Laureen Regan

Vertical Integration in the Property-Liability Insurance Industry: A Transaction Cost Approach

The choice of insurance distribution system is examined from a transaction cost analysis perspective. Under independent agency, the agents ownership of the customer list gives that agent incentives to perform some activities that would be more costly under a more vertically-integrated system. It is argued that independent agency offers advantages to insurers when products are complex, underlying uncertainty is higher, or relationship-specific investments are less important. This hypothesis is tested using 1990 accounting data from a sample of 149 insurance groups.

Agent Discretion and the Choice of Insurance Marketing System

This article argues that different insurance marketing organizations arise as a means to minimize the costs of correctly matching policyholder risks with insurance coverage. When policyholders are easily sorted without sales agent participation in screening, exclusive dealing will be the preferred marketing organization; when agent information is important for risk placement, independent agency may be preferred. Empirical support for our theory is obtained from analysis of compensation contracts and market shares of the different marketing forms. Exclusive dealers are found to be prevalent in relatively standardized, homogeneous product lines and markets, and their agents receive less profit-based compensation than those of independent agency insurers. These findings are consistent with our theory.

Organizational Form in the Property-Liability Insurance Industry

INTRODUCTION Recent research has argued that alternative organizational forms will coexist in an industry because of differential relative advantages. (See, for example, Jensen and Meckling, 1976; Klein, Crawford, and Alchian, 1978; Fama and Jensen, 1983; Williamson, 1985.) The two important elements of organizational form are the ownership structure of the firm, and the degree to which the firm internalizes or outsources production, that is, the level of vertical integration. The property-liability insurance industry is characterized by firms that differ on both of these dimensions of organizational form. The range of ownership structures includes stock corporations, mutuals, and reciprocal organizations. Stockholder-owned insurers dominate the market, with 67.7 percent share of premiums written in 1994. Stock insurers controlled 55 percent of the personal lines market, which includes auto and homeowners insurance, but held a commanding lead in commercial lines, with a 79 percent share. Property-liability insurance firms also vary widely in the degree of vertical integration of the distribution system, with some firms using exclusive dealing arrangements and others contracting the sales function to independent agents who have ownership rights in the client list and who can represent a number of competing insurers. Independent agency insurers controlled 52 percent of the total market in 1994, and 71.8 percent of the commercial lines market.(1) The organizational form literature in property-liability insurance has largely treated ownership and distribution system choice separately. However, some overlap exists between the theory and empirical predictions across the ownership form and distribution system literature. For example, Mayers and Smith (1988) argue that stock insurers should be associated with a more complex mix of business than mutual insurers while Cummins and Weiss (1992), Regan and Tennyson (1996), and Regan (1997) argue that independent agency insurers should be preferred to exclusive dealers when complexity is higher. It is difficult to separate these effects empirically. An exception to treating these elements of organizational form as independent is Kim, Mayers, and Smith (1996), who argue that stock ownership and independent agency distribution are strategic complements, because independent agency is an effective device for minimizing agency costs that arise between owners and policyholders in a stock firm. Therefore, stockholder-owned insurers should choose independent agency distribution rather than exclusive dealing arrangements to minimize agency costs. While the authors of this article agree that independent agency distribution and stock ownership forms are likely to be strategic complements, the reasoning differs from that of Kim, Mayers, and Smith. An alternate explanation for the observed correlation between stock ownership form and independent agency distribution is that each of these elements offers advantages in certain lines of business and underwriting environments. In particular, the authors test the hypothesis that both stock ownership and independent agency distribution are more suited to complex lines of business and underwriting environments characterized by more risk than other combinations of ownership form and distribution system. Thus, rather than stockholder-owned firms choosing independent agency distribution, firms might first choose a business strategy, and then jointly choose ownership form and distribution system. The theory that supports this hypothesis is reviewed below. Several tests of the hypothesis are then presented. The direct correlation between ownership form and distribution system across lines of business is first measured using independence tests. Then, the authors compare the allocation of aggregate underwriting capacity to risky and complex lines of business between stock and non-stock insurers, and between independent agency and exclusive dealing insurers. …

On the Corporate Demand for Insurance: The Case of Korean Nonfinancial Firms

Several theories have been developed to explain the motives for corporate insurance purchases, but there are few empirical tests of these theories. Furthermore, the empirical results are not consistent across studies, suggesting the need for further research. This study uses accounting data for 433 publicly listed nonfinancial firms in Korea to test the determinants of insurance demand for the period 1990 through 2001. Our results support the theory that firm size, tax considerations, and firm ownership are important determinants of insurance demand. Firms that are members of chaebols demand more insurance than unaffiliated firms, all else equal. Contrary to theory, our results also indicate that firms that have higher debt-to-equity ratios demand less insurance than less leveraged firms, and that firms that have greater liquidity demand more insurance. This might be related to the overall high debt levels of firms in the period leading up to the Korean financial crisis in 1997, but that investigation is beyond the scope of this study.

Insurance Distribution Systems

This chapter details the use of different insurance distribution systems in practice, analyzes key issues in distribution system use based on economic theories of the organization of the firm, and discusses public policy and regulatory issues related to insurance distribution. The chapter focuses on what we believe to be the three major economic issues in insurance distribution: the choice of distribution system(s) by an insurer; the nature of insurer-agent relationships, including compensation structure and resale price maintenance; and regulatory oversight of insurance distribution activities, including regulation of entry and of information disclosure to consumers.

The Effects of Regulated Premium Subsidies on Insurance Costs: An Empirical Analysis of Automobile Insurance

State regulation of rates is sometimes used as a means to make automobile insurance more affordable to consumers by restricting insurer profits and pricing practices. Incentive distortions arising from this type of rate regulation might lead to higher accident rates and higher insurance loss costs. Annual state-level panel data for the time period 1980–1998 are used to investigate these effects, using empirical methods that recognize the endogenous determination of states’ regulatory choices. Results suggest that rate regulation that systematically suppresses (some or all) drivers’ insurance premiums is associated with significantly higher average loss costs and higher insurance claim frequency.

Unfair Discrimination and Homeowners Insurance Availability: An Empirical Analysis

There has been an active public policy debate about the availability and cost of homeowners insurance in urban markets, and insurers have been charged with intentional discrimination, or redlining, against minority buyers and neighborhoods with a large proportion of minority population. Studies of relative price, loss costs, agency location, and product quality have attempted to determine whether insurers unfairly discriminate against minority homeowners in urban areas. This study focuses on insurance availability, and examines whether there is a systematic difference in the breadth of insurance coverage in the market that corresponds to the proportion of minority residents in a state. The market share of dwelling fire insurance polices across states for years 2000 and 2003 is analyzed, and evidence is presented that shows a positive correlation between the proportion of minority homeowners in a state and the share of more restrictive dwelling fire policies. However, this difference is not statistically significant once other risk‐related and economic factors are included in the analysis.

Determinants of The Selection of Full or Limited Tort Auto Insurance in Pennsylvania: an Empirical Analysis

In response to rapidly rising insurance prices, Pennsylvania was one of several states to adopt no-fault auto insurance in the 1970s. The Pennsylvania no-fault law, passed in 1975, included a

The Economics of Liability Insurance

750 monetary tort threshold and unlimited no-fault medical benefits. However, because of the easily reached tort threshold, the new law failed to stabilize costs; and so, in 1984 the legislature acted again, this time repealing the tort threshold, while leaving in place an “add-on” system of no-fault “CAT Fund” benefits capped at

EXPENSE RATIOS ACROSS INSURANCE DISTRIBUTION SYSTEMS: AN ANALYSIS BY LINE OF BUSINESS

1,000,000 (see Powers, 1989).