The Economics of Insurance Intermediaries - Article Example

The Economics of Insurance Intermediaries – article review Introduction: This article gives an insight to the functions of economic intermediaries i.e. brokers and independent agents. This gives an understanding on placing of the products to the insurer, the compensations paid to the intermediaries and market competitiveness. As per traditional thoughts brokers were to cater the need of policyholders whereas the agent was supposed to be working for the insurer. However there are no watertight compartments to segregate the functions of both. Both brokers and agents indulge in activities like record keeping, settlement of claims and help the people on selection of the insurer. These people are basically underwriters to the insurer; they actually do the matchmaking between the policyholders and the insurer. The market is going through constant changes in its framework and organization. This entails changes in the way in which consumers transact the commodities in the insurance market. Different networks vary in their nature and the insurers use various kinds of channels to market the products. The Internet, banks, companies and agents lead these networks. (Dumm and Hoyt, 2002) Insurance is a complex process of compensation payments to the policyholders based on certain conditions. The policy holder’s decision is based on the price of the product, the range of coverage offered by the policy, the risk factor entailed and last but not the least factor the market reputation of the policy in settling the claims. The “market making ‘ role played by intermediates are complex where right set of policy holders can be selected from the market having the right financial credibility, risk taking attitude and skills. The insurer getting the right people with right mindset can invest on assets creating deals. (Cummins, 2006, p.359) Taking an instance from the European Union markets, we may find that there is no regulated and well functioning market in European Union. Countries like France and Germany have tried to introduce a liberal structure in the industry and in the process the markets were deregulated. However competition persists rigorously among the individual markets with respect to price and differentiation of the products. This incidence of differentiation of products brings about two kinds of impact. First, consumers can find their respective choice with more options available before them and second there is less clarity in the market and hence insurance companies might reap gains, which are monopolistic in nature. In this context, the welfare of consumers comes down. Incomplete information is a major problem in the insurance markets and the book ‘Insurance intermediaries’ deal with this aspect quite elaborately. Moral hazard and adverse selection are common problems in this market. (Eckardt, 2007, p.1) Research question The question addressed in this article is to analyze whether the contingent and premium oriented commissions are actually a burden to the policyholders or do they also benefit the clients and work as incentives. This is addressed in the light of the PC insurance market. The role of intermediaries is highlighted in this regard and the article also reflects upon how these intermediaries can help in efficient functioning of the markets. Contribution The article unlike the other articles on the insurance market has brought out the internal cost benefit analysis in the process of transaction of the insurance policies. The authors here have underlined the role of intermediaries along with the role the gains accruing to the policyholders. However the article does not explore the other ways in which the trust and reliability factors might be improved by the companies as represented in the work of Mariska and Manson (2005) with respect to the Russian insurance market. These aspects are outside the scope of the analysis presented here as this issue is very specific in nature and the authors in this article are essentially focused on the pricing, premiums and how they can make the market effective and efficient with the help of intermediaries. As discussed above from other works, there are some companies who indulge in direct marketing by telemarketing, sending of emails or through staffs. The maximum impact on sales even today is from the traditional school of agent- led channel. With modernization of financial market the US economy evidenced the era of bank led channel in 1999. The main selection criteria is based on consumer preference which is still now more on traditional school of agents might be due to the complexity of the product. The intermediaries are basically people between the policyholders and insurer. There are some agents who serve several insurer, these people are termed as independent intermediaries. Individual agent and Broker differentiate in terms of size of customers serving. Client base for broker is generally big and serving complex requirements. In case of large commercial houses requiring group insurance, lot of complexity has to deal with. In such case brokers are required who plays a “syndication” role and provides a good solution to the company. After liberalization there is entry of several insurance corporate houses worldwide. These companies offer heterogeneous combination of products with a complex product line. On one hand the various offering matching an individual requirement increases the customer welfare. On other hand, complex product line reduces market transparency. In this situation an intermediary play a pivotal role in selection and selling of the right product to the right person. In the year 2004 there existed about 39000 agencies and brokers selling insurance in US market. It was seen in 2004 the US insurer were more inclining on individual agents for personal investments. Further more it is found the top 10 broker of the world contribute to 56.1% of the revenue from commercial lines of business, 12.2% from services and 10% from wholesale market. (Cummins and Doherty, 2006, p.362) The landscape of the insurance companies is changed after the recent trend of mergers and acquisitions. Plunkett (2008) has concentrated on this aspect in his work ‘Plunketts Insurance Industry Almanac 2009’. The main sector where change is visible is health, life, property and casualty. The most noteworthy acquisition is 2005 $12billion worth acquisition of Traveler’s life and Annuity International. The German investor Allianz had invested in 2008 an amount of $2.5 billion dollars in Hartfold financial services. The mergers and acquisition in insurance sector is caused due to the effects of globalization and competition. However the effect of mergers is less significant compared to international banks. The main reason for this the insurance company working of back office, marketing, distribution and claim processing differs from one company to another. Many of the world’s largest insurance companies need to raise lot of capital in 2009 and 2010 as the global recession has created a lot of damage to their portfolio. (Plunkett, 2008, p.89) It is easier to enter in the insurance market as an independent unit but is highly technical to thrive in the business a broker catering to the technical and complex insurance requirements of a corporate business house. In the following sections the different classification of insurance market participants are summarized. a. Niche Players –These are small and medium sized players in the market. Some of them specialize in a particular range of products or cater to certain kind of industry. These intermediaries can compete with the local brokers within the geographical boundary. b. Retail or Distributor Brokers- These brokers have key skills developed on risk analysis, claim settlements these brokers have wholesale rating to attract brokers. They can compete with global brokers. c. Global Brokers –These are the brokers who are the makers of the policies with insurer and clients. The competition amongst the top brokers is strongc. In their article Cummins and Doherty (2006) show how the intermediaries have found their platform owing to the mergers and acquisitions that have taken place in the industry. The largest buyer segments are catered by a group of top 5 global brokers. The risk managers of the top firms have the potentials to dictate many rules to the insurer. Small insurance buyers however utilize local intermediaries. Due to the complex nature of the insurance market the business become highly competitive. The returns on equity for most of US broking firms from 1994 till 2004 range between 20-25%. The public brokers in US have earned more amounts of profit compared to other counterpart. But portfolio between risk and returns are directly proportional, meaning higher risk guarantees higher returns. (Cummins and Doherty, 2006, pp. 362-365) Thus while the other literatures on insurance market have focused on the issue of information asymmetry, occurrence of mergers and acquisitions and the way the insurers market their products, this particular article has brought about the system of payment and its significance in the functioning of the market and its importance to the participants like the policy holders and insurers and last but not the least, the intermediaries. Methodological approach: The method applied in the research is mainly secondary in nature and collected from Best Company and Business Insurance database. No statistical analysis has been applied or rigorous mathematics done here. Rather it has taken up a sample of 100 brokers of United States based on revenues from clients. The analysis presented here through tables and graphs have highlighted many aspects regarding the turnovers expected by the brokers in commercial and personal PC markets. Again, the primary share distribution according to the categories of the participants presented for the year 2004 also brings out the share of brokers and intermediaries in the total turnover. The final analysis is a combination of quantitative and qualitative approaches and finally brings out the answer to the research question. Answer to the research question The article proves empirically that the commissions finally are passed on to the policyholders and concludes that such commissions might even be a gain to the clients. There are problems of information imbalance which might be addressed by the intermediaries and the contingent commissions provide incentives for entrance of new insurers and thus work out the incentive structure between these new insurers and the intermediaries such that the buyer might finally find the best option available to them with the help of the intermediary who would clear out the information gap to the buyers. They can even inform the insurers about the risks of the customers and thus close up the space between the buyer and seller. This is more likely to promote a competitive structure of the industry Evaluation of the answer The answer is logically derived from the different statistics available regarding the market. However the data collected regarding primary distribution structure is not reliable because one insurer might work for more than one market category. Unlike the other works this article has brought out the intricate detail about the working of the transaction in the insurance market. The article provides a realistic picture rather than taking a one sided decision regarding the benefits accruing to the stakeholders. However one could utilize more systematic information and cover other market segments as well in order to arrive at a decisive answer regarding the insurance market. What it tells us about the real world? The article finally reveals that every time a premium might not be a burden to the stakeholders. The same price, which appears to be costly, is actually the price paid to assure less corruption and more competitive structure. We usually have the opinion that monopolistic prices are higher, but at times especially in the insurance market a higher premium can ensure greater competition and lesser chance of being abused by the providers. References Cummins, D.J. and Doherty, N.A. (2006) The Economics of Insuranc and Intermediaries, The Journal of Risk and Insurance, 2006 Vol. 73, No. 3, 359-396 Dumm, R.E. and R.E. Hoyt (2002). Insurance Distribution Channels: Markets in Transition, International Insurance Society, available at: http://74.125.153.132/search?q=cache%3ADspyd12W4WMJ%3Awww.iisonline.org%2Fpdf%2FInsurance%2520Distribution%2520Channels%2520(JIR%2520submission).pdf+INSURANCE+MARKETING+CHANNELS&hl=en&gl=in (accessed on March 24, 2010) Eckardt, M. (2007). Insurance Intermediation, Physica-Verlag HD Mariska, M.D. and T.NB. Manson. (2005). Reforming the insurance market in Russia, OECD Publishing. Read More