A market is a place where goods or services are bought and sold, and where buyers and sellers are free to transact business with one another.
Some buyers of insurance are multi-national companies operating in many countries and their suppliers of insurance (the insurers) are frequently also multi-national, operating throughout the world. In this sense the insurance market is truly global.
The successful operation of a market depends on the ability of buyers and sellers to communicate and enter into contracts freely. However, this does not mean that they need to be in one particular place. Many insurances are concluded using the internet or telephone, where buyer and seller never meet. However, we can probably understand a market better if we think of it as a place.
The insurance market is made up of the following groups of people:
- buyers (insureds);
- intermediaries (including brokers); and
- Carriers or Insurers
Communication steps between parties
- Buyers talk to their advisers (intermediaries) about placing their business.
- Intermediaries present insurers with information to obtain quotations for new business.
- Intermediaries then advise buyers of the terms of acceptance that insurers have offered and hope to receive instructions to proceed.
- If instructions to proceed are given, insurers and intermediaries will finalise the contract and the risk will be ‘bound’.
- Insurers talk to reinsurers about ways of protecting themselves from very large losses or lots of losses from a single event.
Buyers
Those who buy insurance are known as proposers during the negotiation period leading up to the conclusion of the contract of insurance.
At the point when the insurance comes into force (referred to as the inception of the policy), the buyer is known as the insured or the policyholder.
Buyers of insurance may be divided into five main types:
| Private individuals | Personal insurances, such as motor and household insurance, form a large part of the market, both in terms of numbers of policies and total premium volume although private individuals require other classes of cover, such as travel and private medical insurance too. |
| Commercial customers | In commerce and industry, large amounts of money are spent on a wide variety of insurance products. Often, specially designed insurance packages will be tailored to meet a commercial customer’s insurance needs. |
| Public bodies | Many local councils and schools are major buyers of insurance. They may purchase conventional insurance, such as property or motor insurance, or specialised cover, such as professional indemnity insurance (which compensates people who suffer loss following poor professional advice). Police forces do not have to buy insurance cover for their motor vehicles because they are exempt from compulsory insurance requirements, but may choose to insure risks where there is catastrophe potential, as in the case of personal injury arising out of the use of those vehicles. |
| Clubs and associations | Sports clubs and other ‘affinity’ groups (i.e. those formed around a shared interest) buy insurance to protect assets and to transfer potential liabilities. |
| Sole traders and partnerships | These are found in many walks of life – they might be plumbers, builders or any one of a multitude of different trades or professions – and need insurance to protect their business and earning potential. Partnerships do not have separate legal existence, they are made up of one or more individuals, each of the partners being jointly and severally liable. Partnerships are commonly found in the medical and legal professions, and have specialist insurance needs. |
Intermediaries
The role of intermediaries in the marketplace is to bring buyers and sellers together.
Sellers
There are several different types of insurer operating in the insurance market and we can classify them in two different ways:
- By function and method of operating.
- By ownership.
Function and method of operating
Composite insurers
These insurers accept many different classes of business and may deal with fire, accident, motor and liability classes.
Specialist insurers
An insurer may be classed as a specialist insurer if it covers a number of classes of business for a specific market segment. An example could be Ecclesiastical Insurance which offers cover for customers in faith and heritage markets.
Direct insurers
In strict terms, direct insurers are not in a separate category from the previous two but are classified differently because of the way in which they transact business, rather than the classes of business involved. These insurers only deal direct with the public and most transactions are telephone- or web-based. Such insurers commonly operate in the motor and household insurance markets, where the nature of the products is especially suited to this method of distribution.
Captive insurers
These are insurers that are established as subsidiaries of (usually large manufacturing) companies in order to accept risks that are often seen as undesirable or even uninsurable by the conventional insurance market. They offer the ‘parent’ company a product and price mix that may be unobtainable from conventional insurance markets. Captives are often established in countries with a favourable tax regime that allows premiums payable to the captive by the parent to be tax deductible at source.
There are other incentives to set up a captive and these include:
- having full advantage of the parent’s group risk control programme being reflected in more favourable premiums;
- avoiding the overheads of the conventional insurer; and
- having direct access to reinsurance markets and so avoiding the conventional insurer’s frictional costs (i.e. costs associated with the transaction).
Managing agent
A managing agent is responsible for the day-to-day running of a syndicate.
Reinsurers
It helps to think of reinsurers as those that offer insurance to insurers. Insurers need to buy protection for very large losses (e.g. big industrial premises) or for significant events (e.g. a flood affecting many different risks they insure). They buy this protection from reinsurers.
Sometimes this is on an individual risk basis or it may be across a wide range of risks.
Need for reinsurance: Risk transfer, Balancing peaks & troughs, capacity planning
Major types of Reinsurance:
Facultative (or commonly called ‘Fac’): where the protection covers a single specified risk
Excess of Loss reinsurance: or layered reinsurance
Treaty
Quota Share: a fixed proportion of every insured risk is reinsured upto a maximum limit per occurrence
Surplus Treaty: The loss is shared by insurer and insured in a fixed proportion above a fixed line
Analysis tools used in Reinsurance
Exposure modelling: looks at the various risks that the insurer underwrites to see if there are any adverse conditions due to concentrations in particular areas
Loss modelling: Looks at financial impact of certain events occurring
Catastrophe modelling: loss models for catastrophe events
Some commonly used terminologies in Reinsurance
Bordereau: a report containing coverage or loss data that is provided by the insurer to the reinsurer.
Burning cost: Percentage ratio of total losses incurred to the total premium received for a layer of reinsurance.
Captive: A reinsurance company set up to insure risk belonging to the parent or group companies alone.
Cedant: insurer that transfers (cedes) risk to a reinsurance company
Pool Re: A partnership between UK government and insurers to cover terrorism risks
Retrocession: where the reinsurer covers their risk via taking reinsurance
Return period: number of occurrences of a catastrophic event in a period
Distribution channels
Distribution channels for insurance are not the same as sales channels for tangible products. Take oranges, for example, they are harvested in vast quantities by producers, sold to wholesalers who themselves sell to retailers, and so on until a consumer perhaps buys a single orange.
From an insurer’s point of view, the insurance is not sold to someone who sells it to someone else. The insurance, however it is arranged, ends up as a contract between the insurer and the insured, so when we talk of distribution channels, we mean the different ways in which insurers sell their products.
There are two ways in which products are marketed:
| Direct marketing channels | These may involve a sales force employed by the insurer and will certainly include the activities of the insurer’s full-time staff based in the office. Advertising will be focused upon the target audience whether by television, mail shots, the internet, social media or hoardings. These advertising methods are used extensively by the ‘direct’ insurers |
| Indirect marketing channels | Intermediaries are involved in some way. The insurer may employ agents by paying commission on policies sold. An example of this would be when a motor dealer sells a car to a customer and also a motor policy on behalf of the insurer. However, increasingly, insurers are reluctant to accept introductions from non-professional intermediaries.Professional advisers, such as insurance brokers, act for their clients in placing their insurances with insurers. Insurers’ promotional activities for these ‘channels’ will rely upon the competence and professionalism of the insurer’s sales force, its other promotional activities and seminars. Product specific literature will play a significant part as well. |
The advantages and disadvantages of each method for the insured are listed below.
| Advantages to the insured of direct insurance | Disadvantages to the insured of direct insurance |
| Savings are possible (because no commission is paid to an intermediary) and are passed on through competitive premiums. For personal lines classes of business that are especially price-sensitive – like motor and home insurance – any cost advantage is passed directly from the insurer to the insured.Immediate cover can be obtained via the telephone or the internet. | Some extra costs (such as advertising) are passed on in premiums.Some direct insurers will only accept what they see as standard risks, so cover may not be available.Only one insurer’s products are on offer.There is no professional expert on hand to advise which product is best. |
| Advantages to the insured of indirect Insurance | Disadvantages to the insured of indirect insurance |
| Independent advice can be obtained from many intermediaries.Other services may be available such as help in recovering uninsured losses after a claim.Prices and cover of different insurers can be compared. | Some intermediaries can only advise on one insurer’s products.Even independent advisers will not always be able to access information or rates from ‘direct’ insurers.There is the danger that an insured’s insurance needs will be ‘churned’ (replaced with a new policy effected with a different provider) each year, in order to generate more commission for the intermediary. |
Some other distribution methods include:
Aggregators
Aggregators work with a number of insurance providers to give customers several quotations following the completion of one set of questions. They mostly take the form of a price comparison website and are especially popular for personal lines, such as motor insurance.
Schemes and delegated authority
Insurers may wish to delegate some authority to intermediaries to act on their behalf when it comes to placing business. This is sometimes referred to as ‘passing the pen’ as the intermediary will be authorised to issue cover, provided that new business or changes to existing policies fall within defined criteria.
Some delegated authority schemes (sometimes referred to as ‘binders’) give the intermediary flexibility to place cover, usually for a specific category of client. There can also be schemes put together for particular affinity groups which consist of individuals linked together by a common interest.
Managing general agent (MGA)
A managing general agent (MGA) is a specialist type of intermediary who also has delegated authority to act for one or more insurers. MGAs act like an insurer and perform functions such as underwriting and handling claims. MGAs are utilised by insurers as they normally have specialist expertise in niche areas.
