Chapter 8: General Insurance Markets Flashcards
Reinsurance for insurance providers can be obtained from (5):
- the London Market
- Lloyd’s
- specialist reinsurance companies
- direct insurers who also write reinsurance
- capital markets
Direct insurers
provide insurance for individuals and companies
3 Groups of direct insurers
- Composite insurance companies
- Insurance companies that specialise in writing business in a selection of classes of general insurance
- Insurance companies that write all classes of general insurance
Composite insurance companies
Insurance companies that write both general insurance and life insurance
Corporate structure of general insurers
Most insurance companies are proprietary companies limited by shares.
However, some mutual insurance companies do exist; they are more common in some markets than in others.
Reinsurance companies
Provide cover for insurance providers.
London Market
That part of the insurance market in which insurance and reinsurance business is carried out on a face-to-face basis in the City of London.
Focus of the London Market
Commercial insurance:
insurance & reinsurance cover to COMPANIES.
3 specialisations of the London Market
- larger direct insurance risks (both property and liability) that are beyond the capability of other direct insurance companies.
- international risks
- reinsurance
8 Participants in the London Market
- Lloyd’s syndicates
- UK subsidiaries or branches of overseas companies or reinsurance companies
- reinsurance departments of UK composite companies, or reinsurance subsidiaries of these companies
- small professional reinsurance companies set up by (or acquired by) large broking firms for the specific purpose of transacting London Market business
- captives
- P&I Clubs
- companies owned by a group of insurance or reinsurance companies
- Pools
Lloyd’s of London
A unique insurance institution.
It began in Edward Lloyd’s coffee shop in 1860s, before being incorporated by the Lloyd’s Act of 1871.
It is NOT an insurance company - it is a marketplace made up of members who provide capital and accept liability for risks that are underwritten in return for their share of any profits that are earned on those risks.
Corporate Name
A limited-liability company whose only business is to provide capital to Lloyd’s.
“Limited liability”
means that the corporate member cannot lose any more than the capital it has provided.
Syndicates
Groups of Lloyd’s members who collectively coinsure risks.
Individual syndicates often specialise in particular types of insurance.
Captive insurance company
An insurer that is
… wholly owned by an industrial or commercial enterprise
… and set up with the primary purpose of insuring the parent or associated group companies
… and retaining premiums and risk within the enterprise.
Authorised captive
“open market captives”
A captive that is free to provide insurance to risks other than those of its parent - providing this does not change its main purpose.
They often provide insurance to the parent company’s customers.
5 Usual reasons for setting up captives
in order to:
- FILL GAPS in insurance cover that may not be available from the traditional insurance market
- MANAGE the total INSURANCE SPEND of large companies or groups of companies
- enable the enterprise to buy cover directly from the reinsurance market rather than direct insurers
- FOCUS effort on RISK MANAGEMENT
- to gain TAX and other LEGISLATIVE or REGULATORY ADVANTAGES
Protection and Indemnity (P&I) Clubs
Mutual associations of ship owner that were originally formed to cover certain types of marine risks (marine liability) that could not be covered (at an acceptable price) under a commercial marine policy.
P&I Clubs still provide around 90% of the world’s coverage against marine liability claims.
Pool
An arrangement under which the parties agree to share premiums and losses for specific insurance classes or types of cover in agreed proportions.
Critical difference between insuring with a conventional insurer and insuring with a pool
The insured’s liability to an insurer is limited to the premium charged, whereas the liability to the pool will be related to the insured’s share of the total claims and other costs that arise.
World insurance markets differ in 4 ways:
- the concentration of market shares of major insurers
- whether business is written directly with policyholders or through brokers
- the importance of mutual companies
- whether or not composite companies are permitted.
Securitisation
A mechanism whereby insurers borrow money from capital markets and repay the money subject to the experience on the insurance book being satisfactory.
Catastrophe bonds
A bond where the repayment of capital (and possibly interest) is contingent on a specified event NOT happening.
Sidecar
A financial structure that is created to allow investors to take on the risk of a group of insurance policies.
A sidecar acts like a reinsurance company
… but it reinsures only one cedant
… and the investors need to place sufficient funds in the entity to ensure that it can meet any claims that arise.
Weather derivatives
Where standard derivative techniques such as put and call options and swaps are used to make a derivative contract based on the weather
Advantages of using a derivative approach as opposed to traditional insurance.
- there is no need for an INSURABLE INTEREST because the parties have no control over the weather
- there is no need to understand the UNDERLYING BUSINESS for which cover is being purchased
- there is no need to PROVE the extent of the LOSS to a claims handler because the claim payout is based purely on the weather index.
Committed / contingent capital
Based on a contractual commitment to provide capital to an insurer after a specific adverse event occurs that causes financial distress.
The insurer purchases an option to issue it securities at a predetermined price in the case that the defined situation occurs on the understanding that the price would be much higher after such an event.
3 Channels for obtaining insurance business
- intermediaries such as brokers, banks, building societies, shops, etc
- staff directly employed by the insurance provider
- internet, telesales, post and off-the-page advertising
Brokers
Brokers act as intermediaries between the seller and buyer of a particular insurance or reinsurance contract without being tied to either party.
They are likely to be paid by commission (brokerage) from the insurance.
Binding authorities (binders)
Contracts that set out
… the scope of the delegated authority
… and thus allowing the broker to enter into contracts of insurance and to issue insurance
… and to issue insurance documents on behalf of an insurance company (or on behalf of Lloyd’s managing agents in the case of Lloyd’s)
Line slip
A facility under which underwriters delegate authority to accept a predetermined share of certain co-insured risks on their behalf.
The authority may be exercised by the leading underwriter on behalf of the following underwriters..
Tied agents
Organisations such as banks and building societies are sometimes tied to a particular insurer and sell that insurer’s products alongside their own.
8 Regulatory restrictions on underwriting
Restrictions
• on the TYPE/AMOUNT of business a general insurance company can write / classes it is authorised to write
• on INFORMATION that may be used in UNDERWRITING and premium rating
• on COUNTRIES the company can write business in
• Mandatory restrictions on COVER
• Prohibiting ILLEGAL PRODUCTS from being sold
Limits
• on CONTRACT TERMS
• on PREMIUM RATES that can be charged.
Requirements
• Requirements to file / PUBLISH PREMIUM RATES before they can be used
• Requirements to OFFER CERTAIN COVER eg high-risk flood areas, motor 3rd party liability
Reason for restrictions on the type / amount of business a general insurance company is authorised to write
Ensures companies have appropriate expertise / sufficient capital to write the business classes
Reason for limits on contract terms and premium rates that can be charged
Ensures premium rates are sufficient to meet future claims / ensures policyholders are not overcharged
Reason for restrictions on information that may be used in underwriting and premium rating
For ethical / anti-discrimination reasons
Reason for requirements to file / publish premium rates before they can be used
Prevents anti-competitive practices and therefore protects policyholders
Reason for restrictions on countries a general insurance company can write business in
Prevents exposure to volatile risks and unfamiliar legal systems and regulations
Reasons for mandatory restrictions on cover (e.g. no deductible on employers’ liability)
Protects policyholders and claimants and ensures consistency of cover.
Reason for requirements to offer certain cover (Motor 3rd party)
Promotes social responsibility and helps the economy as a whole
5 Common capital requirements
REQUIREMENTS
- to deposit assets to back claims reserves
- to hold a claims equalisation reserve
- to maintain a minimum level of solvency for risk-based capital calculations
- The use of prescribed bases to calculate
— premiums,
— asset values
— and liabilities
to demonstrate solvency
Reason for the requirement to deposit assets to back claim reserves
Ensures the company has sufficient funds to pay claims.
Reason for the requirement to maintain a minimum level of solvency
Ensures that if claims are significantly worse than expected, the company will still remain solvent
Reason for the use of prescribed bases to calculate premiums, asset values and liabilities to demonstrate solvency
Ensures accurate estimates of liabilities and uncertainty
Reason for the requirement for risk-based capital calculations
Ensures accurate estimates of liabilities and uncertainty.
6 Investment requirements
Restrictions
- on the TYPE/AMOUNT of certain ASSETS allowed to demonstrate solvency.
- on the CURRENCY, DOMICILE and DURATION of assets allowed to demonstrate solvency
- on the amount of investment in any one company / group
- Requirement to hold PRESCRIBED ASSETS
- CUSTODIANSHIP of assets
- PREVENTION from holding CERTAIN ASSETS (eg derivatives for speculative purposes)
Admissible assets
Those assets which can be taken into account for the purposes of demonstrating statutory solvency.
Custodian
A party that HOLDS THE ASSETS for the insurer
and is responsible for:
• SAFEKEEPING of those assets
• all ADMINISTRATIVE matters relating to those assets.
Reason for restrictions on the type or amount of certain assets allowed to demonstrate solvency
• to prevent high-risk assets from backing liabilities
• to encourage diversification
Reason for restrictions on the currency, domicile and duration of assets for demonstrating solvency
Ensures that
… assets match liabilities by term and currency,
… so that short term changes in interest rates and exchange rates will not have an impact on solvency margins.
5 Reporting requirements
• Disclosure / transparency of reporting requirements, eg a requirement to provide detailed reports and accounts at prescribed intervals
• Requirements for a Statement of Actuarial Opinion to be produced by an approved actuary
• Restrictions on the type of reinsurance that may be used
• Restrictions on the discounting of liabilities and discount rates that can be used
• Requirements for general insurance companies to be audited
Reason for requirements on disclosure
This helps
• regulators
• investors
• capital providers
• policyholders
assess the soundness of the company
Reason for requirements for a statement of actuarial opinion
This promotes confidence in the level of reserves and helps to prevent the failure of a general insurance company
Reason for restrictions on the type of reinsurance that may be used
This prevents exposure to risky reinsurers or reinsurance products
Reason for restrictions on the discounting of liabilities and discount rates that can be used
This ensures consistency and that reserves are sufficient
Reason for requirements for general insurance companies to be audited
This gives regulators and investors confidence in the company and prevents fraud.
3 Authorisation requirements
• INITIAL AUTHORISATION of new insurance companies
• Licensing agents to sell insurance and requirements on the method of sale
• Requirements for FIT AND PROPER MANAGEMENT, eg restrictions preventing specific individual from holding key roles in companies
Reason for initial authorisation requirement of new insurance companies
This ensures that companies have appropriate EXPERTISE / SUFFICIENT CAPITAL to write the business classes
Reason for licencing agents to sell insurance and requirements on the method of sale
This ensures that a company has the necessary expertise and that the insured is well informed
Reason for requirements for management to be fit and proper
This promotes confidence in the industry and helps prevent fraud.
7 “Other” requirements to protect policyholders
• Requirement to purchase REINSURANCE
• Legislation to protect policyholders should general insurance companies fail
• The requirement to pay LEVIES to CONSUMER PROTECTION bodies
• Advertising restrictions
• Regulations with respect to treating customers fairly
• Restrictions with respect to anti-competitive behaviour.
• A COOLING OFF PERIOD (eg fourteen day cancellation rules on policies issued)
Reason for legislation to protect policyholders should general insurance companies fail
This protects policyholders and maintains faith in the insurance market
Reason for the requirement to pay levies to consumer protection bodies
This protects consumers and maintains faith in the insurance market
Reason for a cooling off period
This protects policyholders
- promotes confidence in the industry
Reason for restrictions with respect to anti-competitive behaviour
Prevents
- the formation of cartels
- concentrations of risk
- protects policyholders
8 Disadvantages of regulatory proposals
- COST TO COMPLY with and supervise the rules (ito resource & finance)
- the LOSS OF BUSINESS OPPORTUNITIES that arise form any restraint on a free market
- the inability to maximise INVESTMENT RETURNS when there are controls on the investment decision
- the quantum of regulatory bureaucracy DETERRING NEW ENTRANTS
- the difficulties and hence potential inaccuracies in complying with complex (risk-based) liability and capital calculations
- the INCREASED PREMIUM COST to the public arising form levies and the general increase in insurer expenses
- the inability of companies to benefit from economies of scale and cost reductions due to anti-competitive legislation
- the failure of insurance to reach certain sectors of the population due to the increased cost of and restrictions on methods of distribution.
London Market business:
The slip system in the subscription market
- Insured approaches a London Market broker
- Broker proposes a slip with the main features of the risk
- Broker shows the slip to one or more quoting underwriters who quote a premium
- The cedant will then select a lead underwriter and a «firm order» price for the broker with which to approach the market.
- The lead underwriter accepts a share of the risk by stamping and signing the slip.
- The broker then approaches other underwriters to accept the risk on the same terms. All underwriters act as coinsurers.
- Broker continues until he or she has finished placing the risk.
- If the written lines exceed 100% then they are reduced.
- If it is not possible to find capacity to place 100% of the risk, an additional shortfall cover may need to be placed at different terms
