Insurance companies offer many products with different levels of complexity that were designed for different groups of people and companies and other organizations. different underwriting criteria and different distribution systems can result in large differences in losses and other costs that ultimately need to be reflected in the price of the charge.
Furthermore, the insurance industry is highly fragmented, and since insurance companies are largely regulated by states, insurance policies issued by the same insurer may have different requirements and provisions in different states. Auto insurance, for example, can differ greatly in both prices and coverage provided, in different states, even from the same insurance company.
competition of insurance companies
Insurance companies not only compete with each other, they also compete with the government, risk retention groups and self-insurers. The government often offers insurance for risks that private insurers are unwilling or unable to cover, such as floods, hurricanes, and earthquakes. States also provide insurance in some areas to increase competition, particularly workers’ compensation, as companies often decide which state they will do business in based on cost.
Insurance companies also compete with risk retention groups (RRGs) that provide coverage for groups with specific liability risks, such as medical malpractice. Also, unlike insurance companies, RRGs are governed by federal law and the law of their state of domicile, so they can operate in all 50 states without the complexity and cost of complying with state regulations other than those of the state of your domicile. And, in general, RRGs select the states with the most permissible laws that govern their group, which helps reduce their cost of operation. vermont is currently the most popular address. RRGs can be organized as corporations or mutuals or as reciprocal exchanges, but the insured must also own the insurer, as required by federal law. Consequently, policyholders have greater control over costs and can benefit from any savings that would otherwise be profitable for private insurance companies.
Many large businesses and organizations also self-insure for many of their employee benefits, such as health coverage, increasing competition for insurance companies. however, many self-insurers use the services of insurance companies to administer the insurance program, including filing claims.
Insurance companies generally compete on price and the quality of the services they provide.
The price of insurance, like most things offered for sale, is determined by the cost of production and the amount of competition within the industry. income from the sale of insurance coverage:
- losses and loss adjustment expenses
- acquisition costs
- administrative expenses
- make payments/change contract provisions
- get proof of insurance
- add or subtract coverage
- file a claim and view its progress
Most of the insurance proceeds are used to cover losses and related adjustment expenses. The main price difference between different insurance companies is in their ability to predict future losses and their ability to charge the appropriate premium for each class of underwriting, which must also be well defined and accurate.
acquisition expenses consist primarily of marketing costs, such as advertising, and commissions paid to insurance brokers and agents. Some forms of insurance, such as auto insurance and term life insurance, are sold directly, rather than through brokers or agents, which helps lower the premium. however, many types of insurance are more complex, with a greater number of variables, such as commercial property and casualty insurance or variable life insurance, which virtually require the use of a broker or agent.
The administrative expenses are mostly fixed costs, which have little relation to the amount of the premium issued, such as offices and computer equipment.
Like most other companies, insurance companies also pay taxes, but each state also imposes a premium tax which is determined as a percentage of the premium amount and is passed on to the insurance buyer as a hidden tax, as they are never itemized.
profit is what is left over after all expenses have been paid. Every insurance company projects a profit, but the actual amount of profit realized will depend on the amount of losses, as this is the most significant and variable factor.
Underwriting standards are an important determinant of profitability and the prices insurance companies can charge for their products. If an insurance company can select individuals or businesses with lower-than-average losses, it will make a higher profit with lower prices. this, in turn, will impose greater losses on your competitors, leaving individuals or companies with average or higher losses than their competitors.
Insurance companies also compete on the quality of services provided, including broader coverage and faster claims handling. In addition, property and casualty insurers may also offer property inspections and loss prevention services.
The main source of information and the first point of contact for insurance applicants is through insurance brokers and agents, and through websites, either the insurance company’s website, or their brokers. and agents, or third parties, especially those who compare premium quotes from many insurers.
Insurance seekers also judge insurance companies based on their brokers and agents, who often provide the information needed to select the best insurance coverage. insurance agents work for private companies, so they can only offer products offered by companies. Insurance brokers, on the other hand, work for the insurance applicant and may sell insurance from many companies. Agents and brokers will generally discuss the applicant’s insurance needs and then recommend the required coverage to meet their needs. Insurance agents can only select products from companies, but insurance brokers can choose from a wide variety of companies, so they are likely to be able to offer the best prices and most accurate coverage. Brokers and agents often helped process applicants’ loss claims as well, so the insured will also use their claims-processing proficiency to judge the quality of the company.
Websites can also be an important factor in competition. Insurance company websites can greatly improve the quality of their services by providing an online means to:
Insurance company websites may also provide the types of policies they offer and their specific provisions.
Websites can provide interactive questionnaires that allow insurance applicants to select the best available policy for their needs. The insured can also use an interactive website to see how their insurance price varies by selecting or deselecting specific clauses in the contract or changing the amount of coverage for specific occurrences, such as uninsured motorist coverage. Using an agent or broker to get this information would take more time, and it’s easier for the insured to see the specific ways the policy can be changed, since the possibilities are often presented in a drop-down box on the website.
Most major insurance companies also have their own mobile app, where users can view their policy information, file a claim, view its progress, and provide proof of insurance. for example, most states require proof of automobile insurance when drivers pass the police, and states now allow showing the identification card on the mobile phone as proof of insurance.
Third-party insurance websites have also increased competition by providing insurance quotes for many companies. an insurance applicant simply enters the information needed to determine the premium.
insurance cycles: soft and hard markets
A soft insurance market occurs when underwriting standards are more flexible and premiums are lower than in hard insurance markets. Because the insurance market is competitive, when companies become profitable, they begin to adopt more lenient underwriting criteria and lower their premiums to gain more market share. other insurance companies react by adopting the same policies, to avoid having their shares taken away or to increase their market share. eventually, the cellular propagation cycle comes to an end as losses mount, leading to the hard insurance market of tighter underwriting criteria and higher premiums.
Although insurance companies recognize the cycle, they cannot change it, as companies in a competitive industry are forced to be price takers rather than price creators.
cash flow subscription
Property and liability insurers often make most of their profits from investments. Consequently, these insurers often maximize their premium income by relaxing their underwriting standards, hoping that the return on investment from premium income will more than offset the losses incurred due to lower underwriting standards and premiums. this is called subscription cash flow: maximizing investable cash flow at the expense of subscription earnings. therefore, insurance prices will often depend on the performance of investment markets, such as the stock market. soft insurance markets tend to prevail when financial markets are doing well; otherwise, a tough insurance market is more likely.