IAI Actuarial Core Principles · Business Economics · Relationship between economics and business
A Mumbai insurer's owners are separate from its professional managers, who are paid bonuses linked to premium volume. Managers therefore push for rapid expansion even where it lowers profit per policy. Which concept best describes this situation?
This is the principal-agent problem. Owners want profit, but managers, rewarded for premium volume, pursue growth that serves their own pay. The separation of ownership from control lets the agents' objectives diverge from those of the principals.
- APerfect competition
- BPrincipal-agent problemCorrect
- CMoral hazard on the policyholder side
- DNatural monopoly
- Adverse selection in underwriting
Explanation
Owners (principals) want profit, while managers (agents) pursue their own incentives, here volume bonuses. This divergence of objectives from the separation of ownership and control is the principal-agent problem. Moral hazard and adverse selection concern policyholders, not managers.
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