The bloated middleware of the risk transfer (insurance) market

While everyone’s so focused on front-end customer experience and distribution in insurtech circles, while the insurance-linked securities (ILS) market is so focused on providing the lowest-cost and most efficient capital, I thought it was time to talk about the rest of the chain, the bit in the middle.

I’m going to call this middleware.

Before I start. Yes this is simplistic. No I’m not offering any definitive answers. But it might get some people thinking…

Coming from a software focused background originally, developing / managing insurance and reinsurance technology solutions since 1995, also managing large, data intensive e-commerce operations, having front, middle and back-ends of the market makes a lot of sense to me, as a paradigm that’s understandable, simplified and so allows room for bigger thinking.

Middleware is clearly, the bit in the middle.

No prizes for guessing that in the insurance and reinsurance market this middle piece is severely bloated and full of redundancy.

In fact there is so much duplication of effort or roles, that you could highlight as surplus (to requirements), that I’m not even going to bother trying to distinguish between them here.

I’m just going to lump it all together as middleware and talk a bit about what it’s function should (could) be.

If the front-end of risk transfer and risk financing (an easier and more all-encompassing name to include hedging than just calling it insurance and reinsurance) is all about customer interaction, originating, understanding and pricing risks.

While the back-end is all about capital allocation (to the risks) and (in the future) trading it.

What does the middleware bit do?

It’s where the many actors of the risk to capital chain come in.

Broker, agent, underwriter, wholesaler, MGA, insurer, reinsurer, retrocessionaire, etc.

All the different people that touch, interact with, or hold a risk, likely expressing a view on its ultimate cost or value, during its journey down (or around) the market chain to capital.

Also in the middle are a range of different activities, such as risk bundling, pooling, aggregating, sharing. As well as activities that are essentially secondary and tertiary replications of the front-end, or secondary and tertiary transfers, to satisfy different players confidence in the risk and their various appetites for it.

Now don’t get me wrong, there’s an awful lot of value in an awful lot of this activity. This really is an industry steeped in expertise.

But there’s also a lot of cost, friction and waste as well.

Much of it sounds like it could be a bit redundant in a world where efficient risk technology converges with efficient risk capital (a future I for one subscribe to).

That’s because it largely is and find itself increasingly so.

There’s a whole chunk of the market that aggregates and then passes risk on down the line, in different ways/means/structures. While different actors of agents/brokers/wholesalers/consultants/underwriters/modellers etc, all get paid.

That’s not even considering hedging (reinsurance and retrocession, secondary markets, plus layers beyond in the lifecycle of a risk).

These add additional layers of complexity and sometimes duplication as well. They certainly add to the cost of taking a risk from source to its ideal home attached to the right capital.

How did it all develop like this?

Everything has a purpose and is valid, depending on your role in (and view on) this marketplace.

Justification for the existence of certain roles, procedures, processes, actors and actions has always been found by highlighting complexity, expertise, ability, connections and of course relationships.

But none of those factors actually mean it’s needed, especially not when you’re the third, fourth or fifth actor to touch, analyse, express a view on, or transfer a risk.

As a result this middleware is bloated, overly complex and adds significant cost to the process of taking a risk and matching it with capital.

It also adds risk to market participants, given the middleware’s habit of obfuscating the clarity surrounding risk.

We all know data magically disappears as risks travel further down the market chain, especially in secondary and tertiary trades (reinsurance, retro etc).

But there’s a natural obfuscation of risk clarity as more and more people touch it, analyse it, apply their view, their data formats, their underwriting standards etc, meaning risk information can be significantly less clear and embedded risks themselves harder to recognise, in a contract or portfolio the further down the chain you sit.

That’s a problem, requiring more expenditure and effort, ultimately making the market less effective than it could be and risk transfer less efficient.

In my view that’s a key issue here.

The market has naturally developed to a point in which layer upon layer of complexity and duplication has taken it to a stage where it’s now becoming harder and harder to unpick as well.

Which suits some incumbents, as this complexity equals greater security and longevity, for some roles in the chain right now.

That means roles and responsibilities won’t be given up readily. Protectionism is alive and well in risk markets (and always has been).

Depending on where you sit (in the market landscape), I bet you can draw a diagram and pick out pieces of the traditional market chain and highlight some that are redundant, in your view.

But of course your own seat is vital, valid and you deserve to get paid?

As I’ve said before, only if you’re bringing value to the risk to capital chain.

If you’re not? Perhaps you’re a piece of the middleware problem.

The discussion that needs to be had has to begin with taking a simple view of risk and capital, asking how best to connect the two in the most efficient manner.

Stripping back the market to its most basic of functions and roles means this middleware can be reimagined entirely.

Which could result in something new, more efficient, more effective and ultimately fit for the future.

My gut feel is this is going to happen in niches, where risks are more readily streamlined (commoditised) along an efficient chain to capital at first.

Or where the risk is so new there’s a chance to do things differently from the off.

But that will have ramifications for the wider market, as signals of efficiency emerging from niches that have a chance to redesign the chain, show incumbents how to redesign their own niche while maintaining market share and most importantly margin/profits.

As that spreads, so too will market efficiency.

There is an issue coming in some ‘innovation’ and ‘insurtech’ initiatives though and its worth highlighting a risk that may emerge.

Some tech and innovation initiatives are not really making anything more efficient.

Rather they are adding control, designed for the few, perpetuating the status-quo, all under a shiny layer of unicorn dust.

That doesn’t actually help anyone (except some investors & incumbents).

However, the industry does need to go through these phases of innovation and iteration, which will range (often wildly) between control and openness, before a better paradigm (and balance) for efficiency is found.

Some will find it sooner than others and these may be the ultimate winners, at either end of the chain or those seeking to provide an efficient and new form of middleware to connect them.

Bifurcation of the middleware is entirely possible as a result of this iterative approach (I expect we’ll find).

But this change will be positive for everyone adding value and able to demonstrate it.

Those unable to (demonstrate the value they bring to the chain) might have to think again.

As a side note, consider the travel industry, a space I worked in for a number of years.

Incumbents ended up disrupting their own business models as they tried to fight back against start-ups offering a better and more efficient way to connect product and user together.

Playing a zero-sum game while trying to exert ownership and control has resulted in some very large companies disappearing altogether (not just in travel).

As risk industries look to bring risk to capital (or capacity) ever more efficiently, to provide a better product at the front-end, there’s a good chance some may undermine their very reason for existence in this market, by trying to do so while still exerting their control.

Just as you can compete yourself into irrelevance, so too can you disintermediate and disrupt yourself to the same end, commoditising the original value proposition you once had.