Question

Group insurance purchased by a company on behalf of its workers is generally much cheaper, per insured person, than insurance purchased by individuals. The difference in cost is too great to be explained by differences in the cost of sales or administration. Provide an explanation, based on asymmetric information, for this cost differential.

Hint: Consider why some individuals buy insurance and others do not, and whether the reason for buying insurance is different for individuals versus companies.

Answer 1

Insurance aims at giving people better financial support in the advent of any medical emergency or other contingency which may form the content of such a contract arising. Though, insurance companies still aim at making profits, over the years, it is a well settled thing that those that purchase insurance policies end up being much more stable financially than those who don't.

This happens because people get crucial support from insurance companies, at a time when they require it the most i.e. during medical emergencies which have the highest possible costs.

Insurance policies are widely available for the general public to avail from and are of various kinds ranging from life or term insurance to auto, house, medical etc.

Case Specifics:-

In the case presented, we try to analyze the core reason as to why, the costs between group insurance and individual insurance differ.

The main reason for this is that group insurance tends to have a larger population or chunk of population than individual policy buyers. Thus insurance companies can offer its product at a relatively lesser rate to corporations which tend to renew their policies much often and add many customers over the years which join the organization subsequently.

From the cost point, another reason for the rates of individual policies being higher is that not everyone within the organization would purchase the same if the same was made optional.

Companies on the other hand, have the upper hand when they purchase insurance policies for the staff. In most developed nations, this is a mandatory exercise as it avoids unnecessary pain to the judicial system in case of any medical emergency at work and allows for a much stable economy. Further companies portray it as a non cash benefit which they offer to those joining the firm at no added costs, which serves as a way of retaining talent respectively.

Conclusion:-

Thus, we can conclude by saying, that the main reason why premiums of individual insurance policies differ from that of group policies which corporations take is the fact that corporations are repeat buyers of policies and are in a better position to negotiate with insurance providers, thanks to the fact that they have larger populations which can be marketed properly and their financial transactions are not run on margins but on volume. I.e. even though an 8% margin may seem less than a 15% margin, however, the turnover provided by corporations to insurance policy providers is so huge, that they are able to sell the products at a cheaper price. Further, statutory requirements and employee retaining tactics makes such exercises more profitable for business owners respectively.