Chapter 3 - Dynamics of the Insurance Marketplace

Insurance Marketplace

Refers to the space where consumers and insurers interact to exchange insurance policies for premiums.

Commodity

A standard product used for commerce that is traded based on price.

Supply and Demand Theory

Economic theory determining prices based on the balance between product availability and consumer demand.

Law of Supply

Asserts that producers are willing to supply more of a product at higher prices.

Law of Demand

Indicates that demand decreases as price rises and increases as price falls.

Capacity

The availability of insurance products in the market, influenced by the financial strength of insurers.

Soft Market Cycle

Occurs when there is excess financial capacity in the insurance marketplace leading to low premiums and relaxed underwriting.

Hard Market Cycle

Follows a soft market, characterized by decreased capacity, increased premiums, and stricter underwriting standards.

Underwriting

The process insurers use to assess risk before offering coverage.

Residual Market Mechanisms

Plans created by the insurance industry to provide access to mandatory insurance for high-risk individuals.

Mergers and Acquisitions (M&A)

Business strategies where companies combine or purchase others to expand market share and capabilities.

Reinsurance

Insurance purchased by insurers to manage risk by sharing it with other insurance companies.

Investment Income

Profits generated from the investments made by insurance companies, crucial for financial performance.

Market Dislocation

A situation where insurance becomes unavailable or unaffordable due to drastic market changes.

Social Inflation

The increasing costs of claims that exceed general economic inflation, often driven by legal trends.

Class Action Lawsuits

Legal actions taken by a group of individuals against a company, potentially affecting insurer profitability.

Natural Catastrophe

A severe event like hurricanes or earthquakes that causes significant insurance claims.

Toxic Mould Risk

Emerging liability areas related to health implications of mould, impacting insurance costs.

Cyber Risk

Threats to digital assets and data which insurers must now consider.

Climate Change Risk

Long-term risks associated with changes in climate, influencing insurance underwriting.

Government Regulation

Laws governing how insurance should be sold and operated, often affecting prices and availability.

Mandatory Insurance

Insurance products that must be purchased by law, such as automobile liability insurance.

Privatization in Insurance

The trend towards allowing private companies to provide insurance services rather than through government.

Market Growth Trends

Patterns in the increase or decrease of insurance market activity influenced by economic factors.

Equity Market

The market where shares of publicly held companies are issued and traded.

Economy Health Impact

Refers to how economic conditions influence consumer behavior and claims in insurance.

Claims Costs

The expenses associated with processing and paying insurance claims.

Interest Rates

The cost of borrowing money that can affect investment returns for insurance companies.

Insurer Insolvency

When an insurance company cannot meet its financial obligations, leading to its closure.

Claims Reserves

Funds set aside by insurers to pay for future claims.

Premium Growth

The increase in income generated from the sale of insurance policies over time.

Policy Terms and Conditions

The specific clauses that guide the coverage and limitations of an insurance policy.

Direct Writers

Insurers that sell insurance policies directly to consumers without intermediary brokers.

Managing General Agents (MGAs)

Organizations acting on behalf of insurers to underwrite business and manage risks.

Alternative Risk Financing

Unconventional insurance options like captives or parametric insurance to manage risk.

Volume of Business

The amount of insurance policies an insurer writes within a specific period.

Strict Underwriting Practices

Rigorous guidelines to evaluate and accept insurance risks.

Bear Market

A market characterized by declining prices, often causing financial stress in investments.

Bull Market

A market where prices are rising, generally associated with economic growth.

Stakeholder Relationship Management

Strategies insurers use to maintain relationships with brokers, clients, and regulators.

Insurance Market Fragmentation

The distribution of many different insurers in a market leading to competitive pressures.

Catastrophe Reinsurance

Reinsurance specifically designed to protect insurers against large claims from natural disasters.

Profit Margin

The difference between an insurer's income and its expenses.

Insurable Interest

A requirement that policyholders must have a vested interest in the insured item or individual.

Broker Commission

The fee paid to insurance brokers for their services in facilitating insurance transactions.

Public Utilities Commissions

Government entities that regulate the prices and services in certain economic sectors, including insurance.

Market Demand

The total amount of insurance coverage that consumers are willing to buy at given prices.

Regulatory Sanctions

Actions taken by government agencies to enforce compliance with insurance laws.

Expense Management

Strategies insurers use to control costs and maintain profitability.

Financial Stability

The ability of an organization to sustain adequate financial performance amidst fluctuating markets.

Underwriting Profit

The profit remaining after claims and expenses are deducted from premiums.

Insurance Capacity Shortage

A situation where market resources are insufficient to meet consumer insurance demands.

Risk Exposure

The potential for loss or damage that an insurer covers.

Profitability Trends

Patterns regarding the financial success of insurers based on revenue and expenses.

Legislative Reform

Changes in laws intended to modify how insurance is regulated and sold.

Commercial Risks

Risk exposure related to the operations of businesses, which insurers must underwrite.

Insurance Claims Management

The process of handling the assessment and payment of claims made against insurance policies.

Consumer Awareness

The knowledge and understanding consumers have regarding different insurance products.

Liability Insurance

Coverage that protects individuals and businesses from claims resulting from injuries and damage.

Insurance Limits

The maximum amount an insurer will pay for a covered loss.

Market Saturation

When most or all potential consumers already have insurance, limiting new business opportunities.

Risk Management Practices

Strategies implemented to identify, assess, and mitigate risks in insurance.

Insurance Cycle Analysis

Evaluating the recurring pattern of market conditions and their impacts on pricing and profit.

Fundamental Insurance Principles

The foundational concepts guiding insurance practices, like risk pooling and indemnity.

Insurer Portfolio

A collection of different insurance policies held by an insurer at a given time.

Insurance Technology Innovations

New technologies that improve the efficiency and effectiveness of insurance processes.

Fraud Detection in Insurance

Methods used by insurers to identify and prevent fraudulent claims.

Influences of Economic Trends

Factors in the economy that have direct effects on insurance sales and profitability.

What statement describes capacity?

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

What analyzes the way pricing is determined?

Theory of supply and demand

What term refers to the increase in claims costs from generous jury awards

Social inflation

Bond Market

The type of market generally performs well during economic downturns

Run-off

When an insurer has chosen to stop writing new business and service existing policies only until renewal in a certain market.

Relax risk control requirements

In this cycle, a home and auto insurer is losing market share to its competitors.

What happens when policyholders are forced to find a new insurer when their current insurer withdraws from the market?

Market dislocation

What is typically the result of excess financial capacity in the insurance marketplace?

Soft market conditions

What triggers a hard market?

Limited market competition

What makes up the largest share of the P&C insurance industry?

Automobile insurance

The Canadian P&C marketplace is influenced by individual companies and group of companies. Which of the following do these entities control?

Capacity

What analyzes the way pricing is regulated?

The theory of supply and demand

What happens when consumers are forced to find a new insurer when their current insurer withdraws from the market?

Market dislocation

Which one of the following triggers may cause a hard market?

Limited market competition - Hard markets can arise when there is limited market competition, increased regulation on premium rates, and increased demand for a product than can be met by the insurers who actually sell it.

When a company ceases to write new business and services only existing policies, this is known as what?

Run-off - This occurs when an insurer stops writing new policies and only services existing ones, often due to financial difficulties or regulatory reasons.

Breifly explain how market cycles affect risk managers (5 marks)

Soft Market (easier to offer coverages) insurers can deliver risk protection more easily to insureds because they are less demanding loss control requirements

Hard market (consideration of alternate risk financing measures) Insurers must be more creative and explore alternative risk financing propositions when offering options to deal with risks due to stringent guidelines, which means making decisions is more difficult.

Briefly explain how market cycles affect consumers (5 marks)

Soft Market (neutral): In a soft market, consumers are neutral, they find insurance affordable and more readily available.

Hard market (frustrated): In a hard market, consumers become frustrated when premiums become unaffordable, and when coverage become unattainable, consumers are placed in a awkward position when coverage that is mandated by law is unaffordable and unavailable.

Briefly explain how market cycles affect government (5 marks)

Soft market (compliance of insurers): In a soft market the government is more neutral and may review insurers relaxed underwriter rules and guidelines to ensure that they are still in compliance.

Soft market (few consumer complaints) In a soft market, the government will receive fewer complaints from consumers.

Hard market (survival of insurers) In a hard market, the government implements government-backed protection plans (backstops) by capping losses to ensure that insurers can survive a catastrophic loss.

Hard market (recovery assistance): In a hard market, the government may participate in recovery initiatives if severe catastrophic events occur.

Hard market (ensure availability of insurance): in a hard market, the government imposes measures to make insurance more affordable and available for consumers.

What is a Soft Market Cycle?

• Occurs when there is excess financial capacity in the insurance marketplace

• Triggered by strong insurer profitability and capital bases

• Characterized by intense competition among insurers aiming to grow market share

• Common underwriting behaviors include:

  • Reducing premium rates

  • Relaxing policy terms and conditions

  • Easing loss prevention and control measures

• Additional strategies may involve:

  • Launching new products to meet emerging demand

  • Writing riskier or previously avoided business classes

  • Expanding into new geographic territories

• Prolonged soft market conditions often lead to deteriorating underwriting results

• If investment returns also decline, capital depletion occurs, leading to a shift toward a hard market

What is a Hard Market Cycle?

• Follows a soft market when low premiums result in poor underwriting results

• Insurers are slow to raise prices at first, fearing the loss of good business

• Triggered when return on equity drops and investors demand corrective action

• Common insurer strategies in hard markets include:

  • Cautiously evaluating each risk before insuring

  • Imposing stricter underwriting standards

  • Emphasizing loss control and prevention measures

  • Tightening policy terms to reduce exposure

  • Raising premium rates significantly

  • Terminating low-performing broker relationships

  • Withdrawing from unprofitable jurisdictions, business classes, or risks

  • Entering run-off (stopping new business and servicing only existing policies)

• May result in market dislocation, where coverage is unavailable or unaffordable for some insureds

• Investors expect at least low double-digit returns; high single-digit returns may suffice in tougher markets

• Typical insurance cycles last ~7 years (4 years of falling rates + 3 years of hardening market); recent cycles may last 3–5 years

• Market cycles are a natural result of free-market dynamics and overcorrections in insurer behavior

• Financial pressure is often intense before a correction, forcing some insurers

What are the causes of Hard Markets?

Hard market cycles can result from several contributing factors, including:

• Limited market competition: Few market players may lead to higher premiums

• Regulated premium rates: Government-imposed limits can prevent insurers from charging adequate premiums to cover claims and expenses

• Restrictive underwriting: In response to rate regulation, insurers may limit the type or amount of coverage offered

• High demand for new products: When demand outpaces the number of insurers offering coverage, a hard market can emerge in that specific product line

• Inability to exit markets: Insurers may stay in unprofitable markets but reduce expenses and tighten underwriting to manage losses

What are the differences in Market Cycles?

• Insurers:

  • Soft Market: Profitability declines; competition intensifies as they seek new business

  • Hard Market: Profitability returns; face criticism due to rising prices and stricter underwriting

• Brokers:

  • Soft Market: Easier to place coverage; lower rates reduce commission income

  • Hard Market: Must work harder to find coverage; higher premiums increase commissions

• Risk Managers:

  • Soft Market: Benefit from low premiums and lenient underwriting

  • Hard Market: Must explore creative risk financing (e.g., captives, reciprocal exchanges, parametric insurance)

• Consumers:

  • Soft Market: Neutral response due to stable prices and availability

  • Hard Market: Face high premiums, limited coverage, and frustration; may involve political intervention when mandatory insurance is unaffordable

• Governments:

  • Soft Market: Generally minimal involvement

  • Hard Market: May impose affordability measures or create backstops for high-risk coverage (e.g., terrorism, earthquakes)

• Example – 9/11:

  • Massive losses from terrorist attacks led to market withdrawal and exclusions

  • The U.S. government partnered with the industry to create a backstop, helping restore insurance availability and economic stability

What happens in soft market cycles?

Insurers:

• Soft Market: Profitability declines; competition intensifies as they seek new business

Brokers:

• Soft Market: Easier to place coverage; lower rates reduce commission income

Risk Managers:

• Soft Market: Benefit from low premiums and lenient underwriting

Consumers:

• Soft Market: Neutral response due to stable prices and availability

Governments:

• Soft Market: Generally minimal involvement

Example – 9/11:

• Massive losses from terrorist attacks led to market withdrawal and exclusions

• The U.S. government partnered with the industry to create a backstop, helping restore insurance availability and economic stability

What happens in hard market cycles?

Insurers:

• Hard Market: Profitability returns; face criticism due to rising prices and stricter underwriting

Brokers:

• Hard Market: Must work harder to find coverage; higher premiums increase commissions

Risk Managers:

• Hard Market: Must explore creative risk financing (e.g., captives, reciprocal exchanges, parametric insurance)

Consumers:

• Hard Market: Face high premiums, limited coverage, and frustration; may involve political intervention when mandatory insurance is unaffordable

Governments:

• Hard Market: Face high premiums, limited coverage, and frustration; may involve political intervention when mandatory insurance is unaffordable

Example – 9/11:

• Massive losses from terrorist attacks led to market withdrawal and exclusions

• The U.S. government partnered with the industry to create a backstop, helping restore insurance availability and economic stability

What are the Soft Market Cycles - Party Impacts

Insurers:

• Soft Market:

  • Lose profitability

  • Loosen underwriting guidelines

  • Write unusual classes of business

  • Reduce premiums

  • Compete aggressively for new and existing business

Brokers:

• Soft Market:

  • Enjoy abundant capacity and easier placement

  • Experience rate declines and less stringent underwriting

  • Earn lower commissions due to reduced premiums

Risk Managers:

• Soft Market:

  • Benefit from low prices and easier underwriting

  • Meet risk protection goals with less resistance

Consumers:

• Soft Market:

  • Neutral attitude

  • Insurance is affordable and available

Governments:

• Soft Market:

  • Neutral stance, fewer consumer complaints

  • May monitor underwriting practices for compliance

What are the Hard Market Cycles - Party Impacts

Insurers:

Hard Market:

• Regain profitability

• Enforce strict underwriting guidelines

• Increase premiums

• Terminate unprofitable or low-volume broker relationships

• Withdraw from unprofitable markets, risks, or jurisdictions

• Exit the market via run-off

Brokers:

Hard Market:

• Struggle to find capacity

• Spend more time sourcing new insurers

• Negotiate pricing and coverage more intensely

• Earn higher commissions due to rising premiums

Risk Managers:

Hard Market:

• Face stricter underwriting and decision challenges

• Must innovate with alternative risk financing (e.g., captives, parametric solutions)

Consumers

• Hard Market:

  • Experience frustration and difficulty affording or obtaining required coverage

• May trigger political intervention when mandatory insurance is inaccessible

Governments:

• Hard Market:

  • Introduce affordability measures

  • Create or expand backstops for high-risk coverage (e.g., catastrophic loss)

  • Participate in recovery efforts during crises (e.g., post-9/11)

Explain delivering Private Automobile Insurance

• Significance:

  • Automobile insurance represents nearly 40% of total P&C premiums in Canada

  • Any regulatory changes impact insurer operations, expenses, and profitability significantly

• Challenges in Accessibility:

  • High rates or strict underwriting can make mandatory auto insurance less accessible

  • Leads to public pressure on governments, often resulting in regulatory intervention

• Government Actions:

  • May create automobile rating boards or public utilities commissions to control pricing

  • While pleasing to consumers, insurers view price regulation as a burden on free market operations

• Consequences for Insurers:

  • Claims cost ratio may rise

  • Prices may no longer reflect true risk or costs

  • Risk of market withdrawal if rates are inadequate

  • Increases in operating costs due to:

    • Additional staffing

    • New software/system adjustments

  • Lower return on equity and reduced profitability

• Example – Alberta 2023 Rate Freeze:

  • Alberta government froze rate increases for all of 2023

  • Capped future increases for “Good Drivers” at 3.7%

  • Insurers had to rapidly adapt systems, incurring significant expenses

• Cost-Cutting Fallout:

  • Potential loss of quality staff and customer service decline

  • Weakening of internal operations, poor risk selection, and stalled succession planning

• Impact of Government Takeover:

  • Insurers must re-evaluate business plans

  • May delay or abandon growth and expansion strategies

  • May consider withdrawing from jurisdictions in anticipation of reforms

  • Leads to reduced capacity in affected provinces

Define Capacity

The measure of an insurerís ability to issue contracts of insurance. Measured usually by the largest amount it will accept on a given risk or, in certain situations, by the maximum volume of business that the company is prepared to accept.

What is an Managing General Agent (MGA)?

An independent business operation given authority by a number of insurance companies to solicit business on behalf of such companies. Responsibilities include recruiting, training, and supervising agents.

What is a run off?

An article in a reinsurance contract stating that the reinsurer remains liable under the ceding company’s policies in force at termination for losses occurring after the date of termination of the reinsurance contract.

What is a captive insurance company?

An insurance company that provides insurance to, and is controlled by, its owners.

What is a reciprocal insurance exchange?

A means of insurance whereby each subscriber appoints a central underwriter as attorney-in-fact to share insurance costs with other insureds in the same group.