Chapter 3: Dynamics of the Insurance Marketplace C16

1)      What is capacity in an insurance context?

• Capacity is the amount of capital that individual insurers or entire markets make available for insuring risk.

2)      What does the theory of supply and demand do?

• The theory analyzes the way pricing is regulated by balancing the amount of a product made available for purchase with the quantity required by consumers.
• Economic influences on the market include increased demands for insurance and reinsurance that result from a health economy. 
• Such activity increases the need for insurance and this contributes to organic growth in premium income as opposed to premium growth through mergers and acquisitions.  On the downside, it also causes growth in claims costs.
• The economy theory does not strictly apply to insurance and does not apply to all types of insurance.  Insurance that is mandated by law is not fully governed by the laws of supply and demand because the products must be purchased even if the cost is high.

3)      What is a bull market?

• A bull market is a market on the rise.  During this cycle there is a strong demand for securities but a weak supply which causes share prices to rise.
• When a bull market exists, investors are optimistic and have faith that the upturn in the market will continue. 
• The economy is also strong and the employment is high.

4)      What is a bear market?

• A bear market is a market in decline.  Share prices are dropping and investors believe the downward trend will continue.  The fear perpetrates the downward trend.
• When a bear market exists, the economy is sluggish and unemployment rises.

5)      What does the law of supply show?

• Shows that the quantity of a product a supplier will provide is relative to the amount of payment per unit he/she will receive.
• The higher the price, the more the producer wants to supply.

6)      What does the law of demand state?

• States that if all other factors remain equal, fewer people will demand the product as its price rises.
• Conversely, the lower the price the more demand there will be for the product.

7)      What is the effect of mergers and acquisitions in the insurance marketplace?

• M&A tend to increase capacity as larger companies with surplus capital expand their geographic score and product offerings.
• Larger companies have greater resources than smaller competitions to draw from and put to use to compete for market share.

8)      When the investment market is performing badly on what must insurers rely in order to earn a profit?

• In the past when investment returns for insurance companies have been very high, companies have found that they do not have to report an underwriting profit in order to record a profitable bottom line.
• Starting in about mid-2000, a bear equity market took over that lasted close to three years thus insurers had no choice but to work towards earning underwriting profits.
• Those that succeeded in doing so were beginning to record very healthy profits by 2003 and this was sustained through to the 2006 underwriting year.

9)      What THREE (3) imprudent underwriting practices emerge in highly competitive environments in soft market cycles?

• 1) Undercutting rates
• 2) Relaxing policy terms and conditions
• 3) Neglecting loss prevention and control measures

10)  Name THREE (3) strategies employed by underwriters that signify a hardening of the market.

• Soft market conditions arise when there is excess financial capacity in the marketplace and insurers demonstrate reasonable profitability and strong capital bases.
• Hard markets follow poor results because risks underwritten at artificially low prices must eventually be offset with high enough premiums.  Companies tend to react very slowly in a hardening market because they do not want to be the first ot move prices up and loose good accounts.

1)      Approach each risk very cautiously before offering to insure it

2)      Set more exacting underwriting standards

3)      Give loss control and loss prevention measures significant consideration

4)      Tighten policy terms to limit exposures

5)      Mark substantial rate increases

6)      Terminate relationship with brokers with unprofitable results or with only a small volume of business

7)      Withdraw from the jurisdiction, a class of business, or an individual risk when sufficient market share has not been gained or a portfolio or individual risk is not profitable

8)      Withdraw from the market altogether by selling the company to another insurer or placing it into what is known as a run-off (ceases to write new business and only services existing policies)

11)  What is a market dislocation?

• Market dislocation is said to occur when consumers are forced to find a new insurer when their current insurer decides to withdraw from the market after such consumers have come to rely on that insurer for the product.

12)  What is social inflation?

• Refers to the increase in claims costs resulting from generous jury awards, legislated benefit increases, and changing legal concepts of tort and negligence that benefit plaintiffs.

13)  Identify a large loss that exhausted a significant amount of capital for the insurance industry in 2001?

• Hundred of millions of shareholder capital were lost as a result of terrorist attacks on the twin towers in NYC and the scandalously improper accounting practices that occurred in corporate America thereafter.
• Although insurers and reinsurers in the US market were primarily affected by the severe claims filed, the Canadian market also felts its effects because it tends to reaction to the international market.

14)  What effect can an insolvent insurance company have on the marketplace?

• Shrinks the market and its capacity due to fewer market players.
• Canada has created an association to deal with bankrupt P&C insurers, the effects of shrinkage are even more intense for other health companies in the industry.
• When a P&C company goes bankrupt, each insurer that is a member of the association is called upon to pay its share of claims; this could potentially have negative effect on profit levels.

15)  How are brokers affected by market cycles?

• During a soft market cycle, brokers enjoy the abundance of capacity, premium rates decline and underwriters are less demanding.  However a decline in rates means a decline in commission.
• During a hard market cycle, brokers must labour intensively find capacity for their clients needs and must negotiate more diligently to obtain reasonable prices.  Commission income rises when premium increases.

16)  How are consumers affected by market cycles?

• During a soft market cycle, consumers are simply more neutral in their reaction to the insurance industry.
• During a hard market cycle, consumers become wary, distressed and often angry.  They are faced with premiums that are suddenly not affordable, availability that is restrictive and coverage terms that are limited.  Consumers are in an awkward situation as they cannot afford to buy insurance that is mandated by law.

17)  What is backlash can be expected when a mandatory insurance product becomes less accessible to consumers because of high rates?

• Politicians get involved by imposing measures they believe will make insurance more affordable.
• Governments can step in to establish backstops and protection plans such as caps on the amount of a loss.

18)  How may regulatory intervention in the automobile insurance industry affect insurers?

• While regulatory intervention tends to please consumers, price regulation is an unnecessary and expensive administrative burden.
• The free market system anticipates a self-regulating market that will ensure that prices reflect the true cost of doing business; rating boards and commissions only create imbalances in the free market pricing system.
• Higher staffing requirements or different software applications to rate and report data might be required.
• Increased operating costs and politically-imposed premiums could reduce the insurer’s profitability and return on equity.

19)  What are some disadvantages that may flow from an insurer exerting excessive internal cost-cutting?

• They may find that the company’s functional competence suffers, questionable risk selection occurs, succession plans cannot be developed and the company’s financial results are negatively affected.

20)  What action might an insurer take when the effects of government imposed reforms are unknown?

• Projects for premium, loss ratio, and ROE made before the changes must be redeveloped.
• Some insurers may shelve business strategies to achieve organic growth or to expand territorially until the effects of government actions are made clear.
• Other insurers may consider withdrawing from their jurisdiction, adjusting marketing plans for the affected area, or reserving any financial decisions until the regulator’s plans are announced.
• This in turn reduces automobile insurance capacity in the insurer’s jurisdiction.