Can subscription pricing be justified? In this month’s debate Willis’ James Vickers goes head to head with Heike Trilovszky of Munich Re on subscription pricing.
An argument that has plagued the insurance and reinsurance industry for years resurfaced again recently. EU Commissioner for Competition Neelie Kroes asked the insurance industry to justify pricing in the subscription market following an detailed investigation into business insurance. The accusation that “follow-the-leader” pricing could be considered anti-competitive prompted angry rebuttals from many corners of the industry, including the British Insurance Broker’s Association (BIBA) and the International Underwriting Association (IUA).
A few weeks before the Kroes findings were made public, Munich Re created a storm at the annual Rendez-vous in Monte Carlo by rejecting the subscription market and calling for differentiated pricing. The German company said prices should better reflect a reinsurer’s rating, financial strength and better level of service, a view supported by rival Swiss Re.
This month Heike Trilovszky outlines Munich Re’s arguments for differentiated pricing, while James Vickers for Willis defends the subscription model.
James Vickers is chairman of Willis Re International.
From the recently published European Commission insurance sector enquiry to the various comments made by some reinsurers and brokers it is clear that the longstanding practice of subscription marketing is under attack. Some commentators have gone as far as to call for the outlawing of subscription placements claiming that differential marketing will solve all perceived inequalities and deliver best value and transparency to the ultimate client. In the face of such an onslaught, a sober reflection on the benefits and possible demerits of the subscription market appears timely.
The subscription market has been in place for hundreds of years, having first started in the Lloyd’s market. Over time, it has shown itself to be a very flexible marketing approach providing greater capacity and risk diversification, and therefore resulting in better terms and lower prices for clients.
What about the perceived weakness of subscription marketing, namely that the leader sets a price which everyone else follows despite the fact that they may be prepared to offer more competitive terms?
The proponents of differential marketing argue that if every reinsurer could set their own terms and conditions the overall price would be lower. Superficially, this argument appears attractive but the reality is that freed from the shackles of market consensus pricing, leading reinsurers will quote both terms and conditions to their liking and feel no pressure to improve their terms to match the most competitive. In such a position, the client and their broker have only one recourse available to them – that of either signing down or not taking up the shares offered by the most expensive reinsurers.
Reinsurers with higher security ratings often seek to justify their better ratings and superior expertise through higher pricing. If the client is determined to obtain the best possible price, he will often be left with lower quality security from less technically capable reinsurers.
Another of the benefits of differential marketing put forward by its supporters is that of transparency. This cannot easily be refuted, as the original client will see each reinsurers’ quotes. However, transparency is not the exclusive domain of differential marketing. Good subscription market practice requires a broker to reveal to his client all the quotes he has obtained from all the potential reinsurers he has approached. Armed with a full overview of the available terms and conditions the client and his broker can then decide the appropriate firm order terms which best meet the client’s requirements.
Whilst best practice requires brokers to reveal to their clients all the quotes they have received this best practice unfortunately is not universally followed. At the same time, some reinsurers have also acted against the best interest of the subscription market through the application of best terms clauses. The European Commission report has identified the use of such clauses as not being in the best interest of clients, though they have also noted that the use of these clauses is diminishing.
Finally, the challenge of administrative efficiency and claims recoveries needs to be confronted. Proponents of differential marketing propose that it applies mainly to price and the remaining terms and conditions are uniform. In reality, with increasingly complex coverage and bespoke wordings it is naïve to expect that differential placements will only apply to premiums. Allowing placements with differential conditions will result in opening Pandora’s Box when it comes to claims recoveries, with loss adjusters facing an administrative nightmare of individual negotiations with each reinsurer based on their own specific clauses.
A balanced assessment of the relative merits and demerits of subscription marketing as compared to differential marketing clearly shows that the best practice application of subscription marketing delivers the optimum blend of price competition, transparency, and administrative efficiency. All of this has been tested and proven over countless market cycles and billions of loss recoveries.
Heike Trilovszky is head of corporate underwriting at Munich Re.
In a system of free trade, it is not just supply and demand that control prices but also the quality of the products and services offered. Unfortunately, this principle does not always extend to reinsurance. The long-standing tradition in reinsurance, which has survived more or less intact to this day, is that all reinsurers participate in a programme under the same terms and prices. This system no doubt made sense in the days when reinsurance business was still conducted on paper and by hand when the extra administration that different terms and prices involve would not have been viable. This argument no longer holds true in today’s world of highly efficient IT programmes.
The outdated notion that all parties bear the same risk and thus bring the same level of service to an agreement means that we still have a uniform price for covers today. But is it true that all reinsurers provide the same level of service?
Besides capacity, what an insurer wants above all else from a reinsurer is financial security. However, security costs money. In the banking world, it is accepted as a matter of course that the better an applicant’s financial security, the better the terms and conditions of a loan will be. Why then should reinsurers whose rating, solvency and financial strength are better than their competitors not be given better terms? From an insurer’s point of view, it is absolutely essential that it can depend on the long-term ability and willingness of its reinsurer to pay out when a loss occurs.
Legislation is devoting increasing attention to reinsurers’ quality. Under Solvency II, the amount of capital relief an insurer receives for reinsurance cover will depend on the reinsurer’s financial strength. The choice of reinsurer will therefore have direct financial consequences for the primary insurer.
Differences between reinsurers become all the more apparent when one considers the services they offer. It is only large, global reinsurers with expertise in all aspects of insurance business that are able to offer clients services and sound advice on all lines of business and complex issues. For example, many assist clients with risk management, in drafting policies, with claims settlement and by conducting audits. Publications and seminars help to share this expert knowledge with clients.
However, in order to maintain the quality of these services, constant investment in the company’s infrastructure and in highly qualified staff is required. This also costs money. Ultimately, though, it is this expert advice that saves insurers money when a loss occurs. It is therefore entirely appropriate that major differences in the services reinsurers provide should be reflected in the price of cover.
Uniform prices and terms are just as hard to justify from the buyer’s perspective as well. When a buyer selects a leading reinsurer it believes has a lot to offer, it is prepared to pay an appropriate price. Why should an insurer pay the same price for a reinsurer that offers a lower level of service and security? The terms and conditions offered also vary depending on how individual reinsurers assess the risks involved. Uniform terms and conditions simply narrow the buyer’s options. Only terms and prices freely negotiated between buyer and seller can help the buyer to optimise the cost/benefit profile of its overall programme.
A 2006 survey of European non-life insurers conducted by the Flaspöhler Institute revealed that 74% are willing to pay more for better services. The most important criteria for insurers were: a strong existing relationship, a superior rating, superior service, fast claims payment, stronger balance sheet, more experience and superior management/leadership.
Calls by the European Commissioner for Competition to abolish “best terms and conditions” clauses in reinsurance contracts provide further evidence – from a competition law perspective – of the need to change this outdated practice.
Munich Re firmly supports the trend towards different prices for reinsurance based on security and service.