Commitment and Its Consequences in the American Agency System of Selling Insurance

INTRODUCTION The American Agency system of selling insurance, whereby independent agents represent multiple insurers and own the rights to the expirations of the policies they sell, has been the object of much criticism and has come under competitive pressure from alternative means of distributing insurance. In response, some elements of the insurance industry have experimented with forging committed relationships with agents as a means to stay within the independent agency system while achieving better results. Commitment building is an effort by principals (here, insurers) to bind agents (here, independent insurance agents who own the rights to expirations) to them so tightly as to blur the distinction between the principal and the agent. At the limit, the relationship is so close that no party (insurer, agent, or policyholder) is entirely sure that the principal is not vertically integrated. This idea (that the principal can be technically using a market mechanism but enjoy most of the benefits of vertical integration) has attracted considerable attention. A very large literature spanning several fields (including multiple sub-disciplines of business) has developed and has collectively examined two questions: (1) do committed relationships really generate economic, as opposed to solely psychological, benefits and, if so, to whom, and (2) how can a firm create a committed relationship? This study examines both questions and does so in the context of the insurance industry in the United States. The argument made here is that one way for insurers to realize the full benefits of distribution through agents is to cultivate commitment from their independent agents. On the surface, this idea might appear impractical. This study uses a large primary data set collected from pairs of insurers and their agents, each member of the pair supplying confidential information about itself, its counterpart, and their relationship. Using this dyadic data, it is demonstrated that it is possible to build extremely high levels of commitment. However, it requires investments in the relationship that mature over relatively long periods of time and continuing attention and effort devoted to the relationship. Do committed players get anything for their commitment? This study demonstrates that both committed agents and committed insurers report more profits. Further, committed insurers are able to command a substantially higher share of the committed agent's volume. It has been argued within the insurance industry that this is a path to reducing future loss ratios suffered by the insurer. If so, commitment would appear to have a significant influence on future losses. This paper is organized as follows. The following section discusses the literature on the advantages and drawbacks of the American Agency system and on close relationships as a general phenomenon. A framework is proposed delineating conditions under which agents and/or insurers will commit to each other. Effects of commitment on economic performance are also proposed. The next section details how a large primary dyadic data set was collected and presents the results of estimating a system of equations in four endogenous variables representing commitment in an insurer-independent agent dyad. Three performance models are also estimated. The final section discusses the results and their limitations, and compares them to related research in the literature of close relationships. Insurance agents are demonstrated to be driven by the same general factors that influence many other kinds of agents (e.g., industrial distributors), as well as to be strongly influenced by concern about the insurer's commitment to the basic principle of selling its insurance via independent agents which own the expirations. Insurers are shown to be very attentive to financial considerations. Both parties appear to derive benefit from their arrangement, although the insurer's benefit is more difficult to ascertain and is strongly tied to the vagaries of the future. …