Exclusive vs. independent agents: a separating equilibrium approach

We provide a separating equilibrium explanation for the existence of the in dependent insurance agent system despite the potentially higher costs of th is system compared to those of the exclusive agents system (or direct under writing). A model is developed assuming asymmetric information between insu rers and insureds; the former do not know the riskiness of the latter We al so assume that the claims service provided by the independent agent system to its clients is superior to that offered by direct underwriting system, t hat is, insureds using the independent agent system are more likely to rece ive reimbursement of their claims. Competition compels the insurers to prov ide within their own system the best contract to the insured. It is shown t hat in equilibrium the safer insureds choose direct underwriting, whereas t he riskier ones choose independent agents, The predictions of the model agr ee with previous research demonstrating that the independent agent system i s costlier than direct underwriting. The present model suggests that this d oes not result from inefficiency but rather from self-selection. The empiri cal implication of this analysis is that, ceteris paribus, the incidence of claims made by clients of the independent agents system is higher than tha t of clients of direct underwriting. Implications for the coexistence of di fferent distribution systems due to unbundling of services in other industr ies such as brokerage houses and the health care industry are discussed, (C ) 1999 Elsevier Science B.V. All rights reserved, JEL classification: D21; D23; D82; G22; L1.