Competition and the Insurance Sector

John Fingleton, Chairman of the Competition Authority Insurance Institute of Ireland Annual National Conference 17 September 2004

Introduction
I am very happy to have the opportunity to address the annual conference of the Insurance Institute of Ireland today. As you all know, the insurance sector has undergone an unprecedented examination of its performance, resulting in wideranging reforms involving new laws, regulations and institutions. The Competition Authority has participated in this examination, and will issue its final recommendations regarding competition in the sector before the end of the year. While I am not in a position today to outline our final views, I would like to discuss the competition issues that have arisen and the relevance of competition to the wider insurance reform agenda.

The Insurance Price Hike

Serious problems began to emerge in the insurance sector in Ireland between 2000 and 2002 when premiums began to rise rapidly or when we began to notice the sharp upward annual trend. Let me give some examples: Motor insurance premiums rose on average by 53.8% in nominal terms (or 36.1% in real terms) between 1998 and 2002 (see Figure 1). Some groups, such as young drivers, experienced

much greater increases, as well as widely documented difficulties in obtaining insurance at any price;
Figure 1: % Increases in Motor Insurance and Consumer Price Index 1998-2002

60 CPI 50 40 30 20 10 0 1998
Source: CSO

MPI

REAL

1999

2000

2001

2002

TOTAL

The combined cost of employers and public liability insurance doubled as a percentage of payroll from 1.8% in 1999 to 3.6% in 2002, with the biggest hike (from 2.3% to 3.6%) between 2001 and 2002 (see Figure 2);
Figure 2: Average Employer and Public Liability Insurance Premium as a Percentage of Payroll, 1999-2002 4 3.5 3 2.5 2 1.5 1 0.5 0 EL PL Combined

Percentage

1999

2000 Year

2001

2002

Source: IBEC

This sharpness of increase in the cost of liability insurance, as demonstrated in the IBEC research, is supported by an Alliance for Insurance Reform (AIR) survey in 2003. The AIR survey of 173 companies employing 16,000 people found that almost 18% of companies had premium increases of over 100% in 2002, compared to 9% of firms the previous year. That survey also indicated that 38% of companies borrowed to pay their premiums, and 14% were forced to reduce their staff in order to make ends meet; and

Some sectors have provided evidence that their costs rose much more than the average. Examples include many of the construction trades, as well as hotels, leisure and community & voluntary groups. For example, the Irish Hotels Federation has indicated that, for its members, the mean increase in insurance premiums in the hotel and guesthouse sector over the period 2000 to 2003 was 351%.

Insurance makes up several percentage points of GDP, so that the effect of such a price hike on the economy and its competitiveness was tangible. Businesses were affected, including both indigenous companies and inward investors, in relation to their ability, for example, to price competitively, employ more people and innovate. Community and voluntary groups were affected by having difficulties in providing services and events that enhance community life, such as, for example, recreational activities for children.

What caused the hike?

We dont have a fully broken down explanation for this price hike. Evidence from Australia and the UK suggests that much of the hike was probably pass-through from international markets. International (or even inter-temporal) price comparisons are

virtually impossible to do, so we cannot know how much of the Irish hike was international. And, other than resorting to an unhappy coincidence of Irish market conditions such as rising wage rates and the legal environment1, I have not seen any compelling explanation of any gap between the Irish hike and the international hike. I dont think changes in the level of competition can explain the price hike either. In a highly competitive sector, increases in the costs of essential inputs would naturally be expected to lead to price rises. A domestic sector that is not competitive will absorb more of any increase in an input price than will a competitive sector. The corollary, of course, is that when input prices fall, competition in the sector should ensure that the benefits flow through to buyers. I have not heard or seen any arguments that the insurance industry went from being highly competitive to being less competitive over the period of the price hike. Instead the question is whether competition has been strong in the sector all along.

The Structural Problem

The fact that we cannot fully explain the hike is not the issue. It is an ill-wind that blows no good, and the real importance of the price hike is that it drew attention to serious underlying structural problems in the market, and helped build much-needed public support for politically difficult reforms. The timing of the Motor Insurance Advisory Board (MIAB) report was fortuitous because it provided a detailed statistical analysis that, albeit only for motor insurance, was relevant for the sector as a whole. The structural issue, put simply, is that insurance rates in Ireland, even without the price hike after 2000, were too high. I have tried in the table that follows (Figure 3) to summarise some effects of the
1

See, for example, the Datamontitor survey (quoted in Competition Authority preliminary insurance study), which found that, among EU insurers, Ireland was considered to be the least attractive market because of the legal environment.

reform programme by identifying, in the left-hand column, the elements of the structural problem and, in the right-hand column, the reform measures ready in place.
Figure 3: Reform Programme Some Issues and Measures Issue The litigation costs associated with finalising claims, which the MIAB estimated to be 42% on top of compensation and substantially higher than in other countries. Reform Measure Changes to the systems of dealing with and settling claims including the Personal Injuries Assessment Board (PIAB) and the Civil Liability and Courts Act 2004. Offences in the Civil Liability and Courts Act 2004. Making penalty points available to insurance companies.

B C

Fraudulent and exaggerated claims Inefficient pricing of risks, either because relevant information (e.g., penalty points) is not available to insurers, or lack of availability of reliable national statistics, or because insurers fail to use information that is available optimally Levels of compensation being, in many cases, higher than in other countries or than society as a whole desires, particularly for minor injuries, which account for the majority of claims (the MIAB analysis of raw data demonstrated that only 0.1% of claims were valued at 127,000 or more, whereas 80% were under 6,300); Accident frequency combined with the pursuit of claims for compensation.

The Book of Quantum published by the PIAB.

The penalty points, the proposed increase in the use of speed cameras, and the provisions contained in the Safety, Health and Welfare at Work Bill 2004. Regulations requiring insurers to give policyholders 15 working days notice for renewal of private motor insurance policies and also requiring No Claims Bonus information to be provided with renewal notices

Weak competition arising from barriers to entry or obstacles faced by consumers to shopping around

The Relevance of Competition

Competition fits into the reform programme in two ways. Firstly, and directly, important questions have been raised about

competition in the sector: see point F above. In 2002, insurance was the sector in which the Authority received the most complaints. Secondly, and indirectly, competition is relevant because the full benefits of the domestic reforms and better international conditions will only be fully passed on to consumers and businesses in Ireland if the sector is competitive: see points A-E above. The Competition Authority embarked on its Study with several concerns arising not only from the MIAB and the price hike but also from representations made by consumer and business groups and complaints from the general public. At that time, our main concerns were around the following issues: Whether the highly regulated nature of the sector, or market behaviour, creates barriers for new companies to enter the Irish market; Complaints/observations that the sector was very concentrated, with a small number of players, and especially so in some niche markets where buyers complained about lack of choice; Complaints and concerns about barriers to buyers switching suppliers; and Market institutions that bring suppliers together in a way that raised concerns about collusion. In preparing our Consultation Paper, which was published in February 2004, an analysis of the statutory returns 2000-2002 showed that commission paid had increased by as much as, if not more than, the underlying insurance rates, and we were at a loss to understand this. This focused attention on the performance of the broker market. In addition to the responses we received to the Consultation Paper, we have, in recent months, met with a large number of sector

participants and other interested parties with a view to deepening our understanding of how competition works in the market. Let me turn now to discuss some of the detailed issues we have been working on.

Data Sharing
Our focus on data sharing and publication may seem surprising at first glance. Normally competition authorities do not like data sharing among competitors lest it dampen or eliminate competition to the detriment of buyers. Insurance is a special case where data sharing can promote competition. An unusual feature of insurance is that sellers only discover their costs after they set prices. For motor, it is usually in three years but, with some liability insurance, it can be many years later. The more information that a seller has about claims in the market, the more precisely it can calculate its costs and hence the more keenly it can price. The wider publication of such data can also reduce the costs of new entry, an additional stimulus to competition. This is especially important for thin markets, where even a specialist may not have many observations in a year. For this reason, data sharing may be more important in a small economy like Ireland. Indeed, many industry participants have cited the scale of the Irish market as a disincentive to entry. When there is inadequate information about a specific risk, different types of risk may be lumped together into a common grouping. This will seem unfair to what might be termed lower-risk clients, because they are grouped with other somewhat similar but in fact higher risks. This leads to lower-risk clients paying higher premiums than their real risk profile would have required. Better

information about risk, at a useful level of detail, helps in tackling this problem. The fact that data sharing can have a positive effect on competition in insurance is recognised in EC law, where there is a block exemption regulation2 providing for certain specified forms of cooperation, subject to strict conditions. In particular, the collective creation of reliable statistical data on the intensity and frequency of claims in respect of a risk in the past is allowed. No individual insurance undertakings, nor any insured parties, would be identified. Nor should any insurer be obliged to make use of the data. The results should be made available on reasonable and nondiscriminatory terms, e.g., publication. The work done by the MIAB, which analysed raw data from insurers, was a good example of how the creation of reliable statistical data at a market-wide level can comply with competition law. The MIAB recommended3 that the central gathering of statistics on motor insurance premium and claims costs by driver profile be formalised by IFSRA, including monitoring data quality, to ensure that reliable information is available to inform public policy in future years and to improve market intelligence. how to further develop it. The development of market-wide statistics for liability might be less useful, but an improvement could surely be made on the current situation by separating out public and employers liability, either in aggregate or by economic sector. Partly because of the crisis in the insurance sector, we have seen some buyer-led initiatives to improve data quality. Some representative organisations, whose members faced large increases
2 3

IFSRA is carrying on the work done

by MIAB in this regard and is in consultation with the industry on

Commission Regulation 358/2003 MIAB Report 2002, Recommendation No. 5

in premiums in the last two to three years, have worked with brokers to collect relevant data about their specific areas of activity. In some cases, this has led to new underwriters being interested in the risk, and offering quotes significantly lower than had been available up to that point, thereby giving members of those organisations choices that they did not previously have. This type of evidence strengthens the argument for greater data sharing. From an insurers perspective, there may be a number of concerns about central collection of statistics: First, there is the issue of cost to insurers of presenting data and the additional costs of collating them. Such costs, regardless of where initially levied, will be borne by buyers. The important question is to ensure that the public benefit of greater competition outweighs any such cost; Second, there may be a fear that the public availability of detailed statistics would reduce the incentive for insurers to collect such data or to develop innovative approaches to data collection because this intellectual property would then be shared. Let me clarify that the type of data in question is basic aggregate claims data. Providing a common platform would do nothing to inhibit enhanced data work; indeed the increased competition might stimulate it as a source of competitive advantage. Third, better data might lead to a clearer identification of problem segments, with cases in such segments being charged higher premiums or even having difficulty in securing quotes. This would obviously present an immediate problem for the buyers in question. The solution should lie, not in such crosssubsidisation, but rather towards better risk management and greater safety, or possibly other Government intervention if market failure arose. And, to the extent that such risks are

being subsidised by other policyholders, it would reduce that element of cross-subsidisation. Some believe that historical data are of little use to insurers in a changing environment and that international developments, such as the decline of equity returns and the rise of reinsurance premiums and the changes being brought about in the insurance reform programme, mean that it would be dangerous for an insurer to rely on past trends. While it is advisable to treat past trends with caution, it would be up to existing and new insurers to determine the reliability of historical data. In addition, a central ingredient of any enhancement of data sharing should be the speed with which data are produced: virtually all participants in the industry agree that the Insurance Annual Report (Blue Book) is published too late. More generally, it is rather surprising how little public data are collected on the insurance market. Although it accounts for 8% or so of GDP, the official statistics collected are only a tiny percentage of those collected in other sectors, such as manufacturing and agriculture. This is not unique to insurance: it applies to many service sectors of the economy that have grown in importance in recent decades and where data collection is more costly. Nevertheless, there is a strong public policy argument for better data for the sector.

Solvency
The EU lays down minimum solvency requirements, with regulators in each Member State free to set limits above that level. Solvency constraints bite when the market is in a hard phase because capital is relatively scarce. Several parties have suggested that solvency levels should be relaxed in order to attract new entrants. However, no specific cases

were put forward to illustrate how viable potential entrants had been dissuaded from entry by solvency requirements. Furthermore, companies are also free to operate in Ireland subject to the solvency requirements of another Member State.4 A separate concern was raised over higher solvency requirements for new entrants. The justification offered is that this is a riskbased approach, reflecting the higher risk associated. There are moves at EU level to make solvency requirements more risk-based, and this is to be welcomed, even if it raises the EU minimum levels in the case of liability insurance due to the length of time it can take to settle claims (i.e., the long tail.) Some suggestions have been made for a policyholder protection fund, which would pay out, say, 90% of a claim in the event of an insurer becoming insolvent. This would provide some comfort to policyholders that might be worried about the solvency of their insurer. However, on the other hand, issues arise regarding the collection of levies for a fund and whether it would create any negative (i.e. costly) incentives for insurers. A separate question is what Irelands position should be vis--vis any EU-wide policy in this regard.

Motor Insurance Bureau of Ireland (MIBI)

Our Consultation Paper asked whether the MIBI might represent a barrier to entry to the Irish market to motor insurers. Claims caused by uninsured drivers, where the vehicle being used is also uninsured, or untraced, are handled by the leading six insurers (by market share) on behalf of the MIBI, with the costs being shared among insurers in accordance with their market share.

At the Joint Oireachtas Committee on 7 April 2004 IFSRA pointed out that 400 companies are entitled to sell business into Ireland under EU rules.

There was a perception that these cases were not being afforded a high enough priority to settle them quickly and minimise costs. It appears that the high level of uninsured driving, and the high costs associated with settling uninsured and untraced claims, were among the factors that discouraged potential entrants to the motor insurance market. MIBI paid out 30 million in 1993 in respect of uninsured claims. By 2001, the amount paid out had more than trebled to over 90 million. However, from over 90 million in 2001, the cost fell to just under 50 million in 2002, which was a significant drop. In 2003, the figure was up to 70 million, but still considerably less than the peak in 2001. Figure 5:Cost of Uninsured Claims (MIBI only) 100 80 million 60 40 20 0
19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03

Costs of Claims

Year In relation to the handling of such claims, the MIBI has recently introduced new service level agreements with handling offices, which require uninsured driving cases to be dealt with in the same way as the companies' own cases. The MIBI now audits the handling offices to ensure that the required procedures are being followed. Overall, it seems fair to say that the situation regarding uninsured and untraced driving has improved in the recent past in that the

amounts now being paid out are significantly lower than their peak in 2001, and the systems for handling claims appear to be better than they were. Whether we will want to make any recommendations to MIBI is still under consideration. However, I would like to say at this stage that we are satisfied, based on the evidence we have seen, that MIBI is not a forum for collusive practices. Although competitors meet there, they do so in the context of strict MIBI-related agendas, minuted meetings, and attendance by MIBI staff at all meetings.

Declined Cases Agreement

Under the Declined Cases Agreement, the insurance market will provide insurance to an individual seeking insurance if he or she has approached at least three insurers and has not been able to obtain cover from them5. In general, the insurer first approached will be required to provide the individual with a quote. A difficulty with this scheme that potential entrants to the motor insurance market have raised is that an insurer with expertise and information in particular niches might have to quote in respect of other niches where it has no experience. This would seem to create difficulties in some cases in assessing and pricing a risk. However, timely, reliable market-level data on the motor insurance market, would, I think, help insurers to assess and price specific risks.

Brokers/Intermediaries
Our Consultation Paper resulted in enormous attention on the broker/intermediary market. The attention may have been disproportionate relative to that afforded the competition issues in
5

The only circumstances in which the Declined Cases Agreement will not operate are where to provide insurance would be contrary to the public interest.

the underwriting market itself, but it is probably explained by the fact that the Competition Authority was the first to draw out the full importance of this market, and to highlight some apparent questions about its operation. Brokers provide valuable services to buyers and sellers of insurance, not just in matching insurers to buyers, but also in many cases, especially in the liability market, in providing expert technical advice and services. Figure 4 below illustrates the range of services provided to both buyers and seller of insurance.
Figure 4: Some Broker Services to Buyers and Insurers
For Buyer Nature of Service Searching for most suitable product Advice on insurance procedures, risk management and deductibles Insurer Distribution of product Administrative tasks Example Approaching insurers Identification of hazards Explaining options Finding customers Completion of forms & EDI Collection of premiums Both buyer and insurer Development of schemes Liaison between insurer and buyer Accurate risk presentation Policy alterations Helping identify groups of buyers and attracting insurer

This typology of services does not attempt to capture every activity by brokers. Rather, it aims to recognise that brokers can help, not only buyers directly, but also insurers and, indeed, in some cases, both buyers and insurers simultaneously. The Consultation Paper raised the question of whether the way brokers are paid by insurers (particularly the use of percentage fees) could create a conflict of interest for brokers between their obligation to act in the best interest of their clients on the one hand,

and to behave in a commercially sensible way and distribute insurers products on the other. This system may also limit the incentives for any individual insurer to cut broker commissions, for fear it might lose business. Concern was also expressed about the lack of transparency to buyers. On top of this was the somewhat surprising evidence that brokerage fees had increased as much, if not more, than underlying insurance premiums over the period. Some buyer groups have suggested that brokers should only be paid by the buyers. This, they argue, would ensure that the broker was acting only in the buyers interest. While some business in the market is transacted in this way, it is far from the norm. There has been some increased pressure for brokers to provide fee-based services, especially for large clients, and some buyer groups or trade associations have been actively encouraging members to seek such arrangements. It is too early to say whether these market-led initiatives by buyers, and perhaps by some brokers, will result in a substantial proportion of brokerage business being carried out on the basis of buyer-paid fees. An alternative is for the buyer to go direct to the insurer. That model has grown considerably in recent years in the case of motor insurance. For liability insurance, it is less common. Many buyers would no doubt prefer to continue to use a commission-based system for remunerating brokers. For this business, there remains a concern about transparency of the brokerage fee. This is not to suggest in any way that the broker is not entitled to a competitively set fee, but rather that sellers are entitled to see what a broker is charging (ultimately it is the buyer who pays). Such information helps buyers to shop around for the combination of price and service that they want. Whether buyers themselves should simply ask for the information if they want it, or

whether this might be covered by a code of conduct, or regulation, is a matter for further consideration. A related question is whether the current system of regulating brokers is excessive, that it may inhibit market transparency and raise brokerage costs.

Conclusion
Over the last number of years the insurance industry has been under the microscope to an unprecedented degree. The price of premiums and the availability of cover became the focal points for much public debate and scrutiny. Many sectors of the Irish economy do not perform well for consumer, for business buyer, or for the economy as a whole. When we scratch the surface of these poorly performing markets, we find not just that competition is weak or absent, but that there are numerous other structural or regulatory problems that push up costs or inhibit the development of the market. All of these issues, competition included, have in common that a diverse array of vested interests is totally opposed to any change in the status quo. Sometimes, the fear of change and the use of short-sighted, narrow analysis is sufficient to make vested interests oppose reforms that would not harm them, or that might even benefit them. The insurance sector is a rare positive example of the promotion of the broader interests of consumers and the national economy ahead of the narrow self-interest of powerful lobby groups. A combination of cross-departmental Government action (e.g. penalty points, tackling legal costs, punishing fraud), organised buyer pressure (e.g. Alliance for Insurance Reform and many other groups), and industry promotion (whistle blowers ad campaign) has all contributed to some premiums falling back to levels not seen since 2000.

The reform process should lead to substantially lower insurance costs. Even though the full impact of the reforms is still to come, we have seen substantial improvements in industry profit. Competition is hugely important both to ensure that the benefits of the whole range of reforms are fully passed on to buyers, and to stimulate suppliers to find ever more innovative and efficient ways of reducing costs to give further price reductions. While there have been positive developments, such as recent CSO figures that show that motor insurance has reduced by 12.5% in the 12 months to August 2004 and anecdotal reports of reductions in liability insurance, the jury is still out on whether competition is sufficiently intense to deliver rapid and full pass-through to buyers. From the outset of the Authoritys Study, I have made it clear that competition is only one of a range of issues facing the industry. However, it will be critically important as the other reforms begin to take effect. We still have some work to do in finalising our Study, particularly with regard to crafting particular remedies to competition problems in the sector. I hope that, in a decade from now when we look back, we will see this episode in the Irish insurance market as hugely important: an example of how the performance of a market can be improved, bringing benefits for participants and the economy as a whole, and providing a roadmap for the modernisation of many under performing sectors of the economy. Thank you for the co-operation that we have received throughout the process, and I hope that you can continue to co-operate with us as we finalise our work, and beyond.