When bureaucrats act on their ideological opinions and do not consult the best minds available, the law of “unintended consequences” too often ends up causing major collateral economic damage. Then, of course, they persist until the political storm forces them to give in. This scholarly analysis of the regulation of insurance commissions illustrates this point. Dr. Brian Benfield, retired professor, Department of Economics, Wits University, writing for the Free Market Foundation, argues that regulating insurance commissions has never worked…nowhere. Instead, abandon it in favor of full cost disclosure (and therefore regulation based on customers, suppliers and intermediaries), as well as a declaration of any possible conflicts of interest. This would ease the burden on regulators, unlock market efficiency, reduce compliance costs, protect consumers, enable insurers to support emerging intermediaries, and most likely have the ultimate effect of lowering insurance premiums. –Chris Bateman
Insurance commission pricing: an ignominious and damaging failure
By Dr. Brian Benfield*
In the half-century since its introduction in 1977, insurance commission regulation has failed to achieve its stated goal of lowering premiums for consumers. On the contrary, it has:
- significantly increases prices;
- apparently made criminals of otherwise respectable businessmen;
- is easily circumvented by the well-established;
- is largely unresponsive to fair application;
- led to a swelling in the size of the control bureaucracy;
- necessitated new industrial taxes (levies) rising much faster than inflation;
- is passed on to consumers, entirely negating its stated objective of inhibiting premium cost growth;
- led to additional forms of price controls on other outsourced services listed in the FSCA’s so-called “RDR” regulations (now called standards); and
- seriously harmed emerging intermediaries.
In 1977 the industry as a whole was unable to agree with the regulator, Registrar Willem Swanepoel of the Office of Financial Institutions, on any basis for the regulation of fees, citing most points raised above as likely outcomes. As a result, Mr. Swanepoel unilaterally presented his version of the commission’s regulations without industry consensus. Paradoxically, the only material beneficiaries may have been the insurers themselves.
In jurisdictions where it has already been attempted, regulation of insurance commissions has long been abandoned. Significant collateral damage has been caused and the South African public is worse off because of it.
So why do our financial services regulators insist on keeping whips behind their backs? Why do they insist on opening themselves up to more costs, more wasteful and wasteful spending, more angst and more public criticism? Why is this so when the natural workings of a strong market could easily be exploited to do the work for them and to protect consumers, industry and regulators?
Neither the wisest person nor the council of people has the ability to determine the “correct” or “appropriate” price for anything, let alone something that can be as complex as an insurance service. .
The correct price can only be determined through the free interaction of multiple suppliers, intermediaries and consumers acting independently at very different times and in many disparate places. Price fixing by individuals in bureaucratic agencies is seriously detrimental to the progress of any economy. This fact is indisputable and no longer open to informed debate. A single price could never be appropriate for goods or services in all circumstances.
Price fixing hinders the proper functioning of any economy. Insurance – which, among other things, deals with the international distribution of risk – is a complex and multi-part commercial exchange. Its complexity is not less because the final delivery of the service is made so simple for the layman.
Insurers provide risk coverage based on elaborate assessments of a myriad of factors that may affect future events. Insurance intermediaries (agents and brokers) are the interface between insurers and their customers. Traditionally, these intermediaries participate in the risk analysis and investment process and their income is limited to a limited part of the premium paid. The traditional practice is that the intermediary who introduces no business does not receive any income; those who introduce healthy risks are well compensated; and countless positions exist in between. A freely operating compensation or “commission” system has distinct benefits for the consumer and the economy as a whole. This explains why this system was born centuries ago and why it is still relevant in most jurisdictions.
Who should determine the price of a good or service? Who should determine the amount of the insurance premium to be invoiced? Who should determine the amounts to be included to cover the costs and the profit margin of the insurer? Who decides the insurer’s marketing, distribution and new business acquisition costs? Who decides which part of these costs should be allocated to the intermediary’s service, expertise and expenses? Who decides which part of these costs should be allocated to the insurer’s other costs of acquiring and managing a new business?
Should these decisions be made by distant bureaucrats or should they be made by buyers and sellers of insurance on the spot in an open and dynamic market?
The answer is clear. The observed unintended consequence of board regulation is that it ends up harming the very people it ostensibly aims to protect. It tends to reduce competition between insurance companies and between intermediaries. Moreover, it tends to reduce and hamper the number of new competitors entering the industry. Thus, in its working document of March 2006, Contractual savings in the life insurance industry, the South African Treasury noted:
“The modern global trend regarding commissions is one of deregulation combined with increased disclosure…Austria, Canada, Denmark, Japan, Singapore, Uganda and the UK, for example, do not in any way limit commissions (or insurance costs).”
This trend, more recently also recorded in World Bank surveys, is consistent with a global desire to move towards greater ease of doing business. This translates into more competition and more choice for consumers, which in turn translates into better consumer protection.
No economic activity functions efficiently if, within this activity, the ultimate determinant of prices is not the value judgment of the consumers themselves. Government planners do not have, and cannot obtain, the essential, day-to-day, minute-to-minute information needed to emulate the workings of an efficient market. Believing they can is what economists call fatal vanity. Multiple consumer choices determine the prices that guide all production and delivery of all goods and services – including insurance – except when politicized non-economic forces intervene to disrupt the economy.
Careless commission regulation is a straightforward but fruitless attempt to control the price of insurance distribution. It has the same effect as price controls on all other goods and services. Insurance buyers receive less service than they otherwise would due to a reduction in the number of intermediaries. Consumers end up paying more for insurance because the regulated remuneration ultimately translates into higher total costs for them than would have been the case in a market where these prices are completely flexible.
Price controls lead either to a reduction in supply because some suppliers withdraw from the market, or to higher costs for the consumer because the product whose price is controlled is sold at a higher price than the one that would have been practiced in an open and competitive market. This was well demonstrated, for example, when SA’s decades-long price control on soft drinks was lifted and prices immediately plummeted, demonstrating that responsible government officials had unknowingly shielded less efficient producers and forced consumers to pay more.
To make matters worse in South Africa’s complex society, commission price controls mean that insurers can no longer support new and emerging intermediaries as they could 45 years ago. Emerging intermediaries can no longer be paid more than the strictly regulated commission, even when they are starting out and volumes are low. This puts almost all of them out of business before they even start.
The 2006 Treasury discussion paper notes that this is a modern global trend do not regulate the commission in any way. There are valid economic reasons for this which SA should acknowledge without further ambivalence. In any case, commissions have to do with prices and this is now the domain of the Competition Commission and not the FSCA. Premium regulation, however indirect, may well prove ultra vires.
In summary, the regulation of insurance commissions has not – in almost half a century – had the expected effect on consumer protection. As predicted all those years ago, it has driven up prices, had countless undesirable side effects, has hurt emerging middlemen badly, and is largely unenforceable. It is no longer practiced in most major jurisdictions around the world and, perversely, has perhaps benefited insurers the most.
This form of administered pricing should be abandoned immediately in favor of the simple expedient of full disclosure of costs (and therefore regulation based on customers, suppliers and intermediaries), accompanied by a declaration of any conflicts of interests.
Such an arrangement would significantly ease the burden on regulators, free up the market for greater efficiency, reduce compliance costs, protect consumers, enable insurers to support emerging intermediaries, and most likely have the ultimate effect of reducing premiums. insurance.
- Dr Brian Benfield is a retired Professor, Department of Economics, University of the Witwatersrand, writing for the Free Market Foundation. The opinions expressed in the article are those of the author and are not necessarily shared by the members of the Foundation.
(Visited 130 times, 130 visits today)