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For insurance buyers, it's the law of supply and demand.

For Insurance Buyers, It's the Law of Supply and Demand

Managers, as a group, are not overly self-critical. If anything goes wrong with the insurance market--and so far there seems to be always something wrong--then risk managers always look to the supply side, one puts the objectivity of risk managers into question.

The age-old moans of risk managers get such attention nowadays as to hardly need mentioning again. Here is a sampling:

Rates are too high; insurers are at fault for being volatile and creating an unstable market; coverage is either not wide enough or not available on a long-term basis; and capacity is inadequate or overabundant and the cause of instability.

Risk managers and insurance buyers claim that these problems are all the result of a badly run insurance industry: Insurers should not threaten their capacity by charging inadequate premiums. They should vary the cover they are prepared to offer from one year to the next. Furthermore, there is no excuse for ever overcharging their customers. Unfortunately, as everyone knows, markets are the product of both supply and demand contributions. It is ridiculous for risk managers to castigate insurers for the dramatic cyclical changes in insurance prices, capacity and cover when they are contributing to this instability.

In the United Kingdom, the private buyers of auto insurance and household covers do not experience the market highs and lows because individually they have no power to persuade and lack a representative body through which they might try to influence the marketplace. Hence they are ripped off; every year premiums go up by at least the inflation rate.

But for commercial buyers it is a different story. Individually the premiums they control are important enough to earn commercial insurers respect, and, besides having influential representative bodies such as RIMS, corporate buyers have the alternative to conventional insurance of alternative risk financing. The consequence of their power--admittedly or not--is that they effectively manipulate the market. If insurers want commercial business they must accept that they can only have it on the corporate buyers' terms.

This means, of course, that they are always in the situation of being forced progressively into cutting their rates to the point where they may even have to take a loss. Then, as the cycle changes, some insurers pull out of the business, heightening the power of the ones who remain. Those left eventually see no point in cooperating with buyers when the business becomes unprofitable and bring about rapid rate increases and cover contractions.

Oscillation of Power

It is not the insurance market alone. All free markets are characterized by this oscillation of power between supply and demand. Neither side is ever totally to blame. But by the same token, it makes no sense always to blame the same side, in this case, the insurers. Insurers have to play the rate undercutting, to market contraction and the birth of a hard market game. They know risk managers will always chase the lowest rates and that the surest way to lose business is to tell risk managers they are holding rates above market for long-term market stability.

I must not give the impression, however, that I believe insurers to be the abused and misused partners in the market. The nature of the marketplace dictates good times as well as bad, and they usually make up shortfalls on corporate accounts, from personal lines and life business. Insurers are as hypocritical as risk managers. But they are comparable to farmers, in the sense that they are always having a bad year or a reasonable year which only compensates for several years of bad results.

The reason I raise the questions of supply and demand and how the market works is to look at the question of whether corporate insurance buyers have anything to gain from winning the debate.

Would it really help risk managers to have a stable insurance market? After all, the stable market for auto and homeowners' insurance in the United Kingdom works more against than for the buyers. Only under the pressure of competition will risk managers benefit from reduced rates; only when insurers can run their affairs free from customer pressures will they be able to provide stability, which effectively means regular, predictable and good profits. Stability cannot mean anything else. It cannot mean regular, predictable "huge" profits, for there is always too much competition to allow that. It cannot mean regular predictable "losses," because no industry could survive this.

The marketplace in which corporate buyers exert sufficient influence to keep insurers fighting for their business must be a better option than a stable predictably, profitable market which could conceivably come about. The cyclical market causes buyers headaches, but it gives them the opportunity to get a good deal some of the time. And when the market is hard, there is always alternative risk financing.

Chris F. Best is editor of Foresight, a London-based risk management and insurance journal published by Risk and Insurance Group Limited.
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Article Details
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Author:Best, Chris F.
Publication:Risk Management
Article Type:column
Date:Aug 1, 1989
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