INFORMATION ASYMMETRY ON THE CZECH

INSURANCE MARKET

Zdeněk Rybák1

ABSTRACT

The goal of this paper is to describe the problem of information asymmetry within the commercial

insurance market of the Czech Republic. At first, the paper focuses on the history and theoretical

definition of information asymmetry. It is regarded as one of the market failures that may have

possible negative impacts into production or consumption. Negative impact of asymmetry is also

described by the micro-economic model of Michael Rothschild and Joseph E. Stiglitz, who

analyzed the impact of it on market equilibrium. Then paper focuses on the current situation within

the insurance market, which is modelled with three participants (client, broker and insurance

company). Paper covers forms of asymmetry by each participant, sources of asymmetry, motivation

for asymmetry and concrete examples of information asymmetry. Finally the paper also provides

available data which can express the current situation in the Czech Republic and provides actually

applied solutions for solving the information asymmetry problem. There are also mentioned specific

issues, which are related to information asymmetry – lack of financial education and problem of

privacy.

Key words: information asymmetry, insurance, risks, Czech Republic.

JEL classification: D81, F61, G22, G32.

1. Introduction

The Insurance market is one of the risky industries. It is specific in its nature, that insurance

companies operate with another risks and capital of clients. Insurance is a tool which was created

for financial compensation of losses. It is reflected in the fact, that the insurance industry is under

large regulation and supervision by financial authorities.

Each market environment a has number of market failures. In this paper, I would like to focus

on problematic market failure. which is a one of a source of risks for insurance market entities. This

paper will thoroughly describe the problem of information asymmetry and its impact on the

insurance market, taking into account conditions within the Czech Republic.

It is important to define that this paper will focus only on commercial insurance. There will not

be any reflection on the health insurance of the Czech social system. Also it would be good to

explain that the text will understand term insurance broker as a synonym to term insurance

intermediary2.

2. History of information asymmetry

The problem of information asymmetry was firstly discussed by Akerlof [5]. Akerlof firstly

described information asymmetry in his article about “Lemons market”. Akerlof models an

automobile market which contains good cars and also bad cars (lemons) and explains impacts of 1 Ing. Zdeněk Rybák – PhD student;

Affiliation: Department of Banking and Insurance, Faculty of Finance and Accounting, University of Economics, Prague, W.

Churchill Sq. 4, 130 67 Prague 3; Czech Republic; e-mail: xrybz03@vse.cz; Czech Republic. 2 Text won´t distinguish between different types of intermediaries which are available in the Czech Republic.

information asymmetry. The aim of the paper was to describe an impact of information asymmetry

in the automobile market. The automobile market containing agents and clients (both with different

information about car quality - under information asymmetry) results to market with just poor

quality cars. Therefore information asymmetry has been understood as a negative market failure.

After this article information asymmetry was subsequently analyzed and discussed in a lot of

papers. One of the most discussed were papers of Rothschild and Stiglitz [1] who focused on

insurance market. Their results are connected with the statement that information asymmetry have

important negative consequences for the existence and efficiency of competitive market

equilibrium.

3. Information asymmetry

Information asymmetry is well known formula for the situation where a market participant has

an advantage. Information asymmetry can easily be described as a: situation in which one

participant of market has more or more detailed information than the second one, which can be used

for his own benefit. An important fact is that the other parties involved in the deal don´t have this

information, and in case the other parties would know this information the deal would have a

different conclusion.

To make it more complex and to be closer to real market conditions we will understand as

information asymmetry also ”the ability to obtain important information”.

Information asymmetry is one of causes of the market failure with a negative impact of an

insurance market. Information asymmetry is quite critical for insurance industry because insurance

industry operates with risks, and the existence of information asymmetry generates other risks for

subjects of insurance market.

According to the microeconomic theory market failures generally exist which leads to an

ineffective production or consumption. The theory describes couple of market failures and one of

them is information asymmetry (as described in Scheme 1).

Scheme 1 – Market failures

Source: Author; [8]

It causes two situations with focus on asymmetric information:

Moral hazard: Moral hazard is a situation when one party can influence an interest

of another party with an incentive to put own interest first. See an example for

insurance industry : an insurance intermediary sells life insurance for premium and

his commission is based on sum insured3. This attitude can cause that insurance

intermediary will be motivated for selling policies with premium as large as the

client is able to pay. For the risk of death there is a recommended sum insured

which should substitute lost income for approximately 3-5 years of person insured4

but sum insured can be set on higher level than it is necessary. That is the problem of

3 High premium paid by client equals to high sum insured. 4 Rough estimate excluding debt

Moral hazard that client doesn´t get what she/he needs, but gets amount favourable

for insurance intermediary.

Adverse selection: Adverse selection is a case when there are sold products of

different qualities at the same price but the buyer cannot distinguish between

products of different qualities. An example for insurance industry can be purchasing

of travel insurance policy. A client is buying a policy but he/she is not able to fully

distinguish between covered amount and terms and conditions of the selected two

products.

4. Microeconomics of information asymmetry on insurance market

Information asymmetry was discussed in a paper “Equilibrium in Competitive Insurance

Markets: An Essay on the Economics of Imperfect Information.” of Michael Rothschild and Joseph

E. Stiglitz [1]. This paper explains model insurance market and analyzes the impact of information

asymmetry on its market equilibrium.

Model description

Model operates with two clients (individuals) and their accident probabilities. It analyzes an

impact of purchase of insurance contract on the client´s income. Demand is described by an utility

function of the client and supply is a function of expected profit of insurance company.

Figure one describes situation and equilibrium by two risk averse clients and the second figure

shows clients with a different relationship to risk. The nature of imperfect information in this model

is that insurance companies are unable to distinguish among their customers.

Scheme 2 - Illustration of Rothschild, Stiglitz model

I. Risk averse – both clients II. Clients with different relationship to risk

Source: [1]

In Figure I the horizontal and vertical axes represent income in two states: W1 no accident and

W2 accident. The point E with coordinates (W1, W2) is the typical customer's uninsured state.

Purchasing the insurance policy α = (α1, α2) moves the individual from E to the point (W1 – α1,

W2 + α2), which can be understood as competitive market equilibrium which makes zero expected

profits by equilibrium policy α*.

The next Figure shows an example of low-risk individuals with an accident probability PL, and

high-risk individuals with an accident probability PH > PL. Low-risk contract lies on line EL and

the high-risk contract on line EH. High-risk customers prefers complete insurance by point α1.

Low-risk customers would prefer contract β from all contracts on EL, which provides also complete

insurance. But point β is not equilibrium as it is more attractive to high-risk types than αH,

equilibrium has to be in point αL for low-risk customers. This establishes that the set (αH, αL) is the

only possible equilibrium for a market with low- and high-risk customers. Consider the contract γ it

lies above UL, and also above UH. If γ is offered, both low- and high-risk types will purchase it in

preference to either αH or αL. If it makes a profit when both groups buy it, γ will upset the potential

equilibrium of (αH, αL). γ's profitability depends on the composition of the market. If there are

sufficiently many high-risk people that EF represents market odds, then γ will lose money. If

market odds are given by EF' (as they will be if there are relatively few high-risk insurance

customers), then γ will make a profit. Since (αH, αL) is the only possible equilibrium, in this case

the competitive insurance market will have no equilibrium. This establishes conclusion that a

competitive insurance market may have no equilibrium.

Market failure solution – regulation authority

From the microeconomic perspective the legislative can be a tool for managing rules of market.

In this case the authority should set rules for insurance market which should motivate clients,

intermediaries and also insurance companies to behavior which won´t degenerate market.

Legislation authority which creates legislation is Czech government with cooperation with Czech

National Bank (CNB) and Association of Insurance companies. The supervisor authority for

insurance sector is Czech National Bank.

Information asymmetry in insurance industry

Insurance market is specific from its nature because this industry “deals with risks”. Insurance is

a product whose purpose is to compensate losses incurred by realization of risks. Insurance

companies take over risks and then compensate financially their realization by clients.

The important fact is that risks covered by insurance have to be based on coincidence. Then

coverage should be claimed. The problem of information asymmetry is connected with the fact that

coincidence is influenced by human behavior which is based on an information advantage.

For purpose of this paper we will assume insurance market which will be described by three

participants: insurance company, insurance intermediary5 and a client of insurance company. This

paper desists from subjects like reinsurance companies. The role of insurance company (also insurer

in the text) is to create an insurance product, sell policies and provide coverage. Insurance

intermediary role is to be only a seller of insurance policies. And a client will be a policy holder and

insured in one person and the role of this person is to cover own risks.

It is possible to say that all participants of a modeled insurance market can dispose with any

significant information and finally can benefit from it. Below are shortly described examples of

information asymmetry realization:

1. Client to Insurance company: Client has information, for example about own health (property

or about own behavior), which is under insurance or client knows specific details about claim

happened. In this case the insurance company would know this specific information, client

should pay higher premium or wouldn´t be insured.

2. Insurance company to Client: On the other side, insurance company disposes with a large

information base and has sources for obtaining qualified persons. Insurance company is a

professional with a large information base and a qualified participant of insurance market can

profit from “detailed and specific” industry information.

5 General name, but includes all types of intermediaries who are registered by the Czech National Bank. It is possible to get a

registration of six types insurance intermediaries. Source: [13]

3. Client to Broker: This relation is similar to relation 1. Client dispose with more detailed

information and is able to use it by negotiation about insurance contract.

4. Broker to Client: Broker is selling insurance contract to client and his/her motivation is

mostly the profit. Broker can incompletely describe or conceal important information about

insurance product or its conditions. If client knew it, she/he wouldn´t arrange the contract.

5. Broker to Insurance company: Broker is motivated to sell policies and is rewarded according

to sales. There can be asymmetry that Broker will have information about subject or object

which is not insurable or premium would be higher.

6. Insurance company to Broker: Insurance company creates prices for covered risks, which

means insurance company knows limit prices for an insurance product. Therefore information

asymmetry can influence supply of insurance products via commission setting and

motivation.

Asymmetry information with the advantage of a client

In this part we will a discuss market fraud caused by clients. It means that client dispose with

information that portrays him to an advantaged role against insurance provider (insurer or insurance

broker). It means that a client knows about insured object/subject something which is important and

in case the insurer would know it – insurer wouldn´t insure the object/subject or would penalize a

client (through higher premium). In fact a client enriches himself with money gained from the claim

amount.

Client and motivation

At first we have to separate clients into two groups – individuals and corporate clients.

According to this separation we can discuss a problem. Both types of clients have different

insurance products, according to that they have also different motivation for fraud as it is described

in table 1.

Table 1: motivation for insurance according to client needs

Client: Individual Corporate

Main insurance

products: Life, Property

Property, Casualty, Liabilities,

Other

Basic reason for

insurance:

Assurance against revenue

shortfall; Assurance against

losing of property; Assurance of

bereaved persons

Assurance of corporate costs and

liabilities from business

operations; Assurance of

corporate revenue and receivables

from business operations

Insurance indemnity:

Covering unexpected outage of

money and unexpected expenses

Compensation for unexpected

damage caused

Main motivation for

fraud: Client enriching Covering of costs

Risk incurred by

realization of insurance

fraud for insurer:

Risk of excessive payment of

claims; Solvency risk

Risk of excessive payment of

claims; Solvency risk

Risk incurred by

realization of insurance

fraud for client:

Risk of imprisonment; Solvency

risk

Risk of imprisonment; Solvency

risk, Reputation risk

Source: Author

In the table you can see that main reason for insurance of individuals is an assurance against

death, against loss of property and in minor also assurance of client´s liabilities by individuals.

However a sum insurance for individuals should cover outage of money or should replace extra

expenses. According to insurance substance it is necessary that compensation from insurance is

based on coincidence. However clients can get an idea that insurance can cover outage of money or

replace extra expenses without coincidence base and they are trying to make or influence claim that

never happened or claim details are distorted.

On the other hand corporate clients have slightly different motivation for insurance. The main

reason for insurance is to cover an unexpected costs, which can affect company production. This

originate also different motivation for insurance fraud which is replacing of costs by insurance

payment. Corporate client can demand compensation for damages that happened without

coincidence which never happened. Insurance company is exhibited to the risk of extra indemnity

from insurance.

Examples of insurance fraud

concealment of significant information

deliberated stating of false or seriously distorted data (age, health status, size of risk,

amount of damage, origin of claim, documents, etc.)

deliberated overstatement of accidentally incurred claim

deliberated infliction of damage (car accident, injury, etc.)which is presented as a

accidental event covered by insurance

overvaluation of assets in the underwriting and then artificially induced insured event

insurance already damaged things like undamaged (e.g. a crashed car)

various combinations of these negotiations.

Solutions of information asymmetry

The main tool for minimizing of asymmetry should be legislation. A legislation authority should

create effective law rules which should be demotivating. In the Czech Republic there should operate

police service which should effectively enforce law. The most important legislation in favour of

insurance company and insurance intermediary is a criminal code. The definition is mentioned in

Law no. 40/2009 Coll., The Criminal Code, Section II., § 210 Insurance fraud.

The paragraph shortly says that punished will be a person who:

provides false or grossly distorted information or concealing material information in

connection with the making or changing the insurance contract; in connection with the

claim settlement; or in connection with making a claim indemnity or other similar claims

intends to procure himself or benefit someone or pretends an incident which is connected

with insurance claim or other similar transaction

prepares insurance fraud.

The punishment for insurance fraud can be different according to fraud importance. Generally it

is a prison sentence from 6 months to 10 years. A financial compensation can be also included.

Insurance company should also dispose with effective risk management which should be

implemented to its infrastructure. Especially there has to be set up a consistent and fast claim

process containing multilevel validation and revision of claims.

Insurance companies should build a long-term relationship with their clients and there should be

applied the process called “know your customer” as much as possible. Insurance companies and

intermediaries should work on a long term relationship with their customers.

Asymmetry of information with the advantage of insurance intermediaries

Basically insurance intermediaries are motivated by commissions which are high in insurance

industry. This statement can be proved by the number of intermediaries who were attracted by

profitability of insurance industry. According to the Czech National Bank statistics there are

registered 146 6196 insurance intermediaries which can be considered as a high number in

comparison with the Czech population (over 10 million people).

Intermediary to client asymmetry

An initiator of information asymmetry is the profit because intermediary wants to maximize it.

Intermediary is highly motivated for selling of products with the highest commission and it is main

source of asymmetry which finally effects a client. A client usually obtains wrong or incomplete

information and finally conclude a contract which is disadvantageous for her/him. However the

commission for intermediary is maximal.

Intermediary to insurer asymmetry

On the other hand there can also exist asymmetry which is negative for insurance company.

This asymmetry can exist basically in 2 forms:

A. Claim asymmetry: A broker, who is mostly in a friend relationship with client, is helping

him/her with a claim process. According to the broker´s knowledge and his/her practice in

insurance industry he/she is able to provide instructions, guidance and recommendations to

the client to get indemnity (as large as possible) in cases of unclear or complicated claims

(possibly also claims that shouldn´t be claimed).

B. Commission asymmetry: The second form of asymmetry is in a relation to brokerage. It is

possible that a broker misuses her/his position and knowledge, and makes a contract

mainly on his/her own or close relative account which can enrich her/him or enhance

her/his productivity.7

Solutions against information asymmetry

The topic of insurance intermediaries was intensively discussed in the Czech Republic

especially by the Czech National Bank (CNB) in 2014. There were published two official notices by

CNB and they were mainly focused against malpractices of insurance intermediaries. Generally it

was said by notices that insurance companies should manage quality of brokering services and

remuneration shouldn´t be based only on a quantitative performance but also on a qualitative

performance of intermediary.

An update of legislation of insurance intermediation is currently under preparation. The main

reason is a low control over the intermediaries and a high number of intermediaries. The legislation

should consolidate types of insurance intermediaries, specify exacting conditions for entry to

insurance industry and specify behavior in insurance industry.

Another solution can be raised by insurance companies. Their activities are currently client

focused and insurance companies are more interested in insurance intermediaries work. They can

check their work, and in case of serious mistakes an insurance company can stop cooperation with

selected intermediaries.

Towards solution of commission asymmetry insurance companies should revise motivation and

remuneration schemes. The problem is this revision should be done above all insurance companies

because in case one insurer revises something, intermediaries stop selling products and it can be the

end of this insurance company.

Other activities raised by associations operating on insurance market maybe found as useful in

term of solving information asymmetry. Namely it is providing of behavioral codex for association

6 As of 31.12.2014, available at: https://apl.cnb.cz/apljerrsdad/JERRS.WEB07.INTRO_PAGE?p_lang=en 7 Example: Insuring of life insurance policies with high commission (based on disproportionate premium) and after paying of

commission by insurance company follows reinsuring of these policies. It becomes situation, that insurance company is not able to

create sufficient reserve for this policy and it becomes loss-making.

participants, currently there is in the Czech Republic well known Code of ethics of Association of

Financial Intermediaries and Financial Advisers of Czech Republic.

Asymmetry with the advantage of insurance companies

This part of the paper focuses information advantages on the insurance company side. Insurance

company is perceived as a dominant subject of an insurance market. Its dominancy is mainly based

on sources - capital which insurance company disposes and is also able to use. Capital allows

insurance company to have these advantages which can be understood as information asymmetry on

insurance company side.

Detailed knowledge of market insurance and its essentiality: Insurance companies operate

with data or can obtain data which are a base for insurance-mathematic calculations. And they

are also able to hire specialist with detailed knowledge of insurance industry.

Detailed knowledge of legislation: Insurance companies are able to pay for high quality

specialists in law who are able to create terms and conditions which can be advantage

especially in claim process.

Insurance contract: Insurance companies are creating contracts, which means they know all

terms and conditions and they can define exclusions in insurance contract.

Other professional staff: Insurance companies are able to get specialist from different spheres

for insurance company management and risks management.

These sources lead to asymmetry of brokers and clients. However the main reason of this

asymmetry is a profitability of insurance company. Especially it should help for managing costs for

insurance claims and other costs which insurance company faces.

Forms of asymmetry

Insurance asymmetry with the advantage of insurance company exists in two possible forms

which can negatively influence client and intermediaries.

Asymmetry with risk covered: If an insurance company finds a contract risky, insurer can

demotivate clients through the price of insurance or reject insurance contract. In case an

insurance contract is active and claim happens, insurance company can use advantages to be

fully assured that payment for claim is correct and fully appropriate. This form can potentially

be indirectly negative for intermediaries– it can negatively affect her/his commission or a

business relation with client.

Asymmetry with solvency: Insurance asymmetry can also be connected with the fact that

insurance company operates with client´s capital and there can exist a risk of bad

(inappropriate) management and bankruptcy of insurance company. This can finally bring

losses of some insurance products or for example an inability of paying claims.

Solutions of information asymmetry

As it is described asymmetry by insurers, it is important that there needs to be set up rules by

any authority, which will have power to impact the insurers. As it was by client an authority it is

also Czech government. The legislation understands a client as a disadvantaged market subject. The

purpose of legislation is to help client to understand insurance terminology and insurance contract.

Further to protect intermediaries in employment relation with insurance company.

Another important solution is setting requirements and rules for operating of insurance

companies. Insurance companies should be able to operate circumspectly and should provide

specific information about their current situation and status (should be transparent). The collecting

of these data is mainly in the competence of insurance companies, Czech National Bank and also

Czech Insurance Association.

Another solution specifically created codes for selected industry. These codes should especially

define behavior of market participants in this case insurers. It is possible to mention Code of ethics

on insurance of Czech Insurance Association and Code of ethics in financial market of Czech

Insurance Association. Also insurance companies have their own codes which govern the behavior

of the organization.

Czech insurance market and real facts about information asymmetry

The Czech insurance market consists of 53 insurance companies and 146 619 insurance

intermediaries.8 There is 7 834 817 life insurance policies with gross written premium 54 bil. CZK

and 20 138 546 nonlife insurance policies with gross written premium 66 bil. CZK.9

The best understanding to information asymmetry statistics is to describe this problem through

fraud and litigation statistics.10

Insurance companies: count of litigations, litigation about return of commission after end of

policy;

Brokers (intermediaries): count of litigation, litigation about commission for sells, litigation

based on suppression and concealment

Clients: insurance frauds

According to available statistics we are able to analyze just data concerning insurance frauds

and litigations in specific distribution.11

Table 2 – Insurance fraud statistics in the Czech Republic

Year 2005 2006 2007 2008 2009 2010 2011 2012 2013

number of

investigated cases 3 331 5 176 4 548 4 806 4 478 5 142 6 682 6 143 10 624

Insurance claim

amount (thous.

CZK) 1 203 087 1 198 362 836 032 889 863 1 247 504 1 126 161 1 611 648 1 568 112 1 756 752

Amount of

insurance fraud

(thous. CZK) 545 990 515 992 523 968 550 653 630 928 624 987 839 077 1 064 576 1 086 956

Source.: Author; [9]; [19]

The table shows increasing trend in insurance fraud statistics. During time period the number of

investigated cases is increasing, increasing is also the amount of total insurance fraud. The statistics

is further showing the increasing problem of information asymmetry which generates market failure

in a form of insurance fraud with the advantage of a client in the Czech Republic.

8 Data as of 31/12/2014; Regulated institutions and registered financial market entities lists; Czech National Bank 9 Data as of 30/09/2014; ARAD - Czech National Bank’s information service; Czech National Bank 10 Problem is that for this purpose is lack of information in the Czech Republic and it is impossible to get these data 11 Data are available only in very rough numbers. It also reflects low available information base of insurance market in the Czech

Republic

Table 3 – Insurance fraud details of year 2013

Insurance field

Number of

investigated

cases

Insurance

claim amount

(thous. CZK)

Amount of

insurance fraud

(thous. CZK)

Motor insurance 7 047 625 943 398 427

Cargo insurance 10 2 483 1 664

Property and liability insurance 1 353 869 369 458 974

Personal insurance 2 214 258 957 227 891

Total 10 624 1 756 752 1 086 956

Source: Author; [19]

The table 3 shows details of insurance frauds in the Czech Republic in 2013. The most risky

insurance field was property and liability insurance. According to the Czech Insurance Association

[19] the most significant field was in 2013 personal insurance. Insurance companies investigated 2

214 cases of insurance fraud which is 70% increase in comparison to 2012. Insurance companies

also commented that approximately 70% of Amount of insurance fraud in personal insurance field

is connected with frauds of insurance intermediaries who are making insurance contracts only for

getting commission. This also confirms a problem of information asymmetry with advantage of

insurance intermediary.

Graph 1 - Count of court files by district and regional courts

Source: [11]

The graph 1 shows the number of litigations increased significantly in 2011. The graph shows a

high number of litigations during the selected five years this can potentially be associated with the

statement that a negative economic situation of the last years has had an impact on the Czech

insurance industry. Although there is an increase in 2011 we can see a declining trend in 2012 and

2013 which could be associated with an economic recovery.

Information asymmetry and impact on the economic cycle

There is an idea there is a correlation between the number of insurance frauds (as

consequences of information asymmetry) and an economic growth. This hypothesis can be proved

by a simple analysis of available data in table below.12

12 This statement should prove any relation and it can be potentially used for another more detailed research.

Table 4– Development of GDP and count of fraud investigated

Year 2005 2006 2007 2008 2009 2010 2011 2012 2013

Number of investigated

cases 3 331 5 176 4 548 4 806 4 478 5 142 6 682 6 143 10 624

GDP identity from the

expenditure side (current

prices), bil. CZK

3 258 3 507 3 832 4 015 3 922 3 954 4 022 4 048 4 086

Source: Author; [9]; [19]

The table shows the number of cases investigated by insurance companies (participants of the

Czech Insurance Association) and GDP in current prices. As you can see, a year 2009 started a

phase of an economic decline in the Czech Republic and GDP in 2011 raised approximately to

value of the year 2008. On the other hand the number of insurance frauds investigated strongly

increased in 2011.

According to available data there could be conclusion that an increase of insurance frauds will

follow economic decline in two years.

Further can be added economical subjects are losing their jobs (salaries) in the phase of

economic decline. Then short term solutions should be applied, like using of reserves and looking

for part-time jobs and in case of deeper problems as in 2009 in the Czech Republic –new

opportunities for enriching and insurance payment should be offered.

According to the correlation analysis result (correlation coefficient 0,58) which was available

for the selected data it is possible to say there exists medium positive correlation.

Other solutions for information asymmetry on insurance market

EIOPA (European Insurance And Occupational Pensions Authority)

EIOPA is an organization of the European Union whose role is to be an authority for insurance

and pensional systems in the European union. One of its key roles is a client´s protection, which is

mainly assured through a couple of activities, e.g. analyzing of consumer trends, educational

initiatives, developing of market rules, developing of training standards, issuing warnings, etc.

The most suitable view in term of information asymmetry brings Consumer Trends Report [10]

whose results express trends in information asymmetry on insurance market with focus on a client.

Lack of transparency: misleading advertising and marketing/sales literature, incomplete or

difficult to understand costs and charges, performance or investment return information.

Inconsistent information disclosure: often it is impossible to make comparisons between

products.

Focusing mainly on price: not on product coverage. Consumers are not sufficiently invited

to read terms and conditions, or seek advice. Misleading information applied too.

Cross-selling (tying & bundling) and add-ons: regarding to large insurance products which

are in line with consumer products, for example - mobile phones (loss, damage or theft).

Lack information by selling of insurance policy (product coverage).

Mis-selling of unit-linked life insurance: insufficient or difficult to understand information

about products and underlying investments and risks.

Problem of prevailing low interest rate environment: life insurers are developing business

models to reduce the pressure of high guarantees given in the past.

Claims handling: inappropriate claims refusals, disputes over the amount of compensation

paid and undue delays in payments.

Low financial literacy

Another discussed trends which are monitored is creating of comparison website, but there

can be a problem with it transparency and data correctness.

Other trends

One of the big problems of information asymmetry in insurance industry is the fact clients are

trying to get compensation from damage based on distorted or invented situations. Fictive claims

are source of insurance companies losses. In this part we will discuss examples of used innovations.

As it has already been described in the paper there doesn´t exist legislation in the Czech Republic

which should demotivate clients, however an insurance fraud is not excessively understood as

serious criminal act in the Czech Republic 13.

Due to this fact insurance companies are parties of insurance market who have enough sources

and they are hardly working on improving investigation processes of insurance (claim) fraud and

other measures against frauds. This is applied to risk management of every insurance company.

Information systems

One of the current progressively developing areas are information systems. There exists a

couple of systems whose purpose is to share data among insurance companies. An active one is

Czech Insurance Association which is participating on developing ELVIS14 system and SVIPO15

system.

Insurance companies also cooperate with large databases of reinsurance and other specific

companies in insurance industry, e.g. a claim review (review of damage caused by hail) according

to specific databases monitoring weather in specific area in specific time.

On the other hand there exists a data system of the Czech National Bank which provides

information about all objects under its regulation and supervision. It can provide for example details

about insurance intermediaries and their licenses which can be useful for clients.

Also there exist a lot of information systems which can be used by insurance companies for

clarification of claim happened, e.g. weather information system, traffic information systems,

another client databases (other financial institution databases), etc.

Technological progress

Insurance companies dispose with a lot of instruments whose purpose is to minimize an

information gap among insurance companies and clients. These technologies are mainly used in

claim process.

Insurance companies in the Czech Republic has started using a specific software which works as

a voice detector. The program analyzes client´s voice during a phone call between insurance

company and client. The purpose of this phone call is to get as much as possible information about

13 This assertion is based on published year amounts of insurance frauds. As example insurance companies associated in Czech

Insurance Association exposed insurance frauds at more than 1 billion CZK in 2013. Source: [19] 14 System of exchange of data on unlawful activities of the intermediaries (ELVIS). System contributes to prevention and exposure of

insurance fraud and other illegal activities in the sphere of insurance mediation. Source: [19] 15 System for the Exchange of information on Suspicious Circumstances (SVIPO). The system is mainly focused on sharing data

about motor third-party liability insurance, which is highly predisposed for fraud in the Czech Republic. There is an idea about

extension to the sphere of personal insurance. Source: [19]

claim happened and finally it can provide a background for further and more detailed investigation

in case of uncertainty.

Another tool of investigation is using a software that is able to re-run insurance claim happened

according to technical and other known details. This software is mainly used for property and

liability insurance. After re-run insurance company is able to ensure correctness of the insurance

payment.

Insurance companies also use specific tools for insurance products which are mainly distributed

with discount on premium paid, e.g. PAYG16 system. Insurance company gains from the product

type and specific hardware lots of information, which can be later used in claim process.

Client´s rights

Currently (early 2015) there has been discussed another solution for information asymmetry on

insurance market. It is an institute of Ombudsman who is an independent evaluator of clients

complaints. At this moment financial institutions have own Ombudsman offices, however their

independence can be disputable. This topic has also been discussed by European regulations and it

can be expected that there will appear a systematic solution (introduced in the Czech legislation) for

solving disputes between insurers and clients soon.

A problem – the lack of education in the Czech Republic

Another problem connected to information asymmetry could be a financial literacy. The low

level of financial literacy provides a source for information asymmetry.

There is a low level of financial knowledge in the Czech Republic. It means that most of people

do not know basic information about financial products and what is more important they don´t

know basic information about their own products17.

An important fact is that the financial ignorance can have fatal impacts on a life of each person

and the basic financial skills should be taught in lower educational levels.

This problem is also understood by the Czech Government which provides a couple of study

programs focused on a financial literacy under the auspices of the Ministry of Education.

Insurance asymmetry vs. privacy

The solving of an insurance asymmetry problem is connected with an elimination of

informational gap between clients, brokers and insurance companies. This can also bring other

problems, e.g. privacy.

There are methods mainly used by insurance companies which can interfere personal privacy,

and finally insurance companies can operate with really sensitive personal information.

An example of problematic information asymmetry:

It is used by insurance companies in a motor insurance PAYG system. This system usually uses

information about a car usage for calculation of premium. This can be an advantage for specific

types of clients who are using their car occasionally. To apply this system it is important to have a

specific box installed in your car which collects data about a car usage.

Insurance company have a tool that can collect of the following information – fuel usage, time

of a car usage, distance travelled and it can potentially detect also a position of the car. It can be

useful for insurance company in case of claim and for investigation to have these information

because an insurer will have real data about the current situation of claim and then for example 16 PAYG – Pay As You Go; relatively new product of motor insurance connected with navigation systems. Client pay premium

coverage according to her/his usage of vehicle and under collecting data about vehicle usage it provides pricing. 17 For example results of report on financial literacy in the Czech Republic. [20]

refuse a claim payment or find an insurance fraud. However the following problem appears: Does

insurance company have a right to monitor and store data about a car location? If yes, insurance

company will have information about a usage of personal time and it can bring a wide scale of

potential risks.

This example shows that the fight against information asymmetry could also have an alternative

and finally a negative impact mainly on clients´ lives. The fight against asymmetry should have

some borders and these should be defined by the regulation authority.

Conclusion

The paper explains economic theory of information asymmetry with a historical base.

According to this part information asymmetry brings a negative impact into the insurance market in

form, that insurance market may not have its equilibrium.

The paper then describes the current situation on the Czech insurance market. Information

asymmetry is described by each of three market participants (client, insurance intermediary and

insurer). Paper explains source, motivation for asymmetry, forms of information asymmetry and

discuss currently applied solutions. This part also contains couple of real life information

asymmetry examples.

According to available market data, information asymmetry is quite a big problem for the

insurance industry and in the context of the economic situation of last years this problem is

culminating. This fact is a base for creating or updating solutions of information asymmetry, which

this paper is trying to cover. The paper then describes current trends and solutions which are

currently applied on the problem of information asymmetry by the regulatory authority or by other

organizations in the Czech Republic.

Finally the paper discusses two problems which are also connected with information asymmetry

– problem of lack of education (which can possibly cause asymmetry) and problem of privacy

(which can arise from solving of asymmetry to another negative situation).

This paper was limited because of focus on the insurance market. It is a lack of transparency on

the insurance market in the Czech Republic. This provides limitation of available public data and

information, which are reliable for analyzing of asymmetry on insurance market. This paper also

opens up areas of another possible research, especially research in transparency of insurance market

and financial literacy in the Czech Republic. This paper can furthermore be the basis for detailed

research of relation of information asymmetry and the economic cycle, which hypothesis was

mentioned in the text.

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