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Insurance Distribution

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Handbook of Insurance

Abstract

This chapter details the use of insurance distribution systems in practice, highlights the theoretical support for the presence of various distribution systems within the insurance marketplace, and discusses public policy and regulatory issues related to insurance distribution. Three important economic issues form the centerpiece of the discussion. The first is the economic rationale for the choice of distribution system and for the variety of distribution systems observed in the industry. The second is the nature of insurer–agent relationships and the role and consequences of alternative compensation methods for intermediaries. The third is the economics of regulatory oversight of insurance distribution. Both the US and international contexts are considered.

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Notes

  1. 1.

    A “systemically important” nonbank financial institution is one whose insolvency is likely to threaten the financial system as a whole. However, no measures have yet been proposed to define the characteristics of such an institution.

  2. 2.

    While outside the scope of this chapter, we recognize the importance of the Patient Protection and Affordable Care Act of 2010 (more popularly known as President Obama’s Health Care Reform) for insurance distribution. Significant regulatory change in the health insurance industry will affect health insurance distribution and could have spill-over effects into other lines of insurance.

  3. 3.

    See, for example, the chapters on Japan and China in Cummins and Venard (2007).

  4. 4.

    The Gramm-Leach Bliley Act of 1999 allowed commercial banks, insurers, and investment banks to operate as conglomerates under a financial holding company structure.

  5. 5.

    For example, in the USA, regulations prohibited an insurance firm from selling both property-liability and life insurance until the 1940s (Huebner et al. 2000).

  6. 6.

    The classifications are taken from A.M. Best Company’s Best’s Insurance Reports.

  7. 7.

    Market share figures do not add to 100%, as there are small shares of premium volume written by firms using other primary distribution systems (general agents or mass marketing), which are not reported here.

  8. 8.

    Some banks in the USA have begun operating independent agencies, but our data do not allow us to identify this model’s penetration.

  9. 9.

    Statistics for China are from Sun et al. (2007); those for Malaysia and Singapore are from Wong et al. (2007).

  10. 10.

    This is probably due to the greater differences in organizational relationships between firms and agents under the property-liability systems. Moreover, the historical development of property-liability distribution systems in relation to the regulation of rates in this industry has made these differences starkly apparent.

  11. 11.

    See Braeutigam and Pauly (1986), for a critique of this methodology when insurance products are not homogeneous.

  12. 12.

    See Chapter 12 of this volume for an in-depth discussion of this methodology.

  13. 13.

    An earlier study by Cather et al. (1985) compared the mean accounting profitability levels of 68 insurance groups for each year in the time period 1975 to 1982 and also found little evidence of profitability differences across firms using different distribution systems.

  14. 14.

    Cultural distance, according to the authors, is an index reflecting the similarities and differences between the behaviors and business practices in the target market and the home market of the firm entering.

  15. 15.

    Venezia et al. (1999) develop a theoretical model which shows that tied and independent agency insurers may coexist in equilibrium when independent agents provide greater assistance in claims processing. Under the additional assumption that consumers have private information about their risk types, it is shown that higher risk consumers will choose independent agency insurers, which will in turn offer higher prices and lower deductibles in equilibrium.

  16. 16.

    Of course, if consumer complaints are made only when service fails to live up to expectations, there is the possibility that selection bias in the distribution system clienteles will affect these results. For example, if shopping with a particular distribution system is correlated with service expectations or innate tendencies to file complaints, the study results may be compromised.

  17. 17.

    We refer the reader to the prior edition of this book for a more complete literature review related to the market frictions case for persistence of high-cost distribution methods, especially with respect to regulation.

  18. 18.

    Seog (2005) nonetheless shows that equilibrium coexistence of independent and exclusive agency firms is possible even if independent agency firms are less efficient, if the fixed costs of exclusive agency are sufficiently high relative to the variable cost advantages of this distribution formKelly and Kleffner (2006) argue that high fixed costs coupled with small market size may be the reasons that independent agency firms dominate the personal lines insurance market in Canada.

  19. 19.

    See, for example, Pauly et al. (1986), Grabowski et al. (1989), and Gron (1995).

  20. 20.

    In the USA, bancassurance was prohibited until 1999; its slow growth since then is often attributed to cultural differences between banks and insurers rather than to regulatory barriers (Davis 2007).

  21. 21.

    Important early works taking this perspective include Alchian and Demsetz (1972), Jensen and Meckling (1976), Williamson (1979), and Fama (1980). See Holmström and Tirole (1990) for a complete review of the theoretical literature.

  22. 22.

    Independent agents and brokers are referred to as independent agents throughout the remainder of the chapter unless a clear distinction between them must be made for clarity.

  23. 23.

    See Anderson et al. (1998) for a discussion of the creation of more vertically integrated relationships between independent insurance agents and insurers.

  24. 24.

    The authors also find evidence consistent with the predictions of Marvel (1982) regarding differences in advertising intensity across distribution systems, and with those of Sass and Gisser (1989) regarding differences in firm size across distribution systems.

  25. 25.

    Regan and Tzeng (1999) provide additional evidence on the relationship between insurance distribution system and ownership form. This study explicitly treats the choice of distribution system and ownership structure as jointly determined to control for the fact that common exogenous factors may influence both choices. The findings confirm the view that stock ownership and independent agency distribution are likely to be observed together.

  26. 26.

    More recently, some direct carriers have used information from competitor rate filings to provide quotes for up to four competing carriers, even when the competitor has lower premiums. Progressive was an early adopter of this method. However, we are not aware of any studies to determine the accuracy of the quotes provided for other carriers. For example, the competing quotes may not take into account multi-line discounts that may be offered by competitors.

  27. 27.

    Grossman and Hart (1986) present evidence of specialization in term life insurance by independent agency insurers in the USA. However, their arguments regarding why independent agency is optimal for term life insurance rely on differences in client list ownership across the different distribution systems. In life insurance there are no such differences in the USA, with the insurance firm typically retaining ownership of policy renewals (Baranoff and Sager 2003).

  28. 28.

    Group insurance programs and individual whole life insurance were classified by the authors as relatively more complex than other products, such as individual term life or credit insurance.

  29. 29.

    Efficiency is measured using data envelopment techniques, which decompose cost efficiency into technical and allocative efficiency. The authors find that both independent agency and tied agency insurers are less technically efficient than mass marketing insurers.

  30. 30.

    Note that California and Florida allow rebating, which will be discussed later.

  31. 31.

    For details regarding the Spitzer lawsuit, see Chapter 9 in Masters (2006) and the conversation recorded in Cummins et al. (2006).

  32. 32.

    See People ex rel. Cuomo v. Liberty Mut. Ins. Co. 52 A.D. 3d 378, 861 N.Y.S.2nd 294 (June 19, 2008).

  33. 33.

    Both New York and Colorado have adopted laws to require commission disclosure in all cases, while six other states (RI, UT, CT, WA, IL, OR) now require disclosure when the producer receives compensation from the insurer and the insured.

  34. 34.

    Eastman et al. (1996) find that the professional ethics of insurance agents are lower than their personal ethics but do not study the relationship between compensation methods and ethical beliefs.

  35. 35.

    In Gravelle’s model, there is also no competition between agents. Consumers are contacted by at most one agent and cannot seek out advice from other agents.

  36. 36.

    These policies and regulations tend to be similar in intent to those directed toward marketing practices in other financial services industries.

  37. 37.

    The home country retains responsibility for solvency oversight of the insurer.

  38. 38.

    There is still widespread dissatisfaction with the variation in licensing requirements across states. In support of increasing uniformity, a revised version of the NARAB was introduced in the US House of Representatives in March, 2011, with broad bipartisan support. The bill has not yet made it to the US Senate as of this writing.

  39. 39.

    It has been argued that licensing of service providers acts as a barrier to entry and protects the market position of incumbents. There are several studies that test this hypothesis for the accounting industry (see, for example, Jacob and Murray 2006, and Carpenter and Stephenson 2006). These authors find s significant decrease in the number of candidates taking the CPA exam after the adoption of the requirement that undergraduate accounting majors take 150 university credit hours. Similarly, Adams et al. (2002) find a significant decrease in the number of practicing cosmetologists after state imposition of occupational licensing. To our knowledge though, there is no study that examines the impact of producer licensing on competition or market structure in the insurance industry.

  40. 40.

    The NIA refers to all insurance intermediaries as producers and we will follow that standard for the purposes of the discussion here.

  41. 41.

    Much of what follows here is from Regan (2007), The Optional Federal Charter: Implications for Life Insurance Producers, a study sponsored by the American Council of Life Insurers.

  42. 42.

    Source: Search of state insurance department websites as of May, 2007.

  43. 43.

    Source: The Producer Licensing Uniformity Survey, accessed May 31, 2007 at http://www.naic.org/documents/committees_d_plwg_uniform_licensing_survey.xls.

  44. 44.

    The Bureau of Labor statistics reports that 627,346 people were employed in insurance agencies and brokerages in 2002, the last year the data is reported. The author assumes a 2% growth rate that matches the US population growth, and that 85% are licensed producers and 15% are non-licensed support staff. This is consistent with Smith et al. (2000). Based on this, we calculate that there are 543,908 insurance producers.

  45. 45.

    Commission rebating is also prohibited in the Act.

  46. 46.

    Replacement of a policy with one that does not significantly increase insurance or other benefits is costly to the consumer because of the high levels of commission that go to agents at the time of sale. Other detrimental effects may include higher premium rates because the consumer is older, loss of cash value in the policy, and new incontestability and suicide clauses imposed in the new policy.

  47. 47.

    The value of the documentation, in particular, has been questioned by many. Heinrich et al. (2008) provide a case study suggesting that better documentation creates value for the insurer, however.

  48. 48.

    These issues are discussed extensively in Ippolito (1988).

  49. 49.

    At least as significant for consumers is the possibility that product quality may change after the purchase is made. Even if quality can be determined at the time of purchase, it may vary over time and hence continuous monitoring is required. This problem may be mitigated by solvency regulation and regulation of other insurer practices.

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Author information

Authors and Affiliations

  1. Department of Insurance, Legal Studies and Real Estate, Terry College of Business, University of Georgia, Athens, GA, 30602, USA

    James I. Hilliard

  2. Department of Risk, Insurance, and Health Care Management, Fox School of Business, Temple University, Philadelphia, PA, 19122, USA

    Laureen Regan

  3. Department of Policy Analysis and Management, School of Human Ecology, Cornell University, Ithaca, NY, USA

    Sharon Tennyson

Authors
  1. James I. Hilliard
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  2. Laureen Regan
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  3. Sharon Tennyson
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Corresponding author

Correspondence to Sharon Tennyson .

Editor information

Editors and Affiliations

  1. Finance, HEC Montreal, Montreal, Québec, Canada

    Georges Dionne

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© 2013 Springer Science + Business media, New York

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Hilliard, J.I., Regan, L., Tennyson, S. (2013). Insurance Distribution. In: Dionne, G. (eds) Handbook of Insurance. Springer, New York, NY. https://doi.org/10.1007/978-1-4614-0155-1_25

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