Rob Gillies of the LMA examines the impact of European Commission initiatives on subscription markets
Hot on the heels of the European Commission’s Sector Inquiry into Business Insurance came its consultation on the future of the Insurance Block Exemption Regulation. Both subjects raise real issues which could adversely impact the subscription placement model prevalent in London and potentially work to the detriment of customers.
One focus of the Commission is the alignment between the price charged by a leader and that charged by following insurers. The Commission argues that the effect of the subscription process can be to align premium for the whole placement upwards to the highest level required by any subscribing insurer. It has also questioned why it is that the price charged by a following insurer is usually aligned with the price of the leader and why there is not greater competition between potential follow insurers when subscribing to a risk.
The Lloyd’s Market Association (LMA), during discussions with the Commission, worked hard to explain the pro-competitive nature of the process and the Commission no doubt understands more now than when it opened the inquiry. It has possibly realised that its experience, drawn mainly from looking at other industries, is not easily applied to the insurance industry and the subscription process in particular. This is perhaps one reason why the Commission has not told the industry what it wants to happen but has said, here are our questions, you come up with the answers.
The process of producing those answers has started with the publication by BIPAR, the European brokers’ organisation, of high level principles relating to the placement of business with multiple insurers (see box). As guidance for intermediaries (and with implications for insurers) these were accepted by the Commission as an indication of the market’s willingness to address their concerns and as a useful first step.
Expiry of the Insurance Block Exemption Regulation (IBER) was heralded in the sector inquiry and the Commission ran a specific consultation exercise ending on 17 July. The IBER provides automatic exemption from competition law, subject to certain criteria, for a number of activities including, importantly for the subscription market, the production of ‘standard policy conditions’. The IBER expires in March 2010. The Commission’s position seems to be that block exemptions are a blunt instrument and are no longer needed under a self-assessment regime. The industry was challenged to make the case if it feels the IBER is essential and should be renewed.
The Commission has received numerous submissions, including from the LMA, arguing that the available guidance and case law is extremely limited and does not enable organisations to self-assess their compliance with competition law with any confidence. The ending of the IBER will therefore result in considerable legal uncertainty which will cause firms to scale down, if not end, the collaborative activities for which the IBER provides exemption. The benefits arising from those collaborative activities, including the production of model policy wordings and clauses, could therefore end to the detriment, ultimately, of the policyholder.
Both the sector inquiry and the question of renewal of the IBER raise issues of fundamental importance to the London subscription market in which processes have evolved over decades, if not hundreds of years, to meet the needs of a sophisticated client base in a fiercely competitive global (not just European) industry.
The benefits of the subscription process are many and varied, not least the bringing together of disparate capital to bear on some of the world’s largest and most complex risks. However, this can be achieved using a simpler co-insurance structure. What the subscription process adds is benefit to the policyholder arising from, for example, consistent coverage across multiple insurers, a speedy decision making and agreement process and a consistent approach to claims handling and agreement. The use of model wordings, whilst not universal, as a starting point for the negotiation of coverage is one component which facilitates the delivery of these benefits to policyholders.
We have yet to see how intermediaries and insurers will react to the Commission’s concerns over pricing in the subscription process. It may be that insurers, if required to price independently (and possibly pricing a risk more cheaply than their co-insurers), will also seek greater independence in negotiating levels of coverage and will insist on being an agreement party to risk amendments, as well as claims decisions, where they may not have been before. This outcome would make the placement process and post-placement administration less efficient. These processes would be more cumbersome and slower. Hardly a benefit to the policyholder. It would also increase the workload, and so the cost of administering the contract, for both insurers and intermediaries. Inevitably, some of this cost would find its way to policyholders.
Of course, whilst it should not be assumed that independent pricing will result in an overall lower premium, this may be the benefit to some policyholders. Therefore, policyholders would have to decide whether the price difference between a traditional subscription placement and an independently-priced placement outweighed the loss of efficiency resulting from slower negotiation and agreement of a placement and of risk amendments, and a more inconsistent approach to coverage and claims.
Of course, the intermediary would work to remedy these problems by negotiating consistent coverage across the placement and corralling insurers together into more efficient agreement and claims processes, i.e. reintroducing the efficiencies of the subscription process, whilst still seeking the benefits of independent pricing. However, it would not be practical for intermediaries to do this for every risk and so it seems likely they would have to segment their book of business.
One aspect of this situation, the maintenance of consistent coverage across the placement, will not be helped by the lapsing of the IBER. We see a potential situation where those market sectors, which for good commercial reasons make use of model wordings, are discouraged from collaborating in their production by the legal uncertainty which would exist. In the absence of a satisfactory model wording, drafted with broad market (and possibly customer) input, intermediaries and insurers would be encouraged to open negotiations based on their own proprietary wording. In these circumstances, either the intermediary negotiates a consistent wording across the placement or the policyholder remains exposed to differences in cover.
Where insurers may be tending towards providing independent levels of coverage as a result of independent pricing, the continued availability of model wordings would be a useful tool to provide an accepted starting point for the negotiation of coverage. The alignment of the coverage provided by insurers, often across different global markets, delivers real benefit to the policyholder.
The reality is that as regards price alignment the Commission’s report has thrown down a gauntlet to London to justify its practices or to change. It has also given clear warning that renewal of the IBER is unlikely.
It has to be accepted that the Commission works at a macro level and has to lay down broad frameworks within which organisations have to operate. However, the Commission, whilst on the one hand wishing to facilitate competition in Europe, may inadvertently affect London’s ability to compete effectively with other non-European markets. To be disproportionately disadvantaged in this way would be damaging for London.
But all is not gloom. Competition within the London market is already fierce and the market is flexible to the extent that where practices do not deliver commercial benefit for the policyholder, different practices are adopted, as evidenced by the use of vertical placement in some lines of business and by the several market sectors in which model wordings do not predominate.
A realistic implementation of the BIPAR principles and a positive reaction from insurers, will inevitably cause new practices to evolve based on delivering benefit to policyholders. This could result in a market which is more competitive globally. Where our traditional practices persist, this must be because they are best for the policyholder and can be justified to the Commission, against the requirements of competition law, when it revisits these issues in the future, as it surely will.
Rob Gillies is Head of Market Processes, Lloyd’s Market Association
Three of the BIPAR principles deal with the structure of risk placement. They are (1) â€˜Before placing a risk, an intermediary will review and advise a client on market
structures available to meet its needs and, in particular, the relative merits of a single insurer or a multiple insurer placement.â€™ (2) â€˜If the client, on advice of the intermediary, instructs the latter to place the risk with multiple insurers, the intermediary will review, explain the relative merits and advise the client on a range of options for multiple insurer placement. Intermediaries will expect insurers to give careful independent
consideration to the option requested.â€™ (3) â€˜In the case of a placement of a risk with a lead insurer and following insurers on the same terms and conditions, the previously agreed premiums of the lead insurer and any following insurers will not be aligned upwards should an additional follower require a higher premium to complete the risk placement. Indeed, the intermediary should not accept any condition whereby an insurer seeks to reserve to itself the right to increase the premium charged in such circumstances.â€™