Angry industry associations have hit out at suggestions that the subscription market is anti-competitive. Helen Yates asks if this could push differentiated pricing up the agenda

EU commissioner for competition Neelie Kroes has asked the insurance industry to justify or reform pricing in the subscription market. This was part of her conclusion following an extensive investigation into business insurance practices in Europe. Excluding “following market” participants from offering lower premiums than those offered by the “lead” may go against competition law, she believes.

The anti-competitive accusation comes from the idea that all the insurers and reinsurers on a particular risk get the best terms and conditions because they “follow the leader” (see box on page 28). Kroes argues this prevents “following” insurers and reinsurers from offering lower pricing or more favourable terms. It comes at a time when “differentiated”, or “vertical”, pricing has once again been hotly-debated in the industry. This is where insurers can quote different prices on a slip, with the lead insurer quoting the highest.

Differentiated pricing – for and against

The commissioner’s report does not actually conclude that competition law has been infringed and therefore is not threatening enforcement. It says premium alignment – all insurers on a slip offering the same price – is not intrinsic to the operation of the subscription markets. Instead Kroes is challenging the industry to justify its practices and to convince her that the subscription market is not anti-competitive.

“The EU competition commission will say that the block exemption (358/2003) insurers enjoyed is actually antitrust and it will need to be revisited,” predicted John Spencer, group chief executive of reinsurance broker BMS Associates speaking at this year’s Monte Carlo Rendez-Vous, before the release of the report. He wasn’t far off the mark. The commission is not convinced the exemption, which treats the insurance industry differently than other industry sectors, is still necessary. It is due to expire in 2010 and a final decision on its future is due to be made in March 2009.

Calling Kroes’ inquiry “unnecessary and pointless”, Eric Galbraith, CEO of the British Insurance Brokers’ Association, was particularly scathing in an industry statement. “We do not accept the commission’s analysis that subscription market practices are akin to use of best terms and conditions clauses, a practice we have always opposed,” he said.

A more collected response was forthcoming from the International Underwriting Association (IUA). Stephen Riley, IUA chairman, also addressed the comments on the lack of differentiated pricing in the industry. “Such vertical pricing already exists for a number of classes of business and will continue to be adopted by IUA members where appropriate,” he said.

“Whether or not those in the industry agree with Kroes’ judgement, dramatic changes to the subscription market may be forthcoming

Whether or not those in the industry agree with Kroes’ judgement, dramatic changes to the subscription market may be forthcoming, particularly if the European Commission does not renew the block exemption for insurers. “These are very serious issues for the London market,” said Spencer. “They may have to adapt to a world in which they will each have to bid for their share so that it’s more of an auction process – and the broker sits in the middle of that.”

Put this to your average industry professional and it usually elicits a strong response. “It’s just so ridiculous,” said Benfield CEO Grahame Chilton during an interview in Monte Carlo before the publication of Kroes findings. “The subscription market is about choice and competition – it doesn’t work as a cartel.” He said this was “why the broker was king” because they brought so many different quotes together on price. “You’re looking at something that doesn’t need to be regulated. Free markets must have markets.”

It’s not just the implication of poor industry practices that makes the whole idea of differentiated pricing unattractive for many. Introducing it to the market would significantly increase the broker’s workload, a fact most acknowledge. It would also allow those insurers and reinsurers with superior ratings to command higher prices and by default, make profitable underwriting more challenging for those with lower ratings. “Nobody wants to do that because they don’t get the best terms,” said a candid Peter Middleton, managing director, specialty division at Markel International.

Monte Carlo debate

Kroes is not alone in calling for differentiated pricing in the industry. The topic once again got an airing in Monte Carlo. Munich Re raised the issue at its Rendez-Vous press briefing where board member Torsten Jeworrek said prices should better reflect a reinsurers’ financial strength and the level of service. “We think it is time to move away from the subscription, follow-the-leader market,” he said. “We have the support of well-capitalised reinsurers but some others are against the idea. Brokers who were originally strongly against the idea are beginning to come around.”

This was supported by rival heavyweight reinsurer Swiss Re. During an analysts’ conference call in Monte Carlo, head of client markets Michel Lies said: “We totally agree with the view of Munich Re. It makes a lot of sense. This industry seems to be quite reluctant to accept that.” He added that the reinsurer had started to see an increased differentiation of pricing with its clients.

Ted Collins, group managing director of Moody’s, also said it was rational but did not see it “becoming pervasive”. Paddy Jago, CEO of Willis Re, totally disagreed. He said that in his 32 years in the industry he had yet to find a situation where it made sense. “As far as the client is concerned I believe that at this point the best terms and conditions overall is best served by the subscription market.” Basis risk would also be a concern if pricing was differentiated, he added. “You end up with a quilt of covers and none resemble each other so there must be gaps.”

“Introducing differentiated pricing to the market would significantly increase the broker’s workload

The consensus backed Jago’s view. BMS’ Spencer said it was “wishful thinking” on Munich Re’s part. Middleton was also dubious. “Munich Re has said this before but I don’t believe it’s the end of the co-insurance marketplace. London has been around for hundreds of years and I’m sure it will continue.” Others suggested that if a vertical pricing model became the way forward, insurers and reinsurers might be more likely to quote for 100% of the risk.

Distressed markets

Differentiated pricing is already present in certain lines of business. It is common in the primary aviation market for example. “It’s a total vertical placement in aviation. The lead underwriter will have the best terms,” explains Steve Breen, president of Carvill’s New York office. In his opinion it works because it is such a dysfunctional market. “Within a distressed environment differential pricing might make sense,” agrees Jago.

Mark Campe, head of aviation reinsurance at JLT Re, says pricing in the direct aviation market continues to be heavily “verticalised” and that pricing differentials between the lead and lowest terms may vary by as much as 30% in certain cases. Conversely, the aviation reinsurance market has, by and large, resisted vertical pricing. Thus a more traditional, subscription-based placement at a single set of terms is the norm there. Campe said differentiated pricing had not been adopted in other sectors of insurance, which was surprising in some areas, but he believed it was possible in the future.

The lead aviation insurer is likely to use a number of factors to justify the higher quote. These could include credit rating, service, relationship with the cedant and willingness to pay. This comes back to Munich Re’s argument that those with superior ratings should expect to charge more. Breen concedes the reinsurer has a point. “It’s much harder to keep an “AA” rating than an “A-”. If you’re not getting any benefit for maintaining an “AA” then what’s the point?”

In the direct aviation market, the differential terms secured by the leaders are a product of many factors including client relationships, claims servicing and credit rating, offers Campe. But that has to be balanced with commercial realities. As one industry expert put it: “Differentiated pricing will only occur if the client wants it, not Munich Re.”

How the subscription market works

1. The customer (which might be an individual, company or other insurer) approaches a broker with the details of a risk to be insured.

2. The broker approaches a specialist underwriter (a leader) in the relevant class of business to discuss premium, terms and conditions. If the underwriter is interested, a proposal will be made to accept a percentage of the total risk. A number of underwriters may accept portions of one risk. This is known as a subscription market.

3. The broker feeds back information to the customer to enable the customer to place an order.

4. The broker prepares a “slip” with the details of the insurance, which is signed by the lead underwriter. The broker then approaches the other (following) underwriters with a view to obtaining written lines of insurance which total 100% or more of the risk.

5. The slip is processed and the broker adjusts or “signs down” the lines if they have exceeded 100% of the risk.

6. The premium is paid by the customer.