Intermediary Compensation under Endogenous Advice Quality in Insurance Markets

We use Hotelling (1929)’s spatial competition approach to analyze insurance market outcomes when consumers face mismatch risk and can consult intermediaries to obtain product recommendations. Brokers can decide both on their level of advice quality and—if allowed by the regulator—on the size of kickbacks (rebates) offered to consumers, i.e., on what fraction of their commissions to pass on to their clients. We show that when kickbacks are banned, the market is characterized by a pooling equilibrium with either low or high advice quality. By contrast, when kickbacks are allowed, no separating equilibrium with both levels of advice quality exists, since the low-quality broker is always forced out of the market. Endogenous advice qualities promote a market equilibrium in which high advice quality and a direct distribution system coexist. Moreover, the market equilibrium with kickbacks results in higher consumer welfare than the equilibrium without kickbacks.