Are We Finally Ready for Electronic Trading?

What's Happening in Electronic Trading

Since the bursting of the Internet bubble and the hardening of insurance premiums post-September 11, there has been less hype about progress in electronic trading, but there has been steady progress nonetheless in both trading systems and electronic exchange of data between counterparties. Progress varies by sector of the market with the most significant developments being seen in small commercial lines insurance and facultative and treaty reinsurance. Developments include:

• Increasing connectivity of agency management systems to carrier systems. AMS, a leading agency management system, reported that more than 2 million transactions were processed by its TransactNow data connectivity platform in the year from April 2005-2006.
• The embracing of electronic trading by the London market.

• In April 2006, a group of six London underwriters—Amlin, Beazley, Catlin, Hiscox, Kiln, and Wellington (collectively known as the G6)—successfully exchanged risk data electronically on a peer-to-peer basis with brokers. Subsequently, Aon, Willis, Marsh, and Benfield have formed a group of brokers (the G4) to facilitate electronic communication between the brokers and the G6.
• In June 2006, Aon announced that it will transact all insurance and reinsurance business in the United Kingdom electronically by the end of the year, via a combination of direct integration with its broking systems and the use of the RI3K trading service.
• In January 2007, the London Market Reform Group set a target to automate all risk and claims submissions in the Lloyd's and London markets within 3 years. This followed the market's progress to meeting requirements for contract certainty at the end 2006.

• The use of electronic trading systems to process the high volume of transactions seen in facultative reinsurance. In March 2007, eReinsure announced it had processed over 120,000 reinsurance submissions over its electronic trading platform.
• The proposed launch of a new insurance exchange backed by the Council of Insurance Agents and Brokers. Plans for the exchange were unveiled in December 2006, with the exchange due to be operational by the end of this year.

Factors Driving the Growth of Electronic Trading

The latest trend toward electronic trading is being fueled by different forces in the various markets affected, although interesting similarities are emerging.

The strongest regulatory pressures are being seen in London with the Lloyd's and London market becoming subject to oversight by the Financial Services Authority (FSA). The first initiative was the imposition of contract certainty by the end of 2006. Electronic trading is now being embraced as the next step, with support from the Market Reform Group. Elsewhere, the regulatory pressures are less strong, but have been aided by the Eliot Spitzer investigation. The increased focus on transparency and auditing of placement negotiations post-Spitzer has created an industry more receptive to electronic trading.

The strongest driver behind London's reforms is competition from Bermuda, a market not encumbered by centuries-old business practices. With most transactions in Bermuda occurring via email, London realizes it needs electronic trading to exchange data and supplement its traditional in-person trading floor structure. If it can achieve that, London believes it may actually gain a competitive advantage over other markets in being able to feed data directly into back-office systems rather than re-keying data from emails.

The need for reform in the face of competition will not be lost on the recently appointed chief executive of Lloyd's, Richard Ward, who oversaw the development of an electronic trading system for the International Petroleum Exchange in London under competition from Nymex and other exchanges.

Insurers are increasingly automating the underwriting process for smaller commercial lines, encouraging or even requiring that submissions be made via their websites. For some insurers, 80-90 percent of their submissions are received this way. This is creating a serious problem for brokers. No longer can they prepare one submission and send it by email or hard copy to multiple insurers. Instead, the broker is faced with re-entering data into each insurer's website. For low premium and commission business, this is threatening to make these lines of coverage unprofitable.

This problem will get worse for the brokers as more sophisticated rules engines lead to greater insurer automation. While automation has started with the smaller commercial programs and standardized products, it is creeping into the middle market. Already we are seeing business package programs with premiums in excess of $500,000 being handled electronically.

The problems created by insurer automation are forcing the industry to finally create some form of single entry multiple company interface (SEMCI). The threat of losing business is proving a strong enough motivator for brokers to overcome any fears of change.

The bursting of the Internet bubble was shortly followed by 9/11 and a hardening of insurance premiums. Insurers' and brokers' margins increased, and the industry became less receptive to new ways of doing business. As premium rates and margins begin to come down, there is a renewed focus on attacking the high expense structure in the industry. This is helping to fuel the pace of insurer automation which is having a knock-on effect on the brokers' submission process.

This is the most often cited benefit of electronic trading. Competition and the threat of losing business are driving brokers to adopt tools to electronically interface with insurer websites. Efficiency is the main argument, as electronic trading allows the broker service representatives to cover more insurers and be more productive. One of the problems with the efficiency argument, though, is that the real benefits will only be realized with integration allowing straight processing of information. In the short term, the costs of integration, training personnel on a new system, and potential duplication of activities pending integration are likely to increase costs, not reduce them.

Automating the placing process has the potential benefit of providing better management information over both the process and the placements themselves. This could prove to be a significant advantage for brokers and cedants managing decentralized placement processes and for underwriters in managing their producers and own performance. To provide effective management reports, the system needs full adoption by that company. For most users of electronic trading systems, this is an added benefit but not the primary driver.

Service-oriented architectures, Web services, and XML technologies are all helping to make electronic trading more seamless and less costly. These technologies are creating more flexible structures and easing integration between systems, both internal and external. As a result, insurers and brokers are able to leverage existing systems to connect directly to business partners or into trading networks, realizing more of the efficiency benefits from the use of these systems. More flexible architectures are allowing the trading systems themselves to better mimic each user's existing workflows and reduce the amount of change involved.

Strangely, the number of largely failed prior attempts may be helping the current efforts. Electronic trading is a complex undertaking, not least because of the potential changes it involves in existing business processes. There will inevitably be false starts. However, those false starts have served to raise awareness, address concerns, promote industry initiatives, such as the creation of data standards, and test different business models. There have also been survivors and profitable, sustainable businesses which have developed. Their ability to stay the course adds credibility and stability to the electronic trading initiative

Predictions for the Future

The question is not if, but how quickly and where? Electronic trading is happening in the insurance industry and it will continue to grow. How quickly it grows, particularly into the middle and large account insurance market will depend on the market forces driving change. There are significant change management obstacles to overcome. Without a compelling market force driving the change, adoption will be slow. London is driven by both market competition and regulatory compliance; the small commercial insurance sector, by insurer automation. These sectors may be reaching a tipping point where the growth of electronic trading will accelerate. The next 2-5 years should see significant expansion.

Adoption in these sectors will drive adoption in the middle and large account market as insurer automation and market competition expands, but the pace of adoption will be slower. It could be another 10 years before we see much activity in trading large insurance placements electronically. With low volumes of transactions, the first activity in that area is likely to be the electronic exchange of information around the policy (accounting, policy documentation, claims and exposure data) rather than the negotiation of the placement. A change in market forces, such as contract certainty, increased disclosure requirements, or even deregulation could speed adoption. Other forces such as a prolonged hardening of the market may have the opposite effect.

Either way, the train has left the station. Just how quickly we reach our destination and which route we take is yet to be determined.