Question

Case Study: Insurance ‘Cartel’ Gets ServedNew York attorney general Eliot Spitzer recently served subpoenas to several of the nation’s largest insurance companies seeking information on price-fixing and bid rigging. Many of the companies admitted to paying kickbacks to insurance brokers in exchange for preferential treatment and also to submitting fake bids to mislead customers. Spitzer told his staff that this behavior was the “same kind of cartel-like behavior carried out by organized crime.”Spitzer charged that Marsh & McLennan Cos., Inc., the world’s largest insurance company, rigged bids and collected huge kickbacks for sending business to certain companies, cheating corporate clients in the process. Businesses in need of insurance hire insurance brokers like Marsh to find the best deal for them. Spitzer maintains that Marsh, and other big brokers, conspired to cheat these corporate clients. Some allegations indicate that bids were even falsified, and representatives from companies submitting fake bids were oftensent to introduce realism to the “fake” competition for business.Marsh & McLennan Companies are not new to scandal. Last year, it’s Putnam Investments unit settled mutual fund scandal charges against it for $110 million. This year, another Marsh unit admitted to providing false information to the board of the New York Stock Exchange about the pay of NYSE’s former chairman, Dick Grasso. Insurance company stocks have fallen in price by several billions following Spitzer’s allegations. Marsh stock alone fell $9 billion in market value in two days following the inquiry. Talking it Over and Thinking it Through:

1.What is a cartel?

2.Why are cartels considered to be ‘bad’?

3.What insurance industry characteristics resemble a cartel?

4.Why Insurance company stocks were declined?

Answer 1

1. A cartel refers to a group of independent sellers who join hands to operate together by setting prices or output strategies in a way which maximized their profits and dominance in the industry.

2. Cartels are considered to be bad because they are exploitative in nature.

They either charge too high prices or offer too less output in the market, which increases seller profits and surplus at the cost of consumer surplus.

3. Insurance companies resembled cartels by cheating their clients to maximize their own profits.

These strategies included bid rigging, client cheating, offering money in exchange of sending clients etc.

These strategies made insurance buyers worse off or cheated upon, while profits of these companies increased.

4. Stocks of insurance companies declined after allegations by Spitzer.

It tarnished the image of the insurance company, this reduced sales of insurance contracts by the company, leading to lower consumer confidence and investor confidence, lower profits and thus lower stock prices.