On the Implications of the Internet for Insurance Markets and Institutions

Focus ABSTRACT By most accounts, the Internet and related advances in information technology significantly affect financial services in general and insurance markets and institutions in particular. Coupled with other important trends such as globalization and regulatory reform, these changes are forcing far-reaching changes upon the insurance industry and making it more competitive. This article focuses specifically on the implications of the Internet for insurance markets and institutions. The conventional wisdom that the Internet constitutes a sufficient condition for the disintermediation of traditional insurance distribution networks is called into question. To the extent that the Internet reduces transaction costs, it will create opportunities for new intermediaries as well as for existing ones. It will also influence product design, in some cases making it economically attractive to unbundle and repackage various forms of coverage. By removing entry barriers and reducing insurance costs, the Internet will also provide a private market solution to a major insurance regulatory concern-enhancing insurance affordability and availability. INTRODUCTION By most accounts, the Internet and related advances in information technology significantly affect the economic efficiency and characteristics of the financial services industries. In banking, information technology investments have enabled banks to rely more upon ATMs to carry out teller functions, and the lending function has become standardized and automated to the point where far fewer loan officers are needed to manage a portfolio of a given size (Wilhelm, 2001). Similarly, human capital is being leveraged (and in some cases displaced) in the securities markets by technologies such as electronic order processing systems, electronic limit order books, and electronic auctions (Wilhelm, 2001). In insurance, firms are beginning to offer a wide array of online services, including online sales, needs analysis,1 and customer service (e.g., online policyholder account information, claims management and processing, and group insurance certificates). Coupled with other important trends such as globalization and regulatory reform, these developments are forcing far-reaching changes upon the insurance industry and making it more competitive. This article focuses specifically on the implications of the Internet for insurance markets and institutions. It is organized in the following manner. The next section summarizes what we know about Internet trends and related public policy issues. The third section calls the conventional wisdom that the Internet constitutes a sufficient condition for the disintermediation of traditional insurance distribution networks into question. Although the Internet certainly has the potential to create distribution channel conflicts as well as incentives for disintermediation, to the extent that it is successful in reducing transaction costs, it will also set into motion incentives for reintermediation; i.e., the creation of new intermediaries.2 Therefore it is far more likely that the Internet will give rise to more, not fewer, intermediaries. The third section of the article formalizes this dynamic process of disintermediation and reintermediation by introducing a concept invented by Saffo (1998) called disinter-remediation. The fourth section examines some of the commonly held beliefs about the impact of the Internet on insurer costs and offers an alternative framework for addressing how the Internet might impact cost and profitability. Finally, the fifth section offers a set of concluding remarks. INTERNET TRENDS, WEBLINING, AND THE DIGITAL DIVIDE As a starting point for our analysis, it is useful to consider statistics concerning the growth and penetration of Internet connectivity. Worldwide, the number of Internet users has increased more than thirty-fold since 1995. This represents an average annual compound growth rate in the world online population of more than 75 percent per year. …