The Economics of Insurance Intermediaries

This article analyzes the economic functions of independent insurance intermediaries (brokers and independent agents), focusing on the commercial property–casualty insurance market. The article investigates the functions performed by intermediaries, the competitiveness of the market, the compensation arrangements for intermediaries, and the process by which policies are placed with insurers. Insurance intermediaries are essentially market makers who match the insurance needs of policyholders with insurers who have the capability of meeting those needs. Intermediary compensation comprises premium‐based commissions, expressed as a percentage of the premium paid, and contingent commissions based on the profitability, persistency, and/or volume of the business placed with the insurer. Empirical evidence is provided that premium‐based and contingent commissions are passed on to policyholders in the premium. However, contingent commissions can enhance competitive bidding by aligning the insurer's and the intermediary's interests. This alignment of interests gives insurers more confidence in the selection of risks and thus helps to break the “winner's curse” and encourages insurers to bid more aggressively. Independent intermediaries also help markets operate more efficiently by reducing the information asymmetries between insurers and buyers that can cause adverse selection.     

The Value of Contingent Commissions in the Property–Casualty Insurance Industry: Evidence From Stock Market Returns

Insurance producer compensation has incorporated contingent commissions for decades. In 2004, the New York State Attorney General sued insurers and brokers, alleging compensation abuses and calling for elimination of some forms of contingent commissions. Daily stock price return data reveal negative announcement‐period portfolio returns for property–casualty carriers, suggesting expected negative cash flow effects. Firm‐level losses were related to intensity of contingent commission use, suggesting that the effects of such regulatory changes would be felt most by firms that relied on contingent commissions. Investors believed contingent commissions were valuable not only for producers but also for carriers.     

Contingent Commissions and the Management of the Independent Agency

Insurance agencies continue to exist as an important distribution mechanism because they give their contracting insurers advantages in risk selection and enable insurance applicants to transfer complex risks. While independent agencies are compensated by upfront commissions, a key component of their profitability is tied to contingent commissions. A contingency arrangement represents ex post compensation normally tied to underwriting profitability, volume, and annual growth. We report two actual contingency contracts in the context of a decision process for choosing among contingency offerings by insurers. We incorporate both uncertainty and correlation among key variables to arrive at values for competing contracts, then use a downside risk approach that helps agency owners select the better contract. The approach offered in this article is scalable to a selection problem for any number of contingency arrangements.     

Contingent Commissions,Insurance Intermediaries,and Insurer Performance

This research investigates the relationship shared by contingent commission usage and insurer performance. We assess performance using both frontier efficiency and financial performance measures. Our findings reveal that the relationship is complex and varies across differing insurer business models. We find that nonusers of contingent commissions are more cost and revenue efficient than are users of contingents. However, among insurers that use contingents, relatively higher levels of use are associated with more efficient operations and also better financial performance. Additionally, these findings are conditioned on the type of distribution system the insurer employs.     

How (not) to pay for advice: A framework for consumer financial protection

This paper investigates the determinants of the compensation structure for brokers who advise customers regarding the suitability of financial products. Our model explains why brokers are commonly compensated indirectly through contingent commissions paid by product providers, even though this compensation structure could lead to biased advice. When customers are wary of the adviser's incentives, contingent commissions can be an effective incentive tool to induce the adviser to learn which specialized product is most suitable for the specific needs of customers. If, instead, customers naively believe they receive unbiased advice, high product prices and correspondingly high commissions become a tool of exploitation. Policy intervention that mandates disclosure of commissions can protect naive consumers and increase welfare. However, prohibiting or capping commissions could have the unintended consequence of stifling the adviser's incentive to acquire information. More vigorous competition benefits consumers and reduces exploitation, but firms have limited incentives to educate naive customers.     

Market Reaction to Regulatory Action in the Insurance Industry: The Case of Contingent Commission

We examine the market's reaction to New York Attorney General Eliot Spitzer's civil suit against mega‐broker Marsh for bid rigging and inappropriate use of contingent commissions within a generalized autoregressive conditionally heteroskedastic (GARCH) framework. Effects on the stock returns of insurance brokers and insurers are tested. The findings are: (1) GARCH effects are significant in modeling broker/insurer returns; (2) the suit generated negative effects on the brokerage industry and individual brokers, suggesting that contagion dominates competitive effects; (3) spillover effects from the brokerage sector to insurance business are significant and mostly negative, demonstrating industry integration; and (4) information‐based contagion is supported, as opposed to the pure‐panic contagion.     

The Determinants of Financial Derivatives Use in the United Kingdom Life Insurance Industry

This paper examines the determinants of financial derivatives use in the United Kingdom life insurance industry. We estimate a probit regression model and a Heckman two-stage sample selection regression model using a sample of eighty-eight U.K. life insurers in 1995. Our results indicate that the propensity to use derivative instruments is positively related to a firm's size, leverage and international links, and negatively related to the extent of reinsurance. We also find that mutual life insurance firms have a greater propensity than stock firms to use derivatives. The positive relation with leverage and the negative relation with reinsurance support the hypothesis that U.K. life insurers use derivatives to offset risk, rather than as a speculative means of income generation. Firm size and organizational form are the main influences on the extent of financial derivatives use.     

Gewinn- versus Kundenorientierung: Welche Ziele verfolgen deutsche Versicherungsvermittler?

Insurance intermediaries are criticized for behaving consistent with incentives given by insurers and disregarding customer interests. Fees paid by customers should replace commissions paid by insurers. Both the European Commission and the German Government proposed several measures to encourage fee-based advice as well as to ban commissions for PRIP-products mediated by brokers. Associations of intermediaries argue in opposition to politics that their members are interested in long-lasting customer relationships. This study answers the question which targets (customer orientation or profit orientation) intermediaries follow. Empiric results show that intermediaries follow four strategic targets—fairness, profit orientation, quality of life and sustainability of company. Fairness means customer orientation. Intermediaries can be divided into short-term and long-term oriented entrepreneurs. Disparities in the kind of orientation cannot be explained by kind of intermediary (broker or agent) solitary. The results are interesting for regulators who intend to save long-term interests of customers.     

Auditor quality,audit fees,organizational structure,and risk taking in the US life insurance industry

Using a system of simultaneous equations, this study examines the relation among external audit monitoring, in the US life insurance industry. We find insurers with higher leverage risk and surplus risk are more likely to use Big‐4 auditors and to pay higher fees. In return, insurers hiring Big‐4 auditors and paying higher audit fees have lower leverage risk and surplus risk. Second, the results suggest that mutual life insurers have a higher leverage risk and surplus risk than stock life insurers. This evidence is in contrast to that for property–liability insurance companies. Third, we find insurers are less likely to hire Big‐4 auditors and to pay higher audit fees after implementation of the Sarbanes–Oxley Act (SOX). Finally, life insurers with Big‐4 auditors or paying higher audit fees are more likely to take lower risks after the implementation of SOX.     

Fixed-percentage commissions and moral hazard in residential real estate brokerage

If home sellers cannot monitor real estate brokers' efforts on their behalf, fixed-percentage brokerage commissions can promote welfare by giving brokers an incentive to tailor their services to their clients' demands. This article shows how a competitive broker optimally allocates selling effort across clients who pay different commissions. There is an equilibrium in which clients who value brokerage services more highly offer to pay larger commissions and consequently receive more selling effort from the broker. If clients who are selling higher-priced houses tend to value brokerage services more highly, then this result helps explain the prevalence of fixed-percentage commissions in the residential real estate brokerage industry and suggests that they could emerge in a competitive setting.     

When Do International Operations Lead to Improved Performance? An Analysis of Property‐Liability Insurers

In recent decades, insurers have been increasing their exposure to international markets. This article seeks to investigate the relationship between property-liability insurers' international operations and their risk-adjusted returns using cross-section and time-series data for the years 1992 through 2000. Our findings indicate that the relationship between international operations and performance is contingent upon the degree of product diversification. Insurance companies with focused operations in terms of product lines achieve higher risk-adjusted performance as they increase their exposures to international markets. However, insurers who are highly diversified across product lines face declining returns with greater exposure to international markets.     

Determinanten der Liquidität in der deutschen Schaden- und Unfallversicherungsindustrie: Bedeutung,Erklärungskraft und Auswirkung der Finanzkrise

The aim of this paper is to analyze the corporate liquidity and its determinants for the German property-liability insurance industry using company-level data for the period 2002–2014. We first investigate the differences in cash holdings across insurers. We then quantify the relative importance of firm-level determinants compared with macroeconomic determinants in explaining insurers’ cash holding choices. In addition, we examine whether the financial crisis of 2008 has an impact on the liquidity situation of insurers. Our results indicate that cash holdings vary significantly across German property-liability insurers. The firm-level determinants size, group affiliation and reinsurance utilization explain more than 50% of the variation. We also find that macroeconomic conditions appear to have negligible effects on the liquidity situation of insurers. In addition, we do not find evidence that the liquidity of German property-liability insurers is influenced by the financial crisis of 2008. The proportion of cash remains relatively stable at 6% of the total assets.     

Outcome effect, controllability and performance evaluation of managers: some field evidence from multi-outlet businesses

This field study provides evidence of the outcome effect in performance evaluations of managers in an organization. Specifically, in a retail chain, subjective evaluations of store managers by their supervisors were negatively impacted by unfavorable outcome knowledge. As expected, outcome determinants over which the managers have control influence their performance evaluations and environmental determinants of outcome over which they have no control do not influence their evaluations. However, unexpectedly, central management determinants of outcome over which the managers have no control also influence their evaluations. After these outcome determinants are considered, we find evidence of an outcome effect since failure of the store to meet its target outcome results in a more negative performance evaluation of the managers. Also, the extent to which store managers' evaluations are prone to the outcome effect is not contingent on the measure of the outcome used.     

The Liability Regime of Insurance Pools and Its Impact on Pricing

This work formally derives fairly priced premiums for the policyholder of an insurance pool and the risk-adequate equity contributions of the pool insurers’ equity holders in a contingent claims approach. The approach distinguishes between two liability regimes: joint liability and several liability. These regimes regulate the pool’s indemnification when one or more of the pool insurers cannot meet their full obligations because of insolvency. Joint liability is deduced to be the preferable regime for the policyholder in cost-savings terms if corporate income taxation is introduced as a market friction. This regime advantage vanishes if the pool insurers’ asset correlation is substantial or if their risk sharing becomes unbalanced. Additionally, we address risk-shifting problems and their regime-dependent effects on both stakeholder groups.     

MUTUAL FUND BROKERAGE COMMISSIONS

The brokerage commissions paid for portfolio transactions by a large sample of equity mutual funds are investigated. Median brokerage commissions measured as a percentage of net assets are 21 basis points per year with a standard deviation of 27 basis points. The commission levels are negatively correlated with fund size and positively correlated with fund turnover and expense ratio. The average brokerage commission measured as a percentage of assets traded exceeds the typical execution-only commissions for large institutional traders. This finding is consistent with many mutual fund brokerage commissions including payments for research, so-called soft dollar payments. Funds' expense ratios are positively correlated with commissions per trade, inconsistent with the idea that mutual fund managers who pay soft dollars for research have a corresponding reduction in management fees.     

The Use of Performance‐based Remuneration: High versus Low‐growth Firms

This study analyses the CEO remuneration structure and level for 100 Australian‐listed entities. Consistent with expectations, it finds that high‐growth firms pay their CEOs a greater proportion of performance‐based pay, when equity‐based rewards only are considered. High‐growth firms also place greater reliance on market and/or non‐financial performance standards for the award of performance‐based pay. The extent to which performance‐based remuneration is used as a component of CEO pay is positively associated with firm size and growth options. Other potential determinants of performance‐based pay, such as financial performance, are not significantly associated with the use of performance‐based remuneration.     

Real Estate Brokerage Earnings: The Role of Choice of Compensation Scheme

One of the more interesting characteristics about the real estate brokerage industry is that workers are presented with a choice regarding the sort of compensation scheme under which they want to work. An overwhelming majority of workers choose what is referred to as a commission split scheme in which the salesperson splits any commission that they earn with a supervising broker that they generally are required to work under. In this case the firm provides office support and administrative services to the salesperson and, in return, the salesperson must split any commissions that they earn with the firm. Under the alternative compensation scheme, workers pay a substantial up-front “desk” fee to the firm and then are allowed to keep 100% of any commissions that they earn. In spite of the large volume of research on the determinants of real estate salesperson earnings, to our knowledge there are no studies analyzing the choice of compensation scheme and its impact on the earnings of real estate salespersons. This study uses data from the 2001 and 2003 Membership Surveys of the National Association of REALTORs® to analyze the impact of the real estate salespersons’ choice of compensation scheme on their earnings.     

Forestalling capital regulation or masking financial weakness? Evidence from loss reserve management in the property–liability insurance industry

This study examines the extent to which capital thresholds induce insurers to strategically exert accounting discretion to forestall regulatory actions. Using a sample of US property–liability insurers during 1994–2009, we find that when managing their claim loss reserves, the average insurers are insensitive to the pressure of capital regulation as measured by the distance of their RBC ratio to the action threshold. Yet, when the insurers are virtually partitioned by their reserving tendency, the effect of regulatory pressure is significantly related to the downward reserve bias in the under-reserving insurer cohorts. This finding continues to hold even after we utilize the number of ratio violations in the insurance regulatory information systems to purge the financial weakness effect embedded in the distance to RBC bound ratio. Hence, our empirical evidence suggests that insurers that are about to trigger the regulatory threshold will have the incentives to understate their loss reserves to preclude the impending authorized preventive actions. Finally, our analyses also shed light on the heterogeneity of incentives to managing loss reserves among over- and under-reserving insurers.     

The Determinants of Private Debt Holdings: Evidence From the Life Insurance Industry

Life insurers hold the majority of private debt. Lenders in the private debt market must have the ability to evaluate the credit quality of borrowers and to perform ongoing risk monitoring. The purpose of this study is to examine the determinants of private debt holdings in the life insurance industry. The results suggest that larger insurers, insurers with higher financial quality, mutual insurers, publicly traded insurers, insurers facing stringent regulation, and insurers with greater cash holdings are more prevalent lenders in the private debt market.     

中国的“影子保险”:来自监管自然实验的证据

影子保险在金融稳定中扮演着重要角色,但现有文献较多关注影子银行,对影子保险关注不足。“影子保险”即保险公司通过再保险方式将保险业务转移给不受监管或者受监管较弱的关联企业的活动,这会推高其真实的杠杆水平,增加金融体系脆弱性。然而,由于影子保险的不透明性和缺少自然实验,现有研究仅基于有限数据或模型给出简单的特征事实或结构性估计,很少能从因果关系上清楚地识别影子保险活动及其机制。本文利用中国加强对中资保险公司(处理组)再保险关联交易监管的政策冲击这一自然实验,使用微观数据和双重差分方法,识别了中国金融体系中的影子保险活动。研究发现,相关监管有效降低了影子保险活动,这一效应对集团公司的影响尤为显著;在机制方面,相关监管通过影响中资保险公司资产负债表两端的结构性调整进而降低了其风险承担行为,提高了经营稳定性。本文方法对识别金融机构的监管套利和防范系统性金融风险具有一定参考意义。