Fraser Drew, David Humphry, Michael Straughan and Eleanor Watson
For most of us buying insurance nowadays, price comparison websites offer plenty of choice. But how much competition in insurance markets is there? There are very few studies that address this question (see here for a summary), unlike for banking where there is a wide literature. We take an exploratory approach to address the question, applying benchmarks used in competition research to a unique set of reporting data across multiple UK insurance regulatory regimes, with the hope of stimulating further work. We find competition generally works well in UK life and non-life insurance markets, despite increases in life market concentration over the past 25 years. However, competition regulators have found practices in specific markets that harm consumers.
Why did we carry out the research?
The UK has a particularly large insurance market. In July 2020 there were 375 UK-based, and 806 non-UK branches authorised by the Prudential Regulation Authority (PRA) to sell insurance in the UK. In 2017, there were £197 billion net earned premiums in the life market and £67 billion in the non-life market. According to the ABI, the UK insurance market is the largest in Europe and the fourth largest in the world.
Despite the size of the UK market, there is little public information about the level of competition in insurance. Qualitative analysis has been done on specific markets but an overview of competition across the whole UK insurance market has not been extensively explored.
Why is the level of competition important? Protection and savings products offered by insurers are valuable because they allow consumers to smooth consumption over their lives and avoid the risk of large losses. In theory, when the level of competition improves it can make products more valuable by increasing affordability, while maintaining quality (e.g. the level of security for the policyholder) or vice versa. However, there are examples in practice where competition has not worked in this way.
Over the last 25 years, there have been big structural shifts in the insurance industry, making a current perspective on the level of competition timely. The period covers the introduction of price comparison websites, as well as big changes to the regulatory regime such as the implementation of Solvency II, which regulates the finances of insurance companies and how they are run.
To measure the level of competition, we follow a similar approach to analysis of UK deposit takers. We use regulatory data to measure competition in UK insurance markets from 1995-2019. This gives us a long-term perspective, but there are also some limitations with the data. First, the data is reported by UK insurers, and this means we miss the effect of competition created by imports to the UK market, which is particularly prevalent for non-life insurance. Second, prior to Solvency II’s introduction in 2016, reporting treated Lloyd’s of London as a single entity rather than the market of almost 100 competing syndicates that it is in reality. This is a problem because in aggregate Lloyd’s is a large entity, and this skews competition measures. In the end, we decided to exclude Lloyd’s of London in our pre-2016 analysis, expecting that we would be underestimating the extent of competition. Third, our analysis looks broadly at the life and non-life markets. It’s possible that within these markets particular lines of business or classes of customer have different levels of competition to the aggregate results.
We started by looking at the concentration of insurance markets. Economists often worry that if a market becomes more concentrated with larger firms, it could lead to a reduction in competition that could subsequently negatively affect consumers. There may, however, be countervailing benefits if larger insurers are better able to absorb unexpected losses. From data on entry and exit and on transfers of business, we know there has been consolidation in insurance markets. Figure 1 shows the Herfindahl-Hirshman-Index (HHI) — a standard measure of concentration — for life and non-life markets over the last 25 years. The HHI is calculated by summing together the squared market shares of all participants in a market (in our case using market share of net written premiums). A higher score represents a more concentrated market. According to the UK Merger Assessment Guidelines, scores of more than 1000 show concentration and above 2000 show high concentration.
Figure 1: Concentration in UK insurance markets
The life market has become more concentrated over time while the non-life market has remained largely unchanged since 2004. Major transactions in the life insurance market can cause temporary increases in HHI, which we see in 2007 and 2016. Concentration levels in both markets are below levels that competition regulators classify as concentrated.
Next, we looked at a standard measure of competition — the Boone indicator — to see if the increased concentration had an effect on competition. The Boone indicator measures the variability of profits to average variable costs. The theory goes that in a competitive market if costs increase then profits will fall, as firms are penalised for inefficiency. The more competitive the market, the more profits will fall and the more negative the Boone indicator. Its application to insurance is, however, exploratory.
Figure 2: Competition in the non-life insurance market 1995-2019
Figure 2 plots the Boone indicator from 1995-2015 using data from the old insurance regulatory regime, and from 2016-2019, it uses Solvency II reporting data, including Lloyd’s of London syndicates. It shows a slight upward trend in the non-life market between 1995 and 2015 indicating a lessening in competition. Once we include Lloyd’s of London syndicates after 2016 then the Boone indicator falls, measuring competition as more intense. This is as we would expect, although we should not overly rely on the findings from this period because of the wider confidence intervals for our estimates of the Boone indicator. We expect the Boone indicator would show more intense competition if we could include imports from branches of insurers.
Figure 3: Competition in the life insurance market 1995-2017
Figure 3 shows that despite the increase in concentration in the life market, competition hasn’t suffered as a result, although our modelling works less well post 2016. We think there are a few reasons why competition hasn’t been affected by increased concentration. First, insurance is about scale and diversification so consolidation is not necessarily bad. Second, in most lines of business there are a sufficient number of firms competing for risks, whether they are insurers or firms from other sectors — such as asset managers — providing substitutes. There is also the threat of new entrants, particularly from existing insurers that can redeploy their capital by diversifying into new lines of business, which boosts competition. Established insurers that underwrite different risks can move into different insurance markets by hiring underwriters with expertise in those areas, and by sharing risks with reinsurers as they gain experience of the newly underwritten risks.
While we see general trends in the level of competition, we think that our results may also suggest the presence of cycles in the intensity of competition. The underwriting cycle is a well-known feature of non-life insurance — major losses cause some firms to exit the market leading to a reduction in supply, but new firms gradually enter attracted by improved prospects for profitability. We see competition appearing to decrease at times that coincide with major catastrophe losses. Cycles in the life market appear to operate in a different way with decreases in competition coinciding with major financial downturns.
According to our measures, competition looks to be working well in both markets. While it is tricky to compare across studies, the Boone indicator for the UK deposit taking market tended to be less negative, indicating that insurance markets in the UK are more competitive than retail banking.
Other in-depth studies by competition regulators are able to supplement our analysis. In CMA reports into the mergers of insurers in different markets, participants often note low barriers to entry and many different insurers competing for the same risks. This can be seen in the retirement income market from the Just Retirement/Partnership merger, the private medical insurance market from the AXA/Simplyhealth merger, and in private motor insurance market investigation.
Nevertheless, competition regulators also identify specific practices in insurance markets that lessen competition to the detriment of consumers. The recently released FCA Final Report into general insurance pricing practices finds strong evidence of ‘price walking’, where insurers gradually increase prices to loyal customers who renew each year while customers who shop around are able to find good deals. This disproportionately affects older customers and those with less understanding of insurance product pricing. The FCA found that 6 million policyholders paid too much in 2018 and if they had paid the average for their level of risk, they would have saved £1.2 billion. However, there remains fierce competition for new business with insurers often operating policies at a loss for the first year of contracts.
The FCA Retirement Outcome Review also finds “weak competitive pressure and low levels of switching” in the pension drawdown market for non-advised consumers. Drawdown products and their fee structures are often complicated so non-advised consumers tend to stick with their existing providers who charge higher fees. Advised consumers are more likely to switch and get a better deal. Some consumers could increase their annual income by 13% if they switched to a provider with lower fees.
Our exploratory analysis suggests competition in life and non-life UK insurance markets generally work well, despite some consolidation in the life insurance market. Nevertheless, other studies find for the average buyer insurance is a complex product and this can lead to practices that weaken competition by making it harder for the customer to identify whether they are getting the best deal. We hope to encourage future research into competition in insurance markets.
Fraser Drew and David Humphry work in the Bank’s Insurance Policy Division,
Michael Straughan works in the Bank’s Policy Strategy and Implementation Division and Eleanor Watson works in the Bank’s UK Large Banks Division.
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