ICP 11:
Market Analysis
All rights reserved.
The material in this module is copyrighted. It may be used for training by competent organi-zations with permission. Please contact the IAIS to seek permission.
This module was prepared by Jaroslav Kucera, a reinsurance manager based in Pardubice, Czech Republic, who has been engaged in insurance and reinsurance since 1993. He has held various positions in the Czech Insurance Association, which includes being chairman of the Working Group for European Union at the Czech Insurance Association since 2000. He has translated publications on insurance and reinsurance and led the team that created the English-Czech Dictionary of Insurance Terms.
The module was reviewed by Nigel Davies and Randip Jagpal Singh. Nigel Davies is a U.K. chartered ac-countant with more than 20 years in the insurance industry in professional, managerial, and regulatory roles. From 2002 to February 2006, he worked at the International Monetary Fund in Washington, D.C., as a technical assistance advisor in the field of insurance. This involved organizing and providing technical assistance and assessing the strength and stability of the insurance sector as part of the Financial Sector Assessment Program. The role also involved liaising with standard-setting bodies, providing input where appropriate. He has contributed to several major publications. Prior to this, he worked at the Financial Ser-vices Authority in the United Kingdom for seven years, supervising the London insurance market. He also represented the United Kingdom at International Association of Insurance Supervisors (IAIS) meetings and at the European Union Commission and Council of Ministers. Previous roles included being a direc-tor at Marsh and McLennan and an insurance specialist at Ernst and Young. Randip Jagpal Singh is deputy director at the Insurance Regulatory and Development Authority (IRDA) of India. He was part of the team that oversaw the smooth transition in the insurance sector from a state monopoly to competition and part of another team responsible for developing, communicating, and implementing regulatory policy for the supervision of insurers. Prior to joining the IRDA, he worked in one of the four nationalized general insur-ance companies and has more than 13 years of experience in underwriting and claims.
Contents
About the Core Curriculum . . . v
Note to learner . . . vii
A. Introduction . . . 1
B. Role of market analysis . . . 9
C. Sources of information . . . 18
D. Changes in the market environment . . . 21
E. Market analysis tools and methods . . . 25
F. Organizing market analysis at the supervisory authority . . . 55
G. Exercises . . . 60
H. References . . . 63
Appendix I. ICP 11 . . . 65
Case Study 1 . . . 36 Tables
Table 1. Premiums of insurers in the Czech market . . . 29 Table 2. Market shares of insurers in the Czech market . . . 30 Table 3. Insurance products available in the Czech market . . . 49 Figures
Figure 1. Czech insurance market: Concentration ratio development . . . 31 Figure 2. Czech insurance market: Herfindahl index development . . . 31 Figure 3. Insurance density and penetration in the industrialized countries in 2003 51 Figure 4. Insurance density and penetration in the emerging markets in 2003 . . . 52
About the
Core Curriculum
A financially sound insurance sector contributes to economic growth and well-being by supporting the management of risk, allocation of resources, and mobilization of long-term savings. The insurance core principles (ICPs), developed by the International As-sociation of Insurance Supervisors (IAIS), are key international standards relevant for sound financial systems.
Effective implementation of the ICPs requires skilled and knowledgeable insurance supervisors. Recognizing this need, the World Bank and the IAIS partnered in 2002 to develop a “core curriculum” for insurance supervisors. The Core Curriculum Project, funded and supported by various sources, accelerates the learning process of both new and experienced supervisors. The ICPs provide the structure for the core curriculum, which consists of a set of modules that summarize the most relevant aspects of each topic, focus on the practical application of supervisory concepts, and cross-reference existing literature.
The core curriculum is designed to help those studying it to: • Recognize the risks that arise from insurance operations
• Know the techniques and tools used by private and public sector professionals • Identify, measure, and manage these risks
• Operate effectively within a supervisory organization
• Understand the ICPs and other IAIS principles, standards, and guidance
• Recommend techniques and tools to help a particular jurisdiction observe the ICPs and other IAIS principles, standards, and guidance
• Identify the constraints and identify and prioritize supervisory techniques and tools to best manage the existing risks in light of these constraints.
Note to learner
Welcome to ICP 11: Market analysis module. This is a basic-level module on market analysis that does not require specific prior knowledge of this topic. The module should be useful to either new insurance supervisors or experienced supervisors who have not dealt extensively with the topic or are simply seeking to refresh and update their knowledge.
Start by reviewing the objectives, which will give you an idea of what a person will learn as a result of studying the module. Then proceed to study the module either on an independent, self-study basis or in the context of a seminar or workshop. The amount of time required to study the module on a self-study basis will vary, but it is best addressed over a short period of time, broken into sessions on sections if desired.
To help you engage and involve yourself in the topic, we have concluded the mod-ule with a number of hands-on activities for you to complete. If you are working with others on this module, develop the answers through discussion and cooperative work methods. An answer key in appendix II sets out some of the points that you might con-sider when tackling the exercises and suggests where you might look for the answers.
As a result of studying the material in this module, you will be able to do the fol-lowing:
1. List the numerous benefits from market analysis that accrue to supervisors, in-surers, and market participants, including how market analysis can be prepared and used by the supervisory authority in the supervisory process.
2. Describe different measurement categories that are used to assess the nature and performance of a market.
3. Illustrate the above categories with examples of specific measures that may be used.
4. Describe various sources of information, both domestic and international, that are used for market analysis.
5. Explain the strengths and weaknesses of these sources, noting how they can both inform and misinform.
6. Describe a process that might be used to identify possible future issues and sce-narios.
7. Explain the use of trend analysis, noting different techniques that can be em-ployed and describing their strengths and weaknesses.
8. Identify the attributes of competitive markets, and describe conditions that tend to induce market entry and exit.
9. Explain and discuss the presence of hard and soft markets.
10. Describe the sources of market power, and explain how market power might distort market outcomes.
11. Given sufficient information, construct a concentration ratio and a Herfindahl Index for a particular market.
12. Analyze the availability of insurance in relevant classes and market segments. 13. Analyze consumer complaints and investigate market conduct of insurance
companies.
14. Describe the types of aggregate market data that might appropriately be pub-lished by a supervisory authority.
15. Illustrate situations in which a supervisory authority might require systematic reporting to monitor and analyze events of importance to financial stability. 16. Summarize the requirements of ICP 11 Market Analysis.
ICP 11:
Market Analysis
Basic-level Module
A. Introduction
“Market analysis” has been used to describe a wide range of practices and approaches. Market analysis may be performed by various entities and for significantly different purposes. This module opens by describing the general concept of market analysis. It then concentrates on the issues important for an insurance supervisor.
Market analysis is an important tool to enable insurance supervisors to perform their challenging task of evaluating and updating monitoring techniques as well as pri-oritizing their actions. The supervisory authority should not only check and control individual insurers and reinsurers1 but also actively “shape” the market toward
com-petitiveness, stability, transparency, and the mutual respect of the market participants and their clients. Market analysis can play a significant role in achieving these objec-tives. Learning how to prepare market analysis and how to use it for these purposes are the main objectives of this module.
The importance of market analysis to the insurance industry and its supervision is confirmed by the fact that it was chosen as one of the topics of the Insurance Core Prin-ciples (ICPs).2 Market analysis is closely related and has many cross-links with other
topics covered by the ICPs, as shown in greater detail in following sections.
This module is not a simple “directions for use” of market analysis. The framework formed by legislation, market development, the current situation, and many other
fac-1. Supervision of insurers and reinsurers may be performed by different supervisory authorities, depending on stipulations of the respective legislation. To achieve better comprehensibility of this module, only the words “insurer(s)” and “insurance company(ies)” have been used from hereon (except for cases in which these words might be confusing), However, these words should read “insurer(s) and/or reinsurer(s)” and “insurance and/or reinsurance company(ies)” as appropriate in a particular context.
tors existing in individual countries is much too different to enable solving this problem in such a simple manner. Thus, this module should be understood more as a guideline
for market analysis preparation in a particular environment:
• What should be taken into consideration when preparing market analysis? • What are the objectives of market analysis?
• What are the analyzed subjects?
• What are the possible sources of information? • Which indicators can be prepared and analyzed? • What are the analyzing tools?
• How can the analysis be organized efficiently?
• How does market analysis interact with the supervisory authority’s other activi-ties?
When necessary, examples and case studies are included for ease of understanding and use of the topics.
The module has been developed as a self-study material. This module has been or-ganized to enable reading from beginning to end as well as concentrating of individual parts of interest to the reader.
Commonly used terms
Before delving further into the topic of market analysis, it is important to define some commonly used terms. Most of the definitions are taken from the IAIS Glossary of Terms (see IAIS 2006), although some additions have been made. While the vocabulary used in this module is sufficiently described in this section (and, if needed, in the IAIS Glos-sary), in real life, the reader may need a more detailed explanation or an explanation of special, unusual terms. There are numerous books to supply this need, for example, The
Dictionary of Insurance (see Bennett 1992).
Some of the terms used in insurance (and its market analysis) do not have a unique meaning, and their definitions contained in various sources may differ slightly, To avoid ambiguity, prevent possible misuse and misinterpretation, and determine market analysis results that are fully comparable and compatible, it is recommended that each supervisory authority maintain a list of the major terms used within its supervision process for market analysis together with their exact definitions, calculation formulas, and methods.
• Acquisition cost: that portion of an insurance premium that represents the cost of producing the insurance business. It includes the agent’s commission, the company’s field expenses, and related expenses.
• Annual accounts: financial statement of a company set up according to com-mercial law or generally accepted accounting principles, that is, not drawn up for specifically for supervisory purposes. In some countries the annual accounts/ shareholders’ accounts might also be used for submission to the supervisory au-thority. (Equivalent term: Shareholders’ accounts)
• Annual statement: an insurer’s financial report to its insurance supervisory au-thority issued at the end of the year or prepared for its financial year for certain jurisdictions. The report is required by the supervisory authority and is made using a form agreed by the supervising authority.
• Available solvency: Surplus of assets over liabilities. The first sense of the term is the surplus evaluated in accordance with domestic regulation–either rules of public accounting or special supervisory rules. The second sense is of the surplus, taking into account domestic requirements as regards eligible capital elements. In other words, the second sense is surplus as the amount of capital appropriate to cover the required solvency margin in accordance with domes-tic law or supervisory regulations. (see the section of this module on solvency margin for a mathematical formula for calculating available solvency) (Equiva-lent terms: available solvency, available solvency margin, actual solvency margin,
statutory solvency margin, available surplus capital, eligible capital, regulatory capital, free capital, total adjusted capital, policyholder surplus, statutory surplus)
(Related definitions: eligible capital element, required solvency margin) • Catastrophe loss: a loss of unusual size; a shock loss: a very large loss.
• Cession: the amount of a risk that the insurance company reinsures: the amount passed on to the reinsurer.
• Claim: notification to an insurance company that payment of an amount is due under the terms of a policy.
• Claims provision: amount set aside on the balance sheet to meet the total esti-mated ultimate cost to an insurer of settling all claims arising from events that have occurred up to the end of the reporting period, whether reported or not, less amounts already paid with respect to such claims. (Equivalent terms: claims
provision, provision for outstanding claims/claims outstanding, claims reserve, to-tal claim liability)
• Combined ratio: the sum of the claims ratio (loss ratio) and the expense ratio. Gives a rough indication of the profitability of an insurer’s underwriting opera-tions. Other related definitions: loss ratio (claims ratio), expense ratio.
• Coverage: the insurance afforded by the policy.
• Credit risk: the risk of financial loss resulting from default or movements in the credit rating assignment of issuers of securities (in the company’s investment portfolio), debtors (for example, mortgagors), or counterparties (for example, on reinsurance contracts, derivative contracts or deposits), and intermediaries, to whom the company has an exposure. Credit risk includes default risk, down-grade or mitigation risk, indirect credit or spread risk, concentration risk, and correlation risk. Sources of credit risk include investment counterparties, poli-cyholders (through outstanding premiums), reinsurers, and derivative counter-parties. (Related definition: reinsurance credit risk)
• Earned premium: premium for which protection has been provided. When a premium is paid in advance for a policy period, the company “earns’’ a portion of that premium only as time elapses during that period.
• Expense ratio: ratio of expenses to earned premiums. Expenses are the sum of commissions, administrative expenses, and other technical charges. (Related definition: earned premiums)
• Financial institution: a legal entity involved predominantly in financial activi-ties.
• Financial reports: accounting statements, financial returns, and statutory re-ports, including the balance sheet, the income statement and any other nu-merical reports prepared for disclosure to policyholders, investors, or insurance supervisors. Does not refer to reports prepared for other purposes.
• Foreign company: a legal entity whose head office is outside the jurisdiction concerned.
• Foreign insurer: an insurance company chartered in another state. (Related definitions: domestic company)
• Gross premium: premium for insurance that includes the provision for antic-ipated losses (the pure premium) and for the anticantic-ipated expenses (loading). (Equivalent term: office premium)
• Incurred but Not Reported (IBNR) provision: provision for claims incurred but not reported by the balance-sheet date. That is, it is anticipated that there would be a number of policies on which losses have occurred but where the insurer
has not yet been advised, and, therefore, are likely to result in a liability on the insurer.
The magnitude of this provision can be expected to reduce as the time since the insurance risk on the contract expired extends. The magnitude is also likely to vary depending on the type of insurance risk covered by any particular class of insurance contract. (Related definitions: losses incurred but not reported) • Incurred claims (losses): claims (losses) actually sustained during a fixed
pe-riod, usually a year. Incurred claims customarily are computed by this formula: claims paid during the period, plus outstanding claims at the end of the period, less outstanding claims at the beginning of the period.
• Inspection: an examination by those having authority: right usually reserved by an insurance company with respect to any property it insured.
• Insurance: an economic device whereby the individual substitutes a small cer-tain cost (the premium) for a large uncercer-tain financial loss (the contingency insured against) that would exist if it were not for the insurance contract; an economic device for reducing and eliminating risk through the process of com-bining a sufficient number of homogeneous exposures into a group to make the losses predictable for the group as a whole.
• Insurance company: a licensed legal entity that underwrites insurance.
• Liability: a debt or responsibility: an obligation that may arise by a contract made or by a tort committed. (Related definitions: technical liabilities, technical
provision)
• Loss: the unintentional decline in, or disappearance of, value due to a contin-gency.
• Loss ratio (claims ratio): refers to the ratio of claims incurred to earned premi-ums. Other related definitions: claims incurred, earned premipremi-ums.
• Loss reserves (claims provisions): an estimated liability in an insurer’s financial statement, indicating the amount the insurer expects to pay for claims (losses) that have taken place but that have not yet been paid.
• Net retention: the final amount of insurance retained by the company after re-insuring such amounts that it did not wish to retain.
• Nontechnical risks: nontechnical risks represent the various kinds of risk that cannot in any suitable manner be classified as either technical risks or invest-ment risks. Insurance supervisors will also be concerned about these risks (al-though the following list should not be seen as exhaustive):
– Management risk
– Risks connected with guarantees in favor of third parties – General business risk.
There can be debate about the inclusion of what some define as operational risk in this category. Depending on your definition, operational risk can be add-ed or can be includadd-ed in this list.
• Permissible loss (claims) ratio: the maximum percentage of premium income that can be expended by the company to pay claims without loss of profit. • Policy: the written contract of insurance that is issued to the policyholder
in-sured by the company insurer.
• Premium: the payment, or one of the periodical payments, a policyholder agrees to make for an insurance policy.
• Reinsurance: a reinsurance contract is an insurance contract between one in-surer or pure reinin-surer (the reinin-surer) and another inin-surer or pure inin-surer (the cedant) to indemnify against losses on one or more contracts issued by the ced-ant in exchange for a consideration (the premium).
• Reinsurance credit risk: a reinsurer might prove to be unable or unwilling to pay its part of the liabilities or the claims incurred, which lack of payment could put the insurer’s liquidity at risk and even cause its bankruptcy.
• Reinsurance risk: the risk of insufficient reinsurance covers or a failure of rein-surers to pay their part of the overall liabilities (or incurred claims) evaluated on a gross basis.
• Reserve: amounts set aside to meet unforeseeable liabilities (an obligation that has not yet materialized) or statutory requirements, and stemming either from shareholders’ capital or, in the case of mutuals, from members’ contributions and from accumulated surplus. Reserves are part of the own funds (in contrast to provisions that support liabilities to parties other than shareholders or other owners). (Equivalent terms: reserve, appropriated surplus, segregated surplus,
• Risk management: a scientific approach to the problem of dealing with the pure risks facing an individual or an organization in which insurance is viewed sim-ply as one of several approaches for dealing with such risks.
• Solvency margin: surplus of assets over liabilities. (Because these terms are fre-quently used in an imprecise manner, the glossary refers to available solvency (margin) or available surplus capital and required solvency margin or required surplus.) (Equivalent terms: solvency margin, surplus capital)
• Technical provision: amount set aside on the balance sheet to meet liabilities arising out of insurance contracts, including claims provision (whether reported or not), provision for unearned premiums, provision for unexpired risks, life assurance provision and other liabilities related to life insurance contracts (for example, premium deposits, savings accumulated over the term of with-profit policies). (Equivalent terms: technical provision, technical liabilities (technical)
reserves) (Related definitions: reserve, liability)
• Underwriting: process by which an insurance company determines whether and on what basis it will accept an application for insurance.
• Unearned premium: portion of the original premium for which protection has not yet been provided because the policy still has some time to run before ex-piration. A property and liability insurer must carry unearned premiums as a liability on its financial statement.
• Written premiums: premiums on all policies that a company has issued in some period of time, as opposed to “earned premiums.”
Acronyms used within the module include:
APRA Australian Prudential Regulation Authority
CEA Comité Européen des Assurances
CEIOPS Committee of European Insurance and Occupational Pensions
Supervisors
CIA Czech Insurance Association
CZK Czech Crown
GDP gross domestic product
EU European Union
HI Herfindahl Index
IAIS International Association of Insurance Supervisors
IASB International Accounting Standards Board
ICOS In the Course of Settlement (North American equivalent of RBNS)
ICP Insurance Core Principles (see IAIS 2003)
MU monetary unit
NAIC National Association of Insurance Commissioners
RBNS Reported But Not Settled (claim)
ROE return on equity
US United States (of America)
B. Role of market analysis
The term “market analysis” can mean different things. Market analysis can mean testing the business opportunities of new market entrants (that is, targeting business develop-ment, specifically, profit generation). The term also can mean analysis of market condi-tions, and status and development performed as a preparation for legislative changes (that is, targeting market stability, fair competition, and consumer protection).
For this module, the following definition is usable, that is, broad enough while suf-ficiently concise:
Market analysis is a research intended to predict the future of a market.3
This definition could seem too simple; however, the purpose and use of such a pre-diction always must be considered. In the case of insurance supervision, prepre-diction of future market behavior (and behavior of its individual participants) helps to anticipate unfavorable developments and to be prepared to intervene in case of a threat to market stability or consumers’ interests.
The above definition implies that:
• Market analysis is not only the description and analysis of the past (the goal of insurance supervision is informed action, not just knowledge for its own sake!).
• Market analysis is not a one-off process. But
• Market analysis is a systematic, repeatedly performed activity of collecting mar-ket information, putting the information into context, evaluating trends, and taking appropriate action.
Market analysis must be both proactive (studying and analyzing trends during “normal” development) and reactive (studying impact of extraordinary market events such as large natural catastrophes or failures of companies on the whole market). Mar-ket analysis skills will grow with experience.
Market Analysis in the context of the Insurance Core Principles
The following concept of market analysis performed by the supervisory authority has been introduced in the Insurance Core Principles:
3. http://www.investorwords.com/2965/market_analysis.html ICP 11 Market analysis
Making use of all available sources, the supervisory authority monitors and analyzes all factors that may have an impact on insurers and insurance markets. It draws conclu-sions and takes action as appropriate.
The ICPs also list criteria to enable the supervisory authority to check and evalu-ate the implementation level of the market analysis. Together with basic comments and explanations, these criteria are listed below.
Essential criterion a states: “The supervisory authority conducts regular analysis of
market conditions.”
One of the essential criteria of ICP 2 Supervisory Objectives says:
“The key objectives of supervision promote the maintenance of efficient, fair, safe and stable insurance markets for the benefit and protection of policyholders.” This objective is also the main driver for market analysis performed by the supervi-sory authority. The main risks that could affect the market and the insurance companies that operate in the market are:
• Jeopardized financial soundness of an insurance company4
• Bad market conduct of an insurance company when serving policyholders, par-ticularly in claims handling
• Unavailability of products
• Unfair competition and misuse of market power • Changes in the market environment.
Therefore, market analysis organized by the supervisory authority should con-centrate on factors that help to predict unfavorable development and enable adequate, timely responses.
Changes in the environment affecting the operation of insurance companies are discussed in section D. It is impossible to give a universal method of quantitative as-sessment of the impact of such changes on the insurance market. They must be evalu-ated case by case by employing commensurate assumptions and suitable mathematical tools.
Section E deals with basic indicators and methods of market analysis. They enable regular quantitative assessment of the structure of the market, its technical results, and its economic position; conduct of companies; market development; and market compe-tition and availability of products; as well as the development of these factors.
Section F describes how a supervisory authority can establish a market analysis function and perform market analysis.
Essential criterion b states: “The market analysis not only includes past
develop-ments and the present situation but also aims to identify trends and possible future scenarios and issues, so that the supervisory authority is well prepared to take action at an early stage, if required.”
4. Sometimes, endangered finances of one company may even have a positive effect on the market as a precedent leading to effective preventive measures. The main danger of this situation lies in its possible effect on the policyholders.
Correct and efficient performance of market analysis requires timely delivery of well defined, reliable, and accurate data; understandable and unambiguous definition of analyzed factors and indicators; and stable analytic methods. When interpreting the re-sults of market analysis, risk tolerance limits (limits and thresholds representing “warn-ing level” and/or “action level”) must be defined. All of these issues are dealt with in a greater detail in the following sections.
Essential criterion c states: “The market analysis is both quantitative and qualitative
and makes use of both public and confidential sources of information.”
Market development is always a result of the impacts of many different factors. While the results usually are measurable and can be expressed in quantitative form, quite frequently, the origin of the changes is nonmeasurable and difficult to assess (for example, legislative changes).
To the extent that a jurisdiction is observing certain ICPs, accessibility of data should not be an issue. To illustrate:
• For details on insurers’ public disclosure of data, see ICP 26 - Information, Dis-closure, and Transparency toward the Market.
• Reasonable data of any kind (including confidential information) can be re-quested by the supervisory authority from an insurer (see ICP 12 - Reporting to Supervisors and Off-Site Monitoring and ICP 13 - On-Site Inspection).
More difficult are the reasonable amount and structure of data and the availability of data. In particular, data that are newly requested from insurers, (such as complaints files and complaints statistics) may not necessarily be immediately available in a uni-form structure and level of detail. One of the big challenges of current insurance super-vision is to create and maintain a database that
• Has a stable and efficient structure (that is, does not require frequent structural changes and enables preparation of all necessary analyses)
• Does not impose an excessive burden on insurers when they are preparing the data (that is, requires data that the insurers are able to provide and that they can/should use also for themselves, for example, while performing risk manage-ment)
• Does not duplicate activities of other data collectors and providers (the super-visory authority should maintain extensive and intensive communication and cooperation with other institutions operating in this area)
• Is internationally compatible (that is, enables comparison with other markets, at least on regional level) and enables cooperation with other domestic financial supervisory authorities and foreign supervisory authorities
• Brings fast and efficient results (to enable prompt supervisory intervention as requested in ICP 14 - Preventive and Corrective Measures).
Additional notes on sources of data for market analysis are mentioned in section C.
Quantitative analysis deals with indicators that can be expressed in figures. It is also necessary to perform qualitative analysis, that is, the explanation of market changes and developments expressed in words. Qualitative analysis includes reporting on general developments that may impact insurance markets, companies, and clients, including new or forthcoming financial sector and other relevant legislation, developments in supervisory practices and approaches, and reasons for market exits. Qualitative analysis
should always be complemented with a quantitative analysis. The explanation or
predic-tion of development is never complete without quantitative assessment of impacts. In the same way, quantitative analysis also needs its qualitative complement. Each table, fig-ure, or any other form of presentation of quantitative analytical results must be comple-mented with a verbal explanation of
• Reasons for the presented development
• Possible inaccuracies that may influence the results • Expected future development trends
• Relevant comments and remarks of any other kind.
Otherwise, the presentation loses a significant part of its analytic value.
Essential criterion d states: “The supervisory authority or others, such as the
insur-ance industry, publish aggregated market data that is readily and publicly available to the insurance industry and other interested parties.”
Market data are important for insurers and other market players, enabling them to compare their performance and activities. Fact books issued by the Insurance Infor-mation Institute, or annual reports of the Czech Insurance Association may serve as examples. They, along with other sources mentioned in section H, are relevant in this context.
Essential criterion e states: “The supervisory authority requires market-wide
sys-tematic reporting to analyze and monitor particular market-wide events of importance for the financial stability of insurance markets.”
In addition to standard, regular reporting and public disclosures (as requested and described in ICP 12 - Reporting to Supervisors and Off-Site Monitoring and ICP 26 - Information, Disclosure and Transparency toward the Market), specific data collection and analysis may be needed in the case of, for example, catastrophes that may influence the market. The terrorist attack at the World Trade Center in New York on September 11, 2001 and Central European floods in August 2002 may be cited as instances of human-made and natural catastrophes, respectively. Supervisory authorities should be prepared to (re)act immediately to secure the maximal possible consumer protection. Exposure to such events should be monitored by the supervisor because they constitute a potential systemic threat, and will influence how the supervisor monitors financial strength and liquidity.
ICP 11 also includes two advanced criteria. Advanced criterion f states: “Insofar as international relationships affect internal insurance and financial markets, the analysis is not limited to the home market but also includes developments elsewhere.”
International relationships and cooperation have become an inevitable part of today’s life, including insurance and its supervision. Sometimes, the need for coopera-tion is directly embedded in the applicable legislacoopera-tion,5 and the supervisory authority
would not be able to perform its duties without analyzing other markets. Obviously, cross-border market analysis is difficult to perform. Therefore, cooperation and market analysis information exchange between individual national supervisory authorities is totally inevitable. Some of the market analysis indicators mentioned in this module serve the comparison of individual markets (see section E - Analyzing market develop-mental level).
Advanced criterion g states: “The supervisory authority monitors trends that may have an impact on the financial stability of insurance markets. It assesses whether mac-roeconomic risks and vulnerabilities are adversely impinging on prudential safeguards, financial stability or consumer interests.”
Basic thoughts on market analysis are discussed here. Nevertheless, there are a number of related topics not covered or covered only partially due to the limited scope of this module, such as:
• Impact of trading and ownership links to market structure and its operation • Insurance groups and financial conglomerates aspects of market analysis • Nontraditional reinsurance
• Analysis of external markets and their impact to domestic market.
The world is changing and the supervisory authority must keep pace with all rele-vant changes. Therefore, continuous observing of and learning about the market chang-es form inevitable parts of the insurance supervisor’s job.
5. Let us take the situation in the European Union. EU member countries have adopted two tiered legislation: 1. Common EU legislation obligatory for all member states
2. Individual state laws that may not contradict the common EU legislation. The EU legislation enables:
• Single-license principle (license to operate issued in one member state is also valid in other member states) • Freedom to provide services (insurance companies may operate from one member state and in other member
states)
• Right of establishment (insurance companies may establish branches in other member states).
It is not surprising that international cooperation in such a market environment is not only vital but even obligatory (regu-lated by the EU laws).
Use of market analysis and benefits for the supervisory authority
Modern supervisory techniques must include market analysis. The following discus-sion addresses the most important specific areas in which market analysis contributes to the execution of insurance supervision, and the indicators that enable, or assist in, performing it. This section deals with the general benefits and contributions that mar-ket analysis can provide the insurance supervisor.
It is impossible to avoid totally all adverse developments. On the other hand, watching the trends and analyzing the strengths and vulnerabilities of the market enable
supervisors to be proactive, to put them at the ready and poised to (re)act before minor problems become major by adapting techniques as market conditions evolve.
MarketbenchMarks
Market analysis can be used to set up market benchmarks and uncover significant
dif-ferences between the market benchmarks and the positions of individual companies.
In-formation related to individual market participants can be summarized and combined into market values, then analyzed to establish market benchmarks and averages. Such benchmarks and averages may be used for prudential purposes. Deviations from such benchmarks may trigger more intensive monitoring or intervention. Details for indi-vidual indicators addressed in this module appear in section E on market analysis tools and methods.
In a sound market, companies close to the market average that keep pace with market benchmarks are less likely to have problems than insurers that deviate from the market in a negative direction.
Marketefficiency
Market analysis enables the measurement of competition in the market. The market is ef-ficient if products are available and sold at reasonable prices. It has been proven many times both in economic theories and in practice that efficiency can be achieved more easily in markets that have sufficient competition in which the size of individual players is not great enough to enable them to misuse their market power.
insurancesupervisionefficiency
Not only the market but also the insurance supervision itself should be efficient. Here, market analysis can contribute a great deal. Efficiency of the supervisory authority means that:
• The supervisory authority acts in a timely manner. • The supervisory authority acts efficiently.
Analysis helps to set priorities within the supervisory process. The supervisory authority should exercise a uniform, just approach to all market players. On the other hand, it is obvious that supervisory authority intervention and thus closer attention to certain insurers is more needed under adverse circumstances and/or in cases in which policyholders’ rights could be endangered. The overall solution of how to organize clos-er supclos-ervision of “suspect” insurclos-ers in a transparent way, without breaching principles of equality, falls within the scope of ICP 4 - Supervisory Process. However, some con-siderations on setting priorities and concentrating capacities in the supervisory process are mentioned here.
There are several reasons to watch some market players more closely. The most important reasons are, for:
• Biggest insurers:
– They could misuse their market power when pricing and serving their cli-ents.
– More clients could face difficulties in case of the adverse development of the company.
• Smallest insurers:
– They are often more sensitive to market fluctuations.
– Due to their size, it is more difficult for them to keep their fixed costs at an appropriate level and keep pace with their competitors.
• Insurers that deviate significantly from the market average in main indicators (such as provisioning level, combined ratio, solvency margin):
– Such deviations could indicate adverse development of the company, non-professional approach, or poor financial position compared to market benchmarks.
Market analysis helps to concentrate the supervisory authority’s capacities on in-surers with higher potential of problems.
Marketconduct
Compared to measuring purely economic indicators, it is more difficult to measure and analyze the behavior of the market and individual companies. The desirable behavior includes fair and transparent marketing of insurance products, timely response and settlement of claims, resolving complaints, and complying with the requirements of public disclosure. Basic possibilities for such analysis are discussed in section E.
Moni-toring the market conduct of insurance companies is another way that market analysis protects policyholders.
coMparisonofindividualMarketsandcooperationwithother supervisoryauthorities
Some of the market analysis criteria enable the comparison of the developmental level
of individual markets (see section E regarding analyzing market developmental level
for details). Using equal or comparable market analysis in different market enables the
supervisory authority to compare the market status of individual insurers in different markets. Comparable market analysis also facilitates cooperation with other supervisory authorities, which is vital for cross-border cooperation in an international environment
such as the European Union (applying the principles of right of establishment, freedom to provide services, and single license). Additional details and considerations regarding such cooperation can be found in ICP 5 - Supervisory Cooperation and Information Sharing.
Scope and depth of market analysis
Requirements for market analysis are contradictory:
• It should be comprehensive, taking into account all factors affecting (or poten-tially affecting) the market and its development and performing quantitative measurement of such impact (or at least its estimation when quantification is impossible or appropriate mathematical methods are not available).
• If such impact could lead to an adverse development endangering the consum-ers, market, or some of its participants, the analysis should identify decisive factors and suggest their alternative values (in case of quantitative factors) or qualities (in case of qualitative factors) that are achievable and would lead to a more favorable development.
On the other hand, the analysis should: • Be reasonably priced
• Require reasonable capacities in terms of expertise and technological resources • Be fast enough to enable taking measures against adverse development.
Therefore, it is necessary to establish the scope and depth of the analysis to comply as much as possible with the above requirements. The following aspects and methods should be considered when setting the sensitivity:
• Learning by experience:
– Is the market analysis sensitive enough to identify adverse development and negative events affecting the market in the past?
– Would the signals brought by the market analysis come early enough to en-able timely measures?
• Co-operation and exchange of information. The supervisory authority should cooperate and exchange information with:
– Authorities supervising other areas of the financial market – Supervisory authorities of other insurance markets. • Adequacy regarding prudential requirements:
– Is the market analysis sensitive enough to judge the prudential requirements and development of values of their indicators on the market-wide level? – Would the signals brought by the market analysis come early enough to
en-able timely measures?
The scope and sensitivity of market analysis must be continuously followed and assessed, and market developments must be reflected without delay.
C. Sources of information
The majority of the information needed for direct quantitative market analysis is sup-plied by the insurance companies, as both reports to supervisors and findings during on-site inspections. However, a substantial portion of information useful for the analy-sis and its environment also can be obtained from other sources such as in discussions with market participants and other entities. The supervisory authority should not leave out any single facility or opportunity that enhances its knowledge and helps to assess the future market development. These information sources and their possible contribu-tions to market analysis are discussed in this section.
Internal communication and information sharing at the supervisory authority also should be mentioned here. Particularly important is that information from regular re-porting, off-site monitoring, and on-site inspections reach the supervisory authority department responsible for market analysis without unnecessary delay. This timeliness must be in place for all internal communication within the supervisory authority; oth-erwise the results of market analysis can not be used in an efficient way.
Research and market analysis staff also should monitor relevant publications, press releases, market surveys, investigation reports, and discussion groups, both domestical-ly and internationaldomestical-ly, and extract information on issues that could affect the insurance sector. This monitoring also can be done using electronic tools and services (at least in some territories in which such tools are available and legal). Monitoring is not restrict-ed only to items with “pure insurance content” but also to items that relate to insurance relatively loosely, such as demofigureic development, criminality, and exchange rates. Insurance market participants
Market participants and their possible contributions to market analysis are listed be-low:
• Insurance companies and insurance associations
Insurance supervisors could meet formally and informally with management and directors of the insurers. These meetings can be done as adjuncts to on-site inspections. Meetings also can also be held more formally, for example, through periodic meetings of senior management of the supervisory authority with in-dustry counterparts. Mutual exchanges of views will improve communication, understanding, and trust; and complement information collected through other channels.
Insurance associations usually also perform market analyses, prepare com-prehensive market statistics, investigate the overall market environment, and, in mutual communications, prepare such outputs as codes of conduct for mem-ber companies. Results of these activities are communicated in their annual
re-ports,6 press releases, and other outputs; and may be useful and contributive to
the analysis performed by the insurance supervisor. Regular discussions with the top association representatives (who usually are senior management mem-bers of insurance companies) can contribute to estimating and understanding future market development, problems faced by the insurance companies, their solutions, and other issues.
• Reinsurers
Reinsurers perform global market analyses7 as well as analyses of individual
events affecting the international insurance and reinsurance market. Their con-tributions are particularly valuable because of the global perspective of their approaches. It may be useful for the insurance supervisor to keep in contact periodically with reinsurers and study the materials they issue.
• Insurance and reinsurance brokers
The same statements above about reinsurers also are valid for large insurance and reinsurance brokers. In addition, in their efforts to attract consumers, at a certain level, they compete with rating agencies with respect to assessing the financial stability of reinsurers and finding methods for using the results of such assessments in their work.8 Their output may serve as an inspiration and
com-parison tool also for the insurance supervisor. • Other professionals in the insurance sector, including:
– Actuaries and their professional associations – Risk managers
– Compliance officers9
– Advisors.
Furthermore, the insurance supervisor can discuss with them particular tech-nical issues as well as what they see as developing risks and business trends. Wider economic and international environment
Regular discussions with a variety of other parties may be particularly useful for shar-ing views on developments and trends affectshar-ing the financial sector and legal environ-ment.
6. Czech Insurance Association 2003 is an example. 7. Swiss Re 2004 is an example.
8. Benfield Group 2004a may serve as an example in this respect. 9. See explanation in Bennett 1992.
• Authorities supervising other financial sectors
Meetings can be useful even if the counterparty is legally constrained from shar-ing information about specific financial institutions.
• Representatives of other organizations having roles in the financial markets These officials include central bankers, finance ministers, and managers of
poli-cyholder protection funds. • Auditors and rating agencies
All entities included in such discussions have two common interests: investigat-ing the soundness of market players and protectinvestigat-ing the market from adverse developments. Therefore, these meetings should be held frequently.
• Supervisory authorities of other jurisdictions
All entities included in such discussion have two common interests: investigat-ing the soundness of market players and protectinvestigat-ing the market from adverse developments. Therefore, the meetings should be performed on frequent basis. • International institutions
Such institutions include IAIS (International Association of Insurance Supervi-sors), CEIOPS (Committee of European Insurance and Occupational Pensions Supervisors), CEA (Comité Européen des Assurances), and IASB (International Accounting Standards Board). The supervisory authority has a natural interest in following the developments and participating in activities of these institu-tions whenever possible.
D. Changes in the market environment
The environment in which the market operates is determined by the existing political systems, economic and financial contexts, legislation, developmental level of the re-spective country, geographical location (climate), and the society. Political changes may trigger changes in each of these factors.10
It is not only the financial impact that should be considered but also the availability of reasonable and adequate insurance protection for consumers. When preparing the market analysis, the supervisory authority should always consider the particularities of the market. The influence of individual factors is different in different markets. (Fur-thermore, it is possible that some of the market-specific factors are not mentioned in this module).
General economic conditions and financial market situation Any changes should be carefully followed by the supervisory authority:
• If the general economic situation is deteriorating (whatever the cause), it will negatively affect the disposable income of inhabitants, decrease the demand for insurance products, and shrink the insurance market, which may affect the vi-ability of insurers.
• Surprisingly, improvement of the general economic situation (or even a stabiliza-tion of the economy) also may bring problems to insurers. In such an economic environment, interest rates go down so that reaching the yields guaranteed in fixed-interest-rate life policies may be difficult.
• Negative development in the equity market has a negative impact on the value of insurance provisions and reserves invested in equities (and thus to the solvency of insurance companies).
In general, the three points above are valid not only for equities but for all possible types of investments of provisions and reserves.11
Underestimation of changes and inadequately slow adaptation to new environ-ments can significantly harm the insurance market.12
10. Development in East European countries may serve as a good example. In the early 1980s, these countries had state mo-nopoly planning systems (with monopolies also in the insurance sector). Nowadays, they are European Union members, and all aspects of life in these countries have changed, including not only legislation, economy, finance, and demofigureics but also areas seemingly unimportant to the insurance industry such as infrastructure and transportation. The insurance sector itself now operates under conditions of free competition.
11. This is why the investment mix in insurance is regulated: deterioration in one sector may be balanced by improvement in another. Investment risk, particularly in life insurance, should be as low as possible and thus subject to (reasonable) regula-tion.
12. They were the main reason of recent failures even in highly developed markets such as United Kingdom (failure of Equi-table, British life insurance company; see The Treasury Committee 2001) and Germany (failure of Mannheimer Lebensver-sicherung AG, German life insurance company. First failure of a life insurer in Germany in more than 50 years; see Federal Financial Supervisory Authority 2003). These failures triggered large discussions in the EU as to whether they could have been anticipated by their home supervisory authorities through adequate market analyses and prevented by existing (or amended)
Legislation
Legislation not only establishes the framework for insurance market operation but also highly influences its performance and results. The examples below do not represent a complete list of the legislative changes affecting the insurance market. Rather, to be on the safe side, the insurance supervisor should follow the development and changes in legislation as a whole, and for each change analyze the impact on the market.
• Taxation
– Taxation levels and/or changes can widely influence demand, particularly for life insurance products.
– Taxation changes can significantly influence the cost of claims.13
• Claims indemnity
– Indemnity amounts for claims can change significantly over time due to changes in legislation as well as to changes in legal findings (usually, “change” means “increase”)
– New sources of indemnity unknown earlier in national legislation may be introduced in the legislative development process. Examples are pain and suffering awards for relatives of victims of traffic accident and punitive dam-ages.
• Traffic rules
Introducing or changing speed limits, and how strict the police are in enforcing traffic laws, influence the frequency and severity of automobile accidents and, consequently, paid claims.14
• Various liability fields
Some types of claims that were not payable earlier may become payable under new legislation or a legal situation.15
prudential requirements; and whether sufficient measures could have been imposed under the circumstances existing prior to these failures. Consequences can be found even on the European Union level. The European Commission introduced an initiative on the establishment of insurance guarantee schemes to enhance consumer protection. See European Commission paper, Markt/2513/04-EN (October 2004).
13. Changes in the value-added tax (VAT) recently introduced in the Czech insurance market triggered large discussions on the economic impact on the domestic market. This Czech tax has two categories: taxation of category 1 increased from 5% to 7%; category 2 decreased from 22% to 19%. Some commodities were transferred from one category to another.)
14. Even positive changes may have temporarily negative effects. For example, after the introduction of strict right of way for pedestrians on zebra crossings in the Czech Republic, the frequency of accidents on zebra crossings increased by 400%! Pe-destrians’ right of way was relatively ambiguous earlier, so the change was undoubtedly correct and a standard development. Nevertheless, after the new legislation, pedestrians became too careless, while some drivers still do not fully observe the new rules. It will take some time to reap the benefits of the change. Until then, people will be injured or killed, and the accident claims will burden the motor third-party liability insurers.
In this respect, it is not only local legislation and developments that should be considered but also those in international law. Examples are the analysis of cross-border operations16 and participation in the “green card” system.17
Society
The influence of societal factors should be included in the market analysis prepared by the supervisory authority.
• Demographic trends:
– A decrease in population may imply decrease in demand for insurance prod-ucts and thus affect viability of some companies in the market.
– The changing structure of population may lead to changes in the product mix in the market. For instance, an aging population will imply increasing demand for pension products.
– An increase in population density accelerates the process of value concentra-tion. This factor should not be underestimated in market analysis.
• Developmental level of the society:
– The frequency and severity of insured events of a particular kind (terrorist at-tacks, road accidents) that influence the market and its development depend significantly on the general developmental level and other issues in the society. – Increasing life expectancy, which is also closely linked with the
developmen-tal level of the society, may significantly impact the market, particularly on the life insurance companies that underestimated such development.
Country’s developmental level
A country’s wealth and its development also influence the insurance market:
• Improving infrastructure (road system), changing age, number of vehicles, and structure of the fleet has a significant impact on motor insurance in both direc-tions:
– Improving safety of cars diminishes consequences of accidents. – Their higher value increases cost of repair.
16 Arrangement based on European Union directive enabling an insurer based, operating, and supervised in one EU mem-ber state to also operate in the territory of other memmem-ber states without the need for local license.
• Improving medical care means that victims survive accidents that would have been fatal in the past. From the social point of view, this is definitely a positive development, but the consequences for the insurance industry are:
– Increasing cost of medical treatment
– Increasing cost of loss of income after accident, caused by both higher life expectancy and higher income level.
• Improving material wealth:
– Leads to higher value concentration and thus higher loss susceptibility in case of catastrophic events
– Positively affects life expectancy, which decreases the frequency of life insur-ance claims, but also leads to the purchase of larger life insurinsur-ance policies – Increases the demand for savings and investment products
– Increases traffic density and thus also the number of road accidents.
All these factors must be carefully observed both in the risk management of indi-vidual companies and in market analyses performed by the insurance supervisors. Geographical location and climate
Demand for insurance cover and insurance market operation may be significantly af-fected by local geographical and climatic conditions. Some natural perils in some geo-graphical areas are almost uninsurable.18 State (legislative) intervention may improve
the availability of protection.19 It is obvious that market analysis must be concerned
with such issues and concentrate particularly on local problems.20
It is not 100 percent clear and has not been proven yet whether some of catastroph-ic events have been triggered or exacerbated by climate change. Insurance supervisors also should track this global environmental trend and consider scientists’ opinions.
18. Such as the flood in Bangladesh. 19. Examples are mentioned in footnote 42.
20. In this respect, reader may have interest in the discussions on and responses to the recent unprecedented sequence of hurricane landfalls in the US (Charlie, Frances, Ivan, and Jeanne). It was not possible to comment on the final responses of the market (and maybe also of the US insurance supervision) to the hurricanes because the discussions started during the preparation of this module. The basic description of what happened may be found in Benfield Group 2004b.
E. Market analysis tools and methods
To a great extent, market analysis means risk analysis of summarized data collected from individual insurers. Therefore, the analytic methods and considerations applied to risks mentioned in ICP 18 - Risk Assessment and Management can be employed.21
Tools and considerations introduced in this module may overlap and/or be further de-veloped with tools and considerations presented in other ICPs (ICP 12 - Reporting to Supervisors and Off-Site Monitoring,22 ICPs relating to prudential requirements, ICP
18 as well as ICPs 19–2323, and ICP 26 - Information, Disclosure and Transparency
toward the Market24).
Usually, the basic data (gross premium written, absolute amount of provisions) col-lected from insurers25 and other sources are not suitable for market-wide analysis. It is
only by combining them into ratios, processing them through mathematical formulas, monitoring their development over time, envisioning their results, and discussing them with other market and environment entities that enable understanding of market devel-opment, discovering its strengths and vulnerabilities, and forecasting the future.
The extent and level of this module does not allow the introduction of sophisticated market analysis indicators and methods; therefore, only basic ones have been included here. References to sources of more extensive or advanced information are mentioned when necessary or useful.
Subsections dealing with individual indicators or groups of indicators have been structured as follows:
1. Introductory comments on the purpose of the indicator(s), main fields of use, and benefits for the insurance supervisor
2. Definition, scope of use
3. Remarks on how to interpret values of the indicator, how to indicate adverse developments, and what should be the supervisory action in such a case
4. Example or case (sometimes a combined example, or case study, for multiple indicators).
21. ICP 18 deals with risks inherent to insurance companies and markets. Some risks, such as underwriting risks and risks related to the evaluation of technical provisions, are specific to the insurance sector. Other risks are similar to those of other financial institutions, for example, market (including interest rate), operational, legal, organizational, and conglomerate risks (including contagion, correlation, and counter-party risks). Position of insurance supervisors when performing analysis of risks faced by the market is similar to the position of insurance company analysts performing the analysis of risks faced by the company due to economic, competitive, and political factors. See the ICP 18 modules for details.
22. ICP 12 may serve as a guideline on collecting data needed for market analysis from insurance companies.
23. • ICP 19 Insurance activity deals, among other topics, with the use of actuarial, statistical, and financial methods for estimating liabilities and determining premiums, and with reinsurance arrangements. These issues also represent an important subject of market analysis.
• ICP 20 Liabilities deals with establishing adequate technical provisions and other liabilities, and making allowance for reinsurance recoverables, which are items that also should be analyzed throughout the whole market.
• ICP 21 Investments helps in the analysis of investment policy, asset mix, valuation, diversification, and asset-liability matching.
• ICP 22 Derivatives and similar commitments will help with the market analysis on the use of these financial instru-ments
• ICP 23 Capital adequacy and solvency is useful for the market analysis of capital in the market. 24. ICP 26 helps in understanding which information needed for market analysis is publicly available. 25. For details see ICP 12 Reporting to Supervisors and Off-Site Monitoring and ICP 13 On-Site Inspection.
Analyzing market structure and competition
Market analysis indicators discussed in this subsection enable the assessment of the level of competition in the market and the development of competition over time. They also enable comparison with other markets. As regards their possible use in the supervisory process, they have a relatively less important role. These indicators help in assessing the market power of market participants. They also may have practical use for the insur-ance supervisor when considering approval of mergers and acquisitions: mergers and acquisitions should not reduce the competitiveness of the market. On the other hand, in case of exit from the market and/or portfolio transfers,26 more important reasons will
probably play a decisive role in the supervisory authority’s decisionmaking.
Market shares of insurance groups, instead of the shares of individual companies, can be analyzed. There is not a uniform opinion on which of these approaches is more useful. It seems that the most pragmatic approach would be to perform both, compare the results, and use what is more practicable for the particular situation.
Other aspects of market structure also can be analyzed, such as:
• What is the number of insurers operating in a market (and its development over time)?
• What is the number of–and, particularly, the reasons for–market exits (and de-velopment over time)?
• What is the market structure with respect to domestic and foreign insurers, and branches?
concentrationratio
The concentration ratio is often expressed as CRm, for example, CR4. The concentration ratio can be expressed as:
CRm = s1 + s2 + s3 + … … + sm where si = market share of the ith company.
The lower the concentration ratio, the more widespread–and usually, the better–the competition in the market. Competition has four aspects, defined as:
26. For details see ICP 16 Winding-up and Exit from the Market and ICP 8 Changes in Control and Portfolio Transfers. Concentration Ratio
The percentage of market share owned by the largest m companies, where m is a speci-fied number of companies (usually 4 or 8).
1. Perfect competition—very low concentration ratio
2. Monopolistic competition—concentration ratio below 40 percent for the 4-firm measurement
3. Oligopoly—concentration ratio above 40 percent for the 4-firm measurement 4. Monopoly—near to 100 percent concentration ratio for the 4-firm
measure-ment.
The competition in the insurance sector will probably never be so fierce, crowded, and “perfect” in the sense of concentration ratio as it is in, for example, agriculture. The insurance supervisor should, however, take into account the particular market situa-tion. In oligopoly, for instance, the market is dominated by a small number of sellers, and each oligopolist is aware of the actions of the others. Oligopolies have a significantly higher risk of misusing their market power (particularly by dictating prices), to the detriment of consumers.
In addition, comparing market share information over time allows supervisors to identify companies whose operations are expanding or contracting and to inquire fur-ther into reasons for the change and whefur-ther the company has resources to deal effec-tively with growth or loss in business.
herfindahl index
The Herfindahl Index provides a more complete picture of market concentration than does the concentration ratio. This index uses the market shares of all companies in the market. It squares these market shares to place more weight on the larger companies. If there are n companies in the market, the Herfindahl Index can be expressed as:
HI = s12 + s
22 + s32 + … … + sn2 where si = market share of the ith company.
Unlike the concentration ratio, the HI will change if there is a shift in market share among the larger companies.
The Herfindahl Index can be used to determine whether mergers are equitable to society and thus also influence the actions and decisionmaking processes at the super-visory authority.27 As the market concentration increases, competition and efficiency
may decrease, and the opportunities for collusion and monopoly increase.
The Herfindahl Index should not be examined with respect not only to the total market share but also to market share of individual products (that is, in the insurance sector for individual lines of business).28
27. In the United States, increases of over 100 points generally provoke scrutiny, although it may vary case to case. The De-partment of Justice considers Herfindahl Indices between 1000 and 1800 moderately concentrated and indices above 1800 concentrated.
