In most types of business, the seller is primarily concerned with whether the buyer will pay the price for the product it offers. Insurance differs from this model because the seller, the insurer, is also concerned with certain risk characteristics of the buyer it will insure. These characteristics actually determine the price of the policy. Intermediaries help to match insurers with customers to provide accurate coverage at a fair cost.
The most common labels for insurance intermediaries are agent and broker. Technically, brokers work for their clients while agents work for insurers. However, agents and brokers do many of the same types of jobs. Both collect information about their clients and match client needs with products offered by one or more insurance companies. Both retain certain legal and financial records for the insurers, and both advise clients about benefits and drawbacks to certain insurance plans. Because of this large overlap between agents and brokers, they are both often referred to as producers.
Insurers rely on intermediaries to collect thorough and accurate information about potential clients. That's because the price of insurance products depends on the risks each insured person or business represents to the insurer. If agents or brokers do not report this information to the insurer correctly, it may charge the client improper premiums. If the insurer charges too little, it does not collect enough premium money to cover potential losses. If premiums are too high, the client ends up subsidizing someone else's loss and wasting money. If this happens too often, an insurer loses its ability to accurately protect its clients against loss. This is a process called adverse selection.
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Role of Intermediaries
The primary role of intermediaries is to prevent adverse selection. By ensuring that each customer pays appropriate premiums, the intermediary protects the insurer's ability to cover losses while protecting the customers against overpayments. Brokers and independent agents often work with several insurers, so they can search the marketplace for the best insurer to fit their clients' needs. This way, they not only secure an appropriate premium for a policy, but they also find policies that offer necessary coverage, rather than forcing a single policy type on everyone regardless of their risks.
Producers are most commonly compensated for their efforts by a commission from the insurer for each policy they sell, most often calculated as a percentage of the policy premium. Sometimes they receive contingent commissions as well, based on sales performance, loss ratios of their clients or other criteria set by the insurer. Additionally, producers can charge a fee to their customers directly for policy placement. Some customers may not like this system, but the intermediaries provide a valuable service by protecting against adverse selection, which could end up costing customers much more than the simple commission amount.