European Commission finds competition lacking in the business insurance sector

The European Commission, in its role as the EU-wide competition watchdog, has recently released an interim report in respect of its inquiry into the business insurance sector. The Commission’s report has the following key findings: (i) high profitability among insurers indicates a lack of competition between them; (ii) overly long contracts and automatic renewals may harm competition; (iii) common use of credit rating and “best term and conditions” clauses may be anti-competitive; (iv) conflicts of interest for brokers and non-transparent broker remuneration may prevent competition; (v) the current competition law exemption for certain cooperation arrangements between insurers may no longer be justified.

The Commission will now look into these issues further. A public hearing on the report was held by the Commission in February and a final report is expected to be published in September. These key findings are explained in more detail below.

The Commission launched its inquiry in June 2005 as it had seen some indications that certain forms of cooperation between insurers and arrangements for distribution of insurance products and services to businesses possibly distorted competition. The overall purpose of a sector inquiry is to allow the Commission to examine the conditions under which certain products and/or services are provided and whether those conditions are in line with the EC competition rules.

High profitability may indicate lack of competition

The Commission concludes that profitability among larger insurers is high but with significant and sustained variations between Member State and product line. It considers that in some Member States this high profitability may be the result of market power being exercised. Motor and general liability were among the least profitable product lines whereas environmental liability and directors' liability were among the most profitable. Profitability also appears to be increasing over time. The UK would appear to be somewhere in the middle as regards profitability across the different Member States. The Commission is going to consider further whether high profits are being sustained by barriers to competition.

Markets appear to be fragmented on national lines and the Commission is concerned that the cross-border buying and selling of business insurance is limited. Cross-border business accounts for less than 3 per cent of gross premiums written.

In some Member States, there was evidence that higher prices for SMEs were being used by insurers to subsidise lower prices for larger business customers. The Commission is concerned that insurers are offering less favourable conditions to SMEs than to larger businesses and it will look into this issue further.

Are customer contracts too long?

Contract lengths vary considerably from Member State to Member State but the Commission found that clauses allowing for automatic renewal are common everywhere (although the UK had one of the lowest use of such clauses). The Commission considers that long-term contracts in certain product lines may raise competition concerns by acting as a barrier to entry for new players. The Commission will analyse further the potential for such foreclosure by looking at various factors including: whether there are networks of similarly long-term agreements across the market for the risk in question (and the proportion of the market covered); what obstacles there are for new entrants to gain customers from established insurers (e.g. do customers have to pay penalties if they switch providers before their existing contract has come to an end?); and other factors affecting competition such as the importance of customer loyalty.

Credit rating and “best terms and conditions” clauses in reinsurance contracts identified as problematic

The Commission has identified two major issues in respect of reinsurance which it intends to look at further:

  • Whether the practice of insurers insisting on a minimum credit rating for their reinsurers may create a barrier to market entry preventing new market participants from entering the market and whether this is negatively impacting on competition in the reinsurance market. In this regard, the Commission has found that the rating which insurers typically require is relatively high and not actually achieved by a significant proportion of reinsurers. The Commission questions the legality of such minimum credit rating clauses under the EC competition law prohibition of anti-competitive agreements and concerted practices. It notes that the French competition authority has considered that such clauses were likely to breach applicable competition rules; and
  • Whether the use by reinsurers of "best terms and conditions" clauses restricts competition by leading to a harmonisation of terms and conditions in the market at a level more favourable to reinsurers. The Commission believes that a market wide standardisation of terms and conditions in contracts used by reinsurers in combination with little or no information about prices, may reduce competition among reinsurers and instead encourage them to cooperate in ways which do not benefit their customers.

Brokers’ conflicts of interest and non-transparent broker remunerations may restrict competition

The Commission found that brokers are the most commonly used distribution channel for business insurance (and are particularly prevalent in the UK), although the method of distribution varies significantly from Member State to Member State. The Commission also found that the more complex the risk being insured, the more likely that a broker would be involved in placing the insurance.

The Commission considers that while networks of exclusive brokers can act as a barrier to market entry, generally speaking, the existence of brokers makes it easier for new players to enter business insurance markets.

However, the Commission is concerned that brokers increasingly face a conflict of interest between finding the best deal for their client and their own commercial considerations especially where they have underwriting powers from particular insurers. Similar conflicts can also arise because of the nature of broker remuneration. For example, the Commission notes that the use of contingent commissions has the potential to persuade brokers to direct client business to an insurer on the basis of the financial benefits to the broker rather than on the basis of the best interests of the client. The Report also notes that the UK is one of the countries where the use of contingent commissions is widespread, although it has decreased since the Spitzer investigation in the US which focussed on these types of arrangements. The Commission's suspicions on this issue have been further aroused by the fact that brokers are generally not transparent with their clients about the commissions they receive from insurers. This lack of transparency, in the Commission's view, has the potential to restrict competition between brokers. At the Public Hearing, industry representatives argued that customers are only interested in the end price and not in the amount of commission their broker would receive. The Commission rejected this argument because it considers that clients should be able to make a fully informed choice between brokers on the basis of how much commission is charged. It believes that such transparency would also benefit customers as it would increase competition between brokers. The Commission made clear that it intends to look into this issue further.

The Commission also feels that SMEs are not receiving the same service levels from brokers that larger corporates receive and that this could be a factor leading to the higher insurance prices faced by SMEs. For example, the amount of information disclosed to clients was generally less for SMEs than for larger corporates in a number of respects: brokers' commissions; the number of insurers approached for quotes; the scope of coverage; and claims procedures. Interestingly, UK brokers were rated among the least transparent in terms of the information they provided their clients when making their recommendations of insurer.

As evidence that the above practices are having an adverse effect on competition, the Commission points out that insurers tend to concentrate a large proportion of their business with a relatively small number of brokers, although this trend was found to be less pronounced in the UK compared to other Member States.

A further concern of the Commission is that the prohibition by insurers of commission rebating by brokers amounts to resale price maintenance in breach of the EC competition law prohibition on anti-competitive agreements. If the Commission finds that this is the case, this would be a significant charge as resale price maintenance is considered one of the most serious competition law transgressions and could well lead to significant fines for the companies involved.

Threats to survival of block exemption

A number of different forms of co-operation between insurers are currently exempted from the EC competition law prohibition of anti-competitive agreements by the "Insurance Block Exemption" Regulation EC 358/2003 which expires in 2010. The Commission has looked at whether and to what extent insurers actually use the types of co-operation which are exempted under the Exemption. It found large variations between Member States and between different risks in respect of every exempted practice.

The fact that, in respect of each exempted practice, there are national markets where the practice is either uncommon or non-existent, has led the Commission to question whether such practices are essential for the functioning of the insurance industry and should continue to be exempted. Given that restrictions on competition (which include most forms of co-operation between competitors) can only be exempted where they are indispensable, contribute to economic and technical progress, create customer benefits and do not wholly eliminate competition, it will be necessary for the insurance industry to demonstrate that market conditions mean that an exemption is still necessary.

At the Public Hearing, the Commission explained that its preliminary findings on the Exemption should also be considered in relation to pools which are not specifically dealt with in the report (e.g. catastrophe pools, terrorist pools etc.). Some representatives from the industry argued that there was no real evidence that the Exemption had been abused; that the countries which made the most use of the exemption had the most diverse and integrated markets; and that uniform conditions and standards are beneficial to new entrants as they reduce costs. It was also argued that reliable statistics for small markets and new markets are not available even to large insurers, but that such statistics are available to new entrants in respect of existing markets. If the Commission does not change its position in its final report and advocates an end to its Exemption which expires in 2010, this will mean that many forms of continued co-operation between insurers and reinsurers will be subject to significant antitrust exposure.

Next steps

The immediate next step is that the Commission intends to circulate a further round of questionnaires (and possibly interviews) in order to gather further information in respect of the issues and concerns identified above. This further information gathering will concentrate on the competition aspects of the issues raised.

In the meantime, the Commission invites all stakeholders to submit their views and observations on the preliminary findings. The report sets out a number of consultation questions on which it is seeking responses. The consultation period will last until 10 April. The Commission's final conclusions are envisaged to be published in September 2007.