Nothing in our economic system works until something is sold–seems to be a rather trite comment but true. Some transactions are so subtle you hardly notice that a selling technique was involved. Yet in the end some service or commodity was exchanged for something else of value to the parties involved. In meeting the needs of the buying public, some approaches are product driven and some are market driven.
For example, an enterprising young man had the idea of making a square box with a sliding lid on the top of it. Inside of the box he attached a toy spider to a curved wire which was attached to the sliding lid. When you would open the lid, the string would draw tight and the spider would “spring out” touching your hand and scaring the bejeebers out of you. He took it to a county fair where he would allow curious people to open the box. Of course, he got the expected results. People thought this was so funny they would buy one or two so they could get their jollies at the expense of their frightened friends. Scare boxes came into existence by taking advantage of the curiosity and funny bone of the buying public.
A good example of a market driven approach is the advent of universal life insurance. In the last part of the past century, it had become quite popular for people to go to their whole life permanent policies and borrow out of them their cash value. They would then take the cash value and invest in the stock market. The amount they would borrow from their life insurance would be charged interest but that interest was so much lower than the potential return they could make in the stock market, it was worth it for the growth. If they so chose, the loan from the life insurance would never have to be paid back. Also, the cash value in a life insurance policy has a guaranteed rate of interest so if the stock market dropped to a point lower than the guaranteed rate of interest, the insured could always reverse the process and get his money back in the life insurance policy. This situation caused a dilemma for the insurance companies for they were banking on those funds to be there for their investment purposes. Huge amounts of cash reserves were flowing away from the insurance companies causing them to not have the anticipated funds for investing. So they were in jeopardy of not being able to meet the guarantees built into their contracts. (A note of explanation, cash values in permanent life insurance policies are there among other reasons to cover future increases in mortality charges due to an insured’s aging. If they are not there then the actuarial computations are completely skewed and the policy has the chance of lapsing due to lack of funds.)
Since the life insurance companies are taking all the mortality and investment risk in permanent life policies, they are conservative as to how much they are willing to guarantee will be returned to the consumer. In an effort to make their policies attractive as an investment tool, some companies offer guaranteed cash values and non-guaranteed dividends or excess earnings. This didn’t seem to be enough to stop the cash flow. Someone decided to unbundle the insurance mortality and the cash values found in premium computations. They went to a one year renewable term premium so they could still control the mortality charge but would allow the consumer to determine what mutual fund they would have the insurance company invest in. With this technique the insurance companies felt they could at least compete with the “buy term and invest the difference” approach to purchasing life insurance. This then was a market driven product which had some success among a certain segment of the life insurance market. To this day insurance sales tend to follow a market driven approach to being delivered to the buying public.
The insurance companies themselves had to determine what business model they would use for delivering their product into the hands of the consumer.
- Some companies chose to be stock companies where stockholders purchase a portion of the business by investing in the company by purchasing shares and/or bonds. The enticement to the consumers is the potential return on their investment. While these companies are in the marketplace to provide a service to their policyholders, they also need to make a profit for their shareholders. Consequently, premium calculations charged to policyholders need to reflect a return on investment in order to keep shareholders from investing their money somewhere else.
- On the other hand is the marketing system of mutual companies where the profit motive is secondary to the service rendered. In this scenario, the company only needs to establish a premium which reflects as accurately as possible the expenses of the company and reserves required by state department of insurance for future losses. In these companies if there is surplus after all expenses are paid and reserves are established, the difference is returned to the policyholders in the form of dividends or excess earnings. In addition, on the property insurers side of the insurance market is a rather antiquated way of charging for services rendered called assessable policies. This allows an insurance company to go back retrospectively to collect the shortfall in their annual calculations. You may get a cheaper premium to begin with, but you may also get a bill at the end of policy period to make up for that shortfall. Conversely, if the company overcharged, you may get a refund for that period of time. This is not a very common anymore because it is a public relations nightmare and it is very difficult to collect after the fact. Moreover, stock companies counter with more payout to their shareholders and mutual companies give dividends or apply excess to next policy period calculations.
The next function in the insurance delivery system is the type of agent used to deliver the product. Due to the details required to adequately discuss this portion of the delivery system, it will be reviewed in another place.