Thursday, April 10, 2008

Insurance Economics

There are 4 types of economic markets: (1) Perfect Competition, (2) Monopolistic Competition, (3) Oligopoly and (4) Monopoly

1) Perfect Competition - Exist when all the firms in the market produce identical products. Large number of independent firms. Each seller is small relative to total market and barrier to entry is low.
2) Monopolistic Competition - Large number of firms produce (slightly) differentiated products. Firm complete on price, quality and marketing. Barrier to entry is low.
3) Oligopoly - Small number of firms with similar or slightly different products. Profits to be made are interdependent on competitors' decisions. Can collude to form a monopoly.
4) Monopoly - One seller of specific, well-defined products that has no good substitutes and high barrier to entry.
^^^^^
I am not an economist. I like to share 10 short points on how Economics apply to the Insurance Industry and 8 points on how I feel about my analysis.
^^^^^
---------------------

My 10 points on how it applies to the Insurance Industry?
1) The insurance industry seems to lean towards a Monopolistic Competition Model. Policies are about the same but often with funny features to make it different.
-----
2) A lot of money have to be spent on product design, marketing and distribution to differentiate themselves and their policies.
-----
3) By doing so, they can justify that they have better plans so that they can charge a higher premium and earns an Economic Profit.
-----
4) Its unlikely to see standardisation within the Insurance Industry because similar products will turn the industry into a Perfect Competition Model.
-----
5) Perfect Competition Model is no good for the company because company can only price their policies equal to its average total cost. i.e, Everyone shall charge the same premium and earn the same amount of money.
-----
6) Perfect Competition Model may not be good for the consumers in the long run because competion will only be based on price. Innovations and breakthroughs will never be possible.
-----
7) There are people trying to turn the industry into a Perfect Competition Model by grouping or standardising all plans, reduce marketing expenses and distribution cost.
-----
8) The agents factor is one of the distribution cost and commissions paid form part of normal profit and economic profit. Some agents earn a lot more than others
-----
9) Efficiency of a Monopolistics Competition Model in the insurance industry is unclear.
-----
10) Collusion is not possible in the industry because of there are too many firms.

^^^^^

My 8 conclusive points?
1) Insurance Companies will continue coming out with different type of insurance policies to confuse the consumers.
=====
2) It will not to be their interest to educate the public on how to compare different products
=====
3) The call towards transparancy and efficiency is high. The model may gradually change into a Perfect Competition Model when demand for such get higher.
=====
4) The market is not efficient in term of information flow, the consumers are lacking knowledge in products comparison. As a result, consumers may not be getting the best deal.
=====
5) Some agents shall continue to earn an elephant economic profit as they discourage product comparison.
=====
6) An ethical and competent adviser may find it hard to earn as much as them because they are promoting plans that earns them a lower commission.
=====
7) This industry is still bright for the ethical/competent and unethical/incompetent advisers alike. The smart ones may choose the latter and passionate ones the former.
=====
8) Which type of adviser do you choose to be? One who will say that everything offered by your company is good or one who is willing to research before saying what is good.

8 comments:

Anonymous said...

Branding is a monopolistic strategy to create subjective differentials
which may or may not be real. Theoretically every brand is a monopoly.
True monopoly today is Microsoft?

Insurance market is imperfect. That is why consumers can be bullied or cheated by greedy and unscrupulous insurance agents

Terminator

la papillion said...

I wish insurance is a commodity with different firms selling it based on their own branding. I wish it is like buying cola drinks which all taste rather similar but having a choice to choose coca cola over others generic brands because of the perceived better quality.

That should keep the price low for consumers :)

Good article :)

blackbox said...

I think it is inevitable for the insurance industry to evolve this way.

Strong cashflow is the bloodline of an insurer. In order to ensure their capital can continually be invested to reap higher returns, the insurer has to continue coming up with new products, revive old ones and of course set high sales targets to their various distribution channels.

This not only is important for the insurer, but also the consumer, for it protects the solvency of the insurer.

If an insurer is insistent on competing only on prices, its solvency may eventually be affected.

Consumers are bullied or cheated, as mentioned by Terminator because of lack of financial literacy and vested interest by agent.

This is made even more complicated as every agent has their own school of thought of what type of policy is suitable for their client. Some advocate purely term while others advocate at least one critical illness whole life.

As the area is grey, it is difficult to draw the line and say only term should be sold. I think most Singaporeans are too left-minded and logical to realize this.

Btw, I advocate BTIR for myself, but uncertain for others.

Anonymous said...

product pushers don't care whether products are good or bad for thier customers so long the commission is good. Worse when the commission is good they will die die lie and trick the customers to buy. This what most agents will do and ntuc agents are superb in this skill.Only agents with consceince ,honesty and interest of the customers would study the products before deciding to sell it.Of course, the ethical agents will not do as well like those unethical and unscrupulous ones.Those you see in the newspaper you can safely assume
they are product pushers and ethics they keep under their bed or flushed into toilet bowl.

Khiat Han Hwee Adrian said...

I agree with Blackbox that every adviser have their own school of thoughts.

What I studied in CFP and Life Insurance Diploma only teaches us about the identification of needs. They did not mention anything on whether Term or Life is better. or how much Term or Life is recommended.

However, I have to agree that Singaporeans are generally not recommended Term insurance enough. Thats why they end up buying excessive Life Insurance and insufficient coverage.

blackbox said...

Adrian,

There is nothing right or wrong, but thinking makes it so (Shakespeare).

I have the opinion most Singaporeans are bad in managing their personal finance. Take for instance CPFIS. I remembered the report saying majority are losing money. If the report goes further to compare with MSCI World Index, I believe more will underperform due to the inherent zero-sum game in the stock market.

As such, I tend to believe most people have no business buying term and investing the rest. A lower cost whole life may be more suitable for their protection needs. The problem is with low cost whole life. So far, Asialife's Legacy and NTUC Income's Vivolife are probably the most competitive.

Then again, I may be in this category, for time will tell.

Anonymous said...

Conflict of interest is behind whole life.Not becuase the concern is for the client but more for the agents

Anonymous said...

Blackbox, not people are bad money manager. The agents screwed up for them. In all cases the insurance agents screwed up. What do insurance agents know about investment?. With a certificate in ILPs how much do they know.Passed a multiple choice exam and he or she is licensed to screw up customers' finance. It is amazing that insurance agents became investment expert overnight.They talk like pro. They talk like stock brokers giving free tips, advising when to buy and sell.They talk technical. They are are unethical churners.
The problem also lies with the consumers for trusting them. They have no eyes. They deserve to lose.
They are suckers.
To say people have no business buy term and invest the rest tells me you don't understand the role of an adviser. Maybe you are thinking of the salesmen. Salesmen only provide one off transaction and after that the buyers are left on their own. But advisers , No.It is a journey together.
Terminator