The smart-follow movement succeeded in helping to rebrand the London follow market amid a boom in capacity dedicated to this tactic, with new portfolio solutions teams and leaders popping up regularly.
But the term is loose jargon, and some sceptics have queried how “smart” the strategies can truly be, when a large part of the market premium to date consists of broker facilities income.
Naturally, for brokers the facilities drive is a clear win, as it assists with faster placements and brings in enhanced commissions. But carriers are equally plunging into smart-follow with the aim of cutting costs and improving data analytics – so how can they ensure that this development works for them, as well as brokers?
In this two-part series, Insurance Insider will explore how smart-followers are seeking to assemble their portfolios to live up to the first part of their name, and the tactics they believe will help them hit their goals.
In the second part, we will delve specifically into broker facilities to look at the wins that carriers are looking to achieve in the near-term, their mid-term challenges and the long-term outlook.
Unpacking the smart-follow mix
It’s important to note upfront that the smart-follow segment is not a monolith: some carriers might have different goals to achieve than others.
Some are after scale from a well-indexed portfolio and are not seeking to outperform the market, while others are looking to take more of a “smart-beta” approach in picking the best segments of the market to try to outperform an index.
Of the $5bn premiums estimated by Oxbow Partners to comprise what it called ‘enhanced underwriting’ strategies, it’s clear the majority to date is from broker facilities. These can be an initial way of building volume in smart-follow for carriers, as the targeted low-cost expense advantage rests on achieving scale.
Oxbow Partners estimates that $3bn of Lloyd’s GWP currently flows through active portfolio trackers and a further $200mn through digital and algorithmic broker facilities.
Indeed, some argue that facilities in isolation do not fit the smart-follow definition due to the passivity of the structures. “Smart-follow starts off as digitised follow, but to make it smart, it needs to have the ability to select risk and flex line size in an automated manner,” said Caspar Murphy, CEO at algorithmic MGA Vuw.ai.
Many smart-follow teams are trying to create more diverse portfolios by signing up for consortia or line-of-business-specific facilities, as well as bilateral quota shares or even pursuing algorithmic underwriting.
This takes them further away from those seeking pure indexation and closer in spirit – if completely different in approach – to alpha-seeking lead underwriters: essentially more of a “fund of funds” portfolio manager, as Will Roscoe, head of portfolio underwriting and active underwriter for the smart tracker Syndicate 5623, describes Beazley’s approach.
Of course this leaves room for error as well as gain, but it will open up the opportunity to be more than a pure beta strategy.
One common theme among smart-followers is that it is smart merely to be in the game. The expectation is that this form of capacity will squeeze out traditional follow as brokers push more risk through facilities.
But though the change may be structural and smart-follow underwriting here to stay, InsurX co-founder Gilbert Harrap said this does not make it a road “paved with gold.”
“We will see good and bad smart-follow underwriting, just as we have always seen good and bad underwriting in the analogue market,” he forecast.
In terms of the material factors that will impact how smart-followers achieve this success, we will look at how smart-follow underwriters are viewing the role of facilities in their portfolio; the talent and managerial considerations at play; the question of timing the markets and the possibilities offered by data.
The new gen of broker facilities
Even though broker facilities are the most vanilla part of the smart-follow market, these vehicles are also being pitched as “smarter” by design these days than in their early development.
These claims will be examined in more focus in the second part of this series, but smart-followers point to several key design features that are intended to protect carriers.
The key protections comprise leader selection and controls on their line sizes. However, the numbers of leads that any one facility can follow might range anywhere from six to seven to 30-40, one broker said – suggesting a wide range in selectiveness.
Without taking advantage of these filters, broker facilities could quickly revert to “dumb follow again, if they will follow anyone”, a source said.
Bigger, cross-class facilities give little room for manoeuvre by design: they’re targeting indexation.
But other facilities may make use of more rule-based systems or better technology, which is one of the focal points for the McGill Auton facility, for example.
The degree of indexation achieved by facilities across a target portfolio is a perennial challenge for both brokers and carriers. Brokers need to ensure that the risks are evenly balanced and that a uniform range of risk is fed into the vehicles to prevent anti-selection risk, which remains a concern even as larger facilities are starting to be able to provide good metrics on indexation levels.
Underwriting, but not as you know it
Pioneers in smart-follow emphasized that making a success of the strategy will require a focus on portfolio management and technology skills, balancing the volumes of business they’re assuming with the ability of a small team to track and analyse them.
Market participants observed that early pioneers can be divided between carriers that focus on a smaller number of large deals, and those that try to build portfolios with more individual facilities and agreements.
But the latter approach can risk “overwhelm”, one broker said, with many audits and bordereaux to analyse each month.
Similarly, smart-followers also need to focus on portfolio underwriting skills: looking across a portfolio of facilities and not just any individual one.
“You need to be comfortable with not being an expert in every single line of business,” said one underwriter, noting that carriers had to accept that inevitably they would wind up on risks that individually they would never write.
“From a portfolio underwriting perspective, I'm not too concerned about any one individual risk. For me to write that portfolio, there will be some good and there'll be some bad in there, and I've got to find the right balance.”
With that said, you still need good underwriters, InsurX’s Harrap added. “If you do a lot of premium without the right talent, you could do a lot of damage.”
The aggregation analysis expertise is particularly important because as smart-follow portfolios grow, carriers could be exposed to similar types of risk in multiple areas: from direct participation in a facility, from supporting a platform such as Ki or InsurX and from their open market business.
Smart-followers are often seeking to exploit technological advantages to spot trends and improve placement efficiency.
This may require hiring specific talent, bringing in experts with data science skills or extra actuaries. It will be important to ensure their technical expertise is not sidelined in an industry that elevates underwriting prowess, one source noted.
Finally, from a broader management perspective, sources agreed that it was vital that carriers create a sense of unity around a smart-follow initiative by having leaders champion the cause of new divisions, to avoid resentment from lead underwriting teams and to mitigate conflicts over access to business.
Some smart-follow participants argued that the best way to manage potential divisions is to create distinct separation between lead and smart-follow teams.
This is the model for Beazley’s Smart Tracker, and Roscoe said: “We’ve benefited from being able to consult with the ‘stock pickers’ [lead underwriters] and yet we are separately capitalised and reinsured.”
But to date, few have gone to the effort of setting up specific syndicates, although ring-fenced P&Ls are more common.
Some are more tailored in the way they manage the split by the type of follow underwriting in question. “If it's an energy-specific facility, we want the energy underwriters to own it and have it as part of their P&L,” a source said. “If it’s a cross-class facility, we tend to take that away and put that in a separate P&L.”
Though more of a minority position, some suggested that integration of smart-follow and lead underwriters helped to manage concerns with sign-downs. “Underwriters know that if they're losing out, [our smart-follower] might not be.”
Timing and time in the markets
Just as lead underwriters seek to time the insurance markets, so too there is a question over whether and how more passive risk-takers in the smart-follow market will adjust and fine-tune their portfolios, and what impact this will have on the broader rate cycle.
It represents the eternal investment question of whether to focus on time in, or timing of the market to achieve the best results.
After all, the first few years of Aon Client Treaty lost money for participants initially: but in the reworking since, those that stayed the course, like QBE, have gained overall.
Underwriting culture is biased to the idea of trying to time the market. But the ethos of a facility or stock tracker runs somewhat counter to that – however, at the same time, sticking in a facility through a soft market to lose money hardly fits the “smart” tag.
To this end, most smart-followers who say they see participation in broker facilities as a long-term strategy have suggested that they will look to scale allocations up or down as market conditions shift. Having a streamlined team behind them should make this decision easier, it is suggested. One underwriting source suggested that the impact will be to create more compressed pricing cycles with faster reactions.
Meanwhile, it is evident that some enthusiastic smart-followers see their participation in major facilities as more time-bound: picking up access to risk to grow now that it is well-priced. In this vein, it could be easy to see capacity from this type of participant being withdrawn if the rates were not there to support them.
However, sceptics may argue that the weight of capital committed to follow facilities makes it harder for the market to turn.
The data advantages
On the data front, some have also said that the greater availability of data enables follow carriers to be more “smart” – potentially to use facilities as an exploratory tool before going into a new line of business, for example.
Beazley SmartTracker has a “very rich resource of data” now, Roscoe said. “We’re developing internal tools for portfolio optimisation and improved pricing and we’re at a very early stage of exploring using AI.”
But there are also limits on what smart-followers can do with the datasets they get through facilities due to client confidentiality concerns – this would limit the ability of a firm to allow its lead underwriters to benefit from risk-level facility data, for example.
Others said there is still not enough data sophistication across the market despite improvements.
Apollo’s head of smart follow, Farris Salah, emphasised the firm’s preference for facilities and partnerships that provide submission-level data, as otherwise, it feels like “a blind follow play”.
This didn’t mean the firm was seeking to alter deals struck by leads, but that the asset-level data was critical to understand exposures, he added. In turn this enables follow-market carriers to shape their portfolios more effectively, maximise capital efficiency and provide more stable capacity to the market.
The firm aims to leverage its technology and data to support distribution partners with underwriting intelligence, acting as a “booster” for leads in risk analysis, he added.
Meanwhile, Vuw.ai’s Murphy said that most smart follow approaches today are rule-based rather than truly AI-driven, meaning they lack real-time adaptability.
Technology should enable followers to rely on a broader set of metrics, not just the leader's terms – providing carriers more insight into trading patterns, instead of having to gauge the market mood via personal connections. “These patterns will offer forward indicators to a change of behaviour,” he said.
Varying strategies and the fight for control
While some carriers are still in experimentation mode with their smart-follow initiatives, early pioneers said that it will soon be a trend that can’t be ignored.
But what lies ahead for the evolving sector?
To the extent that carriers want to aim to outperform an index, this may require more mixing and blending of different strategies, rather than simply signing up for major facilities.
This could lead to faster growth in consortia or algorithmic capacity – though the expense of developing the latter technology may also drive carriers to sit behind other early smart-followers, rather than going it alone.
This future role has been described as that of a “lead follower”, which attracts capacity behind it in turn.
This could then lead to some tussling over how much smart-follow capacity is controlled by the broker or underwriters. Consortia that amplify lead lines are typically less controversial, as brokers want to encourage strong lead underwriting.
But some intermediaries perceive followers lining up capacity behind themselves as treading on their turf. They cite Ki’s move to support broker facilities as likely a move to secure relationships to support the profile of its open market algorithmically quoted follow-only lines – although it’s understood Ki sees the development more as a case of finding tech synergies with brokers. As well as itself, it now offers capacity from Aspen, Beazley, QBE and Travelers.
Whether this potential fight for control hampers development of a truly smart smart-follow market remains to be seen. However, given that no real index of the London insurance market exists – one could argue that having various carriers starting to approximate one represents progress in itself.