
pressure on brokers to reconsider holdings, as we saw
with Endurance. The intention with all of brokers'
holdings in insurers is to sell out at an opportune
time. This may take some of their patience away.”
Marsh has the most to lose from giving
up investments in reinsurers.
It owns MMC
Capital, a private equity subsidiary that has sponsored
more than 15 insurance companies.
MMC Capital is the manager of
Trident Funds, which, as well as the stake in Axis, also
holds investments in Danish Re and speciality insurer
Gulf Insurance Group.
In a report in November, investment
bank Dowling & Partners said that Marsh would have to
sell MMC
Capital to be completely conflict free. This is a
possibility. Michael Cherkasky,
Marsh's chief executive, reportedly said at the
beginning of December that Marsh is considering the
future of its private equity unit and also its
relationship with insurers and
reinsurers on Bermuda.
MMC Capital is
also facing further scrutiny. On December 21, the US
Securities and Exchange Commission asked Marsh for
information concerning transactions in which a director,
executive officer or 5% stockholder of the company had a
direct or indirect interest, including transactions with
its Trident funds.
Dowling & Partners says an extreme
outcome of the probe would be for all brokers to agree
not to sponsor new underwriters. Even without such an
unlikely agreement, it is probable that brokers will shy
away from funding reinsurers
in the future.
Kirk Roeser,
chairman of reinsurance broker Gill and Roeser, believes it
is inevitable that brokers will have to shed their
investments in reinsurers.
“There will be some spin-offs for the reason that there
is an appearance of conflict, even if there is no
conflict,” says Roeser.
“I expect to see a number of
reorganisations and spin-offs to
give the impression of squeaky-cleanness.”
This process may take some time.
But Steve Wevodau, managing principal at investment bank
WFG Capital Advisors, says brokers that believe
investing in reinsurers
is appropriate will eventually change their minds.
“I don't think the full fallout of
Spitzer has been felt or fully contemplated yet,” he
says. “Regulatory scrutiny and client pressure will
continue. That will mean most successful businesses will
have to go back to traditional broking and stay out of
these types of investment areas. And if some of the
larger brokers maintain investments, it is going to be
on the condition that they disclose it fully to
clients.”
A hollow victory
It is not only brokers'
profits from investments that could fall as a result of
Spitzer's crusade against brokers. If brokers did not
back new ventures it would remove any potential
conflicts of interest, and Spitzer could chalk up
another moral victory. But the industry may have to pay
a high price.
If brokers are stopped from setting up
reinsurers,
reinsurance buyers could be sure that brokers were not
steering them to preferred
reinsurers. But the efficiency of
the market may be reduced. The industry's ability to
generate capital when it most needs it could be
diminished.
Spitzer would argue that brokers
decrease competition by favouring
their own reinsurers.
But, ironically, removing brokers as a source of new
capital could also decrease competition because new
ventures may not get off the ground in times of need.
Some are in no doubt that pulling
brokers' funding would be bad for the industry. “It
would be a detriment,” says Adam
Klauber, analyst at investment
bank Cochran, Caronia
Securities. “When the industry needed the capital,
brokers stepped up and have been one of the primary
starters of businesses. From the clients' standpoint it
has been a good thing.”
Brokers have come to the rescue of
their clients three times by backing start-ups in times
of trouble. The excess liability crisis in the early
1980s led to the formation of Ace and XL Capital; the
capacity shortage after Hurricane Andrew in 1992
prompted brokers to set up Mid Ocean Re and LaSalle Re;
and September 11 resulted in the formation of Axis,
Endurance, Montpelier Re and Allied World Assurance.
As well as making sure capacity was
available, brokers' involvement also made coverage more
affordable for their clients. “At the end of 2001,
prices were going up and they would have gone up a lot
more had brokers not backed these companies,” says
Klauber.
But some say the argument that
brokers are doing the industry a service by funding new
capacity is not enough. “It is outweighed by the
flipside conflict of interest,” says Wevodau. “There is
an abundance of capacity now anyway.”
Capacity may be plentiful now. But
next time there is a capacity crunch in the market, one
of the industry's traditional capital providers may not
be around to bail the market out. “This is not the case
now as we head into the soft market, but it may lead to
limitations of capacity if it is needed,” says Dreyer at
S&P.
If brokers do not help meet that need,
it is possible that no one will. It could be argued that
outside investors in the industry are a lot more
knowledgeable about insurance than they used to be. Thus
they will be able to spot a need in the market. This may
be true, but they are not as well placed as brokers to
understand their clients' needs and they do not have the
same ability to meet them.
“Brokers will be approached by people
who say: ‘You know what's wrong with this business? We
need someone to provide this kind of coverage or
underwriting in this way,'” says
Roeser. “If there is a real need
and it can be met, it is usually the brokers who figure
out a way to do it. So eliminating brokers from the
process of finding new solutions to coverage problems
would be a loss to the buying public.” |
