Competitive Enterprise Institute | 1899 L ST NW Floor 12, Washington, DC 20036 | Phone: 202-331-1010 | Fax: 202-331-0640
Winston Churchill’s famous characterization of the former Soviet Union as "a riddle wrapped in a mystery inside an enigma" also aptly describes how the insurance industry has been traditionally viewed by many consumers and regulators. However, the growing importance of electronic commerce (e-commerce) represents a watershed event for insurance markets and institutions, as it does for most industries. By lowering information costs, e-commerce will enable insurers to classify, underwrite, and price risk more accurately. Insurers will be compelled by competitive market forces to pass their cost savings on to consumers in the form of lower insurance premiums, thereby significantly expanding the overall availability of private insurance. The greater availability of more accurately priced private insurance will result in better loss control incentives for consumers, which will in turn reduce accident costs and insurance premiums even further.
E-commerce causes insurers to move away from a product-oriented approach to more of a consumer-oriented approach. Because search costs will be lower for consumers, there will be more transparency in pricing and quality of service. This will strengthen market discipline in an already competitive environment by making consumers less reluctant to switch from their current carrier. More transparent pricing will further empower consumers and encourage companies to experiment with alternative pricing methodologies such as reverse auctions, where insurers bid for the business of insureds. Although some agents and brokers may not survive in an e-commerce-enabled environment, others will adapt and prosper. Furthermore, by reducing transaction costs, e-commerce will cause insurance products and services to become even more highly intermediated than they are currently. New intermediaries will come into being. E-commerce will also have important implications for product design, thus giving consumers more flexibility in managing their risks.
Challenges & Opportunities for Regulators
E-commerce also presents opportunities and challenges for regulators. By making it easier for consumers to compare prices and product attributes across companies, e-commerce will enhance the private market’s ability to solve informational asymmetry problems that exist between policyholders and insurance companies. In such an environment, the case for price and policy form regulation becomes weaker than ever. In our Statement No. 2 , we endorsed repeal of prior approval regulation of rate changes for all major types of personal and commercial insurance, subject to some monitoring of competitive conditions. By enhancing the informational efficiency of insurance markets, e-commerce provides yet another compelling reason for insurance price and policy form deregulation. The good news for regulators is that this may free up resources that can be focused on addressing market conduct and solvency issues.
Weblining Myth Debunked
E-commerce raises other important public policy issues. During the early stages of e-commerce (circa 1996-1997), concerns were frequently raised about the potential use of the Internet by insurers and other financial service organizations to engage in online redlining, or "weblining". These concerns were raised because the online population, at least initially, was disproportionately white, male, educated, and affluent. This argument is really one of old w(h)ine in new bottles. Evidence does not suggest insurance market redlining with traditional distribution networks (see our Statement No. 4 ). Given the increased competition brought about by innovations in information technology, this latest discrimination claim has even less credibility. Moreover, now that the online population much more closely resembles the general population in terms of gender, ethnicity, and other socioeconomic characteristics, this so-called weblining hypothesis is largely passé.
Lately, consumer activists have expanded the concept of weblining to apply to virtually any selective use of individual data on risk characteristics. While we do not wish to call into question prohibitions on the use of some classification variables such as race or religion, the mantle of privacy is being increasingly used to justify cross-subsidies between all manner of interest groups. Continuation of this tactic promises to erode the many efficiency gains in the insurance market made possible by e-commerce.
Enhanced Efficiency, Lower Costs
Overall, the Internet will significantly enhance the efficiency of insurance markets and institutions, and it will benefit consumers by lowering costs. By making insurance more affordable, more insurance will be purchased. If the regulatory system cooperates and allows the private market to pass these transaction costs savings on to consumers, insurance will be able to live up to its potential as a mechanism for not only funding the costs of accidents but also providing society with appropriate incentives for loss prevention and mitigation.