Switching Cost, Competition and Pricing in the Property/Casualty Insurance Market for Large Commercial Accounts

Lisa L. Posey

Journal of Insurance Issues, 2003, vol. 26, issue 1, 29-50

Abstract: With large commercial accounts, a small number of insurers negotiate directly with clients on an individual basis and prices are set individually. This paper applies a game theoretic bargaining model to analyze a risk manager’s choice of insurer in a multi-period setting, along with insurers’ pricing decisions. Insurers set prices and the risk manager chooses an insurer in each of three periods. There exist switching costs for policyholders which are incurred at the time a switch is made to a different insurer. Other switching costs are revealed over time with a certain probability as the client observes the claims management practices of the insurer in the event of a large claim. The conclusions are that, in equilibrium, it will be optimal for an insurer trying to attract business away from a competitor to price the coverage below cost in the second period with the expectation that it can price above cost in the third period. If the client switches, they will pay a price below marginal cost in the second period, but above marginal cost in the third. If the client remains with the original insurer, they are likely to pay above marginal cost in both periods, but certainly in the third period. Switching from one insurer to another may occur in either period if the original insurer does not provide a highly valuable service during the claims management process and the expectation is that the competitor will be sufficiently better to overcome the initial switching costs.

Date: 2003
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Persistent link: https://EconPapers.repec.org/RePEc:wri:journl:v:26:y:2003:i:1:p:29.50

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