The role of insurance intermediaries
The market for insurance products, like many other markets, is characterised by imperfect information by each party to the transaction, significant search costs to find the “best” deal, and asymmetric bargaining power.
Insurance intermediaries play a key role in the marketplace by contributing to identify the risk faced by clients, reduce insurance distribution costs, search costs, uncertainty and asymmetric bargaining power. They also provide assistance in the claims process to insurance policyholders and more generally support competition in the insurance market
Identifying risks
Insurance intermediaries typically assist clients in identifying the risks they face. Without their expert knowledge and advice, clients would often have only imperfect knowledge of the risks they face, and, as a result, may take ill-informed decisions which could be highly detrimental to their welfare.
Reducing distribution costs
In the absence of intermediaries, each insurance company would need to develop its own fully-owned distribution network to reach its potential client base.
Such a distribution network entails high fixed costs which can act as a deterrent to entry into the insurance market and/or lead to the emergence of an oligopolistic market structure as the minimum efficient scale may be large relative to the total market.
The intermediary function overcomes the issue of distribution costs by allowing insurance companies to reach the client base without having to develop a distribution network.
Reducing search costs
While personal and business customers venture only infrequently into the insurance market, intermediaries are in repeated interaction with insurance providers and have a good knowledge of the products available, their terms and conditions, and, more generally, the risk appetite of the various insurance carriers.
Households and businesses can significantly economise on the costs of searching for the “best” deal by using an intermediary to meet their insurance needs. In other words, intermediaries contribute to reduce the effective price of insurance by reducing search costs and improve welfare by reducing customer detriment.
Insurance companies also benefit from the activities of intermediaries as the latter reduce the cost of finding customers.
Reducing uncertainty
Insurance markets are also characterised by major asymmetric information on both sides of the transaction.
- Uncertainty facing insurance providers
Insurance buyers have an incentive to represent the risk as being a low probability risk so as to pay an as-low-as-possible premium. Moreover, once insurance has been obtained, the insurer faces the classical moral hazard issue – that the insured party may not take necessarily all the appropriate measures to prevent the risk from materialising.
As intermediaries depend on repeat transactions with insurance providers and their reputation for their livelihood, they have every incentive to solicit and present risk information in a balanced and professional manner to insurance providers. The intermediary also advises the client about his own on-going responsibilities in the framework of the insurance contract.
- Uncertainty facing insurance buyers
As noted above, the use of an intermediary reduces search costs. Individuals seeking insurance may not know fully what products exist on the market or the terms of those products in relation to the coverage of policies.
Intermediaries have the knowledge or expertise to help the client identify the risks to which he is exposed and to identify solutions.
The gathering of such information by the insured party directly would be very costly and the information would risk being incomplete as the party seeking insurance does not have the same knowledge of the insurance market due to only infrequent participation in the marketplace.
An intermediary would suffer severe damage to its reputation if it were known in the marketplace that he or she recommended placing insurance with an insurance provider that has the reputation of being unreliable in paying claims correctly.
Because of the potential damage to reputation, the incentives of the intermediary are aligned with those of his or her clients as well as those of the insurance provider. In short, because of its repeated interactions with insurance companies and clients, the intermediary helps overcome the imperfect information that would otherwise hamper the market.
Reducing asymmetric bargaining power
Finally, smaller and medium-sized buyers of insurance may be subject to the bargaining power of large insurance providers when dealing directly with such providers.
As intermediaries place a considerable amount of business with insurance providers, they are in a position to obtain better terms for their smaller and medium-sized clients than the latter would be able to obtain directly. For example, a number of intermediaries have developed schemes to aggregate risks.
Additionally, many intermediaries develop specialist schemes and facilities based on their in-depth knowledge of a particular sector. This knowledge and the ability to aggregate risks enable them to negotiate better terms and broader policy conditions for their clients. Such schemes are usually accessible to other intermediaries.
Providing support to insurance buyer following an event
When an insurance policy holder experiences an event which gives rise to an insurance claim, the insurance intermediary will assist the policy-holder with the filing of the claim and any related interactions with the insurance company.
Support and facilitate competition in the insurance product markets
Intermediaries facilitate competition in insurance markets in a number of additional and important ways.
- The existence of intermediaries means that it is not necessary for new insurers to build up a distribution system in order to enter the insurance markets. Intermediaries provide a distribution channel for new entrants. As a result, insurers do not have to incur the large fixed costs associated with rolling out a distribution system; they only have to carry the costs associated with dealing with the risks which intermediaries present them. For example, a number of international insurers have entered the EU business insurance market over the last 10 to 15 years. Without insurance intermediaries, these new carriers would have found entry into the market very, if not prohibitively, costly because they would have had to build up a distribution network de novo.
- The benefits of a strong insurance intermediary sector have been recognised by international organisations such as the UN/ECE who view such a sector as one of the important elements of the necessary service infrastructure of a prosperous service sector.
- Moreover, because intermediaries sell a variety of competing insurance products, they also make customer switching from one insurer to another relatively easy. The issue of switching is discussed further in Section 4.4.
Not all insurance intermediaries undertake every activity. Generally, the larger intermediaries operating on a world-wide scale provide a very wide range of services to their clients while smaller intermediaries operating on a more local basis will tend to focus more on the traditional intermediation activities reflecting largely different client needs.
Typically, the choice of a particular intermediary by a client depends of a range of factors such as proximity and ease of access, specialisation and knowledge of the intermediary of particular personal or business needs, word-of-mouth reference, Internet search, etc.
Not only do only insurance intermediaries promote competition in the insurance market but they also face considerable competition within in the insurance intermediation market as alternative distribution channels become more prevalent such as direct and indirect distribution through the internet.
