Competition in Property and Casualty Insurance Markets: Practice Questions and Solutions

This section of the study guide is intended to provide practice problems and solutions to accompany the pages of Foundations of Risk Management and Insurance, cited below. Students are encouraged to read these pages before attempting the problems. This study guide is entirely an independent effort by Mr. Stolyarov and is not affiliated with any organization(s) to whose textbooks it refers, nor does it represent such organization(s).

Some of the questions here ask for short written answers based on the reading. This is meant to give the student practice in answering questions of the format that will appear on Exam 5. Students are encouraged to type their own answers first and then to compare these answers with the solutions given here. Please note that the solutions provided here are not necessarily the only possible ones.

The Herfindahl (Herfindahl-Hirschman) Index (HHI)

The Herfindahl Index is calculated as the sum of the squares of the market shares (expressed in decimal form) of all the firms in the market. It is a measure of market concentration. The higher the Herfindahl Index, the more concentrated the market is.

Source:

Nyce, C.M. Foundations of Risk Management and Insurance (Second Edition). 2006. American Institute for Chartered Property Casualty Underwriters. Chapter 6, pp. 6.21-6.27.

Original Problems and Solutions from The Actuary's Free Study Guide

Problem S5-19-1. There are 5 insurance companies in the market in a particular region. The following are their market shares:
A has market share of 30%.
B has market share of 30%.
C has market share of 20%.
D has market share of 10%.
E has market share of 10%.
Find the value of the Herfindahl Index (HHI) for this market.

Solution S5-19-1.

We take the sum of the squares of the market shares, expressed in decimal form:
HHI = 0.3² + 0.3² + 0.2² + 0.1² + 0.1² = HHI = 0.24.

Problem S5-19-2. Insurers can be classified by the products they offer. Nyce 2006, pp. 6.21-6.22, discusses the following classifications:

1. Insurers can be property-casualty insurers, life-health insurers, or multi-line insurers that sell both property-casualty and life-health products.

2. Property-casualty insurers can be personal lines insurers or commercial lines insurers.

3. Property-casualty insurers can be monoline or multi-line insurers.

Classify the following insurers using the categories mentioned above:

(a) Insurer A sells workers' compensation insurance only.

(b) Insurer B sells private passenger automobile insurance and homeowners' insurance for small properties owned by individuals.

(c) Insurer C sells only life insurance and commercial general liability insurance.

(d) Insurer D sells commercial automobile insurance and commercial inland marine insurance.

(e) Insurer E sells pet insurance and only insures cats owned by individuals.

(f) Insurer F sells only health insurance.

Solution S5-19-2.

(a) Insurer A is a property-casualty, commercial lines, monoline insurer.

(b) Insurer B is a property-casualty, personal lines, multi-line insurer.

(c) Insurer C is a multi-line insurer with regard to providing both property-casualty and life-health insurance but is a commercial lines, monoline insurer with regard to the property-casualty insurance it provides, since it provides only one kind.

(d) Insurer D is a property-casualty, commercial lines, multi-line insurer.

(e) Insurer E is a property-casualty, personal lines, monoline insurer.

(f) Insurer F is a life-health insurer. Since it does not provide property-casualty products, the classifications pertaining to property-casualty insurers do not apply.

Problem S5-19-3. Nyce 2006, p. 6.22, states that the "level of competition depends on the number and the size of competing insurers, the existence of insurance substitutes, the buyers' knowledge of the market, and the size and growth of the overall insurance market." For each of the following possible changes in the homeowners' insurance market for Region X, can the change be expected to make the market more competitive or less competitive?

(a) Consumers have become more sophisticated in preventing losses to their homes, leading many to adopt the approach of retaining their losses instead of insuring them.
(b) Consumers have gotten into the habit of getting most of their insurance information from daytime soap opera television shows.
(c) Over the past 3 years, 80 new homeowners' insurers have entered the market.
(d) Due to the presence of special legal favors and barriers to entry into the market, one insurer, Generalized Insurance Co., has obtained a market share of 80%.
(e) The homeowners' insurance market in Region X has been growing at an unusually rapid rate compared to markets in other regions. This has resulted in many companies opening new branches in Region X.
(f) The government of Region X has issued a directive permitting sellers of shrimp to also provide homeowners' insurance without obtaining any additional licenses.

Solution S5-19-3.

Situation (a) is likely to increase competitiveness. If more consumers are retaining losses, then insurers will have to work harder to earn consumers' business; they will do this in part by offering more attractive coverages at more affordable prices.

Situation (b) is likely to reduce competitiveness, as daytime soap operas do not generally offer reliable information about insurance. With reduced consumer knowledge of the insurance market, consumers are more likely to acquiesce to less than ideal insurance policy terms.

Situation (c) is likely to increase competitiveness. The new entrants will compete with existing providers, which is likely to increase quality and reduce price.

Situation (d) is likely to reduce competitiveness, as there are persistent barriers to entry for competitors, and Generalized Insurance Co. has obtained an enormous market share due to special favors derived from the legal system.

Situation (e) is likely to increase competitiveness. The rapid growth of the market makes it attractive for new competitors to enter and is also likely to fuel innovation in the design and marketing of insurance.

Situation (f) increase competitiveness, as it allows a whole new group of companies to enter the market without having to overcome any legal barriers.

Problem S5-19-4. Which of the following statements are true? More than one answer may be correct.

(a) The Gramm-Leach-Bliley Act of 1999 allowed hedge funds to also provide insurance.

(b) As a result of the Gramm-Leach-Bliley Act of 1999, banks have offered more insurance products than traditional insurers.

(c) The Internet has made it considerably easier for insurers to enter new markets.

(d) In a local insurance market, it is important to consider insurers who compete in other states in order to gain an understanding of the competitiveness of the market in question.

(e) All other things being equal, it is more likely that a wealthier individual or firm will choose to retain losses rather than insure them.

(f) The increased ability to retain losses makes it possible for individuals to afford lower deductibles on insurance coverages.

Solution S5-19-4.

Answer (a) is incorrect, because the Gramm-Leach-Bliley Act applies to banks, not hedge funds.

Answer (b) is incorrect, because, despite the permissions of the Gramm-Leach-Bliley Act, banks have comprised only a small percentage of the insurance market, and are generally more interested in marketing insurance products than in developing products of their own.

Answer (c) is correct; the Internet reduces insurers' cost of establishing a traditional marketing force.

Answer (d) is incorrect; the insurers who compete in other states do not have an effect on a local insurance market unless they specifically enter that market.

Answer (e) is correct; wealthier individuals and firms can afford to retain more losses without suffering catastrophic financial consequences.

Answer (f) is incorrect; the increased ability to retain losses makes it possible for individuals to afford higher deductibles on insurance coverages, since more of the loss amount can be comfortably retained.

Thus, (c) and (e) are the correct answers.

Problem S5-19-5. According to Nyce 2006, p. 6.27, which of the following are contributing factors to the decline in the growth rate of the property-casualty insurance market in the United States after 1990? More than one answer may be correct.

(a) There has been a substantial growth in alternative risk financing tools.
(b) More stringent regulations on insurance products have prevented a lot of insurance from being offered.

(c) A lot of insurance products have been outsourced to India and China since 1990.
(d) There has been saturation of market demand for insurable products in property and casualty lines.
(e) The average annual population growth rate has declined, leading to a reduced growth in demand for insurance.
(f) Malthus was right: the increasing population growth rate and our limited resources have meant that more people are concerned with basic subsistence than with purchasing insurance.

Solution S5-19-5. The correct answers are as follows:
(a) There has been a substantial growth in alternative risk financing tools.

(d) There has been saturation of market demand for insurable products in property and casualty lines.
(e) The average annual population growth rate has declined, leading to a reduced growth in demand for insurance.

Whether or not (b) is correct is an open question and is not addressed in the text; it is also not clear whether insurance regulations have become more stringent since 1990. Choices (c) and (f) are both factually untrue. It is difficult to outsource insurance as such, since policies still need to be provided to insureds within the U.S. Moreover, the population growth rate has not been increasing, and the Malthusian conclusion would not be correct even if the population were increasing.

See other sections of The Actuary's Free Study Guide for Exam 5.