Australian Non-Life Insurance since 1909

Australian Non-Life Insurance since 1909-

Outside the United States most of the literature dealing with financial institutions concentrates on their role in the capital market and on the implications of these activities for monetary policy. In contrast to manufacturing industries, little o r no attention is usually paid to their performance viewed as industries selling particular types of service and to the relation of this performance to market structure and conduct. The aim of this paper is to analyse from this latter point of view the Australian non-life insurance industry-the sector known as ‘Fire, Marine and General Insurance’ in Australian government statistics.‘ This excludes life insurance and the medical benefit funds. During 1966-67 this industry received $671.6 m. in premiums and incurred claims of $427.1 m. Expenses of management cost $110.6 m. and $59.8 m. was paid to agents and brokers. Indirect evidence suggests that there may have been something between 22 and 28 thousand employees in the industry in 1960. In 1953 about 40 per cent of employees were women; i t is probable that this percentage has grown since. There is also a large but unknown number of agents: in Queensland 21,553 were licensed in 1966, but this probably includes multiple agencies.

Non-life insurance in each State centres on particular areas of the capital cities, but nearly all companies and the larger broking

* A revised version of a paper presented to Section G of the Fortieth Congress of A.N.Z.A.A.S., Christchurch, January 1%8. It is partly based on an unpublished Ph.D. thesis, The Development of Non-Life Insurance in Australia (Australian National University, 1964). I am grateful for much generous assistance from many individuals in the industry and from officers of the Commonwealth Bureau of Cen- sus and Statistics. Abbreviations: CBCS CTP Compulsory Third Party insurance. FAUA GI0 Government Insurance Office. LP Loss of profits. MV Motor Vehicle comprehensive insurance. wc Workers’ Compensation insurance.

1 Recent studies of the U.S. industry with a similar orientation include Brain- ard and Dirlam [l], Hensley [2] and Sichel [3]. The present author has also recently published a more detailed analysis of the government role in Australia than will be found in this article [l l] . (Figures in square brackets relate to references listed at the end of the article.)

438

Commonwealth Bureau of Census and Statistics.

Fire and Accident Underwriters’ Association.

DEC. , 1968 NON-LIFE INSURANCE 439 firms have head offices for Australia in the insurance areas of either Sydney or Melbourne. New South Wales and Victoria are by far the most important States in terms of volume of business; they account respectively for approximately 41 and 31 per cent of premiums written in Australia.

I . Market r3tructtm-e

Nature of the Product When buying insurance, a small certain loss (the premium) is

exchanged for a low probability of a large loss. I f the items (or ‘es- posures’) in the population from which the insurance company is sampling are homogeneous and independent, and if the sample is ran- dom and sufficiently large, risk disappears for both buyer and seller. (For the seller the ratio of losses to premiums-‘loss ratio’-has 100 per cent ‘credibility’.) In practice none of the conditions are per- fectly fulfilled but are approximated to an extent sufficient t o enable insurance of many types of exposure.2

A basic problem in the sampling activities of the insurance company is the definition of relatively homogeneous risk classes. From one point of view the products of the insurance company are the policies it sells, and for certain kinds of insurance these may be standardized with respect to what is covered o r excluded. From another point of view, however, the product is the contract made with the insured, and no single product on this definition is ever identical with another. In practice the definitions of classes of insurances depend on practical criteria which are easily definable, and so there are obvious distinc- tions between insurance against marine and fire risks, between motor car, workers’ compensation and personal accident insurance and so on. But both cross- and sub-classifications are usually possible. For example, suppose that rates on motor vehicles are determined by horse- power, garage area and usage, and that motor vehicle business overall and in each of the resulting classes is written a t a normal profit. An insurance company may decide that on the existing criteria there is discrimination against drivers in a certain age-group, and if age is a practicable criterion may decide to charge all insured in the age-group a lower premium. If the estimate is correct, the rates for insured not in the age-group must then be increased. However, other insurance companies may select further criteria, such as occupation of the insured, make of car, previous accident record, membership of motoring organizations, etc., and each of these choices may require adjustments in all other rates. In addition, new classifications may be made across

2 As well insurance markets typically perform functions which presumably would be undertaken in the formal absence of insurance. These are: (i) The transfer of funds-geographical and over time. (ii) The provision of a framework of rules and procedures by which losses are shared. (iii) The allocation of money estimates of risk to certain assets and activities. (iv) The laying down of rules and the provision of specialized advice with regard to risk reduction. (v) The provision of information as to the nature of risks which can be readily pooled.

c

440 THE ECONOMIC RECORD DEC.

established definitions ; thus i t may be convenient to separate the insurances of certain large manufacturers and consider loss experience in all lines. For certain kinds of risk, e.g. private houses, several normally separated kinds of insurance cover may be included in one policy and paid for in one premium. Clearly the possibilities are numerous.

I n considering whether its basis of risk classification ought to be changed, an insurance company must consider two factors. First, it must balance the possible gain to itself against the cost of making the change. The cost of making the change may largely depend on the simplicity and reliability of the proposed new or additional criteria, plus the cost of resulting changes in internal organization. Secondly, it must make some appraisal of the credibility of the resulting new classification. Where it expects that the new classification will continue for a substantial period, i t may not need a large number of exposure units in the first period. On the other hand, if it expects that new cIassifications will be made in the near future or that the relevant environment may change substantially, a fairly large initial market may be required. But this in turn could depend on whether other insurance companies are likely to adopt the new classifications, and whether they do so with a short or a long time-lag. Hence the products or lines sold by an insurance market will depend to a large extent on the nature of competition within it. Another consequence is that i t is difficult to define price discrimination. Discrimination can only be discussed in relation to classes of exposure units written on a large enough scale or over a long period (under relatively stable conditions) to produce a relatively high credibility factor with respect to claims experience. Changing risk classifications may make the fulfil- ment of these two conditions difficult.

Demand for Insurance

It has been frequently noted in the economic literature that buyers of insurance are evidently willing t o pay larger premiums than the actuarial value of the risk insured against, since the costs of operation of the insurer are covered by the premium.s This has been explained by postulating decreasing marginal utility of income o r wealth in the region of insurance purchases. An interesting aspect of the discussion by Friedman and Savage4 is that for most individuals there exists a range over which the premium can vary without causing the insurance buyer to wish to withdraw from i n ~ u r i n g . ~ This suggests that demand is likely to be inelastic, and this accords with casual observation of many types of exposure.

3 For a survey of this discussion, sy Pfeffer [ 6 ] . 4 M. Friedman and L. J. Savage, The Utility Analysis of Choices Involving

Risk'. Joiwnal of Political Economv. Vol. LVI. March 1948. 6This range depends on thg'shape of the utility function in the relevant

neighbourhood; Friedman and Savage, op. cit., pp. 74-6.

1968 NON-LIFE lNSURANCE 441

Among the more obvious examples of inelastic market demand are the cases where insurance is legally compulsory (in Australia WC and CTP insurance) and where a mortgage or finance company requires insurance with a specific insurance company on terms fixed by it. In both cases the cost of insurance is likely to be cori- sidered a part of the total cost of the activity in question (e.g. driving a car), and since the insurance cannot be avoided the level of the premium may affect the demand f o r the insurance only indirectly through its effect on the demand for the activity. Demand is also likely to be inelastic where insurance is an input in a productive activity : here elasticity will depend on insurance costs relative to total costs of production, and the elasticity of demand f o r the final product. Another consideration is that it is not usually possible to vary the amount of insurance carried for a given insurable risk. Hence as rates vary there may be no change in demand unless new buyers enter the market or existing buyers decide to give up purchasing altogether.

The suggestion so far is that inelastic market demand provides the possibility for policies by co-operating sellers which would produce high prices in relation to average costs. However, inelasticity of market demand is of course compatible with a considerable degree of sen- sitivity to differences in price between firms in a competitive market situation. I n insurance such price consciousness varies considerably between and within the principal classes of business. On the whole private individuals are more price conscious regarding motor vehicle (MV) and CTP insurance than when it comes to insuring the buildings and content of private homes or taking out other miscellaneous forms of cover. Similarly, firms which own risky premises in risky trades (e.g. sawmilling) are likely t o be more concerned with price than owners of fire-resistant premises with employees in relatively =aft?

occupations. As would be expected, where income effects are relatively small, the influence of non-price variables on demand is likely to be relatively important-in particular the influence of the agency force providing personal contact and convenience, and paid by commission.

At this point it is useful to note two further characteristics of the demand for insurance in Australia-the change in its composition and its very rapid growth since 1945. Fire and marine insurance were the dominant activities of non-life companies in the nineteenth century, but now motor vehicle damage and liability insurance and workers’ compensation insurance account for over 60 per cent of premium income (Table I). The relative decline of the traditional lines is obviously due in part to improved construction, water supply, fire protection, navigation and the like, but the principal reason is that the others have grown much more rapidly. Annual premium income is now seventeen times as great as it was in 1944-45 : most of this growth has come from motor vehicle and associated third party liability insurance.

4.42 THE ECONOMIC RECORD DEC.

TABLE I Composition of Non-Lif e Premkms, Australia

Year

._--

1930-31 1939-40 1945-45 1954-55 1966-07

Proportion of total premiums Total annual

premiums Fire and related Marine :::$ CTP WC Other

lines Sm. % % % % % %

22.2 49 .4 5 . 8 10.5 18.2 10 .1 35 .4 32.6 8 . 5 22 .1 24.5 12.3 40 .5 30.7 9 . 0 9 . 3 5 . 0 28.9 11-1

218.4 20 .9 0 .1 20.9 9 . 0 20 .3 10 .2 671.0 22 .5 3 . 9 27.3 13 .4 21.5 11.4

I I . .

Source: CBCS [7]. Costs and Scale Economies

The structure of costs varies between types of insurance, but Table 11 gives some indication of the general pattern. The break-down of the figures indicates three important features of insurance costs. First, most costs should be classed as variable even in the very short run.

TABLE I1 Percentage of Net Written Premiums, New South Wales, 1966-67

YO Claims (paid and outstanding, including adjustment expenses*) 67-0 Commission 8.7 Management expenses 15.6 Contribution to fire brigades 2.4 Taxation (including income tax, pay-roll tax and stamp duty) 2.9

Total 96.6

*There are no statistics of adjustment expenses in Australia. In the United States in 1959 they were 8.1 per cent of earned premiums (losses incurred 54.4 per cent). They ranged from 1-7 per cent (livestock) to 15.2 per cent (miscellaneous bodily injury liability, i.e. CTP in Australia). Best's Fire and Casuulty Aggregates a d Averages, 1960.

Source: CBCS (N.S.W. Branch), General Insurance Business in New Sowfh

- -

Wales 1966-67.

Consider the marginal cost of writing one additional policy or a group of policies relating to one additional insured. Typically included in this would be expected loss, a portion of loss-adjustment expenses, commission, and taxes on premiums, p l u s a portion of other items such as travel, printing and stationery, and postage and telephone. An American study has estimated the non-variable costs remaining at about 20 per cent of premiums.6 However, if a longer period were considered than that implied above-say six months o r one year-it is likely that an even higher proportion of expenses would be marginal to any increase of business over the period.

6 C. A. Williams, Price Discrimination in Property and Liability Insurance (University of Minnesota Press, Minneapolis, 1959), pp. 9-11.

1968 NON-LIFE INSURANCE 443

Secondly, it follows that in insurance there are no important fixed costs of the kinds prominent in some other industries. Neither buildings nor equipment (typewriters, accounting machines, etc.) are usually highly specialized to the industry.? Despite this it would be a mistake to assume that insurance companies always react to short-run demand changes as though fixed costs were negligible. An important factor not brought out above is the cost of the ‘organization’ of the company. For even medium-sized companies this may be extremely complex and a t critical points depend on the experience of many employees within the organization. If some of the factors listed (which are, in principle, ‘variable’) were in fact altered in response to short-run demand changes (e.g. salaries, rent), the costs in terms of reorganization could exceed the savings. The company may therefore, say in response to a threatened short-term fall in premium volume, prefer to cut rates rather than dismiss employees, reduce the oBce space occupied, and so on. But if the change is expected to be permanent, all these actions could be taken, and conversely for a n expected permanent increase in demand.

Thirdly, the major part of costs (claims and adjustment expenses) are future liabilities. This is especially important in workers’ compensation and CTP-less so in fire, motor vehicle and other lines. Thus there is a constant temptation facing excessively optimistic or aggressive managements, or irresponsible and dishonest ones.

On costs in the long run, a priori considerations and empirical studies support the hypothesis of significant economies of scale. The a priori arguments mainly concern the advantages to large insurers of internal specialization, mechanization of routine functions and greater spread of risk. However, small insurance firms may have access to specialized outside institutions and firms and by using these may minimize their disadvantages. Thus, brokers, reinsurance brokers, loss assessors, marine surveyors, professional reinsurance companies, insurance pools and syndicates are recognizable parts of any developed insurance market. Of growing significance is the leasing of computer time and the establishment of jointly operated data processin, centres. Trade associations typically inspect and classify exposures, develop forms of cover, aggregate and process market statistics, and establish a basic rating framework (especially in the traditional fire and fire- related lines).

Significant but not spectacular scale economies are suggested by cross-section studies in the United States,8 but as they are based on the relation of expenses and commission to premium volume they are not especially reliable. In particular they do not consider the possibilities

?But this may not be true of highly integrated office systems built around computers.

8 R. J. Hensley, ‘Economies of Scale in Financial Enterprises’, Journnl of Political Economy, Vol. LXVI, October 1958; R. A. Hedges, Principles of Finan- cial Analysis of Underwriting Expenses in Property Insurance, unpublished thesis (University of Illinois, 1952).


of differing rate levels, differing portfolios of business, and commission being used as an indirect form of discount. In a study based on unpublished Victorian statistics, the writer attempted to allow for these factors. The basic statistics are presented in Table 111. After various tests (not shown) i t appeared that large companies with premiums over 52 m. (excluding the Government Insurance Office, to which special factors apply) had a 6-8 percentage points advantage over medium and small companies in terms of the ratio of commission plus expenses to written premiums. Medium-sized companies paid relatively higher commissions which more than offset slightly lower expenses. After allowing for differing rate levels and separating CTP insurance from M V , the advantage of large companies appeared more marked in MV and WC. However, these differences could easily be outweighed by differences in claims ratios, but the statistics were quite inadequate for testing t h k possibility, especially in the absence of information about reinsurance. One possible hypothesis is that large companies, owing to lower management and commission costs, operate a t lower rate levels and therefore with higher claims ratios. Another is that, companies specialize in business which by nature has high claims and low expenses.

Entry Barriers I n manufacturing industries a very significant entry barrier

occurs where the plant capacity necessary to exhaust significant scale economies represents a high percentage of total market demand, and where costs increase significantly a t scales smaller than this minimum optimal level. Although the evidence on the long-run average cost curve in insurance is not very satisfactory, there is probably sufficient fo r the negative conclusion that, while costs continue to decline over the whole scale range of companies so fa r studied, there is no crucial scale which, once achieved, gives significant discretionary power to the firms which have reached or moved beyond it.Q In Bain’s terms [8, pp. 104-51, the industry should then be classified as one with ‘relatively unimportant’ economy of scale entry barriers.

Probably of greater significance are what Bain calls the ‘product differentiation’ advantages of established firms [8, Ch. 41. In Aus- tralian insurance these have created barriers to new competition as regards certain sectors of the market, even if not t o the market as a whole. Most companies have attempted to build special or preferred markets for themselves, usually through association with non-insurance organizations or firms. Some of the principal forms of these links are as follows :

1. Ownership o r significant shareholding interests by outside firms o r organizations. Of the 140 or so independent non-life companies in Australia in 1967, only fifteen were listed on Australian stock exchanges. Of these, overseas insurance firms held controlling interests

9 See Hensley, op. cit

3968 NON-LIFE INSURANCE 445 TABLE I11

Victorian Non-Lif e Ifisurance, 1957-58

19.3 17.8 16.5 15.9

17.3

23.8 14.4 18.3 13.3

15.7

17.5

14.9 11.1 6.2

12.8

14.6

Percentage of category premiums

34.8 31.6 30.7 34.7

33-0

33.9 21.6 27.2 18.3

22.5

27.1

21.0 25-6 6 .7

23.1

23.5

No. of independen

msurers

17.0 13.2 21.0 10.3 4.2

Percentage of class

premiums

%

24.4 23.8 26.8 13.7 6.3

Premium range

8'000

12.0

18.4 13.1 19.4 18.2

17.3

Claims %

17.4

35.0 27.5 33.0 30.3

31.1

lommissior

% x Fire, cfc.

0-131

264-396 Over 396

131-264 65 18 12 6

14.1 26.1 29.6 30.2

100.0

27.6 19.8 27.0 30.3

26.1

1.5.6 13.9 14.2 18.8

15.7 101

Marine 0-24

24-48 48-72 Over 72

51 14 7 8

12.8 19.3 17.5 50.4

42.3 82.8 38.7 48.4

10.1 7.2 8.9 5.0

80 100.0 52.6 6.7

Molar vehicle and CTP

0-182

366648 Over 648 1,812 (GIO)

182-365 63 9 6 9 1

88 __.-

74.9 69.5 68.2

75-3 72.a

9.8 8.9 6 - 1

14.5 0.6

19.5 13.1 13.7 43.8 9.9

100.0 72.3 10.3

Workers' compen-

0-123 123-247

Over 369 2,462 (GIO)

salion

247-369

56 13 5 5 1

17-8 17.8 11-5 32-9 20.0

100.0

62.4 60.7 61-4 78-2 77.9

70.5

7.4 10.6 5.8 3.5 2 . 1

5.4 80

Personal ac'r cent 0-15

15-30

Over 46 30-48

77 14 4 7

24.2 21 * o 10.4 44.4

35.5 37.7 32.6 35.8

16.6 14-4 13.6 12.1

102 100.0 35.4 13-8

I


TABLE 111 (continued)

Victorian No%-Life Insurance, 193’7-58

No. of independent

insurers Premium range

5’000

Percentage of class

premiums

~~

Other 0-30

30-62

Over 93 62-93

63 17

ti 8

Total-all classes 0-32

32-63

127-254 254-508

63-127

18.5 24.6 13.9 43.0

0- 508 508-1,015

Over 2,031 4,374 (GIO)

1,015-2.03 1

94 __-__I

34 12 8

17 13

100.0

0.7 1.2 1.6 5.9 9.7

15.1

21.3 17.9 25.3 18.9 1 6 . 6

28.0

34.8 33.0 38.9 31.3 24.7

84 17 7 7 1

116 ----

~~

Percentage of category premiums

18.9 24.9 16.7 31.1

8.4

100.0

Claims YJ

52.7 48.8 14.2 38.1

48.0

18.2 15.6 16.0 12.1 5.3

50.1 35.4 57.3 53.1 49.7

28.8 28.6 28.2 22.5 6.5

50.5 48.6 51.5 63.2 76.8

56.3

Commission %

16.2 14.2 15.6 9.7

12.8

13.5 15.1 13.6 12.4 8.1

10.5 13.0 12.2 10.3 1.2

10-6

- .

22.5 38.1 11.7 1 21.4

Sources: A survey of unpublished statistics carried out with the help of the Victorian branch of the CBCS. G I 0 means the Victorian State Government Insurance Offices : they have been counted as one. They write only motor vehicle, CTP. and workers’ compensation insurance. The ‘Fire etc.’ class includes fire, householder’s comprehensive, sprinkler leakage, loss of profits and hail. The ‘Other’ class includes public risk liability, general property, plate glass, boiler, live stock, burglary, guarantee, pluvius, aviation, all risks, television, and all other classes.

in six and two were New Zealand companies (the New Zealand and South British). Of the remainder only the Victoria’O and the Mercan- tile Hutual were not either owned by o r closely associated with an important non-insurance firm. Few if any non-listed companies were withont outside affiliations.

‘2. All the major finance companies, and many smaller ones, have insurance subsidiaries. Since 1960 i t has been illegal in all States to tie insurance to hire purchase loans, but despite this the finance companies have a clear advantage because of convenience and, frequently, ignorance of alternatives.ll

I0

11 chased

In August 1968, large minority interests (sufficient for control) were pur- in this company by the New Zealand and the Munich Reinsurance Co. In addition, since the mid-l950s, five of the seven major trading banks have

become linked indirectly to insurance companies via major shareholding interests in finance companies. However to date they have not used their influence as lenders or their very extensive branch organizations to develop insurance connections.


3. Since 1956 there has been a revolution in the relation between non-life and life insurance. Previously-ever since the 1890s-there had been a well-established custom under which non-life companies left the life field to the five dominant Australian mutuals, and the life mutuals in turn (as the banks continue to do) allowed borrowers to insure with any companies approved by them. Their lists included most companies operating in Australia, and they made no attempt to enter the business themselves. Some British insurance groups which, outside Australia, were principally important as life insurers, operated in Australia in non-life insurance only (e.g. the Norwich Union, the Legal and General, the Pearl).

After 1956, perhaps precipitated by the entry of the Legal and General into life insurance in that year, all the major life offices set up or bought non-life subsidiaries, and most of the major non-life groups-in particular the British groups-rapidly entered life insurance.

One consequence for non-life insurance has been the tying of fire insurance to mortgage and policy loans. The premium volume involved, if total life loam and property were insured against fire, would only amount t o some three per cent of total Australian fire premiums. However, a prospective entrant would have to consider : (a) where a mortgage is held, it is likely that more than the mortgaged value will be insured, (b) other life assets-especially equities-might be used to influence insurance, (c) non-fire lines (e.g. MV and WC) might follow the fire insurance, (d ) the major life offices have contacts with many private householders and large field staffs which can easily turn to selling non-life lines when discussing life insurance, and (e) a company unable to offer a full range of insurance policies, including life, may be at a disadvantage.

4. Large and influential agency networks give an advantage to well-established firms. As an example, each of the eight major firms of wool-selling brokers in Victoria is connected by a chief agency appointment to one of five of the larger British insurance groups. In addition the appointment of local businessmen as directors o r local directors is frequently motivated by the insurance business they can introduce. This is particularly true of overseas companies in Australia : there still exist local boards, and boards of directors of Australian companies absorbed many years ago, which are virtually functionless in every other respect.

Bain’s third category of entry barriers-absolute cost advantages of established firms [8, Ch. 51-4s not important in insurance. There seems to be no evidence that established firms have any cost advantages based on patented or secret techniques, lower factor prices or control of strategic factor supplies. Government deposit and licensing requirements also have not operated at all restrictively. There are Commonwealth government deposit requirements, but these are mini-

448 T H E ECONOMIC RECORD DEC.

ma1 and very liberal.12 Except perhaps in Queensland, State licences have been granted virtually automatically to all companies applying.

A rather special factor affecting the ease of entry of new companies into insurance is the availability of reinsurance support. With- out this the risk-pooling ability of all except the very largest multi- national firms would be seriously impaired. In Australia direct writing companies have always had ready access to the reinsurance facilities

TABLE IV Independent Insurers in Australia, 1965

Head Office

Australia-

Australia- private cos.

govt. cos. U.K. N.Z. Europe Japan U.S.A. Other

Total

Brokers or agents for overseas insurers

Companies for reinsurance only

No. of comoanies

Total

73

5 30 3

12 3 8 6

140 -

35

13

Independently operated in Australia

71

5 28 3 I0

6 4

-

127

35

10

Approx. total world-wide

remium income 1965

fm. (stg.)

72-81

38 1,300

37 1 16

2,204-2,213

n.a.

496

Approx. market share in

Australia, 1965

% .-

33-37

17

38-46

4-a

Sources: Number and ownership of companies: writer’s card index of insurance companies in Australia. Premiums, Australian private and government companies : Insurance in Atlrtralasia, 1966 and Alwtralesian Insurance and Banking Records [ 91, company reports. Premiums, overseas companies : The Review [S], company reports. Market share, brokers and agents : estimates from industry sources. A number of Australian private companies do not publish premiums. The figures above are lower and upper limits of estimates based on balance sheet data and deductions from other sources.

l2 Under the Insurance Act 1932-1965 the requirements are: Foreign companies $ ~ , ~ Australian companies : $2O,ooO plus $2,000 for every $10,000 of

premiums in excess of $SO,OOO. Maxi- mum: $160,000

The deposit can be in Australian, U.K. or government securities of other Com- monwealth countries, or in other forms including fixed deposits, debentures, bank guarantees, unencumbered freehold titles in Australia and first mortgages on freehold. Foreign companies wishing to avoid an initial deposit of $mO,oOO can register a subsidiary in Australia, and so come under the requirement for Aus- tralian companies. Special provision is made for a single deposit by agents and brokers acting on behalf of ‘one insurer or a group of insurers’ outside Australia (e.g. Lloyd‘s).

1968 NON-LIE= INSURANCE 449 of the London market and to the professional reinsurance companies of Europe. Moreover, since 1949 professional reinsurers have established their own branches in Australia-notably the Swiss Reinsurance Co. of Zurich and the Munich Reinsurance Co. Among the London hoking firms which have opened in Australia since the 1950s are a t least ten which advertise that they specialize in reinsurance. Most have facilities for arranging reinsurances at Lloyd's. The presence of these reinsurers and brokers greatly aids the formation of new, small vompanies which tend to rely heavily on reinsurance, especially in their early stages. The professional reinsurers have a vested interest in it relatively fragmented market of small units, since large companies are not nearly so dependent on their services.

Ee'eller Concentration Table IV sets out the approximate number of independent insurers

operating in Australia at the end of 1965. Although the apparent number was over 260 (there were approximately 240 separate licences issued in Victoria in 1966), many were owned by other insurers also operating in Australia. Also in certain cases companies o r brokers acted as Australian agents: the second column allows for this and shows the approximate number of independent decision-making units.

It will be seen that the world-wide premium income of the non- Australian companies far exceeds that of Australian companies. I n 1966 the world-wide non-life annual premium incomes of the largest British groups were as follows :

h. (stg.) R o yal-Glob e 267 Commercial Union-North Brit ish 147 General Accident 119 NorthernEmployers 116 h'un-Alliame-Lon&n 112 Guardian-Union of Canton 68 Royal Exchange-Atlas 63 Phoenix 61 Norwich U n i o d c o t t i s h Unkn 40

Since then mergers have been announced between the Royal Exchange and Guardian groups, and the Commercial Union and Northern groups, while the General Accident has purchased the Yorkshire-another sizeable British company operating in Australia. I n terms of total premiums and resources, the U.S. companies were next in im- portance to the British ; but in Australia they were not as influential as this might suggest, as they had not built nearly such extensive networks of agencies and subsidiary companies as had the British groups.

The significance of financial size as such is that i t increases underwriting capacity for large single risks (e.g. industrial plants, ships,

450 TfIE ECONOMIC RECORD DEC.

planes, pastoral properties, common law liabilities) before recourse to reinsurance. It is less significant when risks are numerous, small and relatively independent (e.g. motor vehicles, workers ’ compensation, private houses). Another consequence in small markets is that i t gives the large multi-national firms13 considerable bargaining power against small local firms : this has always been a very important consideration in Australia.

The group of agents and brokers for overseas insurers deals almost entirely with the London market, especially Lloyd’s. As will become apparent from later discussion, its presence in Australia has been of great significance. Its numbers grew particularly rapidly after 1952 (Table V.)

TABLE V Independent Brokang Firms Placing Business outside Australk

Pre 1916 1917-25 1925-29 1930-37 193839 1940 1941-51 1952 1955 1958 1961 1967

Nil 1 2 3 5 6 7

10 15 20 33 3s

Source: Writer’s card index.

The new entrants after 1952 included a high proportion of the largest and most influential London brokers; they either set up subsidiaries o r associated companies in Australia, took over Australian broking firms or entered into working arrangements with Australian brokers.

Statistics of market shares require detective work plus guessing, since the CBCS will not reveal individual company statistics, and the overseas branches which do about 42 per cent of the business publish no information whatsoever. (Australia has by far the worst non-life insurance statistics in the western world.) The probable pattern seems to be about 13 companies with market shares ranging from 2-9 per went of Australian premiums, plus 127 with shares less than 2 per cent and mostly considerably less than 1 per cent.

As Table 111 illustrates, the pattern of concentration looks similar broken down by States and principal classes of business, subject to some provisos. The provisos are that seller concentration in motor vehicle, CTP, and WC insurance seems to be higher than in other lines. This is less obvious in Table I11 in the case of motor vehicle, because a large share of this business in Victoria is written by Club

13Ahout half of the major British companies’ premium income is earned in the United States, and up to three-quarters outside Britain.


Motor (RACV)-in effect as an independent company but in theory as agent €or a group of Victorian companies, so that its statistics are not shown separately. However, were this allowed for, the Victorian situation would probably not differ very much from the New South Wales one (Table VII) .

The principal reason for the concentration of CTP business is that rates have been set by governments a t levels which have produced

TABLE VI

Narket Shares of Principal Companies

1 GI0

Company

Largest private insurer

Government Insurance Office of - N.S. W.

Commercial Union o f A w t . State Government Insurance

Ofice (Qld.) N.R.M.A. State Government Insurance

Ofice (Vic.) Manufacturers' Mutual Qwensland Mercantile Mutual

Royal-Globe N wthem-Employers Edward LumleyJ Royal Exchange-A tlas Sun-Alliance-Landon

Head office

-

Sydney London'

Brisbane Sydney

Melbourne Sydney Sydney Sydney

London London London London London

Australian net premiums

1965-66 bm.

52.6 34.4

28.9' 22.03

21.8 20.04 16.4 12.6

208.7

? ? ? ? ?

-

Share of Australian premiums

%

8.6 5 . 6

4.7 3.6

3.6 3 .3 2.7 2.1

34.2

? ? ? ? ?

-

- Notes : 1 Australian head office Melbourne, but London is parent company's

head office. 2Includes WC, of which company has statutory monopoly in Queens-

land. 3 Estimate onlv. 4 Eitimate on&. 5 Principally agent for London market, mainly Lloyd's.

% 30.P (Manufacturers' Mutual) wc

Motor Vehicle I ;$:? 30.0'" ( N R M A ) CTP 88.9 5 . W ( N R M A )

"/o

* Very rough estimates only. Companies' premium incomes not published. Sources: Companies' accounts.

Top four

Total automobile 25.2 Fire 18.8

Top ten -

40.0 35.5

_____


loss ratios in excess of 100 per cent. However, there appear to be important scale economies as well, and as noted there are also more marked scale economies in MV and possibly in WC than in the other classes.

It is interesting that the overall pattern of concentration so f a r described is similar to the American (Table VIII) . In 1964 there were 3,200 domestic fire and casualty companies.

TABLE VIII

Share of Premiums Written, United States, 1964

Sowce: [2, p. 2411.

The sums insured by many buyers are large in relation to the size of many insurance companies. A t a conservative estimate, B.H.P. ’s annual premium payments exceed the total annual net premiums of a t least twenty of the forty-two Australian insurance companies which publish their accounts. Few insurance companies in Australia are large enough not to be seriously affected by the loss of an account from, say, one of the 300 largest insurance buyers. Buyer strength is further increased when premium volume is channelled through brokers. Broker influence has been increasing in recent years. There were over seventy in Sydney in 1966: some of these firms undoubtedly control very substantial volumes of business, although no statistics are published. Implications for Market Ccmduct

The discussion so far suggests the following generalizations about probable market conduct.

1. Inelastic market demand provides a motive for profit-seeking firms to band together in order to exploit the demand curve jointly.

2. But large numbers usually make agreement difficult, unless the major companies can exercise some sort of disciplinary function.

3. In general entry barriers appear to be relatively low, except in some areas where product differentiation barriers may be important and therefore relatively high prices and profits a possibility.

4. In MV, WC and CTP, antagonistic behaviour is more likely to revolve around price ; in the other lines the development of agencies, branches and ‘goodwill’ is likely to receive more attention.

5. Potential competitive variables include price, selling costs, and product variation-including new risk classifications.

6. The nature of costs suggests the possibility of outbreaks of cut-throat competition.


I I . Conduct and P e r f o m w e The 1909 Agreements

The year 1909 is a convenient starting-point, because the arrangements made then established a basic framework which became the benchmark for most subsequent developments. The system had its beginnings in a series of agreements over the previous ten years a t the State level, under which companies agreed to comprehensive tariffs of rates, policy conditions, commissions etc. In 1909 the present Council of Fire and Accident Underwriters was set up with strong executive powers over State associations. The system was the work of the major British companies in Australia. Local insurance companies had succumbed to a period of severe price-cutting in the 1880s and to investment losses and falling business in the 1890s. By 1909 there were sixty overseas companies but only twelve independent Australian ones ; five of the latter were in a weak state and had failed or been absorbed by 1915. In the bargaining process local firms were relatively powerless. The manager of the Victoria wrote in 1907: ‘The bursting of the tariff would not affect the large foreign companies but to us it means ruin. Consequently tact and diplomacy are our only weapons; we cannot always insist on our rights. . . .’14 In the course of the

TABLE IX Number of Independent Insurance Companies, Australia, 1861-1911

Year I Australian 1 Overseas

1%1 I 18 I 8 24 24

53 1891 1901 13 56 1911 1 12 60

negotiations, numbers of crucial decisions were made in London between the major British firms. They were motivated by the fact that most had committed themselves to Australia more permanently than before by replacing agencies with branch organizations. Then in 1906 there had been a disastrous rate war in Western Australia, during which premium volume fell to one-seventh of its previous level. After this insurance in the State remained unprofitable for at least seven years under long-term and forward contracts. Finally nearly all overseas companies in Australia suffered heavily in the San Fran- cisco earthquake of 1907. Against this background it was possible to establish a highly centralized system with strong executive powers. The members were the controlling officers of all non-life insurance com-

14 Manager’s Letter Book, Victoria Insurance Co. Letter to manager for New Zealand, 3.7.1907. I am grateful to the company for access to and permission to quote from this correspondence.

454 T H E ECONOMIC RECORD DEC.

panies in Australia. There was an executive committee (a t present it has twelve members) whose function was t o administer a comprehensive tariff of rates, commissions and agency rules. State associations were responsible for more detailed day-to-day affairs. There was an elaborate system of rating rules, appeal procedures, etc. In abiding by the tariff, ‘tariff companies’ agreed to charge prices (‘rates’) no less than those agreed, not to exceed tariff commissions, and to Emit the number and nature of agency appointments in specified ways. The agreements also sought to prevent the entry of non-tar8 competitors. The extent to which these objectives were achieved is now described, because it provides a convenient way of studying subsequent conduct and performance.

Entry The aim of the agreements was to prevent entry outside the tariff

organization and the development of competition. For this purpose all companies agreed to a reinsurance ‘non-intercourse’ rule, i.e. not to give reinsurance support to companies not joining the trade association. I n addition collective exclusive dealing arrangements were made with brokers and agents. Under these, any broker or agent dealing with tariff companies had to agree not to deal with any non- member company.

Although reinsurance boycotts were applied to many new companies, all of them obtained reinsurance support overseas without much difficulty. That this was likely should have been apparent from the beginning because a concerted effort to block reinsurance to the New Zealand Government Insurance Office, pursued with energy over the period 1904-1906 in London and Europe, failed when the Office obtained the support it needed a t Lloyd’s. In fact the first thirty years of the century were notable for the increasing role of Lloyd’s as a world-wide reinsurance market, and was the great period of development of the professional reinsurers in many countries. In 1926 it was estimated that €here were 156 professional reinsurance companies in the world, twenty of them in Britain.lB

Although many companies which were established in Australia in the face of reinsurance boycotts were small and ephemeral, some quickly became well established ; fo r example :

Year est. Manufacturers Mutual Chamber of Manufactsures joined tariffs

iii:} Mutual which eventually Go-operat ive 1918

1925 Have remained oiitside 1927 the tariffs I Automobile Fire and General 1922

N.R.M.A. Federation Southern Pacific 1935

15 C. E. Golding, A History of Reinsurance. First edition. (Privately published, London, 1927.)


Another factor was that the new and rapidly growing lines (WC, MV, and CTP after 1942) did not require reinsurance as much as did fire and marine. All that was needed was some form of catastrophe reinsurance, and this could not be obtained in Australia in any case. Since 1945 ‘local’ reinsurance (i.e. arranged locally between companies in Australia) has all but disappeared for all classes. Reinsurance is now by ‘treaty’ (i.e. long-term contracts) and predominantly with companies outside Australia. The old ‘non-intercourse ’ rule is quite irrelevant to these arrangements.

The collective exclusive dealing arrangement with brokers was meant to prevent them from playing off tariff against non-tariff corn- panies. In this it probably succeeded, but it did provide an oppor- tunity for brokers willing to deal only with non-tariff insurers. The earliest of these broking firms were Edward Lumley (est. 1916) and Harvey Trinder (est. 1925). Both had underwriting and settling powers from London underwriters, principally Lloyd’s. Through them a significant volume of Australian business began to flow direct to the London market. In Australia they operated by simply taking the tariff rate and quoting 10 o r 15 per cent less. Reference back to Table V will show that the number of firms engaged in this activity increased only slowly until 1952; after this there was a rapid increase. In response, the tariff rules were altered in 1964 to allow tariff brokers to place up to 25 per cent of individual fire risks with non- tariff insurers. By this means it was presumably hoped that some of the new brokers could be persuaded to join the tariff. In fact many of them have done so, but this is probably more a result of the increased flexibility of tariff rules and rates, discussed below.

Still another form of outside competition which tariff companies were powerless to prevent came from insurance offices set up by State governments.16 The founding of these oEces was associated with politically popular legislation introducing o r extending workers’ compensation or CTP insurance. As a rule they agreed to follow tariff rates and procedures, subject to bonus payments based on underwriting results.

Table X shows the pattern of entry and exit over the period. It will be noted that there were especially large net inflows of non-tariff insurers in the 1920s and after 1951. Most of them were locally pro- moted companies. In fact most Australian firms operated outside the tariff, while most new overseas firms joined. Of the sixty-eight non- tariff companies in 1966 only fourteen were overseas-owned. Statistics

16Dates of establishment and entry into the various business classes were as follows :

Victoria 1914 (WC 1914-; MV, CTP 194%). Queensland 1916 (all lines). Tasmania 1919 (all lines).

N.S.W. (WC 1926-32,1938- ; CTP 1942- : MV 1942- ; all other 194%). The record of government insurance is discussed in more detail in Purcell Ill].

W.A. 1926 (WC 1926-; MV 19444.

D

Pcnod

I__

1901-10 1911-20 1921-30

___ --

No. at beginning Entries Exits ~ _ _ . - _

T NT B T NT €5 T NT 3

24 - - 37 3 -

39 19 -

_______________ 69 - - 72 - - 71 10 1 43 41 2

Notes:

Source: Writer‘s card index.

T = tariff companies ; N T = non-tariff companies, including GIOs ; B = non-tariff brokers placing business outside Australia.

i931-40 1941-50 1951-60 1961-65 1966

of the non-tariff market share are unfortunately not available, but rough estimates made in 1960 suggested that the government offices wrote about 15 per cent and private non-tariff companies and brokers another 25 per cent of premiums.

To sum up, the aim of the 1909 agreements of preventing the growth of outside competition in Australia manifestly failed in the long run. New companies were able to operate quite succmfully outside the tariff-especially in accident lines-without tariff reinsurance support or business from tariff brokers. Competition also gradually developed direct from overseas, especially through Lloyd’s. In every State except South Australia it was necessary to come to rather pre- carious and uneasy understandings with government insurance offices. Finally, tariff membership was granted to mutual companies whose bonus systems did not fit the tariff system at all well.

Rates and Profits In fire insurance and related lines such as loss of profits and

householders’ comprehensive, the 1909 agreements established a basic classification system and a system for building u p rates (i.e. prices tixpressed as a percentage per $100 insured), plus the basic rates themselves, all of which have remained substantially unchanged to the present. Despite this the average level has fallen as risks have been reclassified, and new classifications created for new industries. Also in the 1920s a system of special discounts was instituted in order to meet non-tariff competition, especially from the Lloyd’s agents. By the 1960s probably most sizeable business risks were rated in this way.

There is of coiirse no evidence on how well tariff members have observed tariff rates in practice: it would seem reasonable to suppose that observance has not been perfect. The sanction of the under-

75 32 3 10 13 3 ‘20 15 - 65 30 6 12 4 1 3 3 - 74 31 7 27 33 11 2 6 7 2 75 57 16 5 25 12 8 14 4 72 68 24


writers’ associations was never much more than moral pressure and publicity-dthough doubtless these were effective a t times.

Fear of new entrants, suspicion of each other, a desire not to antagonize their clients, the public, o r State governments, all led the originators of the tariffs to set rates a t levels which they consider to be quite moderate. However, the incidence of fire losses declined steadily over the fifty years, and the average level of rates lagged behind. The result has been that the fire lines-especially householders’ comprehensive-have been especially profitable. The fire account results of U.K. companies probably give a good indication of average world-wide underwriting results in this business: it will be seen (Table XI) that Australian profits have been very much higher. Table XI1 shows the remarkably low loss ratios by the main classes. These general conclusions are collfirmed when allowance is made for stamp duties, licence fees and reinsurance.

TABLE XI

Fire and Related Lines, 1926-63

I

Number of years Underwriting surplus on premiums per cent

N.S.W. and Vic. I U.K. cos.

-10- 0

3 j $ 4 2 I :: 1-10 11-20 - 21-30 15

Over 30 - -1 : I- 4%

Notes : ‘Underwriting surplus’ is the difference between ‘earned‘ premiums in a year and claims incurred, commission, fire brigade charges and management expenses. For Australia ‘earned’ premiums have been estimated from premiums actually received during the year by adding in 40 per cent of the previous year’s premiums and deducting 40 per cent of premiums received. The same or a similar procedure has been followed in all subsequent calculations of ‘underwriting surplus’ in Australia. The U.K statistics give companies’ own un- expired risks provisions, which have been used.

Sources: N.S.W. Statistical Register, Victorian Year Book, and Great Britain, Board of Trade [El. Board of Trade statistics not yet available for 1964 and after.

in marine insurance tariff rates were constantly being adjusted to meet Lloyd’s competition, and again there was a consistent down- ward trend in the period after 1911. The original tariffs were extremely complex but in 1950 many were abandoned altogether and others dras- tically simplified. Despite this apparent constant pressure on rates, marine insurance remained exceptionally profitable until 1965 : since then underwriting surpluses have been around 10 per cent of premiums. As Table XI11 shows, they were between 20 and 40 per cent of premiums in most other years, and again very much higher than the

458 THE ECONOMIC RECORD DEC . TABLE XI1

Average Loss Ratios on Earned Premiums, Australia

1942-45 1946-50 1951-55 1956-60 1961 -67

Hail Fire and sprinkler Householders’ Loss of leakage comprehensive profits

29.7 2 5 0 3.1.6 31.6 38.5

N.S.W. and Vic.

- 1 1

I 23.7 1 18.3 1 54.8

U.K. cos. -

1 8

11

24.5 27.2 116.4 40 .1 1 21.9

I 27.5 1 26.8 1 67.9

Note:

Source: Calculated from [7].

‘Loss ratio’ means the ratio of losses incurred (including adjustment expenses) to earned premiums.

surpluses of U.K. companies. Two possible explanations suggest themselves. Until 1957 the tariff prohibited all brokerage on marine business. This, plus restrictions on agents, may have considerably inhibited the development of informed and expert insurance buying within Australia, at least within the tariff sector. Outside the tariff companies the main market is Lloyd’s and it is likely that much Austra- lian business placed there (e.g. by the export marketing boards) does not enter the Australian statistics.

In workers’ compensation, although State associations in some cases set rates under the early Acts, in all States except Victoria and

TABLE XI11 Marine, 1918-63

Underwriting surplus on premiums per cent

-10 and less - 9- 0

1-10 11-20 21-30 3 1-40 41-50 51 and over

Number of years

2 20

17 - 5 5 1

46 1 1 6

Notes: The Board of Trade statistics show premiums net of commission. They have been adjusted by assuming that of the premiums actually received during any one year f , 60 per cent belong to year t + 1, 25 per cent to year t + 2, and 10 per cent to year t + 3. This is the method used by The Rm’m [ 5 ] and fits fairly well the loss distribu- tion shown by Board of Trade statistics for completed underwriting years. To make them comparable, the Australian statistics have been treated in the same way.

Sources: As for Table XI.


Tasmania the government began promulgating maximum rates and instituted competition from government insurance oBces simultane- ously with the amendments making insurance compulsory. In Victoria and Tasmania the FAUA consults with the manager of the State government office before announcing rate changes. Competition also comes from mutual companies, non-tariff insurers and self -insurers. I n New South Wales about 40 of the latter account for approximately 13 per cent of wages covered. In addition to this, since 1945 there has been in New South Wales a system of retrospective profit control called the ‘fixed loss ratio scheme’. As Table XIV shows, underwriting surpluses in workers’ compensation have not been nearly as high as in fire o r marine, especially over the past twelve years.

TABLE XIV

Workers’ Compensation: Average Underwriting Surpluses on Earned Premiums 1942-67

Period 1 N.S.W. i Victoria

1942-45 I 12.2 1 15.9 8.8 1 1;:: 1 11.6 1951-55

1954-60 -1.9 2 . 5

i946-50

1%1-67 1 1.2 1 8.6

Note: ‘Underwriting’ surplus is after renewal bonus payments. Soiwces: Calculated from CBCS, Sydney : General Ipurmce Business in

N.S. W. (annual 1942-). CBCS, Melbourne : Fire, Marine and General Insurance (annual 1942-) .

In MV comprehensive insurcunce tariff rates are the responsibility of the FAUA Council, but quite early in the 1920s it encountered competition from Lloyd’s agents, the mutuals and other non-tariff companies. However, direct competition from Lloyd’s wm less important in this field than others, as the business required a rather extensive field organization, especially for claims assessment and settlement. The Lloyd’s market was probably more important in providing reinsurance backing fo r new Australian companies. More significant was the pressure from private motoring organizations. The Royal Automobile Club of Victoria arranged its members’ motor vehicle insurances with a non-tariff company, the Automobile In- surance Company of Australia, from about 1922. I n 1928 the business went to Lloyd’s a t a still lower discount but was captured by the tariff market under a special arrangement administered by the Victorian FAUA in 1934. I n 1925 the National Roads and Motorists’ Associa- tion started N.R.M.A. Insurance Ltd. in New South Wales, again to underwrite members’ motor insurance at below tariff rates. Later, in all other States except South Australia, similar arrangements were made. In this field government office competition is also of some sig-

460 THE ECONOMIC RECORD DEC . nificance although it has been inhibited to a large extent by a policy of making up for losses on CTP insurance.

As i n other tariffs, the FAUA companies have made adjustments to their agreements in order to meet this outside competition. These have concerned discounts for fleets, ‘no claim bonuses’, and most recently ( in 1966) a complete overhaul of the rating structure when it became obvious that ‘preferred risk’ competition was beginning in earnest in a pattern long familiar in the United States.

Closely associated with MV comprehensive insurance is CTP liability insurance. Originally this cover had been given as an extension of the Mv policy with rates set by the Council. In the late 1930s and early 194Os, following the examples of New Zealand and Britain, all the Australian States introduced legislation making this insurance a prerequisite f o r the registration of motor vehicles. All the Acts provided for government approval of insurers and for government wtting of maximum rates, usually after the recommendation of com- mittees upon which tariff companies were only one of the interests represented. After the war, long delays in adjusting rates to rapidly increasing claims caused many companies to withdraw from the field altogether, especially in New South Wales and Victoria. The result was that most of the business has come to be written (at a substantial loss) by government offices, and so the influence of the Cound l over rates has been even further diminished.

Unfortnnately MV and CTP expenses and commissions are not separated by the CBCS. Taken together they have produced underwriting losses in most years: these losses have been greater than the losses of U.K. companies (Table XV) . Table XVI indicates the extent to which this outcome is accounted for by the CTP results.

I n many other miscellaneous forms of cover tariffed by the Coun- cil, broadly the same pattern was followed as in fire insurance. How- ever, in a few cases there were early difficulties. For example, in plate glass insurance there were originally two small mutuals outside the

TABLE XV

IMV and CTP Underwriting XurpEuses on Premiums Earned Per Cent, U.K. Companies and Australian Btates, 1942-67

1942-45 11 9 19.9 15.6 1946-50 1 -1.7 ! -13.0

1956-60 -2.7 -2.2 1 -1.2 1951-55 0.5 I -8.5 -5.9

1961-67 1 --2.5* 1 -5.4 -5.5

I P e r i d I U.K. cos. 1 N.S.W. 1 Vic. 1 Qld. 1 Sth. Aiist

35.w 1 7.8$ -6.7 -3.5

2 . 2

-2.1 4 3 -~ -

Notes: * 1961-63. Later years not yet available. t 1944-45. $ After all taxes, including income tax.

Sources: CBCS. State branches ; U.K. Board of Trade [ 101.

1968

Periad

1943-45 1946- 50

NON-LIFE INSURANCE

TABLE XVI

Loss Ratios, Austral&

N.S.W. Victoria Qld. Sth. Aust.

27.2 40.1 13.5 37.2 22.2 29.2 I 30.0 28.6

46 1

Period 1 MV 1- CTP

1942-45 1946-50 108.7 1951-55 116.7 1956-60 99.0 1961-67 100.3

Source: (71.

agreement, but this problem was solved when both were absorbed by the London and Laneashire (in 1912 and 1915). Accommodation was also necessary with the Colonial niCutuat Life, which wrote personal accident insurance. I n later years all the major life companies com- menced this business, but they agreed to follow the Council tariff, which was profitable and still very little changed in 1967. I n these and all other lines-sprinkler leakage, hail, public risk, boiler, burglary, fidelity guarantee, pluvius, aviation, all risks etc.-Lloyd’s, government and other non-tariff competition developed in the 1920s, and all became subject to the provisions then introduced for special ratings and discounts. For some c1asses-e.g. hail and aviation-FAUA administered pools were established as the most efficient means of meeting this competition. Over the period, as intended in the agreements, minimum rates were set for all new permissible forms of cover.

As Table XVII shows, underwriting surpluses have been exceptionally high in this broad class, and this is true of the individual sub-classes except perhaps burglary in recent years.

It has been shown so far that tariff companies had to adjust their

1951-55 21.8 26.3 16.7 21 -2 1956-60 1 15.6 I 20.6 I 17.3 I 16.1 196 1-67 5.5* 12.4 11.2 16.2

Notes: 1942 not shown due to change in definition in this year. Surpluses are before tax but stamp duties are insignificant. * Excludes abnormally high guarantee claims in 1960-61 assodated with the demise of the Standard Znsurence Co.

Sources: CBCS State branches.


agreements in the long run to outside competitive pressures. More- over, in two important areas--WC and CTP-State governments intervened directly. Although the original agreements were sponsored by London companies, important and effective competition also came from London, especially from Lloyd’s. However, rates in some areas have been slow to adjust and it could be argued that profits in fire, marine, and the miscellaneous classes have been above-normal. On the other hand, there have been low surpluses o r loss in M T , CTP and WC. What has been the net result for insurance profits? Table XVIII suggests that they have been only a little above the average of Aus- tralian companies but substantially above profits of U.K. insurance companies. They are also higher than the profit rates of U.S. insurance companies over the Same period: in fact approximately double. Does this mean that profits are ‘excessive’ in some sense t Perhaps it does if we argue that the U.K. and U.S. rates are sufficient to induce the efficient performance of insurance functions.

TABLE XVIII

Profits after Tax on 8hareholders’ Funds Per Cent

Period

-

1928-30 1931-35 1936-40 1941 -45 1946-50 1951-55 1956-60 196167

U.K. Australian Ins. public cos. cos.

6.9 3.8 6 .8 5 .9

4 .3 7.9 6 . 3 9.7 5.1 8.6 4.2’ 7 . 5

1 Five Australian insurance companies

U/W and int.

10.2 8.2 8.1 8.2 8.7 11.2 9.2 8.2

Capital Incl. capital profits profits

_- - 10.2 0.2 8.4 - 8.1

-0.1 8.1 0.4 9.1 1.5 12.7 2.4 11.6 1.7 9.9

Notes and Sxtrces: U.K. Insurance companies-calculated from [lo]. Australian public companies-Reserve Bank series. Five Companies-aggregated accounts of Mercantile Mu- tual, Queemsland, United, Victoria, Perpetual General. ‘Capital profits’ are published increases in asset values.

* 1961-63. Later years not available. Product Variation

As already explained, the aim of the tariffs was that all forms of cover issued should be uniform, and that extension should not be granted if not allowed f o r in the agreements. To achieve these aims, standard forms of cover notes, proposals, policies and endorsements were laid down.

F o r two important new classes of business-WC and CTP-the scope of the cover and conditions were set out in the various Acts, and the Council had no say beyond regulating what could be done by way of extensions to these policies (e.g. common law cover to WC policies). Apart from these, one can observe a steady adaptation and broadening


of covers under the pressure of outside competition. This is true, for example, of t a r8 motor vehicle policies, many marine clauses, and innovations in fire insurance such as blanket covers, replacement- value fire policies, declaration policies, the householders’ comprehensive policy, long-term and forward contracts.

Against this long-run flexibility must be set the following considerations: (a ) There is not a single instance where the tariff market has taken the initiative in introducing new covers. (b) Defence against non-tar3 competition and pressure from government offices have been the principal motives behind nearly all important innovations. (c) I n nearly all cases, the policies, wordings, etc. adopted have followed those already in use in England. The Australian market has mot pioneered forms of cover or procedures which are peculiar to it. ( d ) New policies introduced have lagged behind their introduction in Britain, and as a result a t any given time the range of choice available to an insured in Australia has been considerably narrower than in England. (e) Often, when tariffs came to recognize new policies, there were restrictions on their issue or the requirement that the Coun- cil or the State Association should approve of each case. Also, the tariff attitude towards many extended covers was that they should only be granted when necessary in order to defend a connection. A sign of this reluctance was the fact that many extensions were listed as permissible additions to policies, rather than incorporated in policies themselves with provision for reduced premiums if deleted.

It must be recognized alongside this, however, that the innovations in question were available in Australia from the non-tariff firms which pioneered them, and this became a progressively more important consideration as the non-tariff market share grew. Also, private regulation in Australia proved infinitely more flexible than State government regulation in the United States. Under the latter system the Householders’ Comprehensive policy, for example, did not arrive until some thirty years after the Council adopted it in Australia.

Selling Costs The framers of the 1909 agreements recognized that, in precluding

price competition, they were likely above all to channel competition into a struggle for agencies. Such competition could easily lead to the breakdown of rate agreements if high commissions were partly passed on to the insured by agents or brokers, or paid on ‘own business’. Ac- cordingly, companies were required to agree on maximum commissions and to ensure that rebating did not occur. The maximum number of agents each company could appoint was also fixed, and there was a list of ‘prohibited appointments ’ which included, for example, co-operative societies, banks, trustees companies and solicitors.

Probably the most important of these restrictions concerns brokers. Here the objective was to prevent the development in Aus- tralia of brokers on the London pattern. In the London market for a


long time now brokers have performed many of the functions normally carried out by insurance companies, e.g. the settling of claims and a number of the usual routine clerical and accounting tasks. Their bargaining power is very great; frequently they promote and own insurance companies. To prevent ‘ broker domination’ on this scale tariff brokers in Australia must agree: (a) not to rebate commissions; (b) not to settle claims; (c) not to act as agents o r directors of insurance companies; and (d) to observe tariff rates. Companies agreed not to extend ‘brokers’ covers’ to them (in effect agency powers), and as mentioned above also fixed maximum commissions (zero on marine business until 1957).

The freedom of action of brokers working under these agreements was obviously severely limited. They were in theory unable to perform their natural function as professional insurance buyers, which was to search for the cheapest and most favourable terms for their clients. In fact the tariffs were seldom clear-cut on many points, and the brokers became expert at finding favourable interpretations in obscure cases. Before 1932, moveover, some had arrangements in London, aI- though they were probably not very extensive.

As far as the registered brokers are concerned, these restrictions have certainly achieved their objectives despite the recent relaxations in the case of marine and fire insurance. However, as mentioned earlier, non-tariff brokers dealing with London and the Australian non-tariff companies have emerged as an important force.

After 1909, the restrictions on agents remained unchanged over long periods. Fo r example, the Limit per company for Sydney was increased from 100 to 150 only in 1958. If there had not been so many new entrants a serious restriction on agency services available might have occurred, but in the event this does not seem to have happened. However, the limits may have inhibited the expansion of imdividual tariff companies, except by takeover. I n this respect companies with large resources were probably a t an advantage.

The question most frequently asked about the agency force concerns the level of commission : is this too high and in some sense waste- f u l ? The first point to recognize is that commission is not necessarily entirely procuration cost, and that management expenses may contain elements of ‘ selling expense ’ which substitute for commission.17 This is one reason why there is little point in comparing Australian with U.S. commissions (which are very much higher). A more interesting com- parison can be made between Queensland and the other Australian States. Queensland, through its insurance commissioner, is the only State to license agents and regulate commissions. The kind of argu- ment underlying the policies followed is not clearly stated, but it appears to go something like this: (a) ‘Rebating’ of commission and ‘own business’ commission are in some sense unethical. (b) High com-

l7 In a study of U.K. data, the writer found a statistically significant inverse correlation between ratios of commission and management expenses to premiums.


missions are unethical. (c) Low commissions mean a correspondingly low total cost of insurance.

I n accordance with these apparent views the legislation provides that an agent must intend ‘actively to solicit business on behalf of any insurer and insurers and that the agency is not primarily for his own insurance business’.ls Professional advisers such as auditors, medical officers and solicitors are expressly prohibited from receiving commission unless 1icen~ed. l~ As in the tariffs a comprehensive definition of ‘ commission’ is provided.20 Limits on commission, mostly below tariff ,21 are prescribed thus :

Maximum commission, Tariff maximum, Queensland other States

Agents 10 per cent Managing agents

Chief agents

Brokers 10 per cent Directors Local reinsurance 1.5 per cent

15 per cent. (Two per co.

No limit. (One only per

Min. $100, max. $200 p.a.

only)

CO.)

Various up to 15 per cent Not applicable

No limit

Various up to 15 per cent 20 per cent 20 per cent

On arguments (a ) and (b) above, ‘rebating’ of commission is of course a method of price competition between agents, and high commissions are a method of competition between companies buying their services. The attitude that competition in these respects is ‘unethical ’ seems very close to a more frequently found attitude that price competition is ‘unethical’.

The contention that ‘. . . the limitation of brokerage and commission has proved an important factor in keeping down procuration costs. . .‘22 is perhaps true if ‘procuration cost’ is defmed to be commission only. I n fact commission percentages (to premiums) have been lower in Queensland than in other States. However, if it is recognized that an important element of ‘procuration cost’ may be included in the salaries and other ‘management expenses of an insurance company, the statement would appear to be both incorrect in principle and is also not supported by the statistics. I n principle, if an insurance company expands to a new area, it has the choice of appointing agents or of using its own employees, e.g. paid traveller, inspector, branch and branch manager. If it chooses to appoint an agent i t presumably does so because this is the cheaper method. The commission limitations in the Queensland legislation restrict the range over which this choice

18 Insurance Act, 1960, sectn. 14 (b ) . 19 Sectn. 17 (1). 20 Sectn. 17 ( 7 ) . 21 However, marine brokerage of 10 per cent (not before allowed in Australian

22 C. A. Grimley (Queensland Insurance Commissioner), ‘Supervision of In- tariffs) was set in 1916 and paid by the GIO.

surance in Australia’, Journal of Zmrance, December 1960.

466 THE ECONOMIC RECORD DEC ~

-in effect a choice of the most efficient selling ‘input’-can be made, and so leads to higher, not lower, costs.23 In practice, lower commissions in Queensland have been a t least offset, and sometimes more than offset, by higher management expenses. Although comparisons of such ratios must be made with caution, the evidence does not suggest that the commission control has made any clear-cut difference to Queensland expenses.

8olvency Perhaps the most important of all aspects of performance is that

policy-holders should be paid when losses occur. Among the many companies which leave the Australian market there are undoubtedly some which default on claim payments. Unfortunately there are no statistics, but there does not appear to have been any serious failure on a large scale until 1961. About $500,000 was then levied on insurers in New South Wales to meet the CTP and workers’ compensation liabilities of the Standard Insurance Co. (of New Zealand) and three small local companies. Presumably claimants under policies other than CTP and WC went unpaid. A t least six other small companies have been liquidated with probable losses to policy-holders since 1960, and a t least ten in the 1920s, but again there is no precise information.

In contrast to most other countries, there is no real attempt a t solvency supervision in Australia. The deposits required24 are small- the maximum of $200,000 for a foreign company would represent a very small proportion of its liabilities if it wrote a sizeable business in Australia. hiloreover, the technique of relating the deposit to premium volume reduces the requirement of course if a high volume is achieved by charging low rates.

I n the past, a t least implicitly, Australia has relied on the solvency requirements administered by the British Board of Trade, since nearly all foreign companies in Australia also operated in London. However, these controls have defects which have been shown up by six recent failures.25 Subsequent changes seem to have tightened Board of Trade control but the writer remains sceptical.

Although the exit rate of non-tariff companies has been somewhat higher than that of tariff companies in Australia, tariff membership has by no means been a guarantee of financial security. In the 1920s at least seventeen companies were tariff members during periods when their financial situation was such that they would have been declared insolvent by any U.S. insurance commissioner or by the test used by the Board of Trade.26 They included even fraudulent or semi- fraudulent companies of notoriety, such as the Australian Federal Life and General. Since then the tariff record appears to have im-

23 It may be argued that it is preferable to replace relatively unskilled agents with ‘professional’ insurance men, but i f so the cost involved should be recognized.

24 See footnote 12. 25 [ 9 ] , 1967, p. 331. 26 Assets should exceed liabilities by more than 10 per cent of premium income.


proved, but still in the 1950s a company such as the Vanguard was a member when it was insolvent by the same test.

It has been suggested that Australian attempts a t solvency supervision have been less than enthusiastic and that existing regulations are not adequate to prevent serious failures, Moreover, less and less reliance can be placed on the British legislation, as an increasing proportion of overseas companies have headquarters in other parts of the world. Also, the relative absence of lurge-scale loss in Australia in the past does not mean that there is no danger in the future. Indeed the increasing competitiveness of the Australian market, and the growing influence of the new brokers, could lead to more serious failures and deter overseas companies which in the past have often bought out weak Australian companies as a convenient method of entry to a market whose long-term prospects were viewed optimistically.

The present Commonwealth deposit legislation is based on principles which were long ago recognized as inadequate in the United States, Great Britain and in nearly all other countries with it privately- owned insurance industry. There is a strong case f o r the establishment of a Commonwealth supervisory authority, along the lines of the present Life Insurance Commission, and for the adoption of solvency rules as used by the U.K. Board of Trade or by State insurance com- missioners in the United States?? The Commissioner should have power to examine companies and to take action to liquidate them where necessary. His department should also act as the chief statistician for collecting and processing Australian insurance statistics.

I I I . Conclusions

The general picture which emerges from the above sketchy survey of the industry’s conduct and performance since 1909 is broadly along the lines that the survey of structure predicted. The original comprehensive and detailed attempts to exploit jointly-exercised market, power were consistently frustrated by the situation of ‘ineffectively im- peded entry’ [8, Ch. 11. The new entrants were quick to offer alternatives in terms of rates and forms of cover where these seemed profitable, and the tariff market eventually responded and made them available to the whole market, albeit with a time-lag.

The new competitors which exerted this pressure were frequently small, and usually depended heavily on overseas reinsurance support. This would need to be seriously considered by any government con- templating drastic size limitations via high deposit requirements, or restricting access to the Australian market by overseas reinsurers along lines adopted in the United States.

Profit performance was variable, with a marked discrimination between fire, marine and miscellaneous lines (high profits) and MV,

27 For an account of government supervision in the United States, see A. H. Mowbray and R. H. Blanchard, Inswrance, Its Theory and Practice in fhe United States. Fifth edition. (McGraw-Hill, New York, 1961), Chap. 33.


CTP and WC. The high profits in the former seem to be associated with high ‘product differentiation’ entry barriers. Possibilities for government action here include legislation on tying arrangements and perhaps application of the Trade Practices Act. A preliminary step would be to make the tying of insurance to mortgage and policy loans illegal, as is the case in the United States.

Most attention has been focused on the restrictive activities of the tariff associations, but it should be recognized that the inspecting, policy drafting, information and other services which they provide have been quite fundamental to the functioning of the market. They have laid the framework of the rules of the game, and this would need to be done in any conceivable way the market develops in the future as long as it remains competitive.

Suggestions have been made above f o r some form of solvency supervision by a Commonwealth insurance commissioner. A fundamental part of his task should be the collection of improved and more extensive statistics than at present available. In order that brokers, other insurance companies and the public can make intelligent appraisals of the financial situation of companies, the statistics of individual companies should be published?*

The government insurance oEces have an important role and tfheir performance needs improving in many respect~,2~ but this would not be an adequate policy taken by itself.

Monash University 0. PURSELL

2sPublished statistics should include at least the following reforms. (1) At present no balance sheet information is collected. Statistics of principal assets and liabilities in Australia should be published. (2) No information regarding reinsurance transactions is collected. Reinsurance ceded and received, recoveries, claims paid and commissions should be shown separately. (3) Provisions for outstanding claims should be shown separately by lines. (4) Income tax provision should be shown, rather than income tax paid during the year. Provision for income tax, pay-roll tax, stamp duties and licence fees should be shown separately. (5) Estimates of ‘earned’ as well as ‘written’ premiums should be shown for each class. Consideration should be given to the adoption of more accurate measures of ‘earned premiums’ than the assumption of fixed adjustment factors. (6) Estimated changes in market values of assets should be published. (7) The statistics of individual companies should be published. The accounts of parent and subsidiary companies should be aggregated, or a t least there should be some indication of which companies are associated. ‘Companies’ here also refers to agents for overseas insurers, especially Lloyd’s brokers. (8) More detailed breakdown of ‘management expenses’ should be considered, e.g. into salaries, depreciation, other expenses.

29 The role of the government offices is discussed in Purse11 [ll].


REFERENCES [ I ] C. H. Brainard and J. B. Dirlam, ‘Antitrust, Regulation, and the Insurance

Industry: A Study in Polarity’, Antitrust Bulletin, VoI. X I January-April 1%.

[Z] R. J. Hensley, Competition, Reg.dation and the Public Interest in Nonlife Insurance (University of California Press, Berkeley and Los Angeles, 1962).

[3] W. Sichel, ‘Fire Insurance : Imperfectly Regulated Collusion’, Journul of Risk and Inswance, Vol. XXXIII, March 1966.

[4] Insurance in Australasia 1966 ( McCarron Bird, 1966). [ S ] The Rm‘ew: International Inrurance Intelligence (London, fortnightly). (61 I. Pfeffer, Insurance and Economic Theory (Irwin, Homewood, Ill., 1956). [7] CBCS, Finance Bulletin, annually 1929/30-1%1/62. Imwance and Other

Private Finance, annually 1962/63-. [ S ] J. S. Bain, Barriers to N m Competition (Harvard University Press, Cam-

bridge, Mass., 1962). [9] A,wtralm’an Zmurance and Banking Record (monthly).

[ lo] Great Britain, Board of Trade, Insurance Companies Act, 1958, Summuries of Statements o f Insurance Business. . . (annually).

I l l ] G. Pursell, ‘Rate Control aqd Government Competition in Australian Non- Life Insurance’, Journal of Rtsk and Insurance, Vol. XXIV, June 1967.

Documents

Australian Non-Life Insurance since 1909