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Andreas Richter Ludwig-Maximilians-University Muinch. Intermediation, Compensation and Tacit Collusion in Insurance Markets. Uwe Focht University of Hamburg. Jörg Schiller WHU – Otto Beisheim School of Management. ARIA Annual Meeting Washington 2006. Agenda. Introduction Model Framework - PowerPoint PPT Presentation
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Intermediation, Compensation and Tacit Collusion in Insurance Markets
Andreas RichterLudwig-Maximilians-University
Muinch
Jörg SchillerWHU – Otto Beisheim School of
Management
Uwe FochtUniversity of Hamburg
ARIA Annual Meeting
Washington 2006
2Intermediation, Compensation and Tacit Collusion in Insurance Markets
Agenda
1. Introduction
2. Model Framework
3. Market without Intermediation
4. Market with Intermediation
a) Fee-for-Advice
b) Commission
5. Collusion and Intermediation
6. Concluding Remarks
3Intermediation, Compensation and Tacit Collusion in Insurance Markets
Collusive Behavior in German Commercial Insurance
In 2005, the German Federal Cartel Office imposed a 150 Million Euro fine against 17 leading commercial insurance companies.
From 1999 to 2002 insurance companies established a cartel in order to enforce higher premiums as a “reorganization measure”.
In particular, they agreed to
– Increase premiums and deductibles
– Waive premium reductions
– Unify terms and conditions
Enforcement measures for the cartel
– Insurers: Exclusion from pool solutions
– Brokers: Termination of cooperation
4Intermediation, Compensation and Tacit Collusion in Insurance Markets
Main focus
Why is collusive behavior in commercial insurance a common phenomenon?
What is the specific role of an insurance broker in this context?
To what extent does the broker’s compensation affect pricing and collusive behavior of insurance companies?
5Intermediation, Compensation and Tacit Collusion in Insurance Markets
Insurance market with heterogeneous risk profiles and differentiated products (Schultz, 2004).
Consumers’ risk profiles are uniformly distributed in [0,1].
Two insurers (i = 0,1) offer policies at the two extremes of
the risk profile space and compete in premiums pi.
Constant marginal costs c.
Model Framework (I)
6Intermediation, Compensation and Tacit Collusion in Insurance Markets
Model Framework (II)
Willingness to pay v for consumers is sufficiently large.
→ In equilibrium the market is completely covered.
Disutility of mismatch t·, increases linearly in the distance
to the demanded product.
Two types of consumers:
– Informed consumers with fraction (0,1] are perfectly
informed about their risk profile and the premiums pi;
– Uninformed consumers with fraction (1−) only form
rational expectations regarding their risk profile and
premiums pi.
7Intermediation, Compensation and Tacit Collusion in Insurance Markets
Market without Intermediation
Sequence of play:
1. Insurers simultaneously offer contracts at premiums pi.2. Consumers decide whether and where to purchase an
insurance policy.
In the symmetric subgame perfect Nash equilibrium prices and profits are
and
Both premium level and profits decline in the fraction of informed consumers.
One half of the uninformed consumers match with the wrong product
→ Resulting welfare loss:
t
cp *
2* t
t4
11
8Intermediation, Compensation and Tacit Collusion in Insurance Markets
Market with Intermediation
Cost per risk analysis .
Two compensation systems are considered:- Broker is paid by the insured (fee-for-advice)- Broker is paid by the insurance company (commission)
The broker acts completely non-strategic!
The broker is endowed with an information technology which perfectly reveals the risk profile of an individual consumer.
0k
9Intermediation, Compensation and Tacit Collusion in Insurance Markets
Market with Intermediation (Fee-for-Advice)
Broker‘s fee at which uninformed consumers are indifferent
If k ≤ (1/4)t holds, the broker offers risk analyses and all uninformed consumers purchase this service.
Thus, since = 1, equilibrium premiums and profits are
and
tm4
1ˆ
tcp ˆ2
ˆt
10Intermediation, Compensation and Tacit Collusion in Insurance Markets
Market with Intermediation (Commission)
The risk analysis service does not cause any costs for uninformed consumers, therefore = 1.
Broker’s commission at which insurers are indifferent
Insurance companies accept offer and charge the premiums
and
The resulting insurer profit is:
th4
1~
tcp i ~ tcpu
4
5~
2~ t
11Intermediation, Compensation and Tacit Collusion in Insurance Markets
Fee-for-Advice vs. Commisson System
But: In a modified model there might be incentives for a broker to match uninformed consumers with the wrong insurance company (intentional mismatch).
In both cases, due to the increased transparency on the consumer side, the insurers’ profits decrease.→ Greater incentives for collusion
From a social planner‘s point of view both remuneration systems are equivalent.
12Intermediation, Compensation and Tacit Collusion in Insurance Markets
Collusion (I)
Assumption: Insurance companies jointly decide upon premium offers and the broker’s remuneration.
The coalition maximizes its joint profit subject to the broker’s participation constraint .
A commission system is superior to a fee-for-advice system.→ Prices can not be differentiated in a fee-for-advice
system.→ A fee reduces the maximum possible premium, since
0m
mtvpc 2
1max
In our model, rationing is not profitable for the cartel.
13Intermediation, Compensation and Tacit Collusion in Insurance Markets
Collusion (II)
The profit maximizing premium for the cartel is:
The broker is compensated by a break even commission.
In our model, collusion does not affect social welfare (no rationing)→ There is (just) a redistribution of income.
tvpc 2
1
14Intermediation, Compensation and Tacit Collusion in Insurance Markets
Concluding Remarks
In markets with uninformed consumers and heterogeneous risk profiles, intermediation has the potential to improve social welfare.
Intermediation reduces the market power as well as profits of insurance companies and increases collusion incentives.
In a competitive market both remuneration systems are equivalent.
Under collusion– a fee for advice limits the insurers‘ opportunities to extract
rents from informed consumers.– less differentiated products are offered (→ in the paper).
In our analysis we do not examine the broker’s incentive problem.
15Intermediation, Compensation and Tacit Collusion in Insurance Markets
Backup
16Intermediation, Compensation and Tacit Collusion in Insurance Markets
Product Differentiation
Without collusion: Insurance companies maximize profits by offering
differentiated products outside at:
Product differentiation increases consumers’ disutility of mismatching and negatively affects social welfare.
In the case of collusion: Profit maximizing product characteristics are:
In order to maximize the coalition’s joint profit, insurance companies equalize product characteristics.
4
5;
4
1
4
3;
4
1
17Intermediation, Compensation and Tacit Collusion in Insurance Markets
Rationing
Rationing is only profitable, if and only if
Collusion is profitable, if and only if
→ The coalition’s joint profit under collusion is strictly higher without any rationing!
tcv
4
5
tcv
4
7