Discussion on “A Principal-Agent
Model of Optimal Search Effort in
Life Insurance Policy Replacement”
by Carson, Cupach and Russell
Discussed by Enya He
University of North Texas
August 2007
Brief Summary of the Paper
• What does the paper do?
– Modeling the optimal search effort by the agent within the life
insurance policy replacement decision
• How does it fit into the literature
– Conflict of interest created by the traditional agent compensation
structure (i.e. non-recourse, up-front commission system)
– Prior studies finding no connection between agent compensation
and product recommendations have limitations in research
design and measurement
– No prior study on how to improve the alignment of incentives
between consumers and agents in the life insurance policy
replacement decision
• ??? Replacement of policy 1/3
The Model
• Optimal search effort expended by the
self-utility maximizing insurance agent, S*,
is determined by
– Θ: a given state of the world
– R: the fixed regulatory penalty
– β: sensitivity of the regulatory environment to
search effort
Implications of the Model
• Two Scenarios
– Case 1: R = 0 → S* = 0 → Max. policy
surrender
– Case 2: R > 0 → S* is ↑ in β → states with
greater β lower replacement related surrender
• Policy implications
– Change of the agent compensation structure,
or
– More aggressive regulatory authority
Potential Areas to Extend the Study
• Differentiate between exclusive agents
(EA) and independent agents (IA)
• Consider differences in the degree of
regulatory scrutiny among different states
• Possible solutions to the problem of
misalignment of interests between agents
and consumers
IA vs. EA
• Different alignment of interest between insurers
and agents
• Different Incentives of recommend a
replacement
– IA: better replacement opportunities; higher search
costs; no penalty by insurer
– EA: fewer choices of policy; lower search costs;
potential penalty by insurer
• Empirical testing?
– IA vs. EA → Policy surrender activities
Differences in State Regulation
• S* is ↑ in β
• Empirical evidence?
– Difference in policy surrender activities ←
variances in state regulation on agents
– Higher customer satisfaction (e.g. fewer
complaints, lower number of
lawsuits/settlements) ← variances in state
regulation on agents
– Challenge: data available and measurement
Better System of Agent
Compensation?
• A retrospective compensation system
– Difficult for policyholder to assess the
performance of agents
• Double-agent system
– Agent for consumer work with agent for
insurer