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23 views12 pages

Ins 1

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bpsc08
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Analyzing Insurance Markets

RMI 8320
Management of Insurance Institutions
Robert Klein
Topic Objectives
• How should we analyze insurance markets?
– from an economic perspective
– from a business perspective

• What are:
• Relevant
questions?
• Concepts?
• Tools?
• Information
sources?
Structure-Conduct-Performance
• Standard economic paradigm
• Static versus dynamic analyses

Structure Conduct Performance

• Technology • Pricing • Cost Efficiency


• Cost Structure • Product Design • Allocation Efficiency
• No. of Firms
• Innovation • Profitability
• Size/Concentration
• Independence • Quality of Service
• Entry/Exit
• Regulation
• Information
Alternative Market Structures
• Competitive • These “archetypes”
– Perfect/Pure competition are used as theory
– Monopolistic Competition but not always
informative in
• Other analyzing real
– Oligopoly world.
– Monopoly

• “Real World” Application


• Antitrust & regulation  Workable competition?
• Business  Can I make money & increase firm value?
Economic Questions
• What is the relevant market?
• Are there significant barriers to entry and/or
exit?
• How concentrated is the market?
• Do firms act independently or do they consider
responses of competitors?
• How efficient is the industry in terms of
allocating resources and costs of production?
• Do firms earn “fair”, inadequate or excessive
profits; “cost of capital” benchmark?
Business Questions
• What is my market?
– Who are my customers?
– Who are my competitors?
• Value to add at a profit; best use of resources?
• How am I positioned relative to competitors?
– What is my comparative advantage?
– Products and prices?
– Quality of service, reputation, financial strength?
– Cost efficiency and profitability?
• Sunk costs and future prospects?
Defining a Market
Substitutes
Workers
Compensation Self
Insurance
Product

Retro
Plans
Buyer
Compliments Industry
General Large
Liability Employers Trucking
Firms

High
Industry Segment Risk
Entry and Exit Barriers
• Costs to enter and exit market
• Other incumbent firm advantages
– control of key resource/distribution outlet
– information
– reputation and customer relationships
• Regulatory barriers
• Theory of Contestable Markets
– Entry/exit barriers key to competition, not number
of firms or concentration  threat of entry
disciplines firms in market.
Why does State Farm hold
such a large share of the
personal lines market?
Analyzing Structure/Concentration
• Number of firms
• Dominant firm/market leader
• Concentration ratios
– market share of some number of the “largest firms”
– indication varies with where you make the cut; top 5,
top 10, top 20, top ?
• Herfindahl-Hirschman Index (H-Index or HHI)
– calculate the square of each firm’s market share and
sum the squared market shares
– interesting property  HHI increases exponentially
with the market shares of leading firms
• Little problem – what is unbiased size measure?
Illustration:
Tale of Two Markets
Market 1 Market 2
Co. DPW MS% Cum. MS MS2 Co. DPW MS% Cum. MS MS2
A $200 13% 13% 178% A $400 27% 27% 711%
B $200 13% 27% 178% B $300 20% 47% 400%
C $200 13% 40% 178% C $100 7% 53% 44%
D $200 13% 53% 178% D $100 7% 60% 44%
E $200 13% 67% 178% E $100 7% 67% 44%
F $100 7% 73% 44% F $100 7% 73% 44%
G $100 7% 80% 44% G $100 7% 80% 44%
H $100 7% 87% 44% H $100 7% 87% 44%
I $100 7% 93% 44% I $100 7% 93% 44%
J $100 7% 100% 44% J $100 7% 100% 44%
$1,500 HHI= 1,111 $1,500 HHI= 1,467
Market Structure: Personal Auto Insurance
South Carolina and Southeast Region
South Carolina
Entities at Start of Year Entries Exits Net Change
Period Number % Chg. Number % Chg. Number % Chg. Number % Chg.
1990 56 4 5 -1
1991 55 -2% 5 25% 15 200% -10 900%
1992 45 -18% 1 -80% 6 -60% -5 -50%
1993 40 -11% 4 300% 3 -50% 1 -120%
1994 41 3% 9 125% 4 33% 5 400%
1995 46 12% 6 -33% 7 75% -1 -120%
1996 45 -2% 3 -50% 5 -29% -2 100%
1997 43 -4% 5 67% 3 -40% 2 -200%
1998 45 5% 19 280% 9 200% 10 400%
1999 55 22%

South Carolina Regional Average


Year # Insurers CR4 CR8 CR20 HHI # Insurers CR4 CR8 CR20 HHI
1990 56 55.8% 75.3% 92.9% 1,195 99 54.4% 67.7% 83.2% 1,082
1991 55 58.8% 79.2% 95.4% 1,337 97 56.3% 58.5% 83.6% 1,146
1992 45 61.4% 61.4% 97.2% 1,454 96 56.0% 58.2% 84.7% 1,129
1993 40 61.8% 82.5% 97.4% 1,470 97 56.0% 70.5% 85.2% 1,137
1994 41 61.6% 83.0% 97.1% 1,476 96 56.4% 71.2% 85.3% 1,129
1995 46 63.8% 83.7% 97.1% 1,529 92 56.5% 71.1% 85.8% 1,125
1996 45 63.7% 83.7% 97.1% 1,538 93 57.3% 71.4% 86.5% 1,136
1997 43 64.6% 84.3% 97.5% 1,556 89 57.6% 71.9% 87.0% 1,100
1998 45 64.8% 84.1% 97.4% 1,540 87 57.8% 72.3% 87.1% 1,085
1999 55 64.6% 81.7% 95.1% 1,493 82 57.9% 77.9% 87.3% 1,057

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