26.1 Introduction
Important to consider how the firm interacts with a competitive environment in an ERM framework
Price competition is inevitable due to:
Low barriers of entry
Lack of patent or copyright product
Price and quantity is difficult to access outside the firm
Price depends on premium charged as well as limits, deductible, terms and conditions
It’s the ratio of premium to expected losses that define prices
26.1.1 Underwriting cycle
Remark.
Result of a dynamical system with both feedback and external shocks and slow adjustment
Each LoB has it’s own cycle
- Capital plays an important role \(\Rightarrow\) multiline insurers creates dependencies between LoBs’ cycle
26.1.2 Four Stages Insurance Business
Steward describes the evolution of insurance business, the stages has sometimes takes decades to play out
At each stage, different factor drives the cycle
Stage 1: Emergence (Driven by competitive factors)
Classic u/w-ing cycle here at this stage
New LoB, thin data, inaccurate pricing
\(\hookrightarrow\) \(\uparrow\) demand with erratic pricing \(\Rightarrow\) Price wars
\(\hookrightarrow\) solvency crisis \(\Rightarrow\) force out weak competitors \(\Rightarrow\) price correction
\(\hookrightarrow\) \(\uparrow\) profitability \(\Rightarrow\) new entrants and repeat
Stage 2: Control (Driven by statistical lags)
- Stop the cycle with help from rating bureau or insurance department
Stage 3: Breakdown (Driven by mix of the two)
Control regime breaks down due to new technology or social changes
New type of competitors take business away
Stage 4: Reorganization (Driven by competitive factors)
- Return to stage 1, new configuration of the market phase emerges