Insurance Agency Contract with ‘No Claim Bonus’
Posted: 14 Sep 2017
Date Written: September 7, 2017
Traditionally insurance agents are incentivised by payment of a commission on the premium they generate. A bonus payment received by the agent from the insurer, when the insured does not make a claim, is referred to as ‘No claim bonus’ (NCB). NCB rewards the agent for her / his effort in reducing the probability of a loss caused by the insured peril. In case of general (non-life) insurance products, a trained agent can educate the insured about their risk exposure, and about taking risk management measures, to reduce the probability of loss. This effort of the agent reduces the probability of claim and is referred to as the ‘risk management’ (RM) effort. In presence of deductibles, the insured also benefits from reduced probability of loss. But if implementation of risk-management measures is sufficiently costly for the insured, the premium should be reduced to sell the policy. An incentive compatible contract, which induces the agent to choose RM effort, is designed in this paper. If the agent’s cost of RM effort is less than a critical value, there exists feasible ranges of values of the NCB and the insurance premium such that the insurer can offer an incentive compatible agency contract with NCB, and the agent can accept it. The feasible range of NCB shrinks if the insured’s cost of implementing risk-management measures crosses a threshold.
Keywords: Insurance, Agency Contract, Insurance Premium, Agent’s Commission, 'No Claim Bonus', Effort Cost
JEL Classification: D86, G22
Suggested Citation: Suggested Citation