The Cost Structure of Distribution Systems in the U.S. Property/Liability Insurance Market

This paper examines the relative efficiencies of the two major distribution systems for property/casualty insurance : (1) independent agents and brokers (the independent intermediary), and (2) direct writers (the captive intermediary). The cost functions of the independent and captive systems of the property/casualty insurance industry are estimated using the generalized Cox-Box multiproduct cost function model. For firms operating at their mean output level, there are diseconomies of scale in both distribution systems. However, we do find evidence of economies of scale for the direct writers operating at the independent agency firm's output level. Nor do global economies of scope appear to exist for either distribution system. Pairwise cost complementarities for the pairing of commercial liability with either commercial property or personal liability are possible for firms using the independent agent system. This might arise from the range of contracts offered through independent agents and brokers. While for direct writers only the pairing of commercial liability and commercial property or personal liability with personal property have possible cost complementarities. This is consistent with the belief that direct writers have lower marketing costs for the standardized policies, such as those found in the personal lines. These empirical results help to resolve an inconsistency of prior studies of the efficiency of the two types of distribution systems.