A Search Model of Marketing Systems in Property-Liability Insurance

Abstract

Introduction The marketing of property-liability insurance is generally done through one of two distribution systems. In the independent agency system, insurers enter into agreements with independent contractors who sell insurance simultaneously for several firms. These independent agents are intermediaries who match potential policyholders with appropriate insurers. The agents are paid a commission, usually a predetermined percentage of the premium, once a policy has been sold. Insurers that use the second type of distribution system are known as direct writers. Their insurance is sold by individuals who represent only their firm. They may employ salespeople, sell through mass media or mail, or use the services of an exclusive agent. Empirical evidence shows a significant cost differential between these two marketing systems. Joskow (1973), Cummins and VanDerhei (1979), and Barrese and Nelson (1992) found that independent agency firms have higher costs than direct writers, and the latter two articles found no evidence that this cost differential is declining over time. Proponents of the independent agency system claim that this is due to superior services provided by independent agents, but Etgar (1976) and Cummins and Weisbart (1977) found no significant difference in the quality of services provided by the two marketing systems. On the other hand, Berger, Cummins, and Weiss (1995) provide evidence that profit efficiency differentials between independent and exclusive agency insurers are much less than measured cost efficiency differentials, suggesting that at least part of the cost differential between the two groups of insurers represents additional services that are compensated through higher revenues. Barrese and Nelson (1992) explain the cost differential between the two marketing systems by claiming that the principal (insurer) must incur monitoring costs because of agency conflicts between itself and the (independent agent). Agents may feel a need to monitor insurers' relationships with policyholders as well, since independent agents own the policy renewal rights. Direct writers face lower agency costs because the individuals selling their policies do not represent other insurers and direct writers generally own the renewal rights for their own policies. Similarly, D'Arcy and Doherty (1990) argue that, because direct writers do not have to share with their agents the rent on private information about their policyholders, direct writing has a cost advantage over independent agency marketing. However, these two studies stop short of providing a theory for the continuing coexistence of the two marketing systems. The question, then, is how the independent agency system survives despite its cost disadvantage. The Insurer-Agent Relationship Virtually all existing articles answer this question by employing agency theory. Mayers and Smith (1981) expect the agent-policyholder conflict to be greater and the firm-agent conflict to be smaller with exclusive agency. Thus, they expect independent agency firms to specialize in high-service, high-price policies. Cummins and Weiss (1992) suggest that agency conflicts between insurers and policyholders may result in policyholder willingness to pay higher premiums to independent agents as a form of monitoring cost, since such agents own policy renewal rights and can, therefore, protect policyholder interests. The ownership of the client list is also the focus of Grossman and Hart (1986), who argue that the choice of marketing system will depend on which party, the insurer or the agent, has the greater potential to exploit the ownership rights over the client list. Sass and Gisser (1989) argue that, since exclusive agency does not allow the agent to sell other insurers' policies, it must compensate the agent by providing the agent with sufficient business. They conclude, therefore, that larger firms are more likely to use the exclusive agency distribution system. …