Study 3 - Dynamics of the Insurance Marketplace

Question 1

1) What is capacity in an insurance context?

Answer 1

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

Question 2

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

Answer 2

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.

• The 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.

Question 3

3) What is a bull market?

Answer 3

• A bull market is a market on the rise. During this cycle, there is a strong demand for securities but weak supply which causes share prices to rise.
• Investors are optimistic
• Have faith that the market will continue
• The economy is strong
• Employment is high

Question 4

4) What is a bear market?

Answer 4

• A bear market is a market on in decline.
• Share prices are dropping and investors believe the downward trend will continue.
• The economy is sluggish
• Unemployment rises.

Question 5

5) What does the law of supply show?

Answer 5

• The law of supply shows that the quantity of a product a supplier will provide is relative to the amount of payment per unit they will receive.
• The higher the price, the more the producer wants to supply.

Question 6

6) What does the law od demand state?

Answer 6

• The law of demand states that if all other factors remain equal, fewer people will demand the product as it’s prices rise.
• The lower the price the more demand there will be for the product.

Question 7

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

Answer 7

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

Question 8

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

Answer 8

• In the past when investment returns for insurance companies have been high, companies have found that they don’t have to report an underwriting profit in order to record a profitable bottom line.
• Starting in the mid-2000s, a bear equity market took over that lasted close to three years, thus insurers had no choice but to work towards earning underwriting profits.

Question 9

9) What 3 impudent underwriting practices emerge in highly competitive environments in soft market cycles?

Answer 9

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

Question 10

10) Name 3 strategies employed by underwriters that signify a hardening of the market?

Answer 10

• Approach risks cautiously before offering to insure them.
• Set more exacting underwriting standards
• Give consideration to more loss control and loss prevention measures
• Make substantial rates increases
• Terminate relationships with brokers with unprofitable results
• Withdraw from areas that do not provide sufficient market share
• Withdraw from the market altogether by selling the company to another insurer or placing it into what is known as run-off.

Question 11

11) What is market dislocation?

Answer 11

Market dislocation occurs when consumers are forced to find a new insurer when their current insurer decides to withdraw from the market.
-After the consumer has come to rely on that insurer for the product.

Question 12

12) What is social inflation?

Answer 12

Refers to the increase in claims costs from:

• generous jury awards
• legislated benefit increases
• changing legal concepts of tort and negligence that benefit plaintiffs

Question 13

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

Answer 13

Hundreds of millions of shareholder capital were lost as a result of terrorist attacks of the twin towers in NYC.
-Also the scandalous accounting practices that occured in corporate america thereafter.

Question 14

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

Answer 14

• Shrinks the market and its capacity due to fewer market players.
• When a P&C company goes bankrupt in Canada, each insurer that is a member of the association is called upon to pay its share of claims; this can have a negative effect on profit levels

Question 15

15) How are brokers affected by market cycles?

Answer 15

• During soft market cycles, brokers enjoy the abundance of capacity, premium rates decline and underwriters are less demanding.
• However, a decline in rates means a decline in commissions.
• During a hard market cycle, brokers must work more intensely to find capacity for their clients and must negotiate more diligently to obtain reasonable prices.
• Commission income rises when premiums increase.

Question 16

16) How are consumers affected by market cycles?

Answer 16

-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 position as they cannot afford to buy insurance that is mandated by law.

Question 17

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

Answer 17

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

Question 18

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

Answer 18

While regulation tends to please consumers, price regulation is an unnecessary and expensive administrative burden.

• The free market system 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 software may be required to rate and report data
• Increased operating costs and politically imposed premiums could reduce insurers’ profitability and return on equity.

Question 19

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

Answer 19

They may find:

• that the company’s functional competence suffers
• Questionable risk selection occurs
• succession plans cannot be developed
• financial results can be negatively impacted

Question 20

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

Answer 20

• Insurers will need to redevelop their projections for premium, loss ratio and return on equity.
• They may shelve business strategies to achieve growth or to expand until the effects of government actions are made clear.

Question 21

Explain the influences over the Canadian P&C marketplace

Answer 21

Distribution channels:

• Broker channel has historical roots from the UK.
• Continues as an integral part of the general insurance market.
• Direct writers also occupy a significant market segment
• Banks competing in the insurance sector mainly as direct writers
• Some insurers support multiple distribution channels
• Insurance companies control new product offerings (capacity, rates and market consolidation)
• Reinsurers influence the cost of the primary market
• Insurers feel the effects of rate increases in the retrocession market.
• Shrinking retrocession market causes an increase in reinsurance rates
• Consolidation of insurance companies can mean less dependence on reinsurers