Why Premiums Change
The Tariff and the Effect of Competition
Until the mid 1980’s, commercial insurance premiums were routinely stable. This stability was inculcated into the system by tariffs which applied throughout the entire market.
It made little difference whether you bought your commercial insurance from Commercial Union or General Accident.
In the 1970’s, increased competition from American insurers and a developing government view that the tariff system was anti-competitive led to it being formally abolished in 1984.
This freed insurers to charge what they thought was the correct rate for the risk and as demonstration that they are frequently wrong, neither of the above mentioned companies now exist.
Since the abolition of the tariff, over fifty composite insurers have collapsed or been rescued by merger and acquisition.
The reason this has happened and the reason the commercial insurance market remains dangerously unstable is best explained by comparing it to a more conventional business.
Value Chain Analysis
IN A MANUFACTURING BUSINESS, FOR EXAMPLE, THE VALUE CHAIN COMPRISES OF ROUGHLY:
Raw materials + labour + equipment + logistics = cost + profit %
FOR AN INSURANCE UNDERWRITER, THE COST OF CLAIMS IS SIMILAR TO THE COST OF RAW MATERIALS:
Claims? + labour + equipment + marketing = cost + profit?
Uncertainty and Instability
Since the cost of claims is not known at the time the premium is put forward, in effect, the insurance company sells the product, policy by policy, without knowing how much it cost to make.
It is this uncertainty about the results of the underwriting process that has produced such instability over the last twenty years.
This is, of course, a simplistic view of a very complex market which is also affected by other factors, such as interest rates, the supply of capital, reinsurance and so on, but the fundamental problem remains as described above.
The range of catastrophes, natural and man-made, twinned with the ever widening range of illness, accident and compensation culture, have all contributed to make premiums fluctuate wildly.
Although all sorts of devises and risk management models are studied to predict the future, these have proved futile – no one foresaw the World Trade Centre attacks, for example.
Despite the industry’s best endeavours to achieve stability, this is unlikely to be forthcoming in the present structure and premiums will continue to fluctuate.
At the Business Insurance Bureau, we understand this market and guide our clientele through it’s peaks and throughs, whilst maintaining their cover with insurers who can deliver their promises.
We have a true passion for reducing risk and ensuring the success of every business we work with, we pride our self on it, so please, pick up the phone today.