Natural Selection

Choosing a broker for commercial insurance has evolved into a more formalized process in the last several years, replete with RFPs, pre-screening and, in some cases, procurement. Many brokers and risk managers say this is a move in the right direction — if handled properly.

LUCK OF THE DRAW

John Gelston recalls it wasn’t that long ago that bids for major commercial insurance programs resembled a free-for-all on a stock market trading floor. Large organizations would put a notice of tender to brokers, who would line up at the requisite time and then race to get quotes from select markets.

“The broker who won the tender was often the one with the fastest car,” says Gelston, chief broking officer for HKMB International Insurance Brokers. “That didn’t necessarily mean they were the best broker for that particular deal.”

Many risk managers and commercial buyers of insurance tried to refine that model to one called “market allocation,” in which several brokers and companies would share risks according to areas of specialization and competitive rates.

“It didn’t take too long for risk managers to discover they were simply mixing and matching on deals,” notes Gelston’s colleague Craig Wilson, a vice president and partner with HKMB. “If the process is based on price and market allocation, brokers can select a hot market or perhaps a market that doesn’t understand the risk that well. In many ways, it could be selection on a false premise.”

Over a period of time, wise minds began to recognize the selection of one’s broker was too important to rely on a ‘luck-of-the draw’ technique, notes Michael Stonehouse, a consultant with Armour Riley Inc., which provides risk consulting services to organizations. “In short, you could end up appointing the least qualified broker just because their assigned insurer quoted the most aggressively.”

Fast forward to the present: risk managers and commercial brokers are looking at a much different landscape in the selection process. Many sources note there is a far more disciplined approach to broker selection that involves pre-screening teams composed of various representatives (legal, financial, procurement, etc.), a formalized RFP that applies exclusively to broker selection (not insurance purchasing), fee-only models, especially for larger organizations, and an emphasis on performance and deliverables as set out in broker services agreements.

“I think what you are seeing coming out of the broker selection or RFP process is the broker services agreement,” says Karin McDonald, director, risk and insurance for Hydro One, Ontario’s largest provider of electricity. “People are really having to stop and think about what services they require from their brokers and put it into the RFP document, as well as achievable targets and the results of non-compliance.”

WHY AN RFP PROCESS?

It is easy to pin the cause of this increased diligence on the broker commission and conflict of interest controversy that erupted in the United States and spilled into Canada. For larger organizations, many of which had already switched to a fee-only model earlier this decade, the contingent commission scandal was the final straw for transparency and disclosure.

“Most larger insureds wanted to be very clear they are paying money for the services of the broker to represent the interests of the insured, not the carrier,” notes Beaumont Vance, senior enterprise risk manager, Sun Microsystems. “The contingent commission controversy definitely pulled back the veil and showed the man behind the curtain. It forced everyone to be much more transparent, and to change the way they do business.”

Fees are one factor, but the underlying trend behind RFPs and broker selection structure is also based on the need for enhanced corporate governance.

“I would definitely say the evolution has been towards a more disciplined broker selection process, accelerated over the last five years because of the demands of corporate governance,” says John Johnstone, executive vice president and national director of risk management for Aon Canada. “Risk managers typically now will report to the audit committee of the board of directors, and they are driven by corporate governance legislation.”

Yet another reason for more rigorous broker selection is the increasing influence of procurement in many public and private sector organizations. One study co-published by Jardine Lloyd Thompson and the Association of Insurance and Risk Managers (AIRMIC) surveyed 750 of the largest public and privately owned companies in the United Kingdom on insurance procurement. Roughly one-third of the respondents indicated that procurement plays a part in the insurance buying process at their company. Thirty-eight per cent reported that procurement’s role is increasing in importance.

In Canada, many sources say the procurement model for broker selection and insurance purchasing mainly applies to goverment. “Procurement methodology is invariably a factor when it comes to government agencies . . . (but) procedures have matured as well, so providers of professional services are now subject to different criteria than suppliers of commodities,” says Stonehouse.

Vance notes that he has seen procurement methods moving into the private sector. “More and more companies are clamping down on the rules that govern purchasing and procurement is the process that controls it,” Vance notes. “If the procurement model does come into play, it can disrupt insurance relationships. It asks: ‘Why do these relationships exist? How do you know it is the best price and best service?’ And then the house of cards tumbles. A lot of risk managers have lost their jobs over that.”

EVOLUTION OF RFPS

With these motivating factors, the process of broker selection has been refined in the past five to 10 years. One of the most important developments has been the RFP process strictly for broker selection.

“A new technique was developed that involved segmenting broker selection from the process of developing insurance quotations,” says Stonehouse. “The successful broker is then able to negotiate with all qualified, financially acceptable insurers. In our opinion, that approach is now considered to be best practice in the insurance industry.”

“In the RFP for broker selection, 99 times out of 100 it will say there is to be no contact with the insurance marketplace,” notes Johnstone. “Appropriately, the broker selection process takes place insulated from the marketplace. However, it would not be unusual to be asked to provide conceptual pricing.”

Over the past several years, the RFP refinement process has tended to include an invitation for firms to provide expressions of interest and then a short-listing of three or four brokerages. The RFP document focuses clearly on assessment criteria of broker services as they relate to a specific organization. After written responses are evaluated, the brokerage’s service team is typically invited to an in-person meeting to gauge compatibility.

“Some of the more universal characteristics risk managers look for in brokers would be local bench strength, as well as access to global resources,” observes McDonald. “There is also turnaround of staff: you don’t want to go through an RFP, meet your team and then find out that the team is gone before the end of the process. Many also look at practice groups, clientele in a certain industry or sector and auxiliary services such as loss control.”

Detailed knowledge of specific industry sectors and alignment with clients’ needs are the key attributes of brokers, according to Johnstone. “The Number 1 quality risk managers and corporations look for now in brokers is that [brokers] clearly understand the business of the client,” he notes. “That is most often demonstrated by the broker having specialized skills focusing on that particular client’s industry.”

Brokers generally have the skills to handle the transactional elements of the insurance
process. But one firm is distinguished form the next because of what they offer beyond those transactional elements.

“What risk managers are looking for is more consultative brokering skills,” says Wilson. “Not many brokers have a complete list of services to offer. They (risk managers) are trying to discover what kind of consultative services you have and how these match up to their needs.”

The key element of an RFP for brokerage services is whether or not the broker can deliver the services that meets the particular client’s needs, adds Gelston. “For example, it could be claims advocacy, loss control inspection, actuarial service or workers comp consultation,” he says. “You have to line up your services with your clients’ needs, and vice versa.”

Some risk managers believe the partnership between brokers and risk managers drives creative insurance and non-insurance solutions in the market.

“The insurance marketplace does not innovate much in general,” Vance argues. “It is really up to the brokers and clients to drive innovation in order to get solutions that meet our needs. If you have brokers that are more capable of doing that, they have a strategic advantage. That is where it comes into more of a consulting model.”

BEAUTY CONTESTS

Johnstone notes the clear trend of businesses moving towards enterprise risk management (ERM) represents an opportunity for brokers to think outside the box. “Enterprise risk clearly is where brokers bring innovation to the table,” he says. “It is something that is more and more important, driven towards the trend for organizations to evaluate risk on an enterprise-wide basis, and to bring solutions to the table.”

There is a whole menu of services that clients want, and sometimes clients don’t even know what services they want or need, Gelston says of enterprise risk. “If you have a broker that is in sync and on side with your operation, then your broker understands your account,” he says. “The answer is not necessarily selling more insurance; clients are looking for options and choices.”

In fact, many brokers say the more disciplined approach and expanding expectations of innovation are a welcome opportunity for them to showcase their services. But it can also create other problems when it comes to longstanding relationships and the service-driven nature of complex insurance programs.

One typical concern is the traditional bottom-line focus of procurement practices. “Choosing an insurance broker is not radically different than selecting an accounting or legal firm,” Gelston notes. “Generally speaking, you get what you pay for. You wouldn’t think for a moment of measuring either of those services strictly by the cheapest fee. You have to ensure there is a match-up between your needs and the broker’s capabilities to provide substance to those needs.”

Johnstone says that although “there is nothing wrong with applying discipline, when you think of insurance brokering services in terms of procurement, it is risky because it bureaucratizes the insurance process. There are nuances to the transaction that the procurement process might not totally comprehend.”

Vance thinks that brokers and insurance buyers will likely have to adapt to tighter spending practices in the future. “The risk manager doesn’t ultimately call the shots for the corporation financially,” he notes. “If there is a corporate policy that things have to be marketed in a certain amount of years, the relationship may be important, but it is not going to override the standard business practices set by the board of directors. You don’t want to shoot the messenger if the risk manager is in that situation.”

Excessive marketing of insurance programs can burn bridges in the market, according to several brokers. Indeed, the most pressing concern of brokers is that the selection and RFP process be taken mindfully. They should not be “beauty contests,” as Gelston calls some of the more conceptual broker selection processes.

Vance says he has noticed an increased onus on risk managers to test both brokers and the market. “Where I have seen change is that there seems to be more pressure, ever since the whole outsourcing movement started, to market the broker more frequently to ensure the prices you are getting are reasonable for the marketplace,” he notes.

But that process can backfire, according to some brokers. “The insurance underwriting universe is a relatively small one and, believe me, if clients take their risks to that universe to be tendered every two years, then underwriters lose patience,” says Johnstone. “They see that as shopping the risk, and they are not prepared to commit their time and resources.”

The same goes for brokers, according to McDonald. “The problem is that if you are out in the market doing RFPs too often, there is a real cost to brokers in responding to them,” she says. “If they perceive you are merely complying with your procurement policy, there is the risk they will simply not bid on it.”

Valuable resources are committed to the RFP process, both on the broker and client side, argues Johnstone. “If you are going to go ahead with it, it’s important that everyone understands there is serious intent to consider change.”

At the same time, McDonald notes, “you have to be careful, because it (the RFP process) does turn out to be a bit of a dog-and-pony show. Sometimes there is this tendency to provide a whole lot of fluff and not a whole lot of substance in the responses. As a risk manager, I want succinct answers to the questions.”

The risk manager also has a role in creating the right timeframe and conditions for an appropriate RFP response, according to Johnstone. “Risk managers and others have to make sure they are creating realistic deliverables,” he notes. “Timing is very important. The shorter the timeframe, the more you are going to get boilerplate solutions.”

RFPS AND FAIRNESS

Instead of relying on the luck of the draw or the hot market of the day, the evolving RFP process for broker selection generally represents a fairer and more analytical assessment of the services offered to a risk manager, according to sources. If properly used and managed, many say this emergent best practice will yield better long-term results.

“I think this current approach for selecting a broker is a good one,” says Stonehouse. “It is fair to the competition, and affords the company with a pragmatic approach for selecting a broker who is well positioned to accommodate their unique requirements.”

Increasingly, organizations have instilled a discipline that they will subject their risk management arrangements to a formal evaluation process, concludes Johnstone. “As brokers we don’t live in a vacuum,” he says. “To the extent we are expected to be part of that process, I see it as an opportunity for us to demonstrate our value on a broader playing field.”