The Wealth Effect of Demutualization: Evidence From the U.S. Property-Liability and Life Insurance Industries

This study examines the wealth effect of demutualization initial public offerings (IPOs) by investigating underpricing and postconversion long‐run stock performance. Our results suggest that there is more “money left on the table” for demutualized insurers than for non‐demutualized insurers. We show that higher underpricing for demutualized firms can be explained by greater market demand, market sentiment, and the size of the offering. Further, contrary to previous research reporting an average underperformance of industrial IPOs, we show that demutualization IPOs outperform non‐IPO firms with comparable size and book‐to‐market ratios and non‐demutualized insurers. We present evidence that the outperformance in stock returns is mainly attributable to improvement in post‐demutualization operating performance and demand at the time of the IPOs. The combined results of underpricing and long‐term performance suggest that the wealth of policyholders who choose stock rather than cash or policy credits is not harmed by demutualization. Stockholders who purchase demutualized company shares either during or after the IPO have earned superior returns. Our findings are consistent with the efficiency improvement hypothesis.     

Conversion and Efficiency Performance Changes: Evidence from the U.S. Property-Liability Insurance Industry

This study investigates whether the conversion of U.S. property-liability insurers improves their efficiency performance before and after the conversion. We estimate relative efficiency of converting insurers and control insurers using data envelopment analysis. The Malmquist analysis is also used to measure changes in efficiency pre- and post-conversion. The evidence shows that converting insurers experience larger gains in cost efficiency and total productivity change than mutual control insurers before conversion. In addition, the empirical results indicate that converting insurers improve efficiency after conversion. These results are robust with respect to both the value-added and the financial intermediary approaches. The overall results support the efficiency hypothesis proposed by Mayers and Smith (1986).     

Form Over Matter: Differences in the Incentives to Convert Using Full Versus Partial Demutualization in the U.S. Life Insurance Industry

We explore the recent wave of demutualizations in the U.S. life insurance industry and analyze if the motives were similar for mutual life insurers that fully demutualized versus those that converted to mutual holding company (MHC) form. We find that fully demutualizing insurers were primarily motivated by a desire to gain access to external capital markets while those that chose MHC were motivated by other incentives including a tax‐based incentive. We also document that after conversion, fully demutualizing insurers more aggressively increase their exposure to risks they have a comparative advantage to bear than do firms that convert to MHC.     

The Demise of the Mutual Organizational Form: An Investigation of the Life Insurance Industry

We investigate the role of organizational structure in financial services markets by examining the U.S. life insurance industry. Traditionally, stock and mutual life insurers were equally represented, but now the industry is mainly composed of stock firms. We find operational efficiency, access to capital, and tax savings are important determinants for this shift. The incentive to demutualize differs by the type of conversion: full demutualization is chosen for efficiency and access to capital reasons and partial conversion, using a mutual holding company, is chosen for tax savings. Firm operational efficiency improves after conversion. We also find the efficiency of the stock organizational form dominates that of the mutual structure during our sample period, 1995 to 2004.     

Changing organizational form in the stock exchange industry and risk-taking

Recent developments in the stock exchange industry have compelled some exchanges to demutualize and become for-profit entities. We examine the risk-taking behavior of demutualized exchanges and find that prior to the conversion, the exchanges exhibited higher risk than their mutual counterparts. Following demutualization, however, the exchanges experienced a significant decrease in risk, which is not attributable to industry-wide effects. Our results are consistent with the conjecture that higher risk induced the conversion to equity ownership. Interestingly, we find that publicly listed exchanges that have gone through the three organizational structures exhibit risk-taking behavior somewhat similar to that of the mutual, demutualized, and publicly listed exchanges. We also document significant increases in nontraditional income after demutualization and this increase in nontraditional income is significantly related to the reduction in risk. We therefore attribute the risk reduction experienced by the converted exchanges to diversification.     

Effects of Risk Management on Cost Efficiency and Cost Function of the U.S. Property and Liability Insurers

Abstract

This paper adopts the one-step stochastic frontier approach to investigate the impact of risk management tools of derivatives and reinsurance on cost efficiency of U.S. property-liability insurance companies. The stochastic frontier approach considers both the mean and variance of cost efficiency. The sample includes both stock and mutual insurers. Among the findings, the cost function of the entire sample carries the concavity feature, and insurers tend to use financial derivatives for firm value creation. The results also show that for the entire sample the use of derivatives enhances the mean of cost efficiency but accompanied with larger efficiency volatility. Nevertheless, the utilization of financial derivatives mitigates efficiency volatility for mutual insurers. This research provides important insights for the practice of risk management in the property-liability insurance industry.     

Ownership Structure Changes in the Insurance Industry: An Analysis of Demutualization

This article focuses on the demutualization process and investigates why certain mutuals undergo this organizational structure change. The primary motivation for conversion is access to capital. By statute, mutual firms are limited in their capital‐raising activities while stock firms can attract funds through a variety of stock and debt offerings. By examining the financial characteristics of firms that demutualize, changes in business practices in the years surrounding conversion can be observed. Determinants of the conversion decision are explored through logistic regression. In the years before demutualization, converting property‐liability mutuals exhibit significantly lower surplus‐to‐asset ratios. This capital constraint eases after demutualization. Converting life‐health mutuals hold a significantly lower proportion of liquid assets; in addition, they have a higher proportion of separate accounts under management. This liquidity constraint and increased focus on a higher managerial discretion activity drive the demutualization decision. For both property‐liability and life‐health converting mutuals, support for the access to capital hypothesis is found.     

Can Commercialization Improve the Performance of Stock Exchanges Even without Corporatization?

We examine the performance of mutual, demutualized, and publicly listed exchanges and find evidence of improved performance along the exchange governance continuum, with publicly traded exchanges exhibiting better operating performance than demutualized exchanges. However, our robustness test, focusing on the corporatized exchanges that have gone through the three phases of the governance structure, shows that the listed exchanges do not exhibit evidence of incremental gains in efficiency and profitability beyond what they achieved at the demutualization phase. We conclude that commercialization provides sufficient freedom for exchanges to exploit monopoly rents before going public, while corporatization brings about proper valuation of the exchanges’ franchise.     

Financial Intermediary Versus Production Approach to Efficiency of Marketing Distribution Systems and Organizational Structure of Insurance Companies

An examination of the efficiency of the marketing distribution channel and organizational structure for insurance companies is presented from a framework that views the insurer as a financial intermediary rather than as a “production entity” which produces “value added” through loss payments. Within this financial intermediary approach, solvency can be a primary concern for regulators of insurance companies, claims‐paying ability can be a primary concern for policyholders, and return on investment can be a primary concern for investors. These three variables (solvency, financial return, and claims‐paying ability) are considered as outputs of the insurance firm. The financial intermediary approach acknowledges that interests potentially conflict, and the strategic decision makers for the firm must balance one concern versus another when managing the insurance company. Accordingly, we investigate the efficiency of insurance companies using data envelopment analysis (DEA) having as insurer output an appropriately selected (for the firm under investigation) combination of solvency, claims‐paying ability, and return on investment as outputs. These efficiency evaluations are further examined to study stock versus mutual form of organizational structure and agency versus direct marketing arrangements, which are examined separately and in combination. Comparisons with the “value‐added” or “production” approach to insurer efficiency are presented. A new DEA approach and interpretation is also presented.     

Ownership Structure, Agency Costs, Specialization, and Efficiency: Analysis of Keiretsu and Independent Insurers in the Japanese Nonlife Insurance Industry

This article uses the nonparametric frontier method to examine differences in efficiency for three unique organizational forms in the Japanese nonlife insurance industry—keiretsu firms, nonspecialized independent firms (NSIFs), and specialized independent firms (SIFs). It is not possible to reject the null hypothesis that efficiencies are equal, with one exception. Keiretsu firms seem to be more cost‐efficient than NSIFs. The results have important implications for the stakeholders of the NSIFs. An examination of the productivity changes across the different organizational forms reveals deteriorating efficiency for all three types of firms throughout the 1985–1994 sample period. Finally, the evidence also suggests that the value‐added approach and the financial intermediary approach provide different but complementary results.     

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.     

Analyst Earnings Forecasts for Publicly Traded Insurance Companies

Several trends in the insurance and financial services industry, including demutualizationconsolidation, and deregulation, have attracted increasing attention from investors and financial analysts. This paper investigates the accuracy of the earnings forecasts of financial analysts for insurance companies. Our empirical results indicate that analyst forecasts outperform random walk time-series forecasts. Furthermore, we find that both disagreement over earnings forecasts among analysts and the relative forecasting error in the mean forecasts is smaller for life insurers than for property-casualty insurers, whereas the relative errors for forecasts for multiple-line insurers are in between the two. Forecasting error is a negative function of firm size and the number of analysts who are following a company, and is a positive function of the disagreement among analysts.Analyst forecasts have a timing advantage over the random walk model. Our results also suggest that the fair value reporting requirement (SFAS 115), which has been in effect since 1994, has enhanced the accuracy of analyst forecasts. The SFAS 115 has improved the superiority of analyst forecasts over the random walk forecasts for life insurers, but not for property-casualty insurers, and there is a weak improvement for multiple-line insurers. JEL Classification: G15     

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.     

Foreign exchange exposure: Evidence from the U.S. insurance industry

We study the foreign exchange exposure of U.S. insurers. The evidence shows that no systematic difference exists in the currency risk profiles of life and non-life segments within the insurance industry. This suggests that life and non-life insurers have similar risk exposure management strategies arising from similar risk pooling and financial intermediary functions. The empirical results reveal that a sizable proportion of U.S. insurers are exposed to foreign exchange movements against the seven largest U.S. trade partners in insurance services (U.K., Japan, Switzerland, Netherlands, France, Germany and Canada). Significant operational and size effects are also documented and we find that the frequency of foreign exchange exposure increases with time horizon.     

An Efficiency-Based Approach to Determining Potential Cost Savings and Profit Targets for Health Insurers: The Case of Obamacare Health Insurance CO-OPs

This research analyzes the performance of the health insurance consumer-operated and -oriented plan (CO-OPs), examines their medical services and operating efficiency, proposes an efficiency-based goal-oriented approach for cost reductions, profit targets, premium changes, and government subsidies, and provides an important guide for improvement potentials for both the CO-OP health insurance model and other health insurers. The CO-OPs are not satisfactory in the medical services efficiency, and they are much less efficient compared with other insurers. Potential cost reductions are significant using various (conservative) efficiency goals. Most CO-OPs suffer underwriting losses, as do many other insurers; a few CO-OPs are much more operating efficient than other insurers, but all CO-OPs need significant improvement of financial performance relative to benchmark insurers. Incorporating potential cost reductions, many CO-OPs would barely require any “premium changes and government subsidies,” and they are even capable of paying back the federal loans. With both potential cost reductions and premium increases, more CO-OPs would not need any help from the government but survive on their own. This research informs public debates and all stakeholders (including management, consumers, regulators, policymakers) of improvement potentials to be considered for related decision making besides other factors including the political environment and government policies.     

Determinants of bank efficiency during unstable macroeconomic environment: Empirical evidence from Malaysia

The present study investigates for the first time the efficiency of Malaysian banking sector around the Asian financial crisis 1997. The efficiency estimates of individual banks are evaluated by using the Data Envelopment Analysis (DEA) approach. To examine the robustness of the estimated efficiency scores under various alternatives and to differentiate how efficiency scores vary with changes in inputs and outputs, the present study focuses on three major approaches viz., intermediation approach, value added approach, and operating approach. The analysis further links the variation in calculated efficiencies to a set of explanatory variables, i.e. bank size, profitability, and ownership. The empirical findings clearly bring forth the high degree of inefficiency in the Malaysian banking sector, particularly a year after the East Asian crisis. The results suggest that the decline in technical efficiency is more abrupt under the intermediation approach relative to the value added approach and operating approach. The regression results focusing on bank efficiency and other bank specific traits suggest that efficiency is negatively related to expense preference behavior and economic conditions, while bank efficiency is positively related to loans intensity.     

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.     

Organizational Structure and Performance: Evidence From the Nonlife Insurance Industry in Japan

This study examines the impact of organizational structure on firm performance, incentive problems, and financial decisions in the Japanese nonlife (property‐casualty) insurance industry. Stock companies that belong to one of six horizontal keiretsu groups have lower expenses and lower levels of free cash flow than independent stock and mutual insurance companies. Keiretsu insurers also have higher profitability and higher loss ratios than independent insurers. With a limited sample size, there is some evidence that mutual insurers have higher levels of free cash flows, higher investment incomes, and lower financial leverage than their stock counterparts. Overall, empirical evidence suggests that each structure has its own comparative advantage.     

Is Historical Cost Accounting a Panacea? Market Stress,Incentive Distortions,and Gains Trading

Accounting rules, through their interactions with capital regulations, affect financial institutions’ trading behavior. The insurance industry provides a laboratory to explore these interactions: life insurers have greater flexibility than property and casualty insurers to hold speculative‐grade assets at historical cost, and the degree to which life insurers recognize market values differs across U.S. states. During the financial crisis, insurers facing a lesser degree of market value recognition are less likely to sell downgraded asset‐backed securities. To improve their capital positions, these insurers disproportionately resort to gains trading, selectively selling otherwise unrelated bonds with high unrealized gains, transmitting shocks across markets.     

Organizational structure,risk-based capital requirements,and the sales of downgraded bonds

Using bond downgrades as external shocks to life insurers’ asset risk, we document several findings of the impact of organizational structure and risk factors on investment risk taking. First, we find that mutual insurers and widely-held stock insurers are more likely to sell downgraded bonds than are closely-held stock insurers. Second, we find evidence that insurers are less likely to sell downgraded bonds that remain in the same rating class than bonds downgraded to a lower rating class. The result implies that insurers sell downgraded bonds mainly because of additional capital charge is imposed, not because of downgrade itself. In other words, risk factors in risk-based capital regulation do matter on life insurers’ investment risk taking. Finally, we find that life insurers might be reluctant to sell downgraded bonds at fire-sale prices during the 2008–2009 financial crisis.