Do Independent Agent Insurers Provide Superior Service? The Insurance Marketing Puzzle

Abstract

Introduction Property-liability insurance in the United States is marketed through several distribution systems, including the exclusive agency system, the independent agency system, the salaried employee distribution system, and mail marketing and specialty distribution systems (see Flanigan et al., 1979, for a discussion of alternative marketing methods). Exclusive agencies distribute insurance through agents representing only one insurer. The salaried employee (or salaried representative) distribution system is similar to the exclusive agency system in that marketers represent only one insurer, but the salaried employee system uses employees of the company, not agents, to sell and service policies. Insurers using mail order systems distribute insurance directly through the mail, without the involvement of an agent or other intermediary. Insurers using specialty marketing distribution directly contact selected populations such as individuals affiliated with the armed services or franchise operators of a particular corporation. By contrast, independent agents represent and market policies for several insurers. Unlike other distribution systems, the independent agency system gives agents the rights to policy renewal, which means that the insurer cannot contact the policyholder directly to solicit renewal business. The agent determines which of the several insurers represented will receive the renewal business, and typically independent agent renewal commissions are higher than renewal commissions in other distribution systems. In addition, some insurers adopt a mixed approach using more than one type of distribution system. Research suggests that independent agents have higher expense ratios than exclusive agency insurers (see, e.g., Joskow, 1973; Cummins and VanDerhei, 1979; Doherty, 1981; Johnson, Flanigan, and Weisbart, 1981; Cather, Gustavson, and Trieschmann, 1985; Berger, Kleindorfer, and Kunreuther, 1989; Barrese and Nelson, 1992; Flanigan, Winkler, and Johnson, 1993). Higher expenses are consistent with the hypothesis that the independent agency system is less efficient in the provision of insurance or the hypothesis that the independent agency system provides superior policy service. The agency theory literature provides a theoretical explanation for the relative cost inefficiency of the independent agency system (see, e.g., Mayers and Smith, 1981; Marvel, 1982; Sass and Gisser, 1989). Independent agency insurers may need to engage in costly monitoring because, relative to exclusive agents, independent agents have an incentive to switch policyholders to different insurers at renewal time since renewal commissions vary across insurers. Defenders of the independent agency system argue that the expense differential between independent and exclusive agency insurers is attributable to superior policy service provided by independent agency insurers. Pauly, Kunreuther, and Kleindorfer (1986) argue that the expense differential is not a deadweight loss but is due to greater service intensity of independent agency firms. Barrese and Nelson (1992) argue that independent agents may deal more effectively with certain types of agency conflicts (between policyholder and insurer) and receive rents (via higher expense ratios) as compensation for this service. But empirical evidence in support of the view that independent agency firms offer superior or additional services is mixed (see, e.g., Etgar, 1976; Cummins and Weisbart, 1977; Doerpinghaus, 1991; Consumer [Reports, 1988; A. M. Best, 1989). Consistent with the arguments and evidence on the expense advantage of exclusive agency insurers, the total market share of independent agency firms declined from 69 percent in 1970 to 59 percent in 1990 (see Table 1). However, despite the declining market share, the independent agency system survives; from 1970 to 1990, direct premiums written by independent agency insurers grew by 435 percent (while the consumer price index increased by 236 percent). …