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Is it best to buy direct?

22 June 2005 SAFSIA

When buying insurance is it best to buy direct from the insurance company or should one go through an intermediary?

According to a recent study by two Wharton School of Business scholars, Professors J. David Cummins and Neal A. Doherty, intermediaries are usually better informed about the risks of their clients than insurers and when such risk information is accurately transmitted to the insurer, carriers compete more vigorously for business and price more competitively and fairly. In this way, the study reports, agents and brokers "assist the flow of information in the insurance market and enhance the efficiency of the market to the benefit of all players."

Cummins and Doherty argue that if risk information about the buyer is not shared with sellers/insurers, low-risk buyers will be penalised by having to pay higher prices than their risk level warrants; i.e., they would end up unfairly subsidising higher-risk buyers. The authors explain how intermediaries can reduce market inefficiencies and alleviate the cross-subsidisation problem for low-risk buyers by assessing the risk level of the buyer and providing that information to the insurer.

The authors noted that intermediaries match buyers with insurers "who have the skill, capacity, risk appetite, and financial strength to underwrite the risk, and then help their clients select from competing offers."

The SA Financial Services Intermediaries Associations (SAFSIA) supports this view and notes that consumers are currently being bombarded by advertising from a range of direct insurers, suggesting that consumers “cut out the middleman” in order to save on premiums.  However, SAFSIA warns that while the insurance premium may be less expensive and therefore seem more attractive, consumers need to be aware of the pitfalls of not using an intermediary.

Ben Rossouw, executive director of SAFSIA, says a client is not always aware that the product he buys direct from a insurer might not provide the right cover for his needs, that the wording of such policies are often inferior to that which an intermediary will put together, or that there might be clauses that are not fully explained.  “Any problems that may arise usually do so when there is a claim, but by then it is too late,” he says.

The perception that it is cheaper to buy direct rather than using an intermediary is mostly incorrect. An intermediary can in fact often structure a superior product and a lower cost. In any event, buying cheaper often turns out to be expensive in the long run, he says

“An intermediary’s primary job is to fit an insurance product with the client’s needs, to make sure they get the right cover and do not end up paying for cover that is not required.  Sitting down and talking to a professional intermediary is vastly different from talking to an anonymous person in a call centre who is filling in a standard form.  While it may seem convenient to pick up the phone in response to the insurance advertising card that falls out of your newspaper, in reality the product on offer might not be suited to your specific needs at all.  But you won’t know this unless someone explains it to you and offers alternatives.. And of course, you might only find out the hard (and possibly costly) way: when you submit a claim and only then discover that you are do not have the cover that you thought you had – and by  then it is too late!.”

The authors of the Wharton study say that the role of the intermediary is "to increase competitiveness, by providing the buyer access to a wider range of possible insurers and by helping the buyer to compare these bids on the basis of price, coverage, service and the financial strength of the insurer.  By aligning its interest with that of the intermediary, the insurer will have more confidence in the selection of risks and in the information provided by the intermediary. This will help break the 'winner's curse' and encourage insurers to bid more aggressively."

Rossouw also stresses that when claim-time comes, it is invaluable to have someone with inside knowledge of the industry, on your side.  “This is especially important if there are complications and expertise is required to assist in processing the claim. . It is important to remember that the intermediary acts on behalf of the client and not the insurer and has a vested interest in keeping the client happy. .”

“Another compelling reason to use an intermediary,” says Rossouw, “is that of developing a long-standing relationship with someone trustworthy, who keeps abreast of developments in the industry that might affect your policy – and who can help to ensure that you enjoy the best available cover at the right price.”

"The Economics of Insurance Intermediaries" by Professors J. David Cummins and Neal A. Doherty was financed by the American Insurance Association, an insurance company trade association.  The full study is available at www.insurancejournal.com/downloads/WhartonStudy_2005.05.20.pdf

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