Hello If cross-subsidies exist, the financial adviser is likely to select against the company – especially if competitors do not have such cross-subsidies. Could you please explain this? Thanks in advance
Cross subsidies will result in a company offering: 1. a relatively lower price on the 'high' risk contracts than is justified on the basis of the risks embedded in the policy; 2. a relatively higher price on the 'low' risk contracts than is justified on the basis of the risks embedded in the policy. As a consequence (ignoring commission or any other incentive that might affect financial adviser incentives), a financial adviser would recommend: 1. higher risk customers take out the lower priced contract with this company 2. lower risk customers take out a contract with a lower priced competitor This 'selection' would result in this company having a higher proportion of high risk customers. The degree of loss will depend on factors such as the actual proportion of higher risk customers relative to the proportion assumed in the pricing basis.
