icp 11: market analysis

ICP 11:Market Analysis

Basic-level Module

A Core Curriculum for Insurance Supervisors

Copyright © 2006 International Association of Insurance Supervisors (IAIS).All rights reserved.

The material in this module is copyrighted. It may be used for training by competent organi-zations with permission. Please contact the IAIS to seek permission.

This module was prepared by Jaroslav Kucera, a reinsurance manager based in Pardubice, Czech Republic, who has been engaged in insurance and reinsurance since 1993. He has held various positions in the Czech Insurance Association, which includes being chairman of the Working Group for European Union at the Czech Insurance Association since 2000. He has translated publications on insurance and reinsurance and led the team that created the English-Czech Dictionary of Insurance Terms.

The module was reviewed by Nigel Davies and Randip Jagpal Singh. Nigel Davies is a U.K. chartered ac-countant with more than 20 years in the insurance industry in professional, managerial, and regulatory roles. From 2002 to February 2006, he worked at the International Monetary Fund in Washington, D.C., as a technical assistance advisor in the field of insurance. This involved organizing and providing technical assistance and assessing the strength and stability of the insurance sector as part of the Financial Sector Assessment Program. The role also involved liaising with standard-setting bodies, providing input where appropriate. He has contributed to several major publications. Prior to this, he worked at the Financial Ser-vices Authority in the United Kingdom for seven years, supervising the London insurance market. He also represented the United Kingdom at International Association of Insurance Supervisors (IAIS) meetings and at the European Union Commission and Council of Ministers. Previous roles included being a direc-tor at Marsh and McLennan and an insurance specialist at Ernst and Young. Randip Jagpal Singh is deputy director at the Insurance Regulatory and Development Authority (IRDA) of India. He was part of the team that oversaw the smooth transition in the insurance sector from a state monopoly to competition and part of another team responsible for developing, communicating, and implementing regulatory policy for the supervision of insurers. Prior to joining the IRDA, he worked in one of the four nationalized general insur-ance companies and has more than 13 years of experience in underwriting and claims.

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Contents

About the Core Curriculum . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v

Note to learner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii

A. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

B. Role of market analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

C. Sources of information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

D. Changes in the market environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

E. Market analysis tools and methods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

F. Organizing market analysis at the supervisory authority . . . . . . . . . . . . . . . . . . . . . . 55

G. Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

H. References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

Appendix I. ICP 11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

Appendix II. Answer key . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67

Case StudiesCase Study 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

TablesTable 1. Premiums of insurers in the Czech market . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29Table 2. Market shares of insurers in the Czech market . . . . . . . . . . . . . . . . . . . . . . . . . 30Table 3. Insurance products available in the Czech market . . . . . . . . . . . . . . . . . . . . . . 49

FiguresFigure 1. Czech insurance market: Concentration ratio development . . . . . . . . . . . . . 31Figure 2. Czech insurance market: Herfindahl index development . . . . . . . . . . . . . . . 31Figure 3. Insurance density and penetration in the industrialized countries in 2003 51Figure 4. Insurance density and penetration in the emerging markets in 2003 . . . . . 52

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About theCore Curriculum

A financially sound insurance sector contributes to economic growth and well-being by supporting the management of risk, allocation of resources, and mobilization of long-term savings. The insurance core principles (ICPs), developed by the International As-sociation of Insurance Supervisors (IAIS), are key international standards relevant for sound financial systems.

Effective implementation of the ICPs requires skilled and knowledgeable insurance supervisors. Recognizing this need, the World Bank and the IAIS partnered in 2002 to develop a “core curriculum” for insurance supervisors. The Core Curriculum Project, funded and supported by various sources, accelerates the learning process of both new and experienced supervisors. The ICPs provide the structure for the core curriculum, which consists of a set of modules that summarize the most relevant aspects of each topic, focus on the practical application of supervisory concepts, and cross-reference existing literature.

The core curriculum is designed to help those studying it to:

• Recognize the risks that arise from insurance operations• Know the techniques and tools used by private and public sector professionals• Identify, measure, and manage these risks• Operate effectively within a supervisory organization• Understand the ICPs and other IAIS principles, standards, and guidance• Recommend techniques and tools to help a particular jurisdiction observe the

ICPs and other IAIS principles, standards, and guidance• Identify the constraints and identify and prioritize supervisory techniques and

tools to best manage the existing risks in light of these constraints.

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Note to learner

Welcome to ICP 11: Market analysis module. This is a basic-level module on market analysis that does not require specific prior knowledge of this topic. The module should be useful to either new insurance supervisors or experienced supervisors who have not dealt extensively with the topic or are simply seeking to refresh and update their knowledge.

Start by reviewing the objectives, which will give you an idea of what a person will learn as a result of studying the module. Then proceed to study the module either on an independent, self-study basis or in the context of a seminar or workshop. The amount of time required to study the module on a self-study basis will vary, but it is best addressed over a short period of time, broken into sessions on sections if desired.

To help you engage and involve yourself in the topic, we have concluded the mod-ule with a number of hands-on activities for you to complete. If you are working with others on this module, develop the answers through discussion and cooperative work methods. An answer key in appendix II sets out some of the points that you might con-sider when tackling the exercises and suggests where you might look for the answers.

As a result of studying the material in this module, you will be able to do the fol-lowing:

1. List the numerous benefits from market analysis that accrue to supervisors, in-surers, and market participants, including how market analysis can be prepared and used by the supervisory authority in the supervisory process.

2. Describe different measurement categories that are used to assess the nature and performance of a market.

Insurance Supervision Core Curriculum

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3. Illustrate the above categories with examples of specific measures that may be used.

4. Describe various sources of information, both domestic and international, that are used for market analysis.

5. Explain the strengths and weaknesses of these sources, noting how they can both inform and misinform.

6. Describe a process that might be used to identify possible future issues and sce-narios.

7. Explain the use of trend analysis, noting different techniques that can be em-ployed and describing their strengths and weaknesses.

8. Identify the attributes of competitive markets, and describe conditions that tend to induce market entry and exit.

9. Explain and discuss the presence of hard and soft markets.10. Describe the sources of market power, and explain how market power might

distort market outcomes.11. Given sufficient information, construct a concentration ratio and a Herfindahl

Index for a particular market.12. Analyze the availability of insurance in relevant classes and market segments.13. Analyze consumer complaints and investigate market conduct of insurance

companies.14. Describe the types of aggregate market data that might appropriately be pub-

lished by a supervisory authority.15. Illustrate situations in which a supervisory authority might require systematic

reporting to monitor and analyze events of importance to financial stability.16. Summarize the requirements of ICP 11 Market Analysis.

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ICP 11: Market Analysis

Basic-level Module

A. Introduction

“Market analysis” has been used to describe a wide range of practices and approaches. Market analysis may be performed by various entities and for significantly different purposes. This module opens by describing the general concept of market analysis. It then concentrates on the issues important for an insurance supervisor.

Market analysis is an important tool to enable insurance supervisors to perform their challenging task of evaluating and updating monitoring techniques as well as pri-oritizing their actions. The supervisory authority should not only check and control individual insurers and reinsurers1 but also actively “shape” the market toward com-petitiveness, stability, transparency, and the mutual respect of the market participants and their clients. Market analysis can play a significant role in achieving these objec-tives. Learning how to prepare market analysis and how to use it for these purposes are the main objectives of this module.

The importance of market analysis to the insurance industry and its supervision is confirmed by the fact that it was chosen as one of the topics of the Insurance Core Prin-ciples (ICPs).2 Market analysis is closely related and has many cross-links with other topics covered by the ICPs, as shown in greater detail in following sections.

This module is not a simple “directions for use” of market analysis. The framework formed by legislation, market development, the current situation, and many other fac-

1. Supervision of insurers and reinsurers may be performed by different supervisory authorities, depending on stipulations of the respective legislation. To achieve better comprehensibility of this module, only the words “insurer(s)” and “insurance company(ies)” have been used from hereon (except for cases in which these words might be confusing), However, these words should read “insurer(s) and/or reinsurer(s)” and “insurance and/or reinsurance company(ies)” as appropriate in a particular context.2. See IAIS Core Principles and Methodology, Core Principle 11 (IAIS 2003).


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tors existing in individual countries is much too different to enable solving this problem in such a simple manner. Thus, this module should be understood more as a guideline for market analysis preparation in a particular environment:

• What should be taken into consideration when preparing market analysis?• What are the objectives of market analysis?• What are the analyzed subjects?• What are the possible sources of information?• Which indicators can be prepared and analyzed?• What are the analyzing tools?• How can the analysis be organized efficiently?• How does market analysis interact with the supervisory authority’s other activi-

ties?

When necessary, examples and case studies are included for ease of understanding and use of the topics.

The module has been developed as a self-study material. This module has been or-ganized to enable reading from beginning to end as well as concentrating of individual parts of interest to the reader.

Commonly used terms

Before delving further into the topic of market analysis, it is important to define some commonly used terms. Most of the definitions are taken from the IAIS Glossary of Terms (see IAIS 2006), although some additions have been made. While the vocabulary used in this module is sufficiently described in this section (and, if needed, in the IAIS Glos-sary), in real life, the reader may need a more detailed explanation or an explanation of special, unusual terms. There are numerous books to supply this need, for example, The Dictionary of Insurance (see Bennett 1992).

Some of the terms used in insurance (and its market analysis) do not have a unique meaning, and their definitions contained in various sources may differ slightly, To avoid ambiguity, prevent possible misuse and misinterpretation, and determine market analysis results that are fully comparable and compatible, it is recommended that each supervisory authority maintain a list of the major terms used within its supervision process for market analysis together with their exact definitions, calculation formulas, and methods.

• Acquisition cost: that portion of an insurance premium that represents the cost of producing the insurance business. It includes the agent’s commission, the company’s field expenses, and related expenses.

ICP ��: Market Analysis

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• Annual accounts: financial statement of a company set up according to com-mercial law or generally accepted accounting principles, that is, not drawn up for specifically for supervisory purposes. In some countries the annual accounts/shareholders’ accounts might also be used for submission to the supervisory au-thority. (Equivalent term: Shareholders’ accounts)

• Annual statement: an insurer’s financial report to its insurance supervisory au-thority issued at the end of the year or prepared for its financial year for certain jurisdictions. The report is required by the supervisory authority and is made using a form agreed by the supervising authority.

• Available solvency: Surplus of assets over liabilities. The first sense of the term is the surplus evaluated in accordance with domestic regulation–either rules of public accounting or special supervisory rules. The second sense is of the surplus, taking into account domestic requirements as regards eligible capital elements. In other words, the second sense is surplus as the amount of capital appropriate to cover the required solvency margin in accordance with domes-tic law or supervisory regulations. (see the section of this module on solvency margin for a mathematical formula for calculating available solvency) (Equiva-lent terms: available solvency, available solvency margin, actual solvency margin, statutory solvency margin, available surplus capital, eligible capital, regulatory capital, free capital, total adjusted capital, policyholder surplus, statutory surplus) (Related definitions: eligible capital element, required solvency margin)

• Catastrophe loss: a loss of unusual size; a shock loss: a very large loss.

• Cession: the amount of a risk that the insurance company reinsures: the amount passed on to the reinsurer.

• Claim: notification to an insurance company that payment of an amount is due under the terms of a policy.

• Claims provision: amount set aside on the balance sheet to meet the total esti-mated ultimate cost to an insurer of settling all claims arising from events that have occurred up to the end of the reporting period, whether reported or not, less amounts already paid with respect to such claims. (Equivalent terms: claims provision, provision for outstanding claims/claims outstanding, claims reserve, to-tal claim liability)

• Combined ratio: the sum of the claims ratio (loss ratio) and the expense ratio. Gives a rough indication of the profitability of an insurer’s underwriting opera-tions. Other related definitions: loss ratio (claims ratio), expense ratio.


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• Coverage: the insurance afforded by the policy.

• Credit risk: the risk of financial loss resulting from default or movements in the credit rating assignment of issuers of securities (in the company’s investment portfolio), debtors (for example, mortgagors), or counterparties (for example, on reinsurance contracts, derivative contracts or deposits), and intermediaries, to whom the company has an exposure. Credit risk includes default risk, down-grade or mitigation risk, indirect credit or spread risk, concentration risk, and correlation risk. Sources of credit risk include investment counterparties, poli-cyholders (through outstanding premiums), reinsurers, and derivative counter-parties. (Related definition: reinsurance credit risk)

• Earned premium: premium for which protection has been provided. When a premium is paid in advance for a policy period, the company “earns’’ a portion of that premium only as time elapses during that period.

• Expense ratio: ratio of expenses to earned premiums. Expenses are the sum of commissions, administrative expenses, and other technical charges. (Related definition: earned premiums)

• Financial institution: a legal entity involved predominantly in financial activi-ties.

• Financial reports: accounting statements, financial returns, and statutory re-ports, including the balance sheet, the income statement and any other nu-merical reports prepared for disclosure to policyholders, investors, or insurance supervisors. Does not refer to reports prepared for other purposes.

• Foreign company: a legal entity whose head office is outside the jurisdiction concerned.

• Foreign insurer: an insurance company chartered in another state. (Related definitions: domestic company)

• Gross premium: premium for insurance that includes the provision for antic-ipated losses (the pure premium) and for the anticipated expenses (loading). (Equivalent term: office premium)

• Incurred but Not Reported (IBNR) provision: provision for claims incurred but not reported by the balance-sheet date. That is, it is anticipated that there would be a number of policies on which losses have occurred but where the insurer


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has not yet been advised, and, therefore, are likely to result in a liability on the insurer.

The magnitude of this provision can be expected to reduce as the time since the insurance risk on the contract expired extends. The magnitude is also likely to vary depending on the type of insurance risk covered by any particular class of insurance contract. (Related definitions: losses incurred but not reported)

• Incurred claims (losses): claims (losses) actually sustained during a fixed pe-riod, usually a year. Incurred claims customarily are computed by this formula: claims paid during the period, plus outstanding claims at the end of the period, less outstanding claims at the beginning of the period.

• Inspection: an examination by those having authority: right usually reserved by an insurance company with respect to any property it insured.

• Insurance: an economic device whereby the individual substitutes a small cer-tain cost (the premium) for a large uncertain financial loss (the contingency insured against) that would exist if it were not for the insurance contract; an economic device for reducing and eliminating risk through the process of com-bining a sufficient number of homogeneous exposures into a group to make the losses predictable for the group as a whole.

• Insurance company: a licensed legal entity that underwrites insurance.

• Liability: a debt or responsibility: an obligation that may arise by a contract made or by a tort committed. (Related definitions: technical liabilities, technical provision)

• Loss: the unintentional decline in, or disappearance of, value due to a contin-gency.

• Loss ratio (claims ratio): refers to the ratio of claims incurred to earned premi-ums. Other related definitions: claims incurred, earned premiums.

• Loss reserves (claims provisions): an estimated liability in an insurer’s financial statement, indicating the amount the insurer expects to pay for claims (losses) that have taken place but that have not yet been paid.

• Net retention: the final amount of insurance retained by the company after re-insuring such amounts that it did not wish to retain.


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• Nontechnical risks: nontechnical risks represent the various kinds of risk that cannot in any suitable manner be classified as either technical risks or invest-ment risks. Insurance supervisors will also be concerned about these risks (al-though the following list should not be seen as exhaustive):

– Management risk– Risks connected with guarantees in favor of third parties– General business risk.

There can be debate about the inclusion of what some define as operational risk in this category. Depending on your definition, operational risk can be add-ed or can be included in this list.

• Permissible loss (claims) ratio: the maximum percentage of premium income that can be expended by the company to pay claims without loss of profit.

• Policy: the written contract of insurance that is issued to the policyholder in-sured by the company insurer.

• Premium: the payment, or one of the periodical payments, a policyholder agrees to make for an insurance policy.

• Reinsurance: a reinsurance contract is an insurance contract between one in-surer or pure reinsurer (the reinsurer) and another insurer or pure insurer (the cedant) to indemnify against losses on one or more contracts issued by the ced-ant in exchange for a consideration (the premium).

• Reinsurance credit risk: a reinsurer might prove to be unable or unwilling to pay its part of the liabilities or the claims incurred, which lack of payment could put the insurer’s liquidity at risk and even cause its bankruptcy.

• Reinsurance risk: the risk of insufficient reinsurance covers or a failure of rein-surers to pay their part of the overall liabilities (or incurred claims) evaluated on a gross basis.

• Reserve: amounts set aside to meet unforeseeable liabilities (an obligation that has not yet materialized) or statutory requirements, and stemming either from shareholders’ capital or, in the case of mutuals, from members’ contributions and from accumulated surplus. Reserves are part of the own funds (in contrast to provisions that support liabilities to parties other than shareholders or other owners). (Equivalent terms: reserve, appropriated surplus, segregated surplus, contingency reserve)


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• Risk management: a scientific approach to the problem of dealing with the pure risks facing an individual or an organization in which insurance is viewed sim-ply as one of several approaches for dealing with such risks.

• Solvency margin: surplus of assets over liabilities. (Because these terms are fre-quently used in an imprecise manner, the glossary refers to available solvency (margin) or available surplus capital and required solvency margin or required surplus.) (Equivalent terms: solvency margin, surplus capital)

• Technical provision: amount set aside on the balance sheet to meet liabilities arising out of insurance contracts, including claims provision (whether reported or not), provision for unearned premiums, provision for unexpired risks, life assurance provision and other liabilities related to life insurance contracts (for example, premium deposits, savings accumulated over the term of with-profit policies). (Equivalent terms: technical provision, technical liabilities (technical) reserves) (Related definitions: reserve, liability)

• Underwriting: process by which an insurance company determines whether and on what basis it will accept an application for insurance.

• Unearned premium: portion of the original premium for which protection has not yet been provided because the policy still has some time to run before ex-piration. A property and liability insurer must carry unearned premiums as a liability on its financial statement.

• Written premiums: premiums on all policies that a company has issued in some period of time, as opposed to “earned premiums.”

Acronyms used within the module include:

APRA Australian Prudential Regulation AuthorityCEA Comité Européen des AssurancesCEIOPS Committee of European Insurance and Occupational Pensions SupervisorsCIA Czech Insurance AssociationCZK Czech CrownGDP gross domestic productEU European UnionHI Herfindahl IndexIAIS International Association of Insurance SupervisorsIASB International Accounting Standards BoardIBNR Incurred But Not Reported (claim)


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ICOS In the Course of Settlement (North American equivalent of RBNS)ICP Insurance Core Principles (see IAIS 2003)MU monetary unitNAIC National Association of Insurance CommissionersRBNS Reported But Not Settled (claim)ROE return on equityUS United States (of America)VAT value-added tax


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B. Role of market analysis

The term “market analysis” can mean different things. Market analysis can mean testing the business opportunities of new market entrants (that is, targeting business develop-ment, specifically, profit generation). The term also can mean analysis of market condi-tions, and status and development performed as a preparation for legislative changes (that is, targeting market stability, fair competition, and consumer protection).

For this module, the following definition is usable, that is, broad enough while suf-ficiently concise:

Market analysis is a research intended to predict the future of a market.3

This definition could seem too simple; however, the purpose and use of such a pre-diction always must be considered. In the case of insurance supervision, prediction of future market behavior (and behavior of its individual participants) helps to anticipate unfavorable developments and to be prepared to intervene in case of a threat to market stability or consumers’ interests.

The above definition implies that:

• Market analysis is not only the description and analysis of the past (the goal of insurance supervision is informed action, not just knowledge for its own sake!).

• Market analysis is not a one-off process. But• Market analysis is a systematic, repeatedly performed activity of collecting mar-

ket information, putting the information into context, evaluating trends, and taking appropriate action.

Market analysis must be both proactive (studying and analyzing trends during “normal” development) and reactive (studying impact of extraordinary market events such as large natural catastrophes or failures of companies on the whole market). Mar-ket analysis skills will grow with experience.

Market Analysis in the context of the Insurance Core Principles

The following concept of market analysis performed by the supervisory authority has been introduced in the Insurance Core Principles:

3. http://www.investorwords.com/2965/market_analysis.html

ICP 11 Market analysis

Making use of all available sources, the supervisory authority monitors and analyzes all

factors that may have an impact on insurers and insurance markets. It draws conclu-

sions and takes action as appropriate.


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The ICPs also list criteria to enable the supervisory authority to check and evalu-ate the implementation level of the market analysis. Together with basic comments and explanations, these criteria are listed below.

Essential criterion a states: “The supervisory authority conducts regular analysis of market conditions.”

One of the essential criteria of ICP 2 Supervisory Objectives says:

“The key objectives of supervision promote the maintenance of efficient, fair, safe and stable insurance markets for the benefit and protection of policyholders.”

This objective is also the main driver for market analysis performed by the supervi-sory authority. The main risks that could affect the market and the insurance companies that operate in the market are:

• Jeopardized financial soundness of an insurance company4

• Bad market conduct of an insurance company when serving policyholders, par-ticularly in claims handling

• Unavailability of products• Unfair competition and misuse of market power• Changes in the market environment.

Therefore, market analysis organized by the supervisory authority should con-centrate on factors that help to predict unfavorable development and enable adequate, timely responses.

Changes in the environment affecting the operation of insurance companies are discussed in section D. It is impossible to give a universal method of quantitative as-sessment of the impact of such changes on the insurance market. They must be evalu-ated case by case by employing commensurate assumptions and suitable mathematical tools.

Section E deals with basic indicators and methods of market analysis. They enable regular quantitative assessment of the structure of the market, its technical results, and its economic position; conduct of companies; market development; and market compe-tition and availability of products; as well as the development of these factors.

Section F describes how a supervisory authority can establish a market analysis function and perform market analysis.

Essential criterion b states: “The market analysis not only includes past develop-ments and the present situation but also aims to identify trends and possible future scenarios and issues, so that the supervisory authority is well prepared to take action at an early stage, if required.”

4. Sometimes, endangered finances of one company may even have a positive effect on the market as a precedent leading to effective preventive measures. The main danger of this situation lies in its possible effect on the policyholders.


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Correct and efficient performance of market analysis requires timely delivery of well defined, reliable, and accurate data; understandable and unambiguous definition of analyzed factors and indicators; and stable analytic methods. When interpreting the re-sults of market analysis, risk tolerance limits (limits and thresholds representing “warn-ing level” and/or “action level”) must be defined. All of these issues are dealt with in a greater detail in the following sections.

Essential criterion c states: “The market analysis is both quantitative and qualitative and makes use of both public and confidential sources of information.”

Market development is always a result of the impacts of many different factors. While the results usually are measurable and can be expressed in quantitative form, quite frequently, the origin of the changes is nonmeasurable and difficult to assess (for example, legislative changes).

To the extent that a jurisdiction is observing certain ICPs, accessibility of data should not be an issue. To illustrate:

• For details on insurers’ public disclosure of data, see ICP 26 - Information, Dis-closure, and Transparency toward the Market.

• Reasonable data of any kind (including confidential information) can be re-quested by the supervisory authority from an insurer (see ICP 12 - Reporting to Supervisors and Off-Site Monitoring and ICP 13 - On-Site Inspection).

More difficult are the reasonable amount and structure of data and the availability of data. In particular, data that are newly requested from insurers, (such as complaints files and complaints statistics) may not necessarily be immediately available in a uni-form structure and level of detail. One of the big challenges of current insurance super-vision is to create and maintain a database that

• Has a stable and efficient structure (that is, does not require frequent structural changes and enables preparation of all necessary analyses)

• Does not impose an excessive burden on insurers when they are preparing the data (that is, requires data that the insurers are able to provide and that they can/should use also for themselves, for example, while performing risk manage-ment)

• Does not duplicate activities of other data collectors and providers (the super-visory authority should maintain extensive and intensive communication and cooperation with other institutions operating in this area)

• Is internationally compatible (that is, enables comparison with other markets, at least on regional level) and enables cooperation with other domestic financial supervisory authorities and foreign supervisory authorities

• Brings fast and efficient results (to enable prompt supervisory intervention as requested in ICP 14 - Preventive and Corrective Measures).


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Additional notes on sources of data for market analysis are mentioned in section C.

Quantitative analysis deals with indicators that can be expressed in figures. It is also necessary to perform qualitative analysis, that is, the explanation of market changes and developments expressed in words. Qualitative analysis includes reporting on general developments that may impact insurance markets, companies, and clients, including new or forthcoming financial sector and other relevant legislation, developments in supervisory practices and approaches, and reasons for market exits. Qualitative analysis should always be complemented with a quantitative analysis. The explanation or predic-tion of development is never complete without quantitative assessment of impacts. In the same way, quantitative analysis also needs its qualitative complement. Each table, fig-ure, or any other form of presentation of quantitative analytical results must be comple-mented with a verbal explanation of

• Reasons for the presented development• Possible inaccuracies that may influence the results• Expected future development trends • Relevant comments and remarks of any other kind.

Otherwise, the presentation loses a significant part of its analytic value. Essential criterion d states: “The supervisory authority or others, such as the insur-

ance industry, publish aggregated market data that is readily and publicly available to the insurance industry and other interested parties.”

Market data are important for insurers and other market players, enabling them to compare their performance and activities. Fact books issued by the Insurance Infor-mation Institute, or annual reports of the Czech Insurance Association may serve as examples. They, along with other sources mentioned in section H, are relevant in this context.

Essential criterion e states: “The supervisory authority requires market-wide sys-tematic reporting to analyze and monitor particular market-wide events of importance for the financial stability of insurance markets.”

In addition to standard, regular reporting and public disclosures (as requested and described in ICP 12 - Reporting to Supervisors and Off-Site Monitoring and ICP 26 - Information, Disclosure and Transparency toward the Market), specific data collection and analysis may be needed in the case of, for example, catastrophes that may influence the market. The terrorist attack at the World Trade Center in New York on September 11, 2001 and Central European floods in August 2002 may be cited as instances of human-made and natural catastrophes, respectively. Supervisory authorities should be prepared to (re)act immediately to secure the maximal possible consumer protection. Exposure to such events should be monitored by the supervisor because they constitute a potential systemic threat, and will influence how the supervisor monitors financial strength and liquidity.


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ICP 11 also includes two advanced criteria. Advanced criterion f states: “Insofar as international relationships affect internal insurance and financial markets, the analysis is not limited to the home market but also includes developments elsewhere.”

International relationships and cooperation have become an inevitable part of today’s life, including insurance and its supervision. Sometimes, the need for coopera-tion is directly embedded in the applicable legislation,5 and the supervisory authority would not be able to perform its duties without analyzing other markets. Obviously, cross-border market analysis is difficult to perform. Therefore, cooperation and market analysis information exchange between individual national supervisory authorities is totally inevitable. Some of the market analysis indicators mentioned in this module serve the comparison of individual markets (see section E - Analyzing market develop-mental level).

Advanced criterion g states: “The supervisory authority monitors trends that may have an impact on the financial stability of insurance markets. It assesses whether mac-roeconomic risks and vulnerabilities are adversely impinging on prudential safeguards, financial stability or consumer interests.”

Basic thoughts on market analysis are discussed here. Nevertheless, there are a number of related topics not covered or covered only partially due to the limited scope of this module, such as:

• Impact of trading and ownership links to market structure and its operation• Insurance groups and financial conglomerates aspects of market analysis• Nontraditional reinsurance• Analysis of external markets and their impact to domestic market.

The world is changing and the supervisory authority must keep pace with all rele-vant changes. Therefore, continuous observing of and learning about the market chang-es form inevitable parts of the insurance supervisor’s job.

5. Let us take the situation in the European Union. EU member countries have adopted two tiered legislation:

1. Common EU legislation obligatory for all member states2. Individual state laws that may not contradict the common EU legislation.

The EU legislation enables:

• Single-license principle (license to operate issued in one member state is also valid in other member states)• Freedom to provide services (insurance companies may operate from one member state and in other member

states)• Right of establishment (insurance companies may establish branches in other member states).

It is not surprising that international cooperation in such a market environment is not only vital but even obligatory (regu-lated by the EU laws).


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Use of market analysis and benefits for the supervisory authority

Modern supervisory techniques must include market analysis. The following discus-sion addresses the most important specific areas in which market analysis contributes to the execution of insurance supervision, and the indicators that enable, or assist in, performing it. This section deals with the general benefits and contributions that mar-ket analysis can provide the insurance supervisor.

It is impossible to avoid totally all adverse developments. On the other hand, watching the trends and analyzing the strengths and vulnerabilities of the market enable supervisors to be proactive, to put them at the ready and poised to (re)act before minor problems become major by adapting techniques as market conditions evolve.

Market benchMarks

Market analysis can be used to set up market benchmarks and uncover significant dif-ferences between the market benchmarks and the positions of individual companies. In-formation related to individual market participants can be summarized and combined into market values, then analyzed to establish market benchmarks and averages. Such benchmarks and averages may be used for prudential purposes. Deviations from such benchmarks may trigger more intensive monitoring or intervention. Details for indi-vidual indicators addressed in this module appear in section E on market analysis tools and methods.

In a sound market, companies close to the market average that keep pace with market benchmarks are less likely to have problems than insurers that deviate from the market in a negative direction.

Market efficiency

Market analysis enables the measurement of competition in the market. The market is ef-ficient if products are available and sold at reasonable prices. It has been proven many times both in economic theories and in practice that efficiency can be achieved more easily in markets that have sufficient competition in which the size of individual players is not great enough to enable them to misuse their market power.

For details see section E regarding analyzing market structure and competition.


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insurance supervision efficiency

Not only the market but also the insurance supervision itself should be efficient. Here, market analysis can contribute a great deal. Efficiency of the supervisory authority means that:

• The supervisory authority acts in a timely manner.• The supervisory authority acts efficiently.

Analysis helps to set priorities within the supervisory process. The supervisory authority should exercise a uniform, just approach to all market players. On the other hand, it is obvious that supervisory authority intervention and thus closer attention to certain insurers is more needed under adverse circumstances and/or in cases in which policyholders’ rights could be endangered. The overall solution of how to organize clos-er supervision of “suspect” insurers in a transparent way, without breaching principles of equality, falls within the scope of ICP 4 - Supervisory Process. However, some con-siderations on setting priorities and concentrating capacities in the supervisory process are mentioned here.

There are several reasons to watch some market players more closely. The most important reasons are, for:

• Biggest insurers:

– They could misuse their market power when pricing and serving their cli-ents.

– More clients could face difficulties in case of the adverse development of the company.

• Smallest insurers:

– They are often more sensitive to market fluctuations. – Due to their size, it is more difficult for them to keep their fixed costs at an

appropriate level and keep pace with their competitors.

• Insurers that deviate significantly from the market average in main indicators (such as provisioning level, combined ratio, solvency margin):

– Such deviations could indicate adverse development of the company, non-professional approach, or poor financial position compared to market benchmarks.


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Market analysis helps to concentrate the supervisory authority’s capacities on in-surers with higher potential of problems.

Market conduct

Compared to measuring purely economic indicators, it is more difficult to measure and analyze the behavior of the market and individual companies. The desirable behavior includes fair and transparent marketing of insurance products, timely response and settlement of claims, resolving complaints, and complying with the requirements of public disclosure. Basic possibilities for such analysis are discussed in section E. Moni-toring the market conduct of insurance companies is another way that market analysis protects policyholders.

coMparison of individual Markets and cooperation with other supervisory authorities

Some of the market analysis criteria enable the comparison of the developmental level of individual markets (see section E regarding analyzing market developmental level for details). Using equal or comparable market analysis in different market enables the supervisory authority to compare the market status of individual insurers in different markets. Comparable market analysis also facilitates cooperation with other supervisory authorities, which is vital for cross-border cooperation in an international environment such as the European Union (applying the principles of right of establishment, freedom to provide services, and single license). Additional details and considerations regarding such cooperation can be found in ICP 5 - Supervisory Cooperation and Information Sharing.

Scope and depth of market analysis

Requirements for market analysis are contradictory:

• It should be comprehensive, taking into account all factors affecting (or poten-tially affecting) the market and its development and performing quantitative measurement of such impact (or at least its estimation when quantification is impossible or appropriate mathematical methods are not available).

• If such impact could lead to an adverse development endangering the consum-ers, market, or some of its participants, the analysis should identify decisive factors and suggest their alternative values (in case of quantitative factors) or qualities (in case of qualitative factors) that are achievable and would lead to a more favorable development.


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On the other hand, the analysis should:

• Be reasonably priced• Require reasonable capacities in terms of expertise and technological resources• Be fast enough to enable taking measures against adverse development.

Therefore, it is necessary to establish the scope and depth of the analysis to comply as much as possible with the above requirements. The following aspects and methods should be considered when setting the sensitivity:

• Learning by experience:

– Is the market analysis sensitive enough to identify adverse development and negative events affecting the market in the past?

– Would the signals brought by the market analysis come early enough to en-able timely measures?

• Co-operation and exchange of information. The supervisory authority should cooperate and exchange information with:

– Authorities supervising other areas of the financial market– Supervisory authorities of other insurance markets.

• Adequacy regarding prudential requirements:

– Is the market analysis sensitive enough to judge the prudential requirements and development of values of their indicators on the market-wide level?

– Would the signals brought by the market analysis come early enough to en-able timely measures?

The scope and sensitivity of market analysis must be continuously followed and assessed, and market developments must be reflected without delay.


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C. Sources of information

The majority of the information needed for direct quantitative market analysis is sup-plied by the insurance companies, as both reports to supervisors and findings during on-site inspections. However, a substantial portion of information useful for the analy-sis and its environment also can be obtained from other sources such as in discussions with market participants and other entities. The supervisory authority should not leave out any single facility or opportunity that enhances its knowledge and helps to assess the future market development. These information sources and their possible contribu-tions to market analysis are discussed in this section.

Internal communication and information sharing at the supervisory authority also should be mentioned here. Particularly important is that information from regular re-porting, off-site monitoring, and on-site inspections reach the supervisory authority department responsible for market analysis without unnecessary delay. This timeliness must be in place for all internal communication within the supervisory authority; oth-erwise the results of market analysis can not be used in an efficient way.

Research and market analysis staff also should monitor relevant publications, press releases, market surveys, investigation reports, and discussion groups, both domestical-ly and internationally, and extract information on issues that could affect the insurance sector. This monitoring also can be done using electronic tools and services (at least in some territories in which such tools are available and legal). Monitoring is not restrict-ed only to items with “pure insurance content” but also to items that relate to insurance relatively loosely, such as demofigureic development, criminality, and exchange rates.

Insurance market participants

Market participants and their possible contributions to market analysis are listed be-low:

• Insurance companies and insurance associations Insurance supervisors could meet formally and informally with management

and directors of the insurers. These meetings can be done as adjuncts to on-site inspections. Meetings also can also be held more formally, for example, through periodic meetings of senior management of the supervisory authority with in-dustry counterparts. Mutual exchanges of views will improve communication, understanding, and trust; and complement information collected through other channels.

Insurance associations usually also perform market analyses, prepare com-prehensive market statistics, investigate the overall market environment, and, in mutual communications, prepare such outputs as codes of conduct for mem-ber companies. Results of these activities are communicated in their annual re-


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ports,6 press releases, and other outputs; and may be useful and contributive to the analysis performed by the insurance supervisor. Regular discussions with the top association representatives (who usually are senior management mem-bers of insurance companies) can contribute to estimating and understanding future market development, problems faced by the insurance companies, their solutions, and other issues.

• Reinsurers Reinsurers perform global market analyses7 as well as analyses of individual

events affecting the international insurance and reinsurance market. Their con-tributions are particularly valuable because of the global perspective of their approaches. It may be useful for the insurance supervisor to keep in contact periodically with reinsurers and study the materials they issue.

• Insurance and reinsurance brokers The same statements above about reinsurers also are valid for large insurance

and reinsurance brokers. In addition, in their efforts to attract consumers, at a certain level, they compete with rating agencies with respect to assessing the financial stability of reinsurers and finding methods for using the results of such assessments in their work.8 Their output may serve as an inspiration and com-parison tool also for the insurance supervisor.

• Other professionals in the insurance sector, including:

– Actuaries and their professional associations– Risk managers – Compliance officers9

– Advisors.

Furthermore, the insurance supervisor can discuss with them particular tech-nical issues as well as what they see as developing risks and business trends.

Wider economic and international environment

Regular discussions with a variety of other parties may be particularly useful for shar-ing views on developments and trends affecting the financial sector and legal environ-ment.

6. Czech Insurance Association 2003 is an example.7. Swiss Re 2004 is an example.8. Benfield Group 2004a may serve as an example in this respect.9. See explanation in Bennett 1992.


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• Authorities supervising other financial sectors Meetings can be useful even if the counterparty is legally constrained from shar-

ing information about specific financial institutions.

• Representatives of other organizations having roles in the financial markets These officials include central bankers, finance ministers, and managers of poli-

cyholder protection funds.

• Auditors and rating agencies All entities included in such discussions have two common interests: investigat-

ing the soundness of market players and protecting the market from adverse developments. Therefore, these meetings should be held frequently.

• Supervisory authorities of other jurisdictions All entities included in such discussion have two common interests: investigat-

ing the soundness of market players and protecting the market from adverse developments. Therefore, the meetings should be performed on frequent basis.

• International institutions Such institutions include IAIS (International Association of Insurance Supervi-

sors), CEIOPS (Committee of European Insurance and Occupational Pensions Supervisors), CEA (Comité Européen des Assurances), and IASB (International Accounting Standards Board). The supervisory authority has a natural interest in following the developments and participating in activities of these institu-tions whenever possible.


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D. Changes in the market environment

The environment in which the market operates is determined by the existing political systems, economic and financial contexts, legislation, developmental level of the re-spective country, geographical location (climate), and the society. Political changes may trigger changes in each of these factors.10

It is not only the financial impact that should be considered but also the availability of reasonable and adequate insurance protection for consumers. When preparing the market analysis, the supervisory authority should always consider the particularities of the market. The influence of individual factors is different in different markets. (Fur-thermore, it is possible that some of the market-specific factors are not mentioned in this module).

General economic conditions and financial market situation

Any changes should be carefully followed by the supervisory authority:

• If the general economic situation is deteriorating (whatever the cause), it will negatively affect the disposable income of inhabitants, decrease the demand for insurance products, and shrink the insurance market, which may affect the vi-ability of insurers.

• Surprisingly, improvement of the general economic situation (or even a stabiliza-tion of the economy) also may bring problems to insurers. In such an economic environment, interest rates go down so that reaching the yields guaranteed in fixed-interest-rate life policies may be difficult.

• Negative development in the equity market has a negative impact on the value of insurance provisions and reserves invested in equities (and thus to the solvency of insurance companies).

In general, the three points above are valid not only for equities but for all possible types of investments of provisions and reserves.11

Underestimation of changes and inadequately slow adaptation to new environ-ments can significantly harm the insurance market.12

10. Development in East European countries may serve as a good example. In the early 1980s, these countries had state mo-nopoly planning systems (with monopolies also in the insurance sector). Nowadays, they are European Union members, and all aspects of life in these countries have changed, including not only legislation, economy, finance, and demofigureics but also areas seemingly unimportant to the insurance industry such as infrastructure and transportation. The insurance sector itself now operates under conditions of free competition.11. This is why the investment mix in insurance is regulated: deterioration in one sector may be balanced by improvement in another. Investment risk, particularly in life insurance, should be as low as possible and thus subject to (reasonable) regula-tion.12. They were the main reason of recent failures even in highly developed markets such as United Kingdom (failure of Equi-table, British life insurance company; see The Treasury Committee 2001) and Germany (failure of Mannheimer Lebensver-sicherung AG, German life insurance company. First failure of a life insurer in Germany in more than 50 years; see Federal Financial Supervisory Authority 2003). These failures triggered large discussions in the EU as to whether they could have been anticipated by their home supervisory authorities through adequate market analyses and prevented by existing (or amended)


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Legislation

Legislation not only establishes the framework for insurance market operation but also highly influences its performance and results. The examples below do not represent a complete list of the legislative changes affecting the insurance market. Rather, to be on the safe side, the insurance supervisor should follow the development and changes in legislation as a whole, and for each change analyze the impact on the market.

• Taxation

– Taxation levels and/or changes can widely influence demand, particularly for life insurance products.

– Taxation changes can significantly influence the cost of claims.13

• Claims indemnity

– Indemnity amounts for claims can change significantly over time due to changes in legislation as well as to changes in legal findings (usually, “change” means “increase”)

– New sources of indemnity unknown earlier in national legislation may be introduced in the legislative development process. Examples are pain and suffering awards for relatives of victims of traffic accident and punitive dam-ages.

• Traffic rules Introducing or changing speed limits, and how strict the police are in enforcing

traffic laws, influence the frequency and severity of automobile accidents and, consequently, paid claims.14

• Various liability fields Some types of claims that were not payable earlier may become payable under

new legislation or a legal situation.15

prudential requirements; and whether sufficient measures could have been imposed under the circumstances existing prior to these failures. Consequences can be found even on the European Union level. The European Commission introduced an initiative on the establishment of insurance guarantee schemes to enhance consumer protection. See European Commission paper, Markt/2513/04-EN (October 2004).13. Changes in the value-added tax (VAT) recently introduced in the Czech insurance market triggered large discussions on the economic impact on the domestic market. This Czech tax has two categories: taxation of category 1 increased from 5% to 7%; category 2 decreased from 22% to 19%. Some commodities were transferred from one category to another.)14. Even positive changes may have temporarily negative effects. For example, after the introduction of strict right of way for pedestrians on zebra crossings in the Czech Republic, the frequency of accidents on zebra crossings increased by 400%! Pe-destrians’ right of way was relatively ambiguous earlier, so the change was undoubtedly correct and a standard development. Nevertheless, after the new legislation, pedestrians became too careless, while some drivers still do not fully observe the new rules. It will take some time to reap the benefits of the change. Until then, people will be injured or killed, and the accident claims will burden the motor third-party liability insurers.15. For example, asbestos claims in the US.


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In this respect, it is not only local legislation and developments that should be considered but also those in international law. Examples are the analysis of cross-border operations16 and participation in the “green card” system.17

Society

The influence of societal factors should be included in the market analysis prepared by the supervisory authority.

• Demographic trends:

– A decrease in population may imply decrease in demand for insurance prod-ucts and thus affect viability of some companies in the market.

– The changing structure of population may lead to changes in the product mix in the market. For instance, an aging population will imply increasing demand for pension products.

– An increase in population density accelerates the process of value concentra-tion. This factor should not be underestimated in market analysis.

• Developmental level of the society:

– The frequency and severity of insured events of a particular kind (terrorist at-tacks, road accidents) that influence the market and its development depend significantly on the general developmental level and other issues in the society.

– Increasing life expectancy, which is also closely linked with the developmen-tal level of the society, may significantly impact the market, particularly on the life insurance companies that underestimated such development.

Country’s developmental level

A country’s wealth and its development also influence the insurance market:

• Improving infrastructure (road system), changing age, number of vehicles, and structure of the fleet has a significant impact on motor insurance in both direc-tions:

– Improving safety of cars diminishes consequences of accidents.– Their higher value increases cost of repair.

16 Arrangement based on European Union directive enabling an insurer based, operating, and supervised in one EU mem-ber state to also operate in the territory of other member states without the need for local license.17. Uniform Agreement between Bureaux. For details see web page of the Council of Bureaux, http://www.cobx.org/.


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• Improving medical care means that victims survive accidents that would have been fatal in the past. From the social point of view, this is definitely a positive development, but the consequences for the insurance industry are:

– Increasing cost of medical treatment– Increasing cost of loss of income after accident, caused by both higher life

expectancy and higher income level.

• Improving material wealth:

– Leads to higher value concentration and thus higher loss susceptibility in case of catastrophic events

– Positively affects life expectancy, which decreases the frequency of life insur-ance claims, but also leads to the purchase of larger life insurance policies

– Increases the demand for savings and investment products – Increases traffic density and thus also the number of road accidents.

All these factors must be carefully observed both in the risk management of indi-vidual companies and in market analyses performed by the insurance supervisors.

Geographical location and climate

Demand for insurance cover and insurance market operation may be significantly af-fected by local geographical and climatic conditions. Some natural perils in some geo-graphical areas are almost uninsurable.18 State (legislative) intervention may improve the availability of protection.19 It is obvious that market analysis must be concerned with such issues and concentrate particularly on local problems.20

It is not 100 percent clear and has not been proven yet whether some of catastroph-ic events have been triggered or exacerbated by climate change. Insurance supervisors also should track this global environmental trend and consider scientists’ opinions.

18. Such as the flood in Bangladesh.19. Examples are mentioned in footnote 42.20. In this respect, reader may have interest in the discussions on and responses to the recent unprecedented sequence of hurricane landfalls in the US (Charlie, Frances, Ivan, and Jeanne). It was not possible to comment on the final responses of the market (and maybe also of the US insurance supervision) to the hurricanes because the discussions started during the preparation of this module. The basic description of what happened may be found in Benfield Group 2004b.


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E. Market analysis tools and methods

To a great extent, market analysis means risk analysis of summarized data collected from individual insurers. Therefore, the analytic methods and considerations applied to risks mentioned in ICP 18 - Risk Assessment and Management can be employed.21 Tools and considerations introduced in this module may overlap and/or be further de-veloped with tools and considerations presented in other ICPs (ICP 12 - Reporting to Supervisors and Off-Site Monitoring,22 ICPs relating to prudential requirements, ICP 18 as well as ICPs 19–2323, and ICP 26 - Information, Disclosure and Transparency toward the Market24).

Usually, the basic data (gross premium written, absolute amount of provisions) col-lected from insurers25 and other sources are not suitable for market-wide analysis. It is only by combining them into ratios, processing them through mathematical formulas, monitoring their development over time, envisioning their results, and discussing them with other market and environment entities that enable understanding of market devel-opment, discovering its strengths and vulnerabilities, and forecasting the future.

The extent and level of this module does not allow the introduction of sophisticated market analysis indicators and methods; therefore, only basic ones have been included here. References to sources of more extensive or advanced information are mentioned when necessary or useful.

Subsections dealing with individual indicators or groups of indicators have been structured as follows:

1. Introductory comments on the purpose of the indicator(s), main fields of use, and benefits for the insurance supervisor

2. Definition, scope of use3. Remarks on how to interpret values of the indicator, how to indicate adverse

developments, and what should be the supervisory action in such a case4. Example or case (sometimes a combined example, or case study, for multiple

indicators).

21. ICP 18 deals with risks inherent to insurance companies and markets. Some risks, such as underwriting risks and risks related to the evaluation of technical provisions, are specific to the insurance sector. Other risks are similar to those of other financial institutions, for example, market (including interest rate), operational, legal, organizational, and conglomerate risks (including contagion, correlation, and counter-party risks). Position of insurance supervisors when performing analysis of risks faced by the market is similar to the position of insurance company analysts performing the analysis of risks faced by the company due to economic, competitive, and political factors. See the ICP 18 modules for details.22. ICP 12 may serve as a guideline on collecting data needed for market analysis from insurance companies.23. • ICP 19 Insurance activity deals, among other topics, with the use of actuarial, statistical, and financial methods for

estimating liabilities and determining premiums, and with reinsurance arrangements. These issues also represent an important subject of market analysis.

• ICP 20 Liabilities deals with establishing adequate technical provisions and other liabilities, and making allowance for reinsurance recoverables, which are items that also should be analyzed throughout the whole market.

• ICP 21 Investments helps in the analysis of investment policy, asset mix, valuation, diversification, and asset-liability matching.

• ICP 22 Derivatives and similar commitments will help with the market analysis on the use of these financial instru-ments

• ICP 23 Capital adequacy and solvency is useful for the market analysis of capital in the market.24. ICP 26 helps in understanding which information needed for market analysis is publicly available.25. For details see ICP 12 Reporting to Supervisors and Off-Site Monitoring and ICP 13 On-Site Inspection.


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Analyzing market structure and competition

Market analysis indicators discussed in this subsection enable the assessment of the level of competition in the market and the development of competition over time. They also enable comparison with other markets. As regards their possible use in the supervisory process, they have a relatively less important role. These indicators help in assessing the market power of market participants. They also may have practical use for the insur-ance supervisor when considering approval of mergers and acquisitions: mergers and acquisitions should not reduce the competitiveness of the market. On the other hand, in case of exit from the market and/or portfolio transfers,26 more important reasons will probably play a decisive role in the supervisory authority’s decisionmaking.

Market shares of insurance groups, instead of the shares of individual companies, can be analyzed. There is not a uniform opinion on which of these approaches is more useful. It seems that the most pragmatic approach would be to perform both, compare the results, and use what is more practicable for the particular situation.

Other aspects of market structure also can be analyzed, such as:

• What is the number of insurers operating in a market (and its development over time)?

• What is the number of–and, particularly, the reasons for–market exits (and de-velopment over time)?

• What is the market structure with respect to domestic and foreign insurers, and branches?

concentration ratio

The concentration ratio is often expressed as CRm, for example, CR4.The concentration ratio can be expressed as:

CRm = s1 + s2 + s3 + … … + sm

where si = market share of the ith company.The lower the concentration ratio, the more widespread–and usually, the better–the

competition in the market. Competition has four aspects, defined as:

26. For details see ICP 16 Winding-up and Exit from the Market and ICP 8 Changes in Control and Portfolio Transfers.

Concentration Ratio

The percentage of market share owned by the largest m companies, where m is a speci-

fied number of companies (usually 4 or 8).


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1. Perfect competition—very low concentration ratio2. Monopolistic competition—concentration ratio below 40 percent for the 4-firm

measurement3. Oligopoly—concentration ratio above 40 percent for the 4-firm measurement 4. Monopoly—near to 100 percent concentration ratio for the 4-firm measure-

ment.

The competition in the insurance sector will probably never be so fierce, crowded, and “perfect” in the sense of concentration ratio as it is in, for example, agriculture. The insurance supervisor should, however, take into account the particular market situa-tion. In oligopoly, for instance, the market is dominated by a small number of sellers, and each oligopolist is aware of the actions of the others. Oligopolies have a significantly higher risk of misusing their market power (particularly by dictating prices), to the detriment of consumers.

In addition, comparing market share information over time allows supervisors to identify companies whose operations are expanding or contracting and to inquire fur-ther into reasons for the change and whether the company has resources to deal effec-tively with growth or loss in business.

herfindahl index

The Herfindahl Index provides a more complete picture of market concentration than does the concentration ratio. This index uses the market shares of all companies in the market. It squares these market shares to place more weight on the larger companies. If there are n companies in the market, the Herfindahl Index can be expressed as:

HI = s12 + s2

2 + s32 + … … + sn

2

where si = market share of the ith company.Unlike the concentration ratio, the HI will change if there is a shift in market share

among the larger companies.The Herfindahl Index can be used to determine whether mergers are equitable to

society and thus also influence the actions and decisionmaking processes at the super-visory authority.27 As the market concentration increases, competition and efficiency may decrease, and the opportunities for collusion and monopoly increase.

The Herfindahl Index should not be examined with respect not only to the total market share but also to market share of individual products (that is, in the insurance sector for individual lines of business).28

27. In the United States, increases of over 100 points generally provoke scrutiny, although it may vary case to case. The De-partment of Justice considers Herfindahl Indices between 1000 and 1800 moderately concentrated and indices above 1800 concentrated.28. See also subsection on analyzing availability of products.


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exaMple

Tables 1 and 2 and figures 1 and 2 show the development of concentration and Herfin-dahl Indices of the Czech insurance market after the political changes in Central and Eastern Europe. (During the era before 1991, “market” was not market–monopoly of the only insurance company was guaranteed by law.29)

The figures show steady development interrupted only in 1998, when the company Kooperativa merged with its “sister” Msl. Kooperativa.30 The development has been slowing down since the year 2000.31 Shares of companies used to calculate the concen-tration ratio are shaded. Tables are sorted in descending order by market shares in 2003. For conversion of market volume into US dollars, the current approximate exchange rate is 1 US$ = 25 CZK (Czech Crown).

29. Information has been taken from the annual reports of the Czech Insurance Association (CIA) 1993–2003 (available on the internet; see Czech Insurance Association 2003) and from the annual reports of the Czech insurance supervision 2001–2003 (available on the internet; see Ministry of Finance 2003). The CIA annual reports usually show only information on member companies; therefore, the information for the whole market is not fully detailed. The association, however, brings together a vast majority of the market. The Herfindahl Index for the unallocated market share was calculated as if it were owned by one company; the inaccuracy brought in this way is negligible. Official names of the companies were shortened and/or abbreviated and transcribed into English alphabet to be more easily readable by non-Czech readers. Names shown in the table sometimes are not exact with respect to older years: premium volumes and markets shares are shown under the latest names of the companies (old names have been “forgotten”).30. This “irregularity” would not appear if market shares of insurance groups– instead of shares of individual companies (both companies that merged in 1998 were “sisters” with a regional split of their operations)–were investigated. Currently, the ques-tion whether to analyze individual companies or insurance groups is not significant for the market. All companies operate on the whole territory, and differences of results between analyses of individual companies and analyses on the group basis are insignificant. Developments similar to those of 1998 will be seen after the extension of the table to include 2004, when another takeover of market importance (this time a purchase, not a merger, of group-related companies) took place.31. Motor third-party liability insurance was regulated and under monopoly arrangement until 2000, when it was deregu-lated. Since then, the only state-regulated branch of insurance remaining is workmen’s compensation. It seems that the process of further market spreading will not continue in the near future; large companies manage to keep their shares in competition with the smaller firms.


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Tabl

e 1.

Pre

miu

ms

of in

sure

rs in

the

Czec

h m

arke

t


�0

Tabl

e 2.

Mar

ket s

hare

s of

insu

rers

in th

e Cz

ech

mar

ket


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Figure 1. Czech insurance market: Concentration ratio development

120

100.00 100.00 99.1997.24 95.95

93.9492.02

93.7991.63

87.85 86.65 86.99 87.31

100.00 99.8797.98

92.09

87.39

82.6779.75

82.4179.50

72.6871.09 70.04 69.45

100

perc

ent

80

60

20

1991 1992 1993 1994 1995 1996 1997

year

1998 1999 2000 2001 2002 2003

40

0

CR4

CR8

Figure 1. Czech insurance market: Concentration ratio development

12000

10000

8937

7647

5916

4996

4324

3783 3739 3065

19701976 1882 1849

10000

8000

6000

2000

1991 1992 1993 1994 1995 1996 1997

year

1998 1999 2000 2001 2002 2003

4000

0

Figure 2. Czech insurance market: Herfindahl index developmentFigure 2. Czech insurance market: Herfindahl index development


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Analyzing insurance technical risks and provisions

The market analysis indicators discussed in this section enable the calculation of un-derwriting efficiency (“underwriting result” or “technical result” are perhaps used more frequently) of insurance companies.32 When evaluating and assessing claims ratio and combined ratio, it is necessary to watch closely the appropriateness of provisioning. Proper (and improper) estimation and/or calculation of claims provisions (both RBNS 33 and IBNR34) may significantly influence the resulting values.

The mean market value of claims/expense/combined ratios can be obtained as a weighted average of respective indicators of individual insurers in the market (where the respective weight is the market share of individual insurers). These indicators can be calculated as a summary of total portfolios. However, a more accurate and valuable approach is to calculate these indicators by individual lines of business, because the values can differ significantly.

As a rule of thumb, deviation of individual insurers by more than 10 percent from the mean market value should become a trigger for closer examination by the insurance supervisor. Additional remarks are made in the following sections. These indicators should be evaluated very carefully and consider the risk appetite of individual insurers, because the volatility of results may differ significantly. To be specific, the evaluation should explore: what is their average and maximum retention? how much do they cede to reinsurance? what is the composition of the insured portfolio? and is the reinsur-ance adequate for the portfolio? These indicators should be calculated and evaluated on gross (before reinsurance) and net (that is, after deduction of the reinsurance ces-sion). The evaluation requires a skilled and experienced insurance supervisor. A simple example of how misleading the figures can be without consideration of “soft” factors is shown in the case study at the end of this subsection.

The term “claims” has been used in this module to designate what some jurisdic-tions may refer to as “losses.” Hence, some readers may be more familiar with the term “loss ratio” than “claims ratio.” “Provisions” or “technical provisions” have been used here instead of what some jurisdictions would define as “reserves” to distinguish be-tween those relating to the insurance policies and other more general “reserves.”

claiMs ratio

32. Indicators discussed in this section normally are used in non-life insurance. For a specialized life-insurance-oriented market analysis, the reader is referred to in Klein and Grace 1999 and APRA 2002.33. “Reported but Not Settled” (RBNS) are provisions for known outstanding claims; in North America, ICOS (In the Course of Settlement) is used instead.34. “Incurred but Not Reported” (IBNR) are provisions for unknown claims.

Claims Ratio

The ratio of claims incurred to premiums earned.


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It must be mentioned that both values (incurred claims and earned premiums) must relate to the same period of time (usually one calendar year). Otherwise, the relation does not have correct meaning.

Incurred claims include:

• Claims already paid• Claims incurred, reported, but not yet settled (usually called RBNS provisions)• Claims incurred but not known to the insurer (usually called IBNR provi-

sions).

Incurred claims are customarily computed by this formula:

Claims paid during the period plus outstanding claims (both known and unknown, that is, RBNS+IBNR) at the end of the period, less outstanding claims (both known and unknown, that is, RBNS+IBNR) at the beginning of the period.

While, for most purposes, this calculation is sufficient, it must be added that this calculation is not “scientifically” exact. Changes and adjustments of estimates of claims incurred before the beginning of the relevant period performed during the relevant period may impact the amount of incurred claims during the relevant period (and thus also the claims ratio) if calculated in this way.

Similarly, the earned premium is usually calculated as premium written during the period, plus unearned premium at the beginning of the period, less unearned premium at the end of the period. Here also, premium adjustments and returns performed during the period and related to premium earned before the period may influence the correct-ness of the result. However, under normal circumstances, this impact is significantly lower than what can happen with incurred claims.

Therefore, more exact calculations are based on claims that actually were incurred during individual periods (including their triangular extrapolation to calculate the IBNR part35) and use more exact methods to calculate earned premiums. If the claims ratio that is finally achieved exceeds the expected claims ratio, the insurer makes an un-derwriting loss, which must be balanced by decreasing underwriting expenses and/or investment income and/or other measures to achieve profit.

Claims ratios exceeding 100 percent may indicate that the companies (or the whole market) underprice the risk (that is, the premium is too low). While moderate excess of 100 percent may be balanced by investment income, larger excess should be closely watched by the supervisory authority, as should companies that deviate by more than 10 percent from the market average.

35. The reader may learn more on establishing provisions in ICP 20 - Liabilities.


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expense ratio

The expense ratio of individual insurers may vary significantly depending on lines of insurance underwritten, distribution channels used, structure of portfolio (whether large or small policies), and many other factors. Likewise, neither the claims ratio, nor the expense ratio itself, is decisive for the underwriting success of an insurer. Only the combination of both of these indicators, discussed in the next section, gives the real picture of the underwriting (technical) result of an insurer.

coMbined ratio

Combined Ratio

This ratio gives a rough indication of the profitability of an insurer’s underwriting op-erations (investment expenses and income are not included in combined ratio).

If the combined ratio exceeds 100 percent, the insurer suffers an underwriting loss. If it is below 100 percent, the insurer gains an underwriting profit. The underwriting result (loss or profit) is an important factor for an overall result of the insurer. However, a company with a combined ratio below 100 percent is not necessarily profitable and a company with a combined ratio exceeding 100 percent is not necessarily loss-making. Additional considerations on these topics are mentioned in the subsection on analyzing impact of nontechnical risks.

claiMs provisioning

A separate section is devoted to claims provisioning. It may have a crucial influence on the entire result of an insurance company and, therefore, also on the results of market analysis. Two of the ratios above (claims ratio and combined ratio) include claims pro-visions and strongly depend on their correct establishment. Sometimes, provisioning ratios are used as supplementary indicators to evaluate the adequacy of claims provi-sions.

Expense Ratio

Ratio of expenses to earned premiums. Expenses are the sum of commissions, adminis-

trative expenses, and other technical charges.

Combined Ratio

Sum of the claims ratio and the expense ratio.


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Due to the possible impact on the market, on individual companies, and particularly on clients (policyholders), market analysis and the supervision of provisions should be two of the main concerns of the supervisory authority. Failure of the Australian insurer HIH serves as an example of what can happen if the role of market analysis—particu-larly evaluation of provisions—is underestimated and executed too infrequently and too inadequately.36

When evaluating the adequacy of provisions, many items must be taken into con-sideration. Therefore, such an evaluation needs an experienced insurance supervisor equipped with sufficient knowledge and information on the market and individual companies. While reader is referred to ICP 20 - Liabilities for details, some of these is-sues are briefly mentioned below:

• Correct evaluation and estimation of provisions on individual claims. The bigger the claim, the higher can be the mistake of its estimate. It is easy to calculate the impact of average underestimation/overestimation of claims, but it is difficult to prove the underestimation/overestimation and figure out its level–historical record should help in estimating average percentage deviation form the correct value;

• Correct evaluation and estimation of IBNR provisions. Proper calculation us-ing triangulation methods and additional actuarial tools should be employed. While, from the mathematical point of view, these methods are transparent and provable, it is difficult to cope with certain situations:

– Young companies with insufficient time series of data– Estimation of the impact of changes, particularly in legislation, that are dif-

ficult to transpose to monetary units

• Consideration of claims settlement patterns. In cases in which records on indi-vidual claims are not available, or to be used as a comparison tool, RBNS and IBNR provisions can be established on the bases of claims frequency, average claim settlement period, average claim amount, and use of triangulation. How-ever, individual large claims must be taken into consideration and must be dealt with separately. Problems may occur in case of

– Young companies with insufficient time series of data– Small or volatile portfolios in which the statistical stability of data is insuf-

ficient.

36. For details on HIH see HIH Royal Commission 2003.

Claims Provisioning

Proportionate relationship of an insurer’s claims provisions to premium, expressed as a

percentage.


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Here, details and mathematical tools would go beyond the scope of this module.The analysis also should consider that the strength of provisions and levels of re-

ported profits may vary, depending on general market conditions. During favorable market conditions, insurers may increase the margins in their technical provisions, dampening the increase in reported profits. Favorable market conditions mean higher premium rates and wider exclusions. Sooner or later, however, the market will turn “soft,” exhibiting declining premium rates and narrower exclusions. Thus, during a soft market, risk profiles increase, and the margins in the provisions decline (as companies seek to preserve profit streams). Declining financial resources at a time of increasing risk profile is procyclical and signals that the weakest companies may be vulnerable to failure. This procyclicality is possible largely because of the lack of standards over claims provisioning. This lack of standards not only complicates market analysis but also un-dermines the capital adequacy standards.

exaMple

Nice small insurance market Utopia has the

following features:

• There are no natural perils.

• Life insurance is unknown.

• Motor third-party liability insurance is

organized by the state and financed

from taxes.

• Other conditions of life also are very

favorable. Therefore, the only line of

insurance provided by insurance com-

panies in Utopia is motor own dam-

age.

• There are only two insurance compa-

nies in the market.

• No new policies were concluded during

the previous year, because everyone

was happy with her/his own car; no

transfers of policies between insur-

ance companies were made, because

all policyholders were happy with their

insurers.

The following data appear in the mar-ket analysis of Utopia at year-end:

Motor insurance company (company A):

• Number of insured vehicles: 100.000

• Claims frequency: 6 percent

• Average claim reporting period by the

clients: 6 days

• Written premium: 1,000,000,000

monetary units (MU)

• Technical provisions: 600,000,000

MU

Vehicle insurance company (company B):

• Number of insured vehicles: 100.000

• Claims frequency: 6 percent

• Average claim reporting period by the

clients: 6 days

Case Study 1


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Case Study 1, continued

• Written premium: 700,000,000 MU

• Technical provisions: 72,000,000 MU

It is clear at first sight that company A is

better than company B, because:

• Company B underprices the risk.

• Company A has significantly higher

technical provisions.

However, deeper analysis shows that for

Company A:

• Policy renewals are evenly spread

throughout the year.

• Claims average 150.000 MU.

• Claim settlement periods average 2

months.

whereas for company B:

• Renewal date of all policies is January

1t to save administrative costs.

• Claims average 120,000 MU due to

better selection of risks and of con-

tracts with repairers who guarantee

lower prices

• Is faster. Claim settlement periods av-

erage 1 month.

As a result, company A should have:

• 500,000,000 MU unearned premium

provision

• 150,000,000 MU provision for report-

ed but unsettled claims

• 5,000,000 MU provision for unreport-

ed claims.

Therefore, company A is under-provisioned

by 65,000,000 MU.

Whereas company B:

• Already earned all written premium

• Should have 60,000,000 MU provi-

sion for reported but unsettled claims

• Should have 12,000,000 MU provi-

sion for unreported claims.

Therefore, company B’s provisioning is cor-

rect.

Although simplistic, this case study shows:

• The importance of sufficient detail

(sensitivity) of the market analysis

• How misleading the results can be if

all factors are not taken into account

• The importance of “soft factors,” such

as the portfolio renewal date in our

case.

Analyzing impact of nontechnical risks

This subsection deals with evaluating of risks emanating from the core activity of insur-ance companies—insurance activity. The current section deals in brief with other risks connected to the operation of an insurance company. The importance of this topic is


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documented by the fact that the whole set of ICPs was designed to describe supervisory requirements and the supervision itself of these risks.37 Therefore, only selected main is-sues impacting the market situation and position of individual companies are discussed here from the market analysis point of view.

investMent yield

The investments of insurance companies play an important role in their own financial stability. Investments also represent an important factor for the whole financial sector and economy of respective countries. Investments usually are regulated with strict cri-teria issued by respective countries’ legislations (and are the subject of a separate ICP)38 to avoid or limit the impact of financial market volatilities. Nevertheless, the favorable development of investments never can be guaranteed 100 percent. To secure consumers’ protection as much as possible, the legislative requirements and regulations for insur-ance investments are aimed at creating a balanced, conservative investment portfolio. Yet, there is always a certain flexibility in investments and the possibility of unfavorable developments, which represent investment risks for the insurance company.

Insurance companies’ investment risks represent various kinds of risk that are di-rectly or indirectly associated with the insurers’ asset management. These risks concern the performance, returns, liquidity, and structure of an insurer’s investments. Such risks can have a substantial impact on the asset side of the balance sheet and the company’s overall liquidity, and potentially can lead to the company’s being over-indebted or insol-vent. One of the most important indicators measuring the performance of investments is the investment yield.

Market analysis of investment yields can be performed by:

• Creating the market overview of investment yields by asset class• Comparing the insurance market investment yield with the investment yield of

the whole economy by asset class

37. For details see Insurance Core Principles and Methodology, section 6, Prudential Requirements–ICPs 18 to 23 (IAIS 2003).38. For details see ICP 21 - Investments.

Investment Yield

Proportionate relationship of an insurer’s investment income to volume of investments,

expressed as a percentage.


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• Comparing the investment yield of individual companies with their planned expectations (if the respective data are available in the business plans of the companies) and with market averages.39

Unlike technical results of companies, development in accordance with planned expectations (that is, having the investment yield “under control,” in accordance with the business plan) is more important than the comparison with a market average, be-cause individual companies may have different strategies and targets depending on the

• Classes of business related to invested assets• Investment approach (more or less conservative)• Maturity period of investments.

Serious deviations from expectations and/or from the market average indicate that the investment policy of the insurance company was too risky, was significantly im-pacted by adverse developments, or was poorly executed; and that regulatory action may be necessary.

solvency Margin

Solvency of insurance companies is probably the most important issue of insurance authorities. For this reason the discussion here goes into detail.

To come to a practicable definition, it is necessary to make clear under which cir-cumstances the appropriateness of the assets to cover claims is to be considered. For instance, is only written business to be considered, or is future new business also to be considered? In addition, questions regarding the volume and nature of an insurance company’s business, which time horizon is to be adopted, and what is an acceptable de-gree of probability of becoming insolvent should be considered. Similarly, the solvency margin can be defined as the surplus of assets over liabilities (that is, the excess of avail-able assets over minimum assets needed to cover liabilities), which guarantees ability to meet obligations. A more “scientific” definition of solvency margin is given below.

39. The insurance supervisor should have data on the assets of each insurer by type, for example, government bonds, corpo-rate bonds, common shares. If data is available on market yields by asset class, then the expected yield can be calculated for each insurer (and the insurance sector as a whole) and compared with the actual yields. This comparison would indicate the overall investment management performance of the insurers and the insurance sector.

Solvency

Ability of an insurer to meet its obligations (liabilities) under all contracts at any time

(that is, that the insurer has always sufficient assets to cover its liabilities).


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The words “solvency” and “solvency margin,” appear in the insurance vocabulary (particularly in the legislation and supervisory authority) very frequently, and frequent-ly they are used in an imprecise manner, so many more precisely defined indicators (like available solvency, surplus capital, capital adequacy and others) were developed to eliminate this imprecision.

The definition of solvency margin used here is based on the definition of available solvency included in IAIS Glossary of Terms (see IAIS 2006):

Available Solvency

Surplus of assets over liabilities, both evaluated in accordance with domestic regula-

tion (either in accordance with the rules of public accounting or with special supervisory

rules); and taking into account domestic requirements as regards eligible capital ele-

ments, that is, the amount of capital appropriate to cover the required solvency margin

in accordance with domestic law or supervisory regulations.

Let

A be the total amount of assets on the balance sheet,

Ad the amount (included in A) to be deducted for prudential reasons (for example,

intangible items, percentage of market value),

TP the total amount of technical provisions on the balance sheet evaluated in accor-

dance with domestic regulation (either public accounting or supervisory rules),

TPd the amount included in TP representing an eligible capital element to cover the

required solvency margin (for example, the free profit reserve),

OL the total amount of other liabilities (provisions) not directly linked to obligations

under insurance contracts,

OLd the amount included in OL representing an eligible capital element (to cover the

required solvency margin (for example, subordinated loans),

F the total amount of free capital (that is, balance sheet items not belonging to TP

or OL), [J: box continues unbroken]

Fd the amount included in F to be deducted (for example, share capital not paid), and

I the implicit (off–balance sheet) elements eligible to cover the required solvency

margin (for example, hidden reserves, future profits estimated in accordance with

domestic law).

Then the available solvency, AS, is equal to

AS = [A–Ad]–[(TP–TPd) + (OL–OLd)]–Fd + I. (the “solvency formula”)

and

F = A–TP–OL.


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By definition, the formula could be simplified to

AS = F – Ad + TPd + OLd – Fd + I.

This formula may be interpreted as available solvency on the balance sheet, ad-justed for any off-balance sheet item, or as appropriate under supervisory rules.

Solvency Margin then can be defined as follows:

Usually, expressing the solvency margin as a percentage is more useful, as it gives a clearer picture of the solvency situation of the market (and of individual companies).

Analysis of the market solvency situation consists of:

• Calculation of market available solvency and market solvency margin (as a sum of available solvency of individual companies)

• Comparison of the solvency margin level required by legislation with the actual solvency margin

• Evaluation of the positions of individual companies within the market.

Negative deviations of individual companies from legislative requirements as well as significant deviations from the market average (such as -10 percent from the market average) need an immediate supervisory investigation and/or action.

The supervisory authority also should periodically consider whether the requested minimum solvency margin is sufficient from the consumer protection perspective, and whether individual companies submit reliable and reasonable data. In particular, the claims provisioning approach may influence the calculation of required solvency quite significantly. In doubtful cases, as a protective measure, legislative change may be con-sidered.

return on equity

This indicator will be discussed only in brief, as it does not have a direct impact on the supervisory authority’s activities, still it is very important from the investor’s point of view.

Solvency Margin

1. Available solvency expressed in absolute terms (monetary units), or

2. Proportionate relationship of available solvency to liabilities of an insurance com-

pany expressed as a percentage.


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Unsatisfactory return on equity (ROE) can lead to investors’ withdrawal (sale of their investments) from insurance companies and thus lead to instability of the insur-ance sector.

Activity of supervisory authority with respect to this indicator should be to:

• Calculate insurance market ROE• Compare insurance market ROE with ROE of other industries• In case of low performance of the insurance industry, analyze the reasons and,

to the extent that these factors can be influenced by the supervisory authority, implement appropriate measures leading to a more favorable environment.

Acceptable values of this indicator usually are 10 percent to 18 percent, but they may vary significantly in individual markets. Longer-term under-performance of com-panies (low values of ROE) could lead to loss of investors’ interest and thus to market exits, while values exceeding 18 percent are suspect from a consumer protection per-spective.

Analyzing market conduct of insurance companies

This subsection describes indicators the values of which clearly are expressed in fig-ures (in other words, may be subject to quantitative analysis), while verbal commentary plays only a complementary role. It is more difficult to define a comparative scale (or indicator) that enables measuring and analyzing the conduct of insurance companies in the market. Nevertheless, consumer protection is the dominant task of the supervi-sory authority, and supervision of market conduct of insurance companies often forms a significant part of it. Therefore, the market conduct of insurance companies and its development also should be analyzed.

Consumer protection can be split into two processes. The first is general preventive protection through (a) supervising the financial soundness of insurers, which as a conse-quence means their abilities to meet their existing and potential future liabilities–that is, prudential supervision; and also by (b) supervising the market conduct of companies, that is, their compliance with rules of conduct established by the supervisory authority and/or elsewhere in the legislation. The second process is follow-up. This is protection of a particular case, that is, dealing with a given situation in which (a) the consumer is either a victim of an event insured under the existing policy or a (potential) victim of

Return on Equity

Proportionate relationship of a company’s net profits to shareholders’ funds, expressed

as a percentage.


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nontransparent or misleading advertising; and/or (b) there has been market miscon-duct by an insurance company’s distribution network.

The follow-up, particular case protection may involve frequent and detailed re-porting by the insurers (including detailed reporting individual cases and passing the complete case files to the supervisory authority) to be fully efficient and create strong pressure on the insurers with respect to consumers’ (policyholders’) protection. On-site inspections often include inspection of complaints and problematic claims files (par-ticularly those that proceed very slowly and/or lead to a lawsuit), and of revised adver-tising materials, policy forms, and other printouts used for advertising, marketing, and concluding policies, particularly if such an inspection is not performed on the basis of reports to supervisors and/or off-site monitoring.

Dealing with consumers’ complaints and claims is briefly mentioned in ICP 25 - Consumer Protection, in which essential criterion e says: “The supervisory authority requires insurers and intermediaries to deal with claims and complaints effectively and fairly through a simple, easily accessible and equitable process.”

The following sections briefly comment how market analysis may help in assessing this requirement.

consuMers’ coMplaints

Market analysis of consumers’ complaints consists of:

• Analyzing the frequency of complaints• Analyzing the timeliness in answering the complaints• Analyzing the fairness of the approach in answering the complaints.

There are no established standards for how to evaluate the frequency of consumers’ complaints and the timeliness and fair approach of their responses. Therefore, the ex-ample below describes just one possible system, which can be replaced by another one or further developed and/or adjusted to local market environments and legislation.

When analyzing complaints, the insurance supervisor will be in a difficult position. It is not only the number of complaints that must be considered, but also their reason-ability and severity–and here the correct assessment and evaluation not influenced by subjective view need a large experience. Similarly difficult are the assessment and evalu-ation of fair answering of complaints.


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exaMple

To enable transposition of consumers’ complaints40 (collected both by the supervisory authority and by the insurance company) into a measurable indicator enabling evalua-tion of development over time, the insurance authority may establish a “severity scor-ing,” for instance:

• 1 points for ungrounded complaint • 2 point for complaint on incorrect behavior without financial impact on con-

sumer41

• 3 points for complaint on incorrect behavior with small financial impact on consumer

• 4 points for complaint on incorrect behavior with medium financial impact on consumer

• 5 points for complaint on incorrect behavior with large financial impact on con-sumer.

Similarly, “timeliness scoring” may be as follows:

• 1 point for answer without unnecessary delay• 2 points for answer within reasonable period • 3 points for delayed answer • 4 points for significantly delayed answer.42

If the answer needs a preparation period (that is, the complaint cannot be dealt with immediately), the insurance company should send an immediate “registration” letter informing the complainant

• That the complaint was received by the company, or • That the complaint was passed on for further processing (and to whom)• When the “material” reply will be sent.

Loading of 1 point will be added in the case of missing (one of) the above-men-tioned items in the “registration” letter and another 1 point in case of late dispatch of such letter.

“Fairness scoring” may be as follows:

• 1 point for fair and formally correct answer

40. Every kind of complaint should be included: ungrounded or unfair refusal of claim settlement, reduction or delay in claim settlement, incorrect attempt to terminate policies, unfair advertisement, and unclear insurance terms and conditions.41. Any financial effect on the client caused by incorrect behavior by the insurer is not acceptable. Here the words “financial effect” are used only as an abbreviation meaning “What would happen if the client did not raise the complaint?”42. All complaints must be answered. Therefore, a temporarily missing answer is scored as “What would the scoring be if the answer is dispatched at the moment of scoring?”


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• 2 points for fair answer with formal mistakes• 3 points for answer whose fairness is disputable43

• 4 points for unfair answer.

Then, the severity scoring Sc, timeliness scoring Tc, and fairness scoring Fc relative to the number of policies NP in the current period can be expressed as:

Sc = (Σ (si–1)) / NP, where si is the scoring for the i-th complaint44

Tc = (Σ (ti–1)) / NP, where ti is the scoring for the i-th complaint45

Fc = (Σ (fi–1)) / NP, where fi is the scoring for the i-th complaint46

and total scoring of market conduct with respect to giving reasons for complaints and answering them, in the current period, TSc may be calculated as:

TSc = (Σ (si * ti * fi–1)) / NP.

To evaluate the overall situation in complaints (including outstanding complaints from previous periods), indicators St (and similarly Tt, Ft and TSt) may be expressed as:

St = Sc + Sp, where Sp is equivalent of Sc for outstanding past complaints.

Such scoring can be performed either on the basis of the regular reporting of in-dividual insurance companies or, better, as a part of on-site inspections, and further evaluated and analyzed market-wide on a regular basis and with respect to develop-ment over time. Companies showing results worse than the market average will deserve larger attention of the supervisory authority.

claiMs handling

Similarly to complaints, claims handling should be evaluated with respect to timeliness and fairness. Unlike complaints, it is impossible to deal with individual claims. Howev-er, the supervisory authority may require from individual companies statistics showing the average settlement time and percentages of claims and amounts paid within certain time limits after claim notifications by the policyholders. Fairness also may be evaluated as a success ratio of claims disputed by the consumers and/or insurance companies at the court (that is, the number of disputes resolved by the courts in favor of the insur-ance companies, expressed as a percentage of the total number of court cases).

43. All complaints ultimately must be answered in a fair way. Thus, after an unfair answer, the supervisory authority must use a corrective measure and enforce a fair answer that is subject to additional scoring.44. One is deducted to eliminate ungrounded complaints.45. One is deducted to eliminate complaints answered in a timely manner.46. One is deducted to eliminate complaints answered fairly.


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No generally accepted standards exist in this respect. Due to the scope of this mod-ule, it is left to the reader to determine how the supervisory authority may approach this area. Inspiration may be taken from the example presented above. It is obvious that the accepted solution will largely depend on the local legislation, market development level, and capabilities of the supervisory authority.

fair coMpetition behavior

While all indicators mentioned above enable quantitative analysis (although sometimes quantification is difficult), the overall market behavior is hardly quantifiable. Yet, mar-ket analysis is also important in this area. To analyze fair competitive behavior, the definition of such behavior is first needed–and even this is not easy. In general, market behavior includes all ways in which the insurance company interacts with the public:

• Advertising• Policy forms, general terms and conditions, and other printouts intended by the

insurance companies for public use• Internet pages of insurance companies• Branch offices open to consumers• Distribution networks• Activities within insurance associations and similar institutions (such as nuclear

insurance pools, green card offices)• Press conferences, press releases.

Market behavior should be fair to all market players—policyholders, competitors, brokers, and agents—and also to the broader environment, that is, the general public. Significant offenses with respect to market behavior usually are identified and classified in the insurance legislation, including adequate corrective measures that can be clearly imposed on misbehaving companies. Still, there can be a “grey area” of ambiguous in-terpretation of the law, gaps in legislation, and misbehavior that is identified and clas-sified insufficiently.

Fair behavior can be broadly defined in following way:The insurance company behaves fairly in the market if it:

• Does not breach existing legislation• Performs public disclosure in a transparent and adequate way• Its insurance terms and conditions and policy forms are written in a simple,

transparent language and in a manner that does not leave room for misinterpre-tation

• Does not misinform in its advertising and marketing


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• Sells its products in such a way that the consumer always knows what s/he buys.

Markets in which insurance companies have established and adhere to a “code of conduct” (for example, within the insurance association) usually are well “self-regulated.” Competing companies follow the market’s development, identify possible misbehavior, and solve existing complaints either among themselves (that is, at the association) or by complaining to the supervisory authority. Therefore, it is highly recommended to support the establishment of such a code where it does not exist (this code usually ad-dresses issues discussed in this subsection in a more detailed and comprehensive way than does this module).

Misbehavior can include, for example:

• Displaying information important to the policyholder (for example, exclusions from the insurance cover, coverage sublimits, conditions on policy termination, conditions on claims reporting) insufficiently (in small letters or only at the end of forms and printouts).

• Disseminating misinformation in advertising and marketing (emphasizing ad-vantages of insurance products while keeping silent on their disadvantages).

The insurance supervisor’s role is to

• Monitor and analyze market behavior of insurance companies• Take measures against uncovered misbehavior in cases covered by existing leg-

islation• Seek amendment of legislation in cases in which misbehavior cannot be ad-

equately addressed by existing legislation.

Analyzing distribution channels

Insurance legislation also usually includes regulation of distribution channels. Indeed, it would be difficult to supervise insurance without having the possibility to supervise brokers, agents, and other intermediaries and distribution facilities. The challenges in-volved in the supervision of distribution channels have significantly increased with the introduction of distance selling (offer and sale of insurance service via telephone and internet).

Analysis of distribution channels consists in keeping an eye on the development of shares in individual lines of insurance sold through various distribution channels, finding explanations why the share of a particular channel is increasing or decreasing, and checking whether transfer from one channel to another is not triggered by insuf-ficiencies in legislation.


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Sometimes, it may be difficult to obtain fully consistent and detailed data across the market.

Analyzing availability of products

Insurance products should be widely and easily available in a competitive environment to disable the misuse of market power by the dominant players. The insurance super-visor’s task is to collect information on the market with respect to individual products, analyze it, and take measures when necessary.

Availability of products can be shown in the form of simple table, as shown in table 3.47 It is important that such information is broadly available to the public, thus help-ing consumers to find solutions in covering their insurance needs. In case some of the companies do not operate throughout the whole market territory, the information also should be supplemented with information on the availability of products in various geographical areas.

More detailed analysis can be performed by using indicators (concentration ratio, Herfindahl Index) described above, analyzing market structure and competition using information relating to the market shares of companies for individual products.

The supervisory authority can use the results of analysis of product availability in following way:

• concentrate supervision on companies providing products where competition is insufficient (possible misuse of market power)

• taking measures, perhaps including recommending changes in legislation, in case of unavailability or insufficient availability of some products.

If products of significant economic importance are not available to the public, measures can go as far as creating state organized insurance schemes.48

State intervention in response to the unavailability of insurance products may be triggered by

• Reluctance of the private sector to provide cover after bad past experiences• Low possibility of calculating an adequate price for the cover (for example, pro-

tection against terrorism)• Unacceptability to the public of the price (price charged by the private insur-

ance companies is too high due to the uncertainty of results. Again, protection against terrorism may serve as an example.)

• Insufficient capacity of the private insurance sector to cover the potential loss• Other reasons.

47. The example is taken from the Czech Insurance Association Annual Report 2003.48. These schemes may involve pooling arrangements with state participation. Protection against natural catastrophes in France, against terrorism in the United Kingdom, or against floods in the United States may serve as examples.


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Tabl

e 3.

Insu

ranc

e pr

oduc

ts a

vaila

blle

in th

e Cz

ech

mar

ket


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Analyzing market developmental level

Indicators in this section—insurance density and insurance penetration—are of an in-formational nature only. They do not directly impact the execution of insurance su-pervision; therefore, they are mentioned only in brief. They serve as tools to enable the comparison of individual markets and for the analysis of market development over time.49

insurance density

This indicator enables a relatively reliable and fair comparison of individual markets. Its calculation needs only broadly available information (insurance market volume and numbers of inhabitants); therefore, it is easily accessible. Insurance density is usually calculated separately for life and non-life sectors. Its value, however, does not purely reflect the relevant country wealth but can be impacted by local jurisdictional and par-ticular market conditions.

For example, in countries in which local legislation requires or encourages retire-ment pensions to be funded through life insurance products, the ratio of life insurance density compared to non-life insurance density is significantly above average. This is demonstrated in the figures 3 and 4 below, taken from the Swiss Re Sigma publication. 50 Finland, Japan, and South Africa serve as typical examples. In this respect, in Iceland, pensions are not funded through insurance; therefore, Iceland’s spending on life insur-ance is low despite the relative economic wealth of its inhabitants).

insurance penetration

49. Benfield Group 2004c and Swiss Re 2003 may serve as examples of market analyses assessing an insurance market’s devel-opmental level. Swiss Re and the Benfield Group use indicators from this section and combine them with the descriptions of the financial and economic environments of the markets.50. See Swiss Re 2004. This publication may serve as an example of a comprehensive analysis based on relatively simple data; gross domestic product, premium volume, and number of inhabitants.

Insurance Density

Amount spent on purchasing insurance per capita during one year, expressed in mon-

etary units.

Insurance Penetration

Proportionate relationship of total market premiums to gross domestic product, ex-

pressed as a percentage.


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Similarly to insurance density, insurance penetration is also easy to calculate because it is based on widely available information. This indicator normally is used to compare market development: the higher the insurance penetration ratio, the more developed the market. As with insurance density, this interpretation is subject to the caveat that in countries in which pensions are not funded through life insurance, the insurance penetration may be lower than in other countries, despite similar levels of both market development and country wealth.

Differences in the value of this indicator between the most and least developed markets are striking. The values range from less than 1 percent for some African and Asian countries to more than 10 percent (South Africa, Switzerland, and United King-dom, among other countries).

Both indicators described above (insurance penetration and insurance density) highly correlate, despite the fact that one is expressed as monetary units and the other as a percentage.

Insurance companies’ ratings

In some respects, rating agencies, and independent auditors perform tasks similar to those of the supervisory authority. They check financial soundness, performance, and strategies of (re)insurance companies and markets. Outcomes of their activities and comparisons of their findings and conclusions with those of the supervisory authority may be of interest to the insurance supervisor. Development of ratings over time also may serve as an indicator of market stability.51

Reinsurance

Reinsurance is a stabilizing factor for insurance companies.52 It is relatively easy to cal-culate the impact of reinsurance after an event or at year-end; it is not, however, easy to calculate how much reinsurance is needed in advance. There are several basic risks connected with reinsurance that should be analyzed by the supervisor:

• Risk of insufficient reinsurance cover, which can be further split into

– Risk of too high net retention (insurer is not sufficiently covered in case of large claims or an unexpected frequency of smaller claims)

51. The reader can find more details on the way that rating agencies assess insurance companies; see Standard and Poors and Swiss Re 2003. Particularly interesting to the reader may be the comparison of rating scales used by Standard and Poor’s, Moody’s and A.M. Best (Swiss Re 2003, p. 13) and in the internet pages of rating agencies (see links mentioned in the Refer-ences).52. Let us use the Czech insurance market as an example: unprecedented insured losses incurred during August 2002, reach-ing approximately CZK 35 billion (US$ 1.4 billion), which represented an additional loss ratio of more than 60% for the non-life sector. Reinsurance paid more than 98% of these losses; without reinsurance, all the local insurance companies would have gone bankrupt.


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– Risk of insufficient reinsurance capacity (particularly in the case of cata-strophic events)

• Risk of unavailability of reinsurance53

• Counterparty credit risk of failing reinsurers.54

One of the frequently used methods in risk management is modeling results on the basis of various adverse scenarios. This method should be also employed by supervisory authorities on the market-wide level. It is particularly useful for assessing whether their reinsurance protection is adequate for the risks underwritten by the insurance compa-nies. However, the existing sophisticated tools used by the insurance markets55 have not been constructed to serve the needs of insurance supervisors but rather those of the individual insurance companies.

The position of the supervisory authority with respect to the market reinsurance protection analysis is further complicated by the fact that the scope of protection varies over time. Insurers usually tend to buy more protection when the market is weak (that is, reinsurance is cheap) and increase their retentions (that is, buy less reinsurance) when the market is hard.

Individual companies can never be fully protected against all of the risks that they meet when pursuing their activities. On the other hand, they should buy sufficient re-insurance protection. In the case of catastrophic events, many believe that reinsurance should provide protection from failure due to events that are expected to occur no more frequently than once every 200 years.

Non-traditional reinsurance56 and the fact that it may impact the market also should be mentioned here. However, details would go behind the scope of this module. Furthermore, the approach to nontraditional reinsurance by individual supervisory au-thorities is not yet uniform.

53. This may become an issue particularly after large events, when reinsurers become reluctant to participate in potential rep-etition. Indeed, such was the case after the floods mentioned above. An even better example is reinsurers’ reluctance to cover terrorist risk after the 2001 World Trade Center attack.54. The analysis of reinsurance credit risk got a new dimension after the World Trade Center attack, and new approaches to this issue triggered by this event are still under development. See Benfield Group 2004a for a possible approach to this risk.55. Flood modeling software ZURS prepared by the German Insurance Association or its equivalents in England, Czech Republic, and other countries.56. A non-traditional reinsurance contract transfers risk (as does traditional reinsurance), but also has financial elements (such as financial risk hedging).


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F. Organizing market analysis at the supervisory authority

To achieve its objectives, the supervisory authority supervises the financial soundness of individual insurers and contributes to the financial stability of the insurance market. Proper analyses of individual companies, the insurance market, and the national and international contexts are essential to achieve this end.

There are no internationally accepted standards of how to organize market analysis at supervisory authorities. Individual supervisory authorities deal with this matter in very different ways. The following subsections provide a general description of the steps taken by the supervisory authority when preparing and maintaining market analysis. For some supervisory authorities, this information may serve as a guideline how to establish a market analysis function within their frameworks. Others may use it as a checklist for completeness and evaluation of activities already performed.57 To keep it concise and clearly organized, the subsection on the organizing schedule contains only the list of activities, while the following subsection explains individual activities and comments on them.

Organizing schedule

The establishment of market analysis at the supervisory authority should be well planned. The intended nature, scope and purpose of the market analysis function, as well as the market environment (availability of data and availability of analyses from insurance related areas) will significantly influence

• Choice of the person suitable as market analysis coordinator• Needed staffing levels and capabilities.

Depending on the above conditions, the qualifications required of the market anal-ysis coordinator should be established. Market analysis performed at the supervisory authority should include:

• Regular preparation of insurance indicators and their development trends• Regular preparation of indicators from insurance-related areas (such as invest-

ment, demofigurey, and road accidents), their development trends, and the evaluation of their importance (influence) for the insurance market

• Ad hoc, irregular analytical reaction to important events (both with respect to insurance events such as natural catastrophes and market environment devel-opment events such as changes of legislation) influencing significantly the mar-ket.

57. For more detailed information see National Association of Insurance Commissioners, Market Analysis Handbook.


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The main objectives of the market analysis at the supervisory authority (nature, scope, purpose) will be further fine-tuned during the market analysis establishment process.

1. Appoint a responsible market analysis coordinator.2. Define data to be collected for market analysis and information to be publicly

released.3. Explore and communicate possible sources of data and data publishers.4. Establish procedures to check accuracy of data provided.5. Define indicators to be calculated and market analysis procedures to be per-

formed on the basis of data provided.6. Define tolerance limits for individual indicators.7. Establish regular schedule of communication with data providers (sources of

data) and data publishers, and the schedule of market analysis activities. 8. Draw conclusions with respect to actions to be taken as part of the supervisory

process based on results of market analysis.9. Regularly review and modify scope of market analysis and publicly released data

as defined in the paragraph numbers above.10. Decide on the scope of additional reporting and analysis in case of particular

market-wide events of importance for the market’s financial stability.

Comments and explanations

Market analysis is work with information. As with any work that depends on infor-mation, the market analysis will be unsuccessful and not useful if the information is incomplete, delayed, not available, or not used. The features of availability, timelines, completeness, and proper use are particularly important for the exchange of informa-tion within the supervisory authority. Indeed, the insurance supervisors themselves (among others) should supply the data for market analyses and also should obtain the largest benefit from it!

1. The market analysis coordinator should be a:

• Skilled person with experience in the insurance industry and financial mar-kets

• Good organizer and communicator• Person with mathematical background and good analytical abilities.

Performance of market analysis requires skilled resources, which may not nec-essarily be immediately available at the supervisory authority. Therefore, the market analysis coordinator may think also of using market analyses from oth-


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er sources and/or outsourcing some of the required activities. If this is done, confidentiality of information within the particular legal environment must be observed and taken into account. It is the responsibility of the market analysis coordinator to establish sufficient capacities and resources to apply the market analysis results in the supervisory process. From a long-term perspective, these working capacities should be available direct (internally) at the supervisory au-thority, as required in general in ICP 3 - Supervisory Authority.

2. Data:

• Must be clearly and unambiguously defined to enable market-wide compari-son and compatibility

• Will include

– Information required to assess the financial soundness of insurers (that is, data from financial statements of individual insurers)

– Other information collected by the supervisory authority during report-ing and off-site monitoring

– Data collected during on site inspections – Data collected from other sources.58

Information that might be publicly released by the insurance supervisory au-thority or others comprises not only “pure insurance” data but also data de-scribing the general development of the economy (such as GDP, inflation, and interest rates). Publicly released information should contain not only the cur-rently collected data, but also

• Data from previous periods (to show development trends)• Results of market analysis (analytical indicators) when appropriate• References to other information sources• Verbal comments on the development of the insurance market, and on

the economic, legal, and financial sector environments• Evaluation of the period since the previous public release, including the

description, comments, and data on particular market-wide events.

The scope of market-wide, publicly available information might be broadly con-sistent with the information requested for public disclosure by individual insur-ers.59

58. Description and analysis of the market, its financial environment, international comparison, and insurance-linked data require numerous sources of diverse data, for example, police (statistics of street accidents), financial analysis institutions (de-velopment of prices), and firemen (fire statistics). For understanding on the variety of collected (and consequently published) information in a developed market see, for example, Insurance Information Institute 2004. Further considerations of data sources data are included in section C.59. For details see ICP 26 - Information, Disclosure and Transparency toward the Market.


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3. As explained in paragraph 2 above, diverse data (and data sources) are needed to enable a comprehensive market analysis and public release of relevant infor-mation. Initial contacts must be made and regular communication established with such sources. It is not necessary that the supervisory authority itself carries out the public release of information. However, even if the release is made by another entity (such as the association of insurers or an independent analyst in-stitution), the supervisory authority is responsible that sufficient market data is available. Therefore, external publishing may be organized in cooperation with the supervisory authority and the minimum scope of published information mutually agreed.

4. Correctness of data (particularly data important to evaluate the financial sound-ness of individual insurers) must be checked to ensure that it will provide a proper basis for the supervisory evaluation and reliable information for con-sumers. Tools and requirements for relevant checking processes are described in other ICPs.60 Collected data should be analyzed, combined into indicators, and further processed to enable efficient and transparent use in supervisory processes. This thorough processing requires written clear and unambiguous definitions and descriptions of involved indicators, formulas, methods, and pro-cesses.

5. An important purpose of market analysis is to prompt supervisory intervention as referred to in ICP 14 - Preventive and Corrective Measures. To achieve this end and to act transparently, tolerance limits (limits and thresholds representing “warning level” and/or “action level” of individual indicators and other results of market analysis) must be defined.61 Exceeding these limits should trigger an appropriate supervisory reaction as mentioned in paragraph 8 below.

6. To achieve reliable and timely performance of all activities, a detailed schedule (including description of activities, time limits, and responsible persons) must be defined, recorded, and made available for all concerned This schedule should include not only communication with external partners but also communica-tion and data flow among individual departments of the supervisory authority, as well as communication with other concerned financial market authorities, both domestic and foreign.

7. Exceeding the tolerance limits should trigger an appropriate (re)action. This paragraph number has a close link with paragraph 6. The supervisory process

60. See ICP 12 - Reporting to Supervisors and Off-Site Monitoring and ICP 13 - On-Site Inspection for details.61. “Warning signals” can be, for example, significant change in the consumer ratio, sharp increase or decrease of written pre-mium, significant change in product mix, rapid expansion in new areas, large exposures and concentration of risks, significant changes in management expenses, changes in ownership and key managers, significant changes in provisions not correspond-ing to paid claims, fast changes in claims ratio, and significant deviations from market benchmarks. These “signals,” and particularly threshold values of relevant indicators, may be substantially different depending on particular market conditions. It is not possible to go into details within the framework of this module.


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is a complex issue, and excess of tolerance limit(s) must be considered together with all circumstances. In other words, the excess does not necessarily imply an immediate automatic intervention activity defined in advance but rather a deci-sionmaking process on how to address the current situation. To emphasize this factor, setting the tolerance limits was separated from defining the (re)action. Comments on timeliness, completeness, and availability of information men-tioned in the introductory paragraph of this section are of highest importance here.

8. All the above activities should be designed in a stable way that does not require frequent changes. However, due to

• Changes in the market• Development of the skills and capacities of the supervisory activity• Achieving a higher level of consumer protection

it is necessary to regularly check and review the appropriateness of market anal-ysis activities and publicly released information.

9. It is impossible to predict all possible developments.62 Consequently, particular market-wide events that are not sufficiently envisaged in the numbered para-graphs above must be addressed case by case.

62. Examples are the terrorist attack in New York on September 11, 2001 or Central European floods in August 2002.


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G. Exercises

The following exercises are designed to help you evaluate your understanding of mar-ket analysis. Therefore, where an answer requires using words, you are encouraged not to use the exact words and sentences that appear in this module (although the sample answers in appendix II are constructed in this way) but to answer using the key words succinctly.

On the other hand, the exercises that require numerical answers should be accom-panied with explanations (words, not mathematical proofs) showing that the correct answer is not a result of guessing but of understanding. Some questions are relatively difficult with respect to numerical calculations, so the preferred way to solve them is to use an electronic calculator or personal computer. It is not the purpose of this module to test your numerical calculation abilities. On the other hand, market analysis is a world of numbers, figures, and tables and figures.

1. What are the learning objectives of this module? List as many as possible!

2. What are the essential criteria of ICP 11 - Market Analysis?

3. What are the benefits of market analysis for the insurance supervisor?

4. What are the steps to establish a market analysis function at the supervisory authority?

5. What are the methods of checking and improving the sensitivity of market anal-ysis?

6. What are some possible changes in the environment in which the market oper-ates? How can they influence the market?

7. The concentration ratios of a market are: CR4 = 56 percent, CR8 = 82 percent. Can we guess something about the number of companies in this market? What is the minimum number of companies in a market with these parameters?

8. What is the maximum possible value of the Herfindahl Index?

9. What is the minimum possible value of the Herfindahl Index in a market with 25 participants?

10. The average claims ratio of an insurance market is 77 percent and the average expense ratio is 26 percent. The combined ratio is thus 103 percent. Does this percent mean that this market is unprofitable?


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11. The following lines show some figures relating to the operation of an insurance market:

• Overall annual profit 100 million monetary units (MU)• Annual earned premium 800 million MU• Nontechnical (overall) result 4 times higher than technical (underwriting)

result• Incurred claims during the respective year twice as high as the insurers’ ex-

penses.

Calculate the claims, expense, and combined ratios of the market.

12. Due to a measure taken by the supervisory authority, the existing claims provi-sions relating to claims incurred during the current period by insurance compa-nies A, B, and C operating in the market must be increased by 20 percent. What is the impact of this measure on the claims, expense, and combined ratios of the market, provided that:

• Company A claims provisions for claims incurred during the current period represent 50 percent of the earned premium; claims ratio is 60 percent; and expense ratio is 35 percent.

• Company B claims provisions for claims incurred during the current period represent 20 percent of the earned premium; combined ratio is 92 percent; and expense ratio is 26 percent.

• Company C claims provisions for claims incurred during the current pe-riod are 20 million monetary units (MU); company’s expenses are 30 million MU; earned premium is 100 million MU; and paid portion of the incurred claims is 40 million MU.

• Market shares of companies A, B, and C based on earned premiums are 50, 30, and 20 percent respectively.

We assume that earned premium of companies A, B, and C is equal to their writ-ten premium.

13. Insurance company A has 1,000,000 clients and on average 1.5 policies per client, and during previous year recorded 50 complaints per month. Insurance compa-ny B has 30,000,000,000 MU of written premium, average premium 60,000 MU per policy, and 60 outstanding complaints from previous year; 80 percent of the complaints have been already settled. Which company has a lower frequency of complaints?


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14. Given the situation in the previous question, can we conclude that the insurance company with a lower frequency of complaints has a better market conduct than the other company?

15. A market has the following parameters:

• GDP 10,000,000,000,000 MU• 20,000,000 inhabitants• Insurance penetration 4.5 percent.

What will be the increase in insurance density (insurance spending per capita) after 5 years if GDP grows 4 percent per year and population 0.5 percent per year, and the insurance penetration ratio at the end of this period is 7.5 per-cent?

16. What will be the market growth of the market described in question 15 in nomi-nal terms and in real terms (considering 2 percent inflation) over this period of 5 years?


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H. References

All sources mentioned below are in English (except Czech Republic item, which is avail-able only in Czech), some of them are available also in other languages.

Australian Prudential Regulation Authority (APRA). 2002. “Life Insurance Trends.” December Quarter. <http://www.apra.gov.au/Statistics/loader.cfm?url=/com-monspot/security/getfile.cfmandPageID=5493>

Benfield Group. 2004a. “Looking for a Premium” (Reinsurance Credit Risk and Bond Default Rates). February. http://www.benfieldgroup.com/research/reports/industry+analysis+and+market+review/lookingforapremiumfeb2004.pdf.

———. 2004b. “Hurricanes Hardly Ever Happen.” <http://www.benfieldgroup.com>———. 2004c. “Central and Eastern European Insurance–Accession Dividends”. Octo-

ber. <http://www.benfieldgroup.com/research/reports/industry+analysis+and+market+review/central+and+eastern+europe+october+2004.pdf>.

Bennett, C.1992. Dictionary of Insurance. London: Pitman Publishing.Czech Insurance Association. Annual Report 2003. <http://english.cap.cz/soubor.

aspx?id=46>Czech Republic. State Insurance Supervision, Ministry of Finance of the Czech Repub-

lic. Vyrocni zprava 2003 (Annual Report 2003). (Available only in Czech). <http://www.mfcr.cz/static/FinTrh/Pojistovny/VyrocniZpravy/VZ_2003_POJ.pdf>

European Commission. 2004. Paper, Markt/2513/04-EN. October.Federal Financial Supervisory Authority. 2003. Jahresbericht der Bundesanstalt für Fi-

nanzdienstleistungsaufsicht (BaFin) (German). <http://www.bafin.de/jahresberi cht/jb03.pdf>

HIH Royal Commission. 2003. “Failure of the HIH Insurance. Report of the HIH Royal Commission.” http://www.hihroyalcom.gov.au.

Insurance Information Institute. 2004. Property Casualty Fact Book 2004. <http://www.iii.org/.>

Description and orders: <http://www.internationalinsurance.org/international/publications/.>

Online version: http://www.internationalinsurance.org/international/toc/.International Association of Insurance Supervisors (IAIS). 2003. Insurance

Core Principles and Methodology. October. <http://www.iaisweb.org/358coreprinicplesmethodologyoct03revised.pdf.>

———. 2006. Glossary of Terms. March. Available at <http://www.iaisweb>.Klein, R.W., and M.F. Grace. 1999. “The Industrial Organization of the U.S. Life Insur-

ance Industry: Issues and Analysis in the Structure of the Industry.” Georgia State University Center for Risk Management and Insurance Research. No. 99-7. http://rmictr.gsu.edu/Papers/IndOrg.pdf.


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National Association of Insurance Commissioners. Market Analysis Handbook. Description: <http://www.naic.org/insprod/catalog_pub_supplementary.

htm#market_ana>. Order: <http://www.naic.org/insprod/catalog_pub_svo_how_to_order.htm>.Standard and Poor’s. Ongoing. A Guide to Insurance Ratings. <http://www2.standarda

ndpoors.com/>. Swiss Re. 2003. “sigma 4/2003 Insurance company ratings.” http://www.swissre.com/.———. 2004. “sigma 3/2004 World Insurance in 2003.” <http://www.swissre.com/>.The Treasury Committee. 2001. “Equitable Life and the Life Assurance Industry: An

Interim Report.” March. <http://www.parliament.the-stationery-office.co.uk/pa/cm200001/cmselect/cmtreasy/272/27206.htm>.

Useful internet links

Additional sources of information relating to insurance market analysis:

• A.M.Best (insurance rating agency). http://www.ambest.com. • Axco (consulting firm preparing market analyses). http://www.axcoinfo.com/.• Moody’s (insurance rating agency). http://www.moodys.com/.• Benfield (reinsurance broker). http://www.benfieldgroup.com. • Standard and Poor’s (insurance rating agency). http://www.standardandpoors.

com. • Swiss Re. http://www.swissre.com/.


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Appendix I. ICP 11

Explanatory Notes

11.1. In order to achieve its objectives, the supervisory authority supervises the fi-nancial soundness of individual insurers and contributes to financial stability of the insurance market. Both require an analysis of individual insurers and insurance groups as well as the market and the environment in which they operate.

11.2. In today’s globalised financial markets and rapidly integrating financial systems, economic developments and policy decisions of one jurisdiction may affect many other jurisdictions. Similarly, developments in the economy as a whole, or in one part of the financial sector, may impact the business operations and financial stability of the insur-ance market. To enable an assessment of financial data, it will be necessary to have an understanding of the basis of financial reporting in relevant jurisdictions.

11.3. In-depth market analysis helps identify risks and vulnerabilities, supports prompt supervisory intervention as referred in ICP 14 and strengthens the supervisory framework with a view to reducing the likelihood or severity of future problems. It is recognised that in-depth market analysis requires skilled resources.

11.4. A quantitative analysis of the market could include, for example, developments in the financial markets generally; the number of insurers and reinsurers subdivided by ownership structure whether a branch, domestic or foreign; the number of insurers and reinsurers entering and exiting the market; market indicators such as premiums, balance sheet totals and profitability; investment structure; new product developments and market share; distribution channels; and use of reinsurance.

11.5. A qualitative analysis could include, for example, reporting on general devel-opments which may impact insurance markets, companies and clients; new or forth-coming financial sector and other relevant legislation; developments in supervisory practices and approaches; and reasons for market exits.

ICP 11: Market analysis

Making use of all available sources, the supervisory authority monitors and analyses all

factors that may have an impact on insurers and insurance markets. It draws conclusions

and takes action as appropriate.


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Essential criteria

a. The supervisory authority conducts regular analysis of market conditions.

b. The market analysis not only includes past developments and the present situa-tion, but also aims to identify trends and possible future scenarios and issues, so that the supervisory authority is well prepared to take action at an early stage, if required.

c. The market analysis is both quantitative and qualitative and makes use of both public and confidential sources of information.

d. The supervisory authority or others, such as the insurance industry, publish ag-gregated market data that is readily and publicly available to the insurance in-dustry and other interested parties.

e. The supervisory authority requires market-wide systematic reporting to analyse and monitor particular market-wide events of importance for the financial sta-bility of insurance markets.

Advanced criteria

f. Insofar as international relationships affect internal insurance and financial markets, the analysis is not limited to the home market, but also includes developments elsewhere.

g. The supervisory authority monitors trends that may have an impact on the financial stability of insurance markets. It assesses whether macro-economic risks and vulnerabilities are adversely impinging on prudential safeguards, financial stability or consumer interests.


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Appendix II. Answer key

1. Compare your answer with the learning objectives in the Note to learner sec-tion.

2. Compare your answer with section B.


4. Compare your answer with section F.


6. Compare your answer with section D.

7. We can find the minimum number of companies in the market. The companies in 5th to 8th place have a market share of 26 percent. Therefore, the company in 9th place cannot have more than 6.5 percent (that is, the average of the 5th- to 9th-place companies, which is valid also for the 10th company). Hence, there are at least 11 companies in the market.

8. The Herfindahl Index formula is constructed to decrease when the competition improves. It reaches maximum value in the monopoly market: 10,000.

9. The Herfindahl Index formula is constructed to decrease when the competi-tion improves. In a market with given number of companies, the minimum is reached when the market is split into equal shares; in our case, 25 companies with a market share of 4 percent. In such a situation, the Herfindahl Index equals 400.

10. No. The negative underwriting result can be balanced by investment income.

11. Given the conditions of this example, the nontechnical result is 80 million mon-etary units (MU); technical result is 20 million MU. Claims and underwriting expenses, therefore, represent 780 million MU; the combined ratio is thus 97.5 percent. Two-thirds of it represents incurred claims (claims ratio = 2/3 of 97.5 percent = 65 percent), remaining third are expenses, that is, expense ratio = 32.5 percent.

12. Given the market share of individual companies and earned premium of Com-pany C, the earned premium of company A is 250 million MU, and the earned


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premium of company B is 150 million MU. Claims provisions of company A are 50 percent of the earned premium, that is, 125 million MU, and must be increased to 150 million MU. For company B, the respective figures are: claims provisions 30 million MU, and 36 million MU after the increase; for Company C 20 million MU and 24 million MU respectively. The whole market situation (after the calculation of missing items) is shown in the following table.

13. In the respective year, insurance company A had 1,500,000 policies and 600 complaints, a rate of 40 complaints per 100,000 policies. Insurance company B had 500,000 policies and 300 complaints, a rate of 60 complaints per 100,000 policies. Hence, company A has a lower frequency of complaints.

14. No. This information has only an indicative value. Further analysis must be per-formed and other factors must be taken into consideration. These factors include line of business, complexity of policies issued by both companies, severity of complaints, and ways in which the complaints were settled. Besides, complaints comprise only one part of the market conduct of companies. Their behavior in other areas such as advertising, sales, and transparency of their policy condi-tions also must be taken into account.

Earned premium

Claimsincurred

Claims paid

Claimsprovisions

Other tech. expenses

Claimsratio (%)

Expense ratio (%)

Combined ratio (%)

Before the increase

Company A 250 150 258 125 87.5 60.0 35.0 95.0

Company B 150 99 69 30 39.0 66.0 26.0 92.0

Company C 100 60 40 20 30.0 60.0 30.0 90.0

Market 500 309 134 175 156.5 61.8 31.3 93.1

After the increase

Company A 250 175 25 150 87.5 70.0 35.0 105.0

Company B 150 105 69 36 39.0 70.0 26.0 96.0

Company C 100 64 40 24 30.0 64.0 30.0 94.0

Market 500 344 134 210 156.5 68.8 31.3 100.1


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15. The answer is shown in the following table.

The increase in insurance density is from 22,500 MU to 44,501 MU, a growth of 22,001 MU, or by 97.8 percent.

16. The answer is shown in the following table.

The market growth is from 450 billion MU to 912.5 billion MU, which is a nom-inal growth of 103 percent over the five year period. After inflation adjustment, the growth was 84 percent.

GDP (MU)GDP

increase (%) PopulationPop.

increase (%)Insurance

penetration (%)Insurance

spending (%)

Insurancedensity (MU)

Startingposition

10,000,000,000,000 4.00 20,000,000 0.50 4.50 450,000,000,000 22,500

After 1 year 10,400,000,000,000 4.00 20,100,00 0.50

After 2 years 10,816,000,000,000 4.00 20,200,500 0.50

After 3 years 11,248,640,000,000 4.00 20,301,503 0.50

After 4 years 11,698,585,600,000 4.00 20,403,010 0.50

After 5 years 12,166,859,024,000 20,505,025 7.50 912,489,676,800 44,501

Insurance spending (MU)Insurance spending at starting

position (MU) (inflation adjusted)

Starting position 450,000,000,000 450,000,000,000

After 1 year 459,000,000,000

After 2 years 468,180,000,000

After 3 years 477,543,600,000

After 4 years 487,094,472,000

After 5 years 912,489,676,800 496,836,361,440

icp 11: market analysis

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