What should be the market structure?
In this section, we analyze the question whether there should be unlimited private entry insurance markets or whether only a few players are allowed to operate.
This question hinges around the issue of "adverse selection" described below. Individuals buying an insurance contract pay a price (called the "premium") to the insurance company and the insurance company in turn provides compensation if a specified event occurs.
By making such contractual arrangements with a large number of individuals and organizations the insurance company can spread the risk. This gives insurance its "social" character in the sense that it entails pooling of individual risks. The price of insurance i.e., the premium is based on average risk. This premium is too high for people who perceive themselves to be in a low risk category.
If the insurer cannot accurately determine the risk category of every customer and prices insurance on the basis of average risk, he stands to lose all the low risk customers. This in turn increases the average risk, which means premia have to be revised upwards, which in turn drives away even more customers and so on.
This is known as the problem of "adverse selection". Adverse selection problem arises when a seller of insurance cannot distinguish between the buyer's type i.e., whether the buyer is a low risk or a high type. In the extreme case, it may lead to the complete breakdown of insurance market.
Another phenomenon, the problem of "moral hazard" in selling insurance, arises when the unobservable action. Of buyer aggravates the risk for which insurance is bought.
For example, when an insured car driver exercises less caution in driving, compared to how he would have driven in the absence of insurance, it exemplifies moral hazard.
Given these problems, unbridled competition among large number of firms is considered detrimental for the insurance industry.
Furthermore, even the limited competition in insurance needs to be regulated. Insurance companies can differentiate among various risk types if there is a wide difference in risk profile of the buyers insuring against the strong insurers. It also called for keeping life insurance separate from the general insurance. It suggested the regulation of insurance intermediaries by IRA and the introduction of brokers for better ‘professionalisation'
In this section, we analyze the question whether there should be unlimited private entry insurance markets or whether only a few players are allowed to operate.
This question hinges around the issue of "adverse selection" described below. Individuals buying an insurance contract pay a price (called the "premium") to the insurance company and the insurance company in turn provides compensation if a specified event occurs.
By making such contractual arrangements with a large number of individuals and organizations the insurance company can spread the risk. This gives insurance its "social" character in the sense that it entails pooling of individual risks. The price of insurance i.e., the premium is based on average risk. This premium is too high for people who perceive themselves to be in a low risk category.
If the insurer cannot accurately determine the risk category of every customer and prices insurance on the basis of average risk, he stands to lose all the low risk customers. This in turn increases the average risk, which means premia have to be revised upwards, which in turn drives away even more customers and so on.
This is known as the problem of "adverse selection". Adverse selection problem arises when a seller of insurance cannot distinguish between the buyer's type i.e., whether the buyer is a low risk or a high type. In the extreme case, it may lead to the complete breakdown of insurance market.
Another phenomenon, the problem of "moral hazard" in selling insurance, arises when the unobservable action. Of buyer aggravates the risk for which insurance is bought.
For example, when an insured car driver exercises less caution in driving, compared to how he would have driven in the absence of insurance, it exemplifies moral hazard.
Given these problems, unbridled competition among large number of firms is considered detrimental for the insurance industry.
Furthermore, even the limited competition in insurance needs to be regulated. Insurance companies can differentiate among various risk types if there is a wide difference in risk profile of the buyers insuring against the strong insurers. It also called for keeping life insurance separate from the general insurance. It suggested the regulation of insurance intermediaries by IRA and the introduction of brokers for better ‘professionalisation'